Nancy Prior, President of Fidelity's money market unit, was just promoted to President of the company's Fixed Income division and vice chairman of Pyramis Global Advisors (Fidelity's institutional investing arm). Prior spoke Tuesday morning at iMoneyNet's Money Market Expo, a money fund conference held in Orlando, Fla., on pending money market mutual fund regulations with a talk entitled, "Get It Right on Regulation." (Note: Crane Data hosts a competing event, Money Fund Symposium, which will take place June 23-25 in Boston, where Prior will also deliver a keynote speech.) Prior's released comments say, "A year ago at this conference, I spoke about the need to strike the right balance for regulation of MMFs. At that time, Fidelity and the entire fund industry had been engaged in deliberations for three years about whether further regulation was needed -- and if so, what shape it should take -- following the comprehensive rule changes adopted by the SEC in 2010. I discussed how the 2010 amendments to Rule 2a-7 had made all MMFs safer, more resilient to market stress, and more transparent … and how the regulations had been tested in the summer of 2011, with the European debt crisis, the U.S. debt ceiling showdown, and the eventual downgrade of the United States by S&P. I shared the results of stress tests that Fidelity had conducted on our funds and discussed the study the SEC had done in response to questions posed by Commissioners Aguilar, Paredes and Gallagher."
She continues, "Both our stress test results and the SEC study clearly demonstrated that the 2010 reforms significantly reduced risk across all MMFs. I noted that the SEC study independently confirmed that most types of MMFs were not subject to large, abrupt redemptions during the financial crisis and that the SEC's own analysis could provide a constructive framework for moving forward. The SEC study clearly identified the problem they were seeking to address -- namely that MMFs may be susceptible to "run risk" which can lead to financial instability and a significant advantage for first-movers. But more importantly, the SEC study unambiguously showed that the only type of MMFs that proved to be susceptible to run risk and experienced significant outflows both in 2008 and 2011 were prime funds purchased primarily by institutional investors. Fidelity's position was clear: Based on the facts, data and empirical evidence, we saw no justification, or benefit, for further regulation of Treasury, government, municipal or retail prime MMFs. We felt strongly that any further regulation should be limited to institutional prime funds ... and should be narrowly tailored to address the concern about run risk in this specific segment of the industry. And that position was widely shared by many others who were closely following this debate."
Prior explains, "Now, fast forward to today. The SEC issued its long-awaited rule proposal last June, and Fidelity and many of the firms represented here this morning filed comment letters. I will focus my remarks on Fidelity's assessment of the proposal and offer some specific suggestions based on the analysis set out in the SEC study for improvements that we believe the SEC should make before finalizing the rules. First, I want to thank everyone in this room who has remained engaged in the process -- the prolonged deliberations and complex discussions in search of the best solution to ensure the strength and stability of MMFs for our customers. I also want to give credit to the SEC for its thoughtful proposal, which reflects considerable research and thorough analysis. We appreciate the Commission's efforts to attempt to craft tailored regulations targeted at the limited set of MMFs that have proven susceptible to runs. Indeed, the Commissioners or staff used the word "targeted" nine times in the Open Meeting. We believe the SEC proposal strikes the right balance in certain areas, but misses the mark in others. Still, with some important modifications, it could provide a good framework for a final resolution that serves to strengthen the resiliency of MMFs and our financial system, while preserving the benefits these funds provide retail investors, issuers and our economy."
She tells us, "There is much at stake, however, so it's critically important that we continue to advocate for regulation that strikes the right balance and is based on sound cost-benefit analysis. We've come this far; it's important that we get it right. That said, we also believe it is important to bring closure to this long and comprehensive examination of how to regulate MMFs -- and to do so promptly. Uncertainty is not an investor's friend. MMF shareholders and issuers want and need clarity about the future of this vitally important financial product. It's time to move ahead ... and remove the cloud of uncertainty that has been hanging over the MMF industry for years. We call on the SEC to move quickly to complete its rules so investors know what to expect ... and the industry can begin planning for a smooth implementation."
