Though the April 30 deadline is passed for responding to the SEC's "Request for Comment on Potential Money Market Fund Reform Measures in President's Working Group Report," a couple of submissions were posted in June. One of these is from Federated Hermes, who posted additional feedback, entitled, "Comment Letter Of Federated Hermes, Inc. On Structural Reforms To Mitigate Systemic Risk And The Root Causes Of The Liquidity Crisis Of March 2020." The letter from Chief Risk Officer Michael Granito explains, "I am writing on behalf of Federated Hermes ... to provide additional comments in response to the Report of the President's Working Group on Financial Markets, Overview of Recent Events and Potential Reform Options Report on Money Market Funds ... which was issued in December 2020. Federated Hermes has already provided detailed comments that respond to the specific policy options identified in the PWG MMF Report (the 'First Federated Hermes Comment Letter) and are incorporated and restated herein by reference."
It continues, "In this comment Federated Hermes recommends structural reforms that address the root causes of the failure of critical funding markets in March 2020 and the consequent systematic risks. We propose: (i) considerations relating to the Federal Reserve ('Fed') posture for providing liquidity in stressed markets, as well as reforms to promote market-making in stressed conditions; (ii) amendments to rule 2a-7; (iii) reforms to the short-term market structure itself that could improve liquidity in times of stress; and (iv) considerations for balancing the SEC's statutory mandate with liquidity and financial stability concerns."
Granito writes, "Federated Hermes has been in the investment management business since 1955 and has more than 45 years of experience managing MMFs. During that period, Federated Hermes has participated actively in the money market as it developed over the years. Federated Hermes currently manages over $400 billion in money market assets including registered domestic and offshore funds, private funds and state government-sponsored local government investment pools ('LGIPs') that invest in money market instruments. MMFs managed by Federated Hermes in the United States include U.S. government MMFs, municipal MMFs and prime MMFs. As of year-end 2020, over two-thirds of the MMF assets managed by Federated Hermes were U.S. government securities and less than 30% consist of commercial paper and other non-government instruments. Federated Hermes also manages MMFs and other investment funds and accounts in Canada, Europe and Asia. In addition to MMFs, Federated Hermes manages accounts for institutional customers that invest in money market instruments."
The Executive Summary states, "At its inception in 1913, the Fed's original mission was to increase the money supply to support a growing economy, help develop the commercial paper market -- and even more importantly, to quickly supply liquidity to the economy to avert a panic. These objectives were to be achieved, or facilitated, through use of the discount window (then Section 13(2)) of the Federal Reserve Act ('FRA') that could be responsive to the real time needs of the economy."
It tells us, "The challenge today is that the discount window has fallen into disuse as a result of an associated stigma; and the Fed's predominant means of injecting liquidity in a crisis is the emergency lending power established in 1932 (FRA Section 13(3)). However, this tool is calibrated to deal with an already existing crisis, not prevent it. Thus, an origin of the problem lies in the construction of the relevant lending powers as emergency measures and not tools that can react in real time. For example, under Dodd Frank Act Section 1101, the Fed's emergency lending authority is no longer discretionary and independent of the Administration. Approval of the Secretary of the Treasury, with related documentation is, required. Similarly, after the 2008 financial crisis, the Fed introduced a broad array of capital, leverage and liquidity constraints on banks that have enabled them to withstand severe economic conditions. But those constraints have also curtailed a bank's ability to fulfill market-making objectives in the stressed markets experienced in March 2020, thus limiting liquidity when it is most needed."
The summary also says, "Importantly, on March 15, 2020, the Fed announced constructive measures to encourage use of the discount window to stem the crisis, and additional measures to promote market-making by bank broker-dealers. On April 1, 2020 the Fed announced temporary amendments to the Supplementary Leverage Ratio ('SLR'). However, these actions came weeks into the crisis and unnecessary damage had already been done. We recommend that the Fed make the amendments to the discount window permanent; and that the Fed critically examine and amend regulations that have curtailed market-making, including the SLR. In addition, the Dodd Frank Act ('DFA') Section 1105 defines the concept of a Liquidity Event, which broadly characterizes the conditions in February and March 2020. We recommend that the Fed consider the timely designation of a Liquidity Event, or similar concept, as: (i) a means of alerting banks to respond to the real time needs of the markets by using these facilities; and (ii), a potential threshold for temporary waiver of regulations that may hinder market-making."
Under "Reforms to Rule 2a-7," Federated comments, "The credit quality and liquidity levels of prime and tax exempt MMFs met or exceeded regulatory requirements during March 2020. Outflows from these funds in March 2020 resulted in significant part from 2014 MMF reforms that linked the 30% weekly liquid asset ('WLA') test to board action on fees or gates. The Fed predicted this would trigger redemptions -- and it did. We recommend that the SEC delink the WLA test from required board action while continuing to empower (and obligate) MMF boards to take actions on fees and/or gates that are in the best interest of shareholders. We believe that an objective review of the data from and the events of March 2020 would result in the conclusion that no other reforms are necessary or appropriate."
