Today, we excerpt from another of the post-deadline Comments on the SEC's Proposed Money Market Fund Reforms. A recent letter from John McGonigle, Vice Chairman, Federated Investors, entitled, "Comments Regarding Penny Rounding Alternative," says, "This letter supplements our comment letters regarding the Securities and Exchange Commission's release proposing Money Market Fund Reform [and] Amendments to Form PF (the "Release"), and relates to a money market fund reform alternative that we discussed with the staff of the Securities and Exchange Commission (the "Commission") on October 29, 2013. During our meeting, we provided an overview regarding the following proposal made in a previous comment letter: "The Commission could address [problems inherent in the penny rounding method] by permitting stable NAV MMFs to rely on the prior day's share price, derived using market-based factors and penny rounding, to transact throughout the subsequent business day, absent action by the board." At the meeting, we undertook to file a comment letter discussing our proposal."
The comment explains, "Federated Investors, Inc. ("Federated") was among the first MMF managers to obtain an exemptive order permitting use of the amortized cost method to maintain a stable net asset value per share (a stable "NAV"). As noted in the Amortized Cost Comment Letter, Federated continues to believe that the amortized cost method of valuation is a fair, accurate and efficient means of valuing money market fund portfolio securities. We have never used the penny rounding method for our MMFs, and are not aware of any MMF that currently uses this method of maintaining a stable share price. We are aware that there are some in the regulatory community that oppose continued use of amortized cost in connection with money market fund; therefore, we have analyzed the steps required to convert our MMFs' operations to the penny rounding method. This letter develops an alternative means of penny rounding that preserves the benefits of the amortized cost method for MMF shareholders while addressing the concerns (which we still consider unsubstantiated) of those who insist that MMFs must base their share price on a current estimate of their portfolios' market values. We would reassert that all MMFs, not just government or so-called "retail" funds, should be permitted to attempt to maintain a stable NAV using this penny rounding method, if the amortized cost method were no longer permitted."
McGonigle's summary says, "Federated's proposal is similar to the "stability band" recommended by Capital Advisors Group. MMFs would calculate their NAV each day in the same manner as other mutual funds, except that the NAV would be calculated to the nearest basis point (an "unrounded NAV"). MMFs would disclose their unrounded NAV on their websites, as currently proposed. The NAV would be rounded to the nearest cent per share, however, for purposes of shareholder transactions. Thus, a $1 share price would remain stable so long as the unrounded NAV remained between $0.9950 and $1.0049."
It continues, "Capital Advisors Group did not address the operational aspects of the penny rounding method in its comments. Operationally, Federated believes that it is critical that the penny rounding method not require repeated attempts to estimate whether a MMF's portfolio has experienced minute fluctuations in value during the course of a day. We believe it should be sufficient for a MMF to calculate an unrounded NAV once each business day, and that a MMF should be permitted to continue to use the resulting portfolio valuation for any interim NAV calculations. For example, if a MMF calculates its unrounded shadow NAV as of 3 p.m. each business day, and also calculates its NAV as of noon of each business day for purposes of paying same-day redemptions, the MMF should be permitted to use the estimated portfolio value determined as of 3 p.m. on the prior day for the noon calculation."
Federated explains, "A MMF should not be permitted to rely on an earlier portfolio valuation if there was an intervening significant market event that materially affected the portfolio's estimated value. As Rule 2a-7 already requires MMFs to monitor general market conditions for purposes of determining an appropriate weighted average maturity and to monitor the minimum credit risk of all portfolio holdings, MMFs should already have procedures for identifying such significant events. To return to the example of a MMF with a noon valuation, if the issuer of securities held in the portfolio unexpectedly filed for bankruptcy after 3 p.m. the previous day, the MMF would have to update its estimates of the fair values of portfolio securities issued by that company for purposes of its noon calculation."
They add, "Finally, to protect shareholders from material dilution or other unfair results that might occur even though an unrounded NAV has not fallen below $0.9950, Federated recommends the Commission incorporate into the penny rounding method certain responsibilities for a MMF's board of directors or trustees (a fund's "Board") currently only required under the amortized cost method. These would include the responsibilities to (a) adopt written supervisory procedures, which should include procedures for responding to significant events, (b) monitor the deviation between the unrounded NAV and the stable $1 share price and (c) take action if necessary to prevent such a deviation from resulting in material dilution or other unfair results to investors and existing shareholders."
The letter tells us, "Some critics of MMFs find it difficult to understand how a money market instrument's amortized cost closely approximates its current market value or how quickly occasional fluctuations from the amortized costs are rectified. Such people may also erroneously believe that estimates provided by pricing services represent the "marked-to-market" value of a MMF’s portfolio. While Federated does not accept either of these views, we do not object to using daily price estimates for portfolio securities to calculate a MMF's penny-rounded NAV, so long as this does not impair the benefits of a MMF to its shareholders."
Federated writes, "Our Amortized Cost Comment Letter explains how the penny rounding method, as currently employed, would impair the benefits of MMFs by forcing shareholders to wait (possibly until the next business day) for redemption proceeds. Unless modified, use of the penny rounding method would also make MMFs less reliable and create significant risks to the payment system. The costs of additional price data feeds would also make MMFs more expensive and reduce their returns to shareholders."
They state, "To preserve the benefits of MMFs under the penny rounding method, it is necessary to reduce the number of price data feeds required to calculate the MMF's unrounded NAV throughout the day. If the Commission required a MMF using the penny rounding method to update its price estimates only (1) once each business day and (2) following a significant market event occurring after the time as of which the previous price estimates were determined, then a penny rounding MMF could operate on much the same basis as an amortized cost MMF. A MMF should need to update the estimated prices only for securities affected by the significant event. This use of earlier valuations would be entirely consistent with existing precedent -- specifically, the valuation of securities traded primarily in foreign markets."
Federated explains, "This approach would fully disclose to shareholders and the market a MMF's estimated market-based NAV calculated to the nearest basis point, without requiring shareholders to transact at that estimated price. It would make the settlement of shareholder transaction less dependent on the availability of estimated price data feeds from pricing services and would permit multiple settlement times with little incremental cost or operational risk."
The letter adds, "Finally, if the Commission requires MMFs to use the penny rounding method in any form, it should amend Rule 2a-7 to require Boards to exercise the same degree of supervision as they do under the amortized cost method. Nothing in the nature of the penny rounding method reduces the need for oversight of deviations of the unrounded NAV from $1."
