Earlier this week, we excerpted from recent "Comments on Money Market Fund Reform" posted by the SEC, including one from the largest money fund manager, Fidelity Investments and one from mutual fund trade group ICI. Today, we quote from the second largest MMF manager, BlackRock. Elizabeth Kent and Jonathan Steel write, "BlackRock supports the Securities and Exchange Commission's efforts to continue to improve the resiliency and transparency of United States money market funds. The proposal, which incorporates certain feedback from market participants in response to the December 2020 President's Working Group Paper on potential MMF reform options, represents a positive step toward the Commission's goal of making MMFs more resilient during periods of stress. In particular, we support the proposal's elimination of redemption gates from Rule 2a-7 and amendments to specify the appropriate methodology for calculations of the dollar-weighted average maturity ('WAM') and dollar-weighted average life ('WAL') of MMF portfolios."
They state, "However, we continue to oppose mandatory swing pricing for MMFs, as we do not believe the implementation of swing pricing will achieve the goal of protecting against first-mover advantage while maintaining the usefulness of MMFs for participants in the industry. The Commission's concern is that early redemptions may result in a dilution of value for the remaining MMF investors, triggering an incentive for all MMF investors to redeem quickly in times of stress, a classic 'bank run' scenario. To solve this problem, economic analysis suggests 'internalizing' the costs to the early redeemers, thereby preserving fund value. The Commission has proposed swing pricing as a method of achieving this internalization. In our view, this is not the appropriate method for MMF's, due to the high levels of liquidity that an MMF is required to maintain."
BlackRock explains, "The current proposal's swing pricing solution will introduce unnecessary operational complexity while having only a tenuous relationship with the true cost to an MMF of managing redemptions. Further, the computation of the swing factor when net redemptions breach the threshold in the proposed rule is hypothetical and not representative of the true cost of managing redemptions in an MMF, as explained in more detail below. This complexity and uncertainty would likely diminish the utility of MMFs for investors."
The letter continues, "If the Commission believes internalization of redemption costs is necessary, we believe a redemption fee would be more appropriate for MMFs. In contrast to swing pricing, a redemption fee has the same economic effect as swing pricing but is operationally simpler to implement. We propose a redemption fee that would initially be imposed only if net redemptions exceeded 10%, which equates to half of our proposed level of Daily Liquid Assets ('DLA') (we discuss below why a 20% DLA requirement is more than sufficient for meeting redemptions without the need to sell other assets), and certain levels of market stress are present as measured by Weekly Liquid Asset ('WLA') levels. The maximum value of this fee would be transparent to investors who expect to trade in MMFs at close to net asset value."
BlackRock adds, "We have also identified several other areas where the Commission's proposal should be modified prior to the adoption of a final rule to allow MMFs to (i) continue to meet large redemptions while addressing any concerns about redemption costs and liquidity without causing significant operational challenges to the industry and (ii) retain their availability and utility for participants in the industry. Specifically, we recommend: Adjusting the proposed portfolio liquidity requirements of MMFs; ... Removing the requirement for MMF providers to determine the capacity of intermediaries for implementing a per share floating net asset value ('FNAV') in Government and Retail MMFs and clarifying that intermediaries need only be able to implement manual processes for redemptions in a negative interest rate environment; and, Implementing suggested specific recommendations regarding the proposed reporting requirements."
They then discuss short-term funding markets (STFMs), explaining, "BlackRock firmly believes that the issues in the underlying STFMs must be addressed initially or concurrently with additional MMF reform. While we agree that the lack of liquidity in the market in March 2020 exposed a vulnerability related to the difficulty of liquidating assets, this is a vulnerability of the STFMs as a whole, not a vulnerability exclusive to MMFs.... Changes to MMFs will do little to address the underlying vulnerability of limited liquidity during market stress in certain portions of the STFMs. Moreover, if the changes to MMFs were made in isolation, driving investors away from MMFs and into other corners of the STFMs, these reforms might decrease the limited existing transparency in the STFMs.... [W]e note that a significant reduction in the footprint of MMFs in the STFMs would not necessarily mean a reduction in the possible need for central banks to intervene in future market crises."