Prior continues, "Now, let's review the proposed rules ... and assess how well the SEC achieves its stated goal of targeting only those funds that need further regulation.... The SEC absolutely gets it right by excluding both Treasury and government funds from structural changes, while including them in proposed provisions for enhanced disclosure.... Unfortunately, the SEC missed the mark in its proposed treatment of tax-exempt or municipal funds. In our view, based on the facts and the data (including the data laid out in the SEC study), muni funds should have been excluded from both the floating NAV and the fees and gates proposals. The SEC recognizes that muni funds are not susceptible to runs and that they serve as an important source of funding for state and local governments.... But, instead of excluding muni funds from structural regulation, the SEC attempts to limit the harm to these funds by proposing a definition of "retail" funds and excluding such newly defined retail funds from only the floating NAV proposal."
She states, "There are two big problems with the SEC's application of this approach. The first is that the SEC's proposed definition of "retail" does not work. The second is that retail funds are not excluded from the fees and gates proposal. As a result, both muni funds and retail prime funds are subject to structural regulation -- an outcome not supported by empirical evidence.... The stability of both of these categories during these periods points to the fact that they should be excluded from structural regulations. Since muni funds are not susceptible to runs, pose no systemic risk, and provide enormous benefits to the economy, the costs of imposing structural change on these funds certainly outweigh any perceived benefit. So, the solution is simple. The SEC should treat muni funds the same as it treats Treasury and government funds.... by excluding them from both the floating NAV and liquidity fees and redemption gates. But, at this time, it is unclear how the SEC will proceed.... This is why it is crucially important to get the retail definition right and just as important to make sure that retail investors do not face either a floating NAV or fees and gates."
Prior also says, "So the next important task for the SEC is to properly identify retail MMFs, so that individual investors can continue to enjoy the benefits of MMFs. This was the great innovation of MMFs nearly 40 years ago -- average investors gained access to professional money management for their cash and finally had a choice to compete with low bank deposit rates. In the proposed rules, the SEC recognized that retail funds were not the problem, and therefore should not be targeted for further regulation. However, the SEC's proposed retail definition, which would limit a shareholder's daily redemptions, fails to achieve their stated purpose. It is unduly complex, and a sizeable portion of retail assets are excluded from the proposed definition. What's more, implementing the daily redemption limit would create a host of issues for both funds and third-party intermediaries.... Such redemption restrictions clearly don't address any issue the SEC is trying to solve with further regulation."
Prior comments, "There has to be a simpler way, and we believe there is. Fidelity and eight other asset management firms submitted a joint comment letter to the SEC in October, proposing a simpler and more cost effective way to achieve the Commission's goal of providing an exemption for retail investors.... Specifically, we propose that a MMF would qualify as a retail fund as long as it limits beneficial ownership interest to natural persons -- individuals with a Social Security number. This would include anyone investing in MMFs through individual accounts, retirement accounts, college savings plans, health savings plans and ordinary trusts. It would not permit investments by accounts established by businesses, including small businesses, defined benefit plans, endowments or similar accounts where individuals do not represent the beneficial ownership interest of those accounts.... We urge the SEC to adopt this simple, workable approach to defining retail money market funds. If this workable definition is accepted, all retail funds -- muni and prime -- should be excluded from both the floating NAV and redemption gates and fees."
Prior then states, "Let's turn now to the final item for the SEC, which is how to address institutional prime funds. We continue to believe that the floating NAV proposal, which I addressed in detail here a year ago, simply does not provide an effective means to achieve the SEC's stated goal of stemming rapid and significant redemptions in times of market turmoil. Not only would a floating NAV fail to prevent massive redemptions, but the extent of the structural changes to institutional prime funds actually could cause significant redemptions, disrupt the financial marketplace, and increase systemic risk by increasing concentration of short-term assets in the banking system. The SEC has not provided, nor are we aware of, any empirical evidence to support the idea that in a period of market turmoil, funds with floating NAVs would be at lower risk of significant redemptions from shareholders. To the contrary, floating NAV funds in Europe experienced redemption pressures during the 2008 financial crisis as stable NAV MMFs. In addition, the floating NAV proposal would create new tax and record-keeping requirements for investors unless regulators provide additional administrative relief. For all these reasons, we believe the floating NAV proposal is simply a not a good idea. That said, it is apparent that some on the SEC and others clearly believe a floating NAV should be part of the final rule. If that's to be the case, then let's do all we can to make sure the rule is as effective and workable as possible."
