The U.S. Securities & Exchange Commission (SEC), which is scheduled to discuss and vote on Final Money Market Fund Reforms Wednesday morning, July 23, at 10am Eastern, has posted an Agenda for the meeting. (We'll excerpt from the expected press release as soon as it's available tomorrow morning, and we'll forward this to subscribers. Visitors should also be able to view the Webcast of the Sunshine Meeting here.) We quote from the Meeting Agenda, and include comments from some analysts that have been weighing in with their expectations and the ramifications of money fund reform below. Wednesday's "Open Meeting Agenda" (July 23, 2014) lists, "Item 1: Money Market Fund Reform; Amendments to Form PF, Office: Division of Investment Management, Staff: Norm Champ, Diane Blizzard, Sarah ten Siethoff, Thoreau Bartmann, Sara Cortes, Adam Bolter, Erin Loomis, Andrea Ottomanelli Magovern, Kay Mario Vobis, Amanda Wagner." It says, "The Commission will consider whether to adopt amendments to certain rules under the Investment Company Act of 1940 that govern the operation of money market funds and related amendments to Form PF under the Investment Advisers Act of 1940. For further information, please contact Thoreau Bartmann, Division of Investment Management, at (202) 551-6745."
The agenda continues, "Item 2: Notice of Proposed Exemptive Relief, Office: Division of Trading and Markets, Staff: Steve Luparello, Haimera Workie, Natasha Vij Greiner, Jonathan Shapiro, George Makris." It says, "The Commission will consider whether to issue a notice of proposed exemptive relief. For further information, please contact Natasha Greiner, Division of Trading and Markets, at (202) 551-4563."
Finally, it lists, "Item 3: Removal of Certain References to Credit Ratings and Amendment to the Issuer Diversification Requirement in the Money Market Fund Rule, Office: Division of Investment Management, Staff: Norm Champ, Diane Blizzard, Penelope Saltzman, Amanda Wagner." It explains, "The Commission will consider whether to (i) re-propose amendments to the principal rule under the Investment Company Act of 1940 that governs the operation of money market funds to address provisions that reference credit ratings and (ii) propose an amendment to the diversification provisions in that rule. For further information, please contact Amanda Wagner, Division of Investment Management, at (202) 551-6762." Watch for more coverage Wednesday morning as it becomes available.
On Friday, JP Morgan Securities' US Fixed Income Strategy projected what reform could look like. "For years the regulators have indicated their intent to structurally reform MMFs to prevent another run in the event of a severe liquidity or credit crisis. However, in doing so, they have the potential to significantly impact the money markets. Worst case scenario, the reforms could cause a huge structural shift in money permanently moving away from prime MMFs and into government MMFs and bank deposits. All else equal, this could cause short borrowing rates for banks and corporations to materially increase while those of sovereigns and agencies to decrease, which would have ramifications on any financial contract that is tied to Libor. Based on recent public comments, the Commissioners still seem to be divided on what the appropriate path should be going forward. Regardless, MMFs are likely going to be shoring up their liquidity as we head into next week in anticipation of potential outflows post-meeting. We wouldn't be surprised if prime funds' 7d liquidity moves above the current 42% level in the near-term."
The update from Alex Roever, Teresa Ho, and John Iborg, outlined their expectations for what reform will look like. Variable NAV: "Most likely, reforms will require targeted MMFs to transition from a constant NAV model to one of a variable NAV <b:>`_. MMFs will have at least two years to implement the change. Of course, this is predicated on Treasury providing some sort of relief on the tax consequences that would be created by buying and selling fund shares on a daily basis. We are less certain on the imposition of liquidity fees and redemptions gates on targeted funds given the resistance from the Fed. However, as this is the only method that addresses run risk and would only be applied in times of stress, we would not be surprised if the SEC decides to combine this with the variable NAV alternative."
