We wrote on Monday about our recent "Crane's Money Fund Webinar: Mini Fund Symposium," a 3-hour series of sessions including segments on "`The State of the Money Fund Industry," "Strategists Speak: Treasury, Fed & Repo;" "Regulatory & ESG Money Funds Update;" and, "Major Money Fund Issues 2020." (See our News, "Hopkins, Lontai, Tobin Talk Major MF Issues: ESG MFs, Sticking w/Prime.") Today, we quote from the Regulatory & ESG session, which featured Dechert LLP's Stephen Cohen. (The full recording is available here and materials are available via our "Webinar Download Center," and mark your calendars for our future online events: "Crane's Bond Fund Webinar: Ultra-Shorts & Alt-Cash" on Sept. 24 from 1-2pmET, where Crane Data's Peter Crane and a panel of ultra-short bond fund managers will give a brief update on the space; "Crane's Money Fund Symposium Online" on Oct. 27 from 1-4:30pmET, which will feature another afternoon of money fund discussions; and, "European Money Fund Symposium Online" on Nov. 19 from 10am-12pmET.)
Cohen tells the Mini Fund Symposium, "I don't want to give anyone PTSD, but I thought we'd talk a little about the March 2020 market conditions and the government response to lay the groundwork for potential future reforms at the end. And then, to talk a little bit about potential negative interest rates, and in particular ... the reverse distribution mechanism. We'll talk a little bit about ESG money funds and the actions that regulators are taking relating to ESG. And then finally, we'll talk about the potential future reform."
He says regarding, "March 2020 market conditions and the government's response," "Institutional money market funds were forced to sell their most liquid securities to meet redemptions and that put pressure on weekly liquid assets. As most of you recall, the SEC adopted a number of reforms in 2014. Most notable, at least here, was the adoption of fees and gates -- liquidity fees and gates for non-government money market funds. Those are triggered when a fund's weekly liquid assets fall below 30 percent.... Redemptions were putting pressure on weekly liquid assets and funds. One case fell below 30 percent, but others were getting very, very close."
Cohen continues, "What really stopped these redemptions, and provided liquidity to the market, was the Federal Reserve Board stepping in and establishing ... the Money Market Mutual Fund Liquidity Facility, the MMLF. Under that, the Federal Reserve Bank of Boston began making loans to eligible financial institutions that would be secured by the high-quality assets that they purchased from money market funds.... The MMFL, out of all the actions that the government took, this was the one that really helped the industry the most. It restored liquidity in the market, reduced the fear of institutional prime funds falling below that 30 percent weekly liquid assets and causing a fee or gate, or the consideration of a fee or a gate. And shortly after that, the weekly liquid assets started going back up to normal levels."
He adds, "A couple of other things to note: That week in particular, the SEC staff issued some no action relief. The ICI, on behalf of its members, in particular members who were affiliated or are affiliated with banks, were limited in their ability to purchase securities from money market funds using Rule 17a-9, because the banking regulations conflicted with that rule. To address that, staff provided no action relief that allowed funds to use the price that's required under the banking regulation to purchase securities from money market funds under the Rule 17a-9. That was sort of emergency no action relief that week, the week of March 16th, to help sponsors be able to step in and shift their money market funds during that difficult, difficult time."
On "Form N-CR filings," Cohen comments, "Historically, those filings are made on routine items, like topping up a fund as part of a liquidation.... It's never been used for an emergency situation. No funds have had to file to notify the SEC of an emergency until that week. Several money market funds had to make Form N-CR filings in connection with purchases that were made by their affiliated sponsors. So, another regulatory development that occurred that week."
He also says, "Another area that the industry has been very focused on and is trying to be proactive about is potential negative interest rates. This occurred in Europe, and there's concern that it could happen here in the United States as well. All else equal, if a fund is purchasing negative yielding securities, over time the market-based NAV of a stable NAV money market fund will decline over time.... Government money market funds ... are likely to sort of experience the pressure first.... So, the industry has been prepared for this and thought about it to sort of mitigate the pressure of a negative interest rate environment."
Cohen explains, "There are a number of actions that funds can take. One, implementing fee waivers. We're seeing that.... I think most money market funds are waiving some fees. The Wall Street Journal reported on this just a couple days ago, too. Closures of the funds is another way to help address this. It's just a short-term fix, but some funds have closed to new investors or any new money. This is not usually done, but a sponsor could, in theory, contribute capital to stabilize the NAV in a negative yielding environment. And then, of course, there's the option of converting a stable NAV money market fund to a floating NAV. All of those are not great options, and won't deal with a negative yielding environment for any period of time."