She explains, "Let me offer a couple suggestions.... First, we urge the SEC to change the proposed transaction pricing standard for institutional prime and muni funds to three digits from four digits. The proposed transaction level is ten times more precise that that used by other mutual funds that typically hold securities with greater risk characteristics than MMFs. We believe this increased precision greatly exaggerates the risks of investing in a MMF as compared to other types of mutual funds with floating NAVs and it causes shareholders to suffer unnecessary recognition of gains and losses. Thus, we believe the SEC should apply the same transaction level pricing to MMFs that it applies to other mutual funds if it chooses to adopt a floating NAV structure ... and that MMFs transact at three digits rather than four. It is also important for the SEC to work with the Treasury, IRS, and others to resolve any tax and recordkeeping issues related to applying a floating NAV to MMFs. Applying current tax rules to floating NAV funds would result in substantial complexity and increased administrative costs and burdens for the funds, broker dealers, and shareholders. These issues must be resolved before any new rule takes effect."
Prior also says, "Turning to Alternative 2, we believe an objectively triggered standby liquidity fee and redemption gates presents the most effective means of achieving the Commission's objective of discouraging and ultimately halting significant redemptions from institutional prime MMFs during times of extreme market stress. This proposal is preferable to a floating NAV, which would be in effect at all times and would eliminate the fundamental stable NAV feature that makes MMFs so attractive to shareholders. As the SEC recognizes, liquidity fees would help offset the costs of the liquidity provided to redeeming shareholders, and any excess could be used to repair the NAV of the fund, if necessary. Yet, the SEC offers no data to support its proposal to set the liquidation fee at 2%. We have examined the liquidation costs for our MMFs that sold securities during the period immediately following the bankruptcy of Lehman Brothers and determined that the highest liquidation cost was less than 50 basis points of face value."
She continues, "Recognizing that liquidation costs in a future market stress scenario may be greater, we think it is reasonable to set a liquidation fee at 100 basis points. We are concerned that a 200 basis point liquidity fee rate will be unnecessarily punitive on shareholders willing to pay a fee in order to redeem their shares. We urge the SEC to reduce the liquidity fee rate to 1%, which will suffice to pay for any liquidation costs. Finally, we urge the SEC to extend the implementation period for any structural regulations to three years following the effective date of a final rule. The changes under consideration are significant. We need to allow money market funds and intermediaries sufficient time to implement systems modifications and other necessary changes, possibly including launching new MMFs or seeking board and shareholder approval to restructure existing funds."
Finally, Prior adds, "Let me close by reiterating Fidelity's commitment to ensuring the safety, stability and viability of the money market product. Our MMF portfolio management team is focused each and every day on researching and analyzing the short-term markets to help ensure that our funds deliver -- today and tomorrow, in stable and volatile markets -- the principal stability, ready liquidity and market-based return that our shareholders count on. We take our fiduciary responsibility to our shareholders very seriously, and we are proud of our track record over the past 30 years. And, I am proud of our industry's track record too -- as we all should be. We have all been actively engaged in the money market regulation debate for several years now, working closely with investors, issuers, providers, academics and policymakers. We have each done our best to represent the interests of our shareholders throughout this process. While there is more road to travel, the end of this lengthy journey is in sight. Still, important issues need to be addressed to make sure we strike the right balance between ensuring the strength and stability of money market mutual funds ... and preserving the many benefits they provide to investors, issuers and our economy. We've come this far. Let's get it done, but let's make sure we get it right."