The letter also urges, "Reforms To The Short-Term Money Market Structure," explaining, "The commercial paper ('CP') market is unnecessarily fragmented. Today non-financial corporate CP is traded on several electronic platforms (e.g., TradeWeb and BOOM). However, a large volume of the CP market is bank paper, where only the issuing bank makes a market. This comes at the expense of liquidity in the market, and ultimately, financial stability. The Fed and SEC should take steps necessary to broaden bank CP market-making just as the market for non-financial CP has evolved over time. Additionally, a further expansion of electronic venues would be to enable investors, issuers and broker/dealers to all view and post bids and offers -- an 'all to all' platform. We urge the SEC and Fed to convene a working group of private market stakeholders to arrive at a model that provides greater transparency and liquidity, particularly in periods of market stress. Recent examples of on-going dialogs between the industry with the Fed include, particularly since 2007 – 2009, frequent NY Fed inquiries on market conditions, the increased usage of cleared repo (through FICC) as opposed to bilateral settlement to reduce the risk of collateral fire sale, and a dialog on the Fed's reverse repo facility -- particularly on mechanics of the program."
Federated's letter states, "Prime and tax-exempt money market funds ('MMFs') have been among the most successful financial products in history providing investors with over $200 billion in returns in excess of bank deposit rates while significantly lowering borrowing costs for corporations and municipalities. Just two MMFs have ever 'broken the buck', with zero cost to taxpayers, and investors recovering over 96% percent of their principal in one case and over 99% of their principal in the other. Over this same period, over 3,600 federally insured depositories have failed costing taxpayers over $180 billion, which should provide some helpful perspective for those who assert that it's MMFs that have 'structural vulnerabilities' or needed 'taxpayer bailouts'."
They continue, "To be clear, we understand that mitigating the on-set of and preventing the damage from a financial crisis are daunting responsibilities that requires constant vigilance. It is understandable that one response of the Fed would be to advance macroprudential regulation to enable banks or other financial institutions to withstand significant, even catastrophic, events without Fed intervention. However, there is a point at which this imposes too great a cost on business and the economy; and the Fed must ultimately step in to address a true crisis. This is particularly relevant in light of the Fed's current realization that the discount window is an essential near-real time tool for providing liquidity and preventing panic conditions; and that banking reforms that limit market-making in stressed conditions can be re-examined."
The letter elaborates, "Nonetheless, as happened after the 2008 crisis, it is likely that the SEC will be pressured to adopt a financial stability mandate that would ultimately come at the expense of its actual statutory mandate; and, among other things, lead to reforms to 2a-7 in excess of what is required. We believe that any SEC action must remain true to its statutory mandate of investor protection, efficiency and capital formation. Successful execution of this mandate is what has created the foundation of financial stability in the US capital markets; and it should not be diluted to mitigate the risk of another agency failing to timely fulfill its own statutory mandate."
It tells us, "There is however an overlap of the SEC's mandate with financial stability: liquidity, which is essential for orderly markets. Within the SEC, the Division of Trading and Markets particularly has this responsibility. The SEC's regulation of fixed income markets, including alternative trading systems (ATS, or electronic venues), has promoted market efficiency and lowered trading costs in normal periods, but this has not necessarily translated to improved liquidity in turbulent periods. The SEC's Division of Investment Management has taken steps to enhance the liquidity risk management of mutual funds generally, and MMFs in particular, in recent years. We suggest that the SEC focus greater attention on regulations that can enhance liquidity in fixed income and short-term markets in crisis periods. More generally, we recommend that the Division of Trading and Markets undertake a thorough review of money markets to identify additional means of improving liquidity during stressed market periods."
The PWG comment letter's Conclusion says, "The March 2020 liquidity crisis stemmed from the worst pandemic in 100 years and a concurrent global economic shutdown that was deeper, more sudden and more synchronized than the Great Depression. Disruption to the money markets only came after deep contractions in equity and bond markets and even pronounced illiquidity in segments of the U.S. Treasury market. In considering further reforms to MMFs, it must also be noted that the credit quality and liquidity levels of prime and tax exempt MMFs met or exceeded regulatory requirements during the duration of the crisis. Outflows from these funds were exacerbated by a defect in the 2014 MMF reforms that linked the 30% WLA test to board action on fees or gates. The Fed predicted this would trigger redemptions -- and it did. There are no additional reforms needed for these funds, other than to correct that defect."
Finally, it adds, "Both the Fed and the SEC should address a root cause of financial contagion in the March 2020 crisis -- a widespread and sharp drop in liquidity across markets, particularly in the funding markets that are vital to the functioning of the capital markets. We recommend that both agencies examine regulations that may stifle rather than promote liquidity and market-making in crisis periods. In recognition of the Fed's unique role, while its actions in 2020 quickly stemmed the market turmoil when enacted in mid-March, significant damage had already, and unnecessarily, been done. We recommend that the Fed consider steps be more proactive in preventing panics -- in line with a central feature of its original statutory mission. A helpful step would be to make the very effective measures on use of the discount window announced on March 15, 2020 permanent; and to similarly relax regulations that curtail market-making in stressed market conditions. We suggest that the Fed also consider making timely use of the Liquidity Event, or similar designation, defined within DFA, as a means of alerting banks to make use of the ensemble of facilities available to them to support liquidity and market-making. We believe that these actions would significantly stem a cycle that neither industry nor the Fed want -- the creation of ad hoc Section 13(3) special facilities."