He states, "Another potential solution that's getting traction in the industry is the idea of implementing a reverse distribution mechanism, or RDM. This is an approach that was used in Europe. Europe called it share cancellation or share destruction.... Again, this was used in Europe, and it's a method that operationally can be used here in the United States as well. The industry, the ICI, has been in discussions with the SEC on this and the IRS. There is, I think at this point, reluctance by the SEC staff to move forward or bless this, but there are sort of ongoing discussions around it. So, I think, more to come here, but the industry is trying to work on providing this as a potential option in a negative yielding environment."
Cohen then tells us, "ESG is obviously a very hot topic these days.... Institutional investors increasingly are focused on ESG, it is part of their investment mandate, especially outside of the United States. And regulators are becoming more and more focused on this, too. Everybody probably knows ESG refers to environmental, social and governance, and a number of funds in the money market fund industry have incorporated social and/or ESG into their investment mandates.... BlackRock, Dreyfus, DWS, Federated, Goldman, Morgan Stanley, State Street, UBS. Other money market fund advisors have integrated ESG into their investment processes.... It's become a very popular strategy and there actually have been assets going into these funds.... ESG funds are not just being launched, but they're actually doing well. At least some of them."
Regarding "regulatory developments, he comments, "The SEC established what's called an Investor Advisory Committee, and in May of this year, that committee actually recommended that the SEC, 'begin in earnest an effort to update the reporting requirements of issuers to include material decision useful ESG factors.' So, that was just in May this year that that committee recommended it. Shortly thereafter, in June, Chair Clayton ... stated that the SEC is in the process of developing a rule to help asset managers to compare sustainability metrics across portfolio holdings. There's no timing, no further sort of details that have come out from the SEC, but it was an important and notable announcement in June. To date Chair Clayton and the majority of the SEC have been very methodical and slow moving on ESG."
Cohen explains, "This may be the next Administration's, or the next Chair's issue, because it seems like they're not going to likely move too far before November. But behind the scenes, interestingly, the SEC has been very focused on it. The staff of OCIE, which is the Office of Compliance Inspections and Examinations, included its review of ESG strategies as part of its examination priorities. They said in particular that they're going to focus on the accuracy and adequacy of disclosures related to sustainable and responsible investment strategies. To make sure that funds, for example, that say they are including ESG in their strategies are actually doing what they say. The staff that's responsible for rulemaking, issued a request for comment relating to what's called the Names Rule for funds, rule 35d-1 ... and there's a debate as to whether ESG is a type of investment or a type of strategy.... ESG is a hot topic within disclosure as well."
He continues, "The Department of Labor is moving in a different direction.... [DOL] issued a proposed new rule that actually, if it gets adopted, would make planned fiduciaries make sure that they do not invest in ESG vehicles when another strategy is better. In that release, the Department of Labor notes that the goal of the plan fiduciary should be to maximize the financial objective of the plan, not to focus on social, or governance, or environmental issues. That's secondary if there's a strategy that provides a better financial return to the plan, that should be made available as opposed to the ESG strategy."
Finally, Cohen comments, "I don't have a crystal ball about what's going to happen in terms of future reforms.... But I do follow the statements here that some of these regulators are making. And the first to note is the Center for Economic Policy Research. It published 'Runs on Prime Money Market Funds During the Covid-19 Crisis.' The economists on this all work for the Fed [and] they say, given the notable role of money market funds in short term funding markets in the shadow banking system, more research and collaborative regulatory efforts are warranted to enhance the stability of the industry. They’re clearly stating in that paper that regulatory efforts are necessary. The person responsible for regulatory reforms at the Federal Reserve is Vice Chairman Randall Quarles. He noted that, we have already announced that our next evaluation exam in the post-crisis reforms to money market funds, which were once again front and center in the Covid event. Another statement sort of pointing that the Fed is very interested in money market fund reforms."
He adds, "In Europe, it's the same. The Central Bank published the Financial Stability Review in May 2020 -- lessons from the recent stress in the money market fund sector should be drawn, including more regulation. And then I think the big item that'll come out later this year ... similar to the President's Working Group and the other reports that were published after the 2008 market crisis ... The Financial Stability Board, which is a collection of global regulators, is expected to review the March turbulence by November. It will no doubt discuss money market fund reform. I do think there will be a push, a strong push for reforms. I don't know how successful the industry will be pushing those back, and what the next administration will focus on. But I do think there will be a push."
