Attorney David Freeman, Jr. of Arnold and Porter LLP has posted another letter to the SEC's "Comments on Proposed Rule: Money Market Fund Reform" on behalf of Federated Investors. The latest summarizes the arguments and comment letters opposed to a floating NAV ("Alternative I") and in support of Alternative II (the emergency "gates and fees" option). Freeman writes, "We are writing on behalf of our client, Federated Investors, Inc. and its subsidiaries ("Federated"), to provide concluding comments concerning the Securities and Exchange Commission's ("Commission's") rulemaking file on money market fund ("MMF") reform. The stated goal of the rulemaking is to address the Commission's concerns about the potential for large-scale redemptions from MMFs during a period of financial stress or in response to a significant credit event at a MMF. The Commission in its Release and Chair White in public statements have assured investors that the Commission seeks to preserve the benefits of MMFs for investors. The question confronting the Commission as it moves toward adoption or reproposal is whether these two goals can be reconciled in a manner consistent with the Commission's obligations in conducting rulemakings."
He tells us, "The data, studies, and commentary in the Commission's extensive comment file point to a clear answer: Give due consideration to the comments, follow the facts, and insist upon a data-driven, cost-effective rule that best provides the benefits the Commission seeks to achieve, including, especially, the protection of investors. There is no question that authorizing MMF boards in rare and limited circumstances to temporarily halt redemptions for periods of short duration will stop a run. Forcing prime MMFs to float their net asset values ("NAVs") will not. Importantly, a tailored gates and fees proposal will preserve the day-to-day utility of MMFs for investors. Forcing investors to redeem at a fluctuating NAV will not. As the overwhelming comments, surveys, data, and other materials in the comment file make clear, adopting a limited gates and fees rule will fulfill the Commission's articulated rulemaking objectives; imposing a floating NAV will not."
The Federated letter continues, "Moreover, after reviewing the great weight of the evidence in the comment file, it also is clear that the Commission cannot reach a decision to impose both a floating NAV and gates/fees in combination on certain MMFs; commenters are clear that the combination would make those funds a product no rational investor would ever buy and would “lead nearly all investors to choose other options -- further exacerbating the costs associated with a massive migration of assets to government money market funds and riskier and less-regulated alternatives."
It states, "The Commission and its rule writers are well aware of the Commission's obligations under the Administrative Procedure Act, the Investment Company Act of 1940 and other Federal laws, the holdings of federal courts regarding applicable statutory requirements, as well as the Commission's own binding rulemaking guidance ("Guidance"). Those obligations compel the Commission to consider the protection of investors and the impact of the various alternatives on efficiency, competition, and capital formation. They further require the Commission to weigh the benefits and costs of alternatives and make cost-effective regulatory choices. The Commission cannot meet those obligations if it arbitrarily chooses a regulatory alternative that, according to the overwhelming weight of commentary, data, studies, and other evidence in the comment file, costs the most but does the least in terms of accomplishing the Commission's objectives. Indeed, the Commission will violate those requirements if it makes a regulatory choice that would destroy a product for a large segment of investors, when a far less disruptive alternative that better achieves its regulatory goals, better protects investors, and preserves the product is available."
Freeman tells us that, "Imposing a floating NAV on institutional investors does not achieve the Commission's stated regulatory goals, imposes far greater costs and burdens on investors and market participants than other alternatives, and negatively impacts efficiency, competition, and capital formation. The floating NAV does not prevent or mitigate run risk in a crisis. The overwhelming number of comments in the Commission's current comment file (as well as comments filed in other dockets over the past three years) from MMF users, service providers, academics and analysts, and most fund sponsors reject the proposition that a floating NAV would prevent or reduce the potential for large-scale redemptions from MMFs in a crisis or in response to a significant credit event. Data from the financial crisis showing that investors ran from floating NAV funds in Europe and ultra-short bond funds in the U.S. provides a real-world example of investor behavior. Although the Commission's Release speculated that a floating NAV "could alter investor expectations," and that investors therefore "should become more accustomed to, and tolerant of," fluctuations in MMF NAVs, and that investors therefore "may be less likely to redeem shares in times of stress," there is no data in the comment file or the Release to support what is merely the Commission's predictive judgment. Indeed, the majority of commenters who address this issue reject the Commission's theory, and the Commission itself has conceded that "a floating NAV may not eliminate investors' incentives to redeem fund shares, particularly when financial markets are under stress and investors are engaging in flights to quality, liquidity, or transparency." The Commission has acknowledged, however, in contrast, that "[G]ates are the one regulatory reform in this Release ... that definitely stops a run on a fund (by blocking all redemptions).""