The piece adds, "Prime institutional funds are likely going to be the bulls-eye that the SEC targets. They will be subject to the most stringent reforms relative to other types of MMFs. As prior crises have shown, institutional shareholders of prime funds are most prone to run risk. In 2008 post Lehman's bankruptcy, they withdrew $428bn over the course of two weeks. In 2011 during the European crisis and the US debt ceiling debacle, they withdrew $192bn over the course of two months." On the other hand, on "Prime retail funds, government funds, and municipal funds," "We think these types of funds will most likely be exempt from structural reforms.... Retail funds will most likely be defined as MMFs that limit their share ownership to natural persons.... This definition will include individuals that invest in MMFs through individual accounts, retirement accounts, college savings plans, health savings plans and ordinary trusts."
On "Disclosures:," they say, "We're fairly certain that the SEC will require MMFs to provide additional disclosures and/or more frequent disclosure of holdings either to the SEC, the public, or both. The idea is that these disclosures would provide greater transparency regarding MMFs such that investors have an opportunity to better evaluate risks of investing in a particular fund and the SEC and other financial regulators can obtain important information needed to monitor financial stability risks. How frequent or in what form remains to be seen. At a minimum, we suspect the SEC would require funds to disclose their overnight and weekly liquidity levels as well as their market-based NAVs on a daily basis."
Finally, Roever and his team went into more depth about the impact of potential reforms on institutional prime funds. "It remains unclear how institutional prime fund shareholders will react. While the transition period will give prime fund sponsors time to create VNAV funds, there's no guarantee the affected shareholders are going to stick around while this transition happens. Corporate treasurers and other institutional shareholders may be willing to evaluate the suitability of VNAV prime funds, but some may be wary of leaving cash in orphaned CNAV prime funds in the interim. As this regulatory transition takes place, these institutional class shareholders may prefer to shift holdings someplace else, particularly if they get concerned other shareholders might pull out. Just where these shareholders would take their money is an interesting question. For reasons we discussed already, large banks may be resistant to taking on more deposits. A more likely destination would be treasury and government MMFs that will likely be allowed by regulators to remain CNAV."
In related news, "Marketwatch's "The Tell" blog ran a piece Tuesday, "SEC Rule Could Shift $500 Billion of Money Fund Assets, Analyst Says," citing analysis from Bank of America Merrill Lynch U.S. Rates Analyst Brian Smedley. Blog author Ben Eisen writes, "During the darkest days of the financial crisis in September 2008, a giant money-market fund called the Reserve Primary Fund saw its net asset value drop below $1 per share, a rare event called breaking the buck. Nearly six years later, the scars that event left on the money-market industry haven't fully healed. That's the backdrop for a slew of new reforms that are due for a vote before the Securities and Exchange Commission Wednesday morning. If the SEC adopts changes to Rule 2a-7 -- which have been a long time in the making -- it could dramatically reshape where investors park their cash within the money-funds industry, according to Brian Smedley, rates strategist at Bank of America Merrill Lynch. He believes $500 billion could flow out of prime funds (which invest in commercial paper as well as government securities) and into government funds (just government securities)."
The piece continues, "But let's back up a second. There are a number of key measures within the reforms, including potential redemption fees, new definitions for fund types, and new treatments for municipal bond funds. But the most important would be a measure to let the net asset value of prime funds float, rather than stay fixed. Currently, the NAVs are fixed at $1, which is why it was so consequential that a fund broke the buck. But the institutional non-government funds that were most susceptible during the financial crisis are now thought by many to be more stable if their NAVs are allowed to float. Government money-market funds may stay fixed. If those regulations pass, Smedley thinks investors would thus leave the floating-NAV funds for the fixed-NAV funds."
MarketWatch adds, "He writes in a Tuesday note: 'Funds that designate themselves as institutional prime fund have assets of roughly $900bn, equal to 35% of total money fund AUMs. We expect the SEC to move ahead with the proposed requirement. This will likely spur fund investors to reallocate a material portion (perhaps half a trillion dollars over time) of prime fund assets into government-only funds, which will likely retain a fixed NAV. Note that institutional MMF investors have not altered their allocation between prime and government money funds since the SEC's proposal was released.'" It goes on, "An exodus from some funds in favor of others could noticeably impact prices of short-term rates, Smedley believes: 'This should result in upward pressure on Libor over time and cause short-dated Treasuries and agencies to richen even further, especially given the negative supply outlook for bills and repo.'"
