An article published in American Banker, entitled, "Enough Already. Money-Market Funds Aren't Shadow Banks," argues against further regulation of money market funds following the latest set of reforms. Written by Paul Schott Stevens, President & CEO of the Investment Company Institute, it says, "In July 2014, the U.S. Securities and Exchange Commission enacted sweeping new rules for money-market funds, setting an aggressive implementation deadline: Oct. 14, 2016. Though the rules required significant operational changes, money-market funds have met the new requirements on time. As a result, today's money-market funds are very different products than their precrisis predecessors."
He explains, "The reforms, which are meant to prevent a repeat of the heavy redemptions from money-funds brought on by the banking crisis of 2008, have added layers of transparency and redundant safeguards that more than adequately address any risks that may have existed. Moreover, the reforms have prompted a large shift in assets from prime to government money market funds. Yet with all of these new rules, some still clamor for further regulation, using disparaging terms like "shadow banking" to spark fear in the minds of regulators and investors alike. Enough already. Money-market funds are not shadow banks. They are fully transparent, regulated investment vehicles that have been a reliable cash management tool for millions of individuals and institutions for decades. Calls for additional layers of burdensome regulation over this industry are not only premature, but unwarranted."
Stevens writes, "Though sweeping in scope, the new rules are actually just the latest in a series of SEC regulations that have been designed to reduce risk in money-market funds following the financial downturn of 2008. The latest rules add to an earlier, comprehensive rulemaking in 2010, which set a number of new standards -- including liquidity requirements and stress tests -- to enhance the resiliency of money-market funds. These reforms were tested and proven in 2011, when Europe's sovereign debt crisis and the federal debt-ceiling crisis rattled markets, and showed their value again after the Brexit vote in the United Kingdom."
He continues, "Now, the latest rulemaking has added even more protection against market shocks, in a number of ways. First, the SEC's reforms require institutional money market funds (both prime and tax-exempt) to price and transact their shares using a floating net asset value, rather than a constant NAV of $1.00, based on the market value of portfolio holdings at the time they calculate their NAVs. The new rules also require funds to calculate their NAVs to four decimal places (for instance, for funds with a $1.00 NAV, to one-hundredth of a penny, or $1.0000). Though this change required fund sponsors and pricing vendors to spend significant time and money reprogramming and testing system algorithms that calculate NAVs, this highly technical work has succeeded -- firms are prepared to meet the demand for unprecedented levels of precision on the valuation of floating NAV money-market funds."
The article tells us, "Many investors, meanwhile, will be able to continue to use floating NAV funds as cash management vehicles because fund sponsors have created systems to strike the funds' NAV multiple times a day, ensuring that investors have intraday access to their balances. Fund prospectuses and other investor education materials will inform investors about how the floating NAV requirement is implemented for each fund. Secondly, the SEC reform permits money-market funds' boards of directors to impose certain conditions on redemptions (so-called liquidity fees and gates) during extraordinary circumstances. This is also a significant change.... In addition to making the operational changes required to implement this requirement, funds have subsequently spent a considerable amount of time communicating to shareholders about fees and gates, including explaining why the likelihood of fees and gates actually being imposed is so small."
It adds, "Funds have worked overtime to prepare for the new regulatory landscape, with remarkable success. While the new rules went into force on Oct. 14, large shifts of assets have already been occurring in the money-market fund sector -- a process that funds and their advisers have smoothly managed. Since November 2015, nearly $1.1 trillion in assets have moved out of prime and tax-exempt money market funds, with a nearly equivalent inflow of cash into government money-market funds. On its face, this is a staggering sum of money -- but the industry foresaw this migration, and shortened the maturities of portfolio holdings to increase liquidity and meet investor demands."
Finally, Stevens says, "Markets and products evolve. While today's money-market funds are very different products than their precrisis predecessors, the $2.6 trillion in assets they hold today prove investors are confident in the industry's ability to continue meeting their needs for years to come."
In other news, the recently released "Minutes of the Federal Open Market Committee" reveal that the Federal Reserve discussed the shifts driven by money market fund reforms at its Sept. 20-21 meeting. Under, "Developments in Financial Markets and Open Market Operations," they say, "The manager reported on developments in financial markets during the period since the Committee met on July 26–27, 2016. Over much of the period, financial market volatility was relatively low, but volatility increased somewhat in the last couple of weeks.... The deputy manager followed with a briefing on open market operations and developments in money markets, including investment flows and changes in market interest rates in anticipation of the upcoming implementation of reforms to the money market fund (MMF) industry. Usage of the System's overnight reverse repurchase agreement facility increased modestly in the most recent intermeeting period. Federal funds generally continued to trade close to the middle of the FOMC's target range of 0.25 to 0.50 percent."
In a "Staff Review of Financial Situation," the minutes explain, "Domestic financial conditions remained accommodative since the July FOMC meeting. Asset prices moved within a fairly narrow range for much of the intermeeting period.... Market expectations for a policy rate increase by the end of this year rose a bit since the July FOMC meeting, reportedly reflecting comments of Federal Reserve officials that were viewed, on balance, as suggesting that the case for policy firming had strengthened over recent months. Nominal Treasury yields across the curve edged up. Anticipation of the impending deadline for compliance with MMF reform measures continued to prompt net outflows from prime MMFs and put upward pressure on some term money market rates."
Finally, they add, "MMF reform continued to affect several short-term funding markets in advance of the October 14, 2016, compliance date. While total assets under the management of MMFs changed little over the intermeeting period, investors continued to shift from prime funds to government funds. As a result, MMF holdings of commercial paper (CP) and certificates of deposit continued to decline, and prime institutional funds further reduced their weighted-average maturities to historically low levels. Reflecting MMFs' reduced appetite for term lending, spreads of three-month money market rates over rates on comparable-maturity overnight index swap contracts rose during the intermeeting period. Rates on short-term municipal securities and net yields on tax exempt MMFs also increased sharply, primarily because of outflows from these funds."