He adds, "A floating NAV is an unnecessary and excessively burdensome means of communicating MMF risks to institutional investors. Moreover, a floating NAV is a wholly unnecessary means to communicate what investors -- particularly institutional prime MMF investors who are the target of the Commission's proposed floating NAV reform -- already know, that the underlying fair value of a MMF portfolio fluctuates and that a MMF may lose value. Here, the Commission has a very stark cost-benefit calculation to make in choosing among regulatory alternatives designed to inform investors of the risk of investing in MMFs. It can choose to impose multi-billion dollar costs on institutional investors, fund sponsors and intermediaries, to overhaul and convert systems to accommodate an NAV that fluctuates, based upon mark-to-model fair valuations, to the fourth decimal point -- for the benefit of informing institutional investors of facts they already know. In the alternative, if the Commission concludes that there are marginal benefits in providing more information to investors, it could choose the more cost-effective approach of requiring daily mark-to-model NAV disclosure (which is already provided by many funds), additional portfolio disclosure and other enhanced disclosures as proposed in the Commission's rulemaking. Of course, if the Commission chooses to adopt the gates/fees alternative (the most effective alternative to address run risk), the accompanying disclosures will make clear to investors that MMFs are subject to the risk of temporary loss of liquidity or redemption fees."
The letter says, "Moreover, the Commission has not provided any basis, apart from creating arbitrary and trivial fluctuations in the share price, for requiring MMFs to calculate their NAV to the nearest basis point for shareholder transactions, when all other mutual funds are held to only a ten basis point standard of valuation. Even MMF managers who expressed qualified support for Alternative One objected to requiring their funds to transact at a four decimal place NAV. The Investment Company Act of 1940 authorizes the Commission to regulate the NAV of redeemable securities only for "the purpose of eliminating or reducing so far as reasonably practicable any dilution of the value of other outstanding securities of such company or any other result of such purchase, redemption, or sale which is unfair to holders of such other outstanding securities...." The Release did not articulate any risk of dilution or other unfair results unique to MMFs that would require a different standard of valuation for their NAVs. Furthermore, nothing in the Release or comment file justifies the abandonment of amortized cost method of valuing MMF portfolios -- a method MMF boards may use under Rule 2a-7 only if it fairly represents market-based valuation."
It explains, "The billions of dollars of costs associated with a floating NAV cannot be justified. The Commission concedes that a floating NAV will have a more disruptive effect than gates and fees, stating in the Release that "investors may withdraw more assets under the floating NAV proposal than they would under the liquidity fees and gates alternative because the floating NAV proposal may have a more significant effect on investors' day-to-day experience with and use of money market funds than the liquidity fees and gates alternative and because many investors place great value on principal stability in a money market fund." Comments in the file support this view."
The Federated letter tells us, "The Commission's need to choose a regulatory alternative that preserves MMFs for investors further is compelled by the statutory obligation to consider the effects of its rules on investor protection, efficiency, competition, and capital formation. Neither the Commission's Release nor the comment file provide adequate support for a finding that a floating NAV would protect investors or promote efficiency, competition, or capital formation. The record does support a finding that Alternative Two maintains MMFs as an efficient, pro-competitive investment that positively impacts short-term funding markets and that it avoids the negative impacts of a floating NAV."
It explains, "Alternative Two, as compared to a floating NAV -- Preserves MMFs as a cash management option for investors, rather than forcing investors to shift funds to less transparent and more risky assets such as bank deposits because of statutory or other legal barriers to investing in floating NAV assets; Provides MMF boards with an additional tool to protect investors by ensuring equitable outcomes in a crisis; Promotes efficiency by preserving the existing tax, recordkeeping, and operational benefits of stable value MMFs (including same-day settlement periods) rather than adding additional burdens; Avoids increasing systemic risk by avoiding the possibility that MMF assets will shift to too-big-to-fail banks or that pricing vendor outages will lead to cascading payment system failures; Promotes competition by preserving a higher yield, more transparent, less risky alternative to bank deposits (particularly for funds in excess of FDIC insurance limits) or other less regulated products; Avoids the possibility that the bulk of prime and municipal MMF assets would shift into government securities MMFs and potentially overwhelm the available supply of short-term government securities; and Promotes capital formation by preserving the role of MMFs as suppliers of lowercost short-term funding to issuers, including corporations and state and local governments, rather than reducing the role MMFs play in short-term funding markets as investors shift assets away from prime MMFs."
Finally, the letter concludes, "The record justifies adoption of Alternative Two, which would be more effective if modified along the lines that Federated and other commenters have proposed. We urge the Commission to adopt Alternative Two with the suggested modifications, along with appropriate enhanced disclosures, to achieve its stated reform goals. The record is utterly bereft of data, analyses, or fact-based evidence supporting adoption of Alterative One. Therefore, we urge the Commission to reject Alternative One given the Commission's statutory obligations and binding Guidance. We hope this letter proves helpful to the Commission as it considers final rules for MMF reform. We appreciate the opportunity to provide comments on the Release."
