U.S. Securities & Exchange Commission Chair Mary Jo White spoke Wednesday at the Chamber of Commerce's "8th Annual Capital Markets Summit", but she gave little indication of when we might see pending money market fund reforms and what form they might take. We also excerpt from the SEC's Craig Lewis, who spoke Tuesday at ICI's MFIMC conference in Orlando. Yesterday, White commented, "The terminology 'shadow banking' is used fairly widely and to some degree it's taken as a pejorative [to mean] somehow that markets aren't regulated.... I'm a member of FSOC and also a member of the FSB steering committee.... I think it is very important that we distinguish between effective systematic risk regulation and the means to get there. Banking regulation, that prototype, isn't necessarily what works best in the capital markets space.... We certainly gave input on the OFR process.... For example, on money market funds, FSOC has made it very clear that they regard the SEC as the expert."
When asked about money fund reform, she adds, "On the status of that, we are as a Commission, and obviously together with the staff, actively involved and proceeding to the adopting phase. We have taken a very in-depth look at all the impacts of [the] two alternative proposals that we can proceed with, or in combination. We have gotten extensive, invaluable comments on this. We are very sensitive to preserving the product as part of this process. [But] what we are obviously focused on is what happened during the financial crisis and the heightened redemptions in the prime institutional funds."
White continues, "If we were to go with, as part of what we ultimately adopt, a floating NAV, that's where I think most of the significant cost, tax and accounting concerns come in. We are laser-focused on those. We're in discussion on the tax consequences with the IRS.... If we did go the route of the prime floating NAV, having to compute and report small gains over time.... On the accounting side, we're in dialogue with FASB on this, [we're] ensuring that MMFs would continue, were we to go that route, as cash equivalents. Those two sets of issues -- not the only cost issues -- we're looking very closely. [We're looking] at the systems and operation issues as well."
She adds, "In 2010, the SEC did take significant action to enhance the resiliency of money market funds... We also did an in-depth study.... Those reforms don't solve that [redemption] problem was one of the conclusions of that study. That's what we're about now, trying to do it in the best, most optimal, cost effective way as we can."
The SEC's Lewis commented Tuesday on "The Example of Money Market Fund Reform," "As many of you may know, the Commission has been considering the question of what, if any, further reforms to money market funds may be appropriate. As I'll describe, this process has been marked with a high level of public engagement with relevant economic issues by DERA. For example, before any policy choices were even proposed, DERA staff authored a memorandum intended to assist in formulating a well-considered proposal. That memo contained both a quantitative and qualitative analysis responding to certain questions regarding money market funds raised by Commissioners Aguilar, Paredes, and Gallagher. Those questions focused on three issues: (1) What were the determinants of investor behavior and its effect on MMF performance during the 2008 financial crisis; (2) What has been the effect of the 2010 money market fund reforms; and (3) How future reforms might affect the demand for investments in money market fund substitutes and the implications for investors, financial institutions, corporate borrowers, municipalities, and states that sell their debt to money market funds. That staff memorandum, which was made public, helped inform the subsequent proposal."
He continues, "Now let's turn to the proposal itself. The proposing release itself exemplifies the way that the Commission, rulewriters, and economists are working closely together to develop rule releases. The proposal contained a fully integrated qualitative and quantitative analysis. For example, the release contained an analysis of the economics of money market funds, including the combination of MMF features that may create an incentive for their shareholders to redeem shares in periods of financial stress. The release considered the economic consequences of a floating NAV and liquidity fees and gates as well as effects on efficiency, competition, and capital formation. And we examined the potential implications of these proposals on current investments in money market funds and on the short-term financing markets. The analyses indicated, in part, that the economic implications of the floating NAV and liquidity fees and gates proposals depend on investors' preferences, and the attractiveness of investment alternatives."
Lewis explains, "DERA also placed additional data analyses into the comment file as part of the proposal process. For example, one of the many issues that the Commission thought through as part of the proposal is determining the appropriate size of diversification limits in money market funds. To assist the Commission and to inform the public, DERA staff developed memoranda that quantitatively evaluated the exposure and concentration money market fund portfolios have to the parent companies of guarantors and the parent companies of issuers. Those memos were included in the public comment file."
He adds, "Moreover, as I mentioned earlier, DERA has a strong research program designed to focus on issues of importance to the Commission. Flowing from my work on the money market fund release, I have authored a working paper entitled, The Economic Implications of Money Market Fund Capital Buffers. That working paper has more recently been included in the public comment file. I'll briefly describe its principal findings. If one considers the possible rationales for employing a capital buffer, which was discussed but ultimately not proposed by the Commission, one possible objective is to protect shareholders from losses related to defaults in concentrated positions, such as the one experienced by the Reserve Primary Fund following the Lehman Brothers bankruptcy. If complete loss absorption is the objective, a substantial buffer would be required. For example, it has been suggested that a 3% buffer would accommodate all but extremely large losses. While such a capital buffer could make a money market fund better able to withstand significant credit events, it would be a costly mechanism from the perspective of the opportunity cost of capital because those contributing to the buffer would deploy valuable scarce resources that are being used elsewhere in presumably more valuable opportunities."
Lewis tells us, "Moreover, a basic precept of financial economics is that rational investors demand compensation for bearing risk. Since a capital buffer is designed to absorb the risk associated with credit events, it follows that those investors contributing funds to a capital buffer will demand compensation for bearing this risk. My paper illustrates that to the extent a capital buffer could insulate money market fund shareholders from adverse credit events, it would have the additional result that money market funds would only be able to offer shareholders returns that mimic those available for government securities, thus effectively converting prime money market funds into "synthetic" Treasury funds."
He adds, "So now the question is why does any of this matter to you? Why should you care about a simple memorandum on economic analysis authored two years ago? Of course, I imagine that some of you might be interested in the outcome of the Commission's consideration of money market fund reform. And so at a minimum I hope you can see how much significant, rigorous thought has already gone into that process. But beyond this single rule, I challenge you to become an active part of the Commission's engagement with economic thought. As I have described, the Commission and staff are exploring different ways to demonstrate publicly our thinking on various issues. We will continue to have robust and transparent analyses in rule proposals. And importantly, we will continue, as appropriate, to put additional analyses into the comment files. Thus, the most obvious way you can become part of this is through engagement in the comment process. I have said this in many settings and I will say it again -- I encourage you to submit comment letters that contain robust qualitative and quantitative economic analyses of our rules."
Finally, Lewis comments, "I too often read a comment letter that engages only with the policy discussions in a rule and see a missed opportunity to respond to the entirety of the rule release. The economic analyses that are crafted as part of the Commission's rule releases are not simple tabular accountings of costs and benefits that are after-the-fact calculations and monetizations of the effects of our rules. They are wide-ranging, sophisticated analyses that reflect months (or maybe years) of engagement among DERA, the rulewriting staff, the Office of the General Counsel, and the Commissioners. They animate and fully explain the Commission's thinking on particular policy choices. When commenters offer a rigorous and full engagement with the economic analysis -- and I don't mean with a throw-away line about benefits or burdens -- it helps to ensure that the public is fully engaged in the same, economically driven discourse that is flourishing within the walls of the SEC. And the end results of that conversation can only be positive for investors and our markets."