BlackRock writes, "Turning to the Commission's proposed increases to the DLA and WLA, these levels should not be raised as high as proposed by the Commission. As stated in our response to the Financial Stability Board ('FSB') report 'Consultation report on Policy Proposals to Enhance Money Market Fund Resilience,' we believe that USD-denominated prime MMFs should hold a minimum of 20% of their assets in DLA. With the removal of the threat of a redemption gate, an enhanced DLA of 20%, coupled with an enhanced WLA of 40%, will provide a strong source of available liquidity to ensure MMFs are able to continue to manage significant and rapid investor redemptions."
The letter argues, "For the following reasons, we do not believe swing pricing is a workable tool for MMFs: Market impact calculations would be based on hypothetical assumptions and, therefore, may unfairly benefit some investors over others. MMFs do not meet redemptions by selling a vertical slice of their portfolio. Rather, an institutional prime MMF typically relies on its DLA to meet redemptions.... Additionally, an MMF is usually aware of an impending large redemption during normal market conditions and manages its liquidity to account for that redemption. Therefore, calculating a 'market impact' each time net redemptions were more than 4% based on the sale of a vertical slice of an MMF would not be reasonable given that such sales do not happen in normal ... market conditions. Without such sales, an MMF would be forced to calculate a swing factor based on a hypothetical sale of a vertical slice of an MMF's portfolio resulting in a hypothetical cost unrelated to the actual impact on an MMF of such redemptions."
It says, "[T]his fictitious market impact factor would (i) potentially disadvantage certain investors (subscribers or redeemers) over others because it is not accurate, and (ii) result in potential moral hazard as sponsors seek to avoid competitive disadvantages resulting from high calculations. Notably, the proposal lacks guidance on how an MMF should estimate these hypothetical costs and, instead, calls on MMF sponsors to be guided by 'good faith.' ... [The] Lack of or Narrow Bid-Ask Spreads make calculating, and applying, the swing factor challenging [and] The operational changes and costs required to implement swing pricing in the U.S. are significant and will impact the viability of institutional prime MMFs."
BlackRock also states, "Certain MMF's are 'Internal Only' which makes them particularly ill-suited to swing pricing. A significant number of the institutional MMFs that exist today are not sold to public investors, but rather are used for money management by mutual fund sponsors. For example, there are prime MMFs that serve only as a sweep vehicle for other open-end mutual funds in the same fund complex or that serve as collateral management vehicles for securities lending done by mutual funds in the same fund complex and are not as sensitive to 'runs' as publicly offered funds.... [T]hese Internal Only MMFs are particularly ill-suited to any anti-dilution mechanisms such as swing pricing."
On the topic of "Swing Pricing Alternative: Modified Redemption Fee," they propose, "The additional proposed portfolio liquidity requirements along with the removal of gates adequately positions MMFs to absorb redemptions during a stressed market. However, if the Commission continues to believe that redeeming investors should bear a cost for redeeming in stressed markets, we believe a modified version of a redemption fee is the most appropriate solution. A redemption fee would best address the concern of placing some cost of redeeming on the redeeming investor during times of stress but still allow an institutional MMF to retain the features that make it useful in the STFMs, such as multiple strikes and a high degree of certainty for redeeming investors. As compared to swing pricing, the infrastructure for a redemption fee is already available in institutional MMFs and our proposed structure could be applied consistently by all institutional MMFs in the market.... An institutional MMF would be required to impose a prescribed redemption fee based on the following factors on a particular day. `The following fees would be applied: If net redemptions were 10% or higher and the prior day's WLA is less than 30% but greater than or equal to 20%, a fee of 0.25% would be applied to all redemptions; If the prior day's WLA is less than 20% but greater than or equal to 10%, a fee of 1.00% would be applied to all redemptions; If the prior day's WLA is less than 10%, a fee of 2.00% would be applied to all redemptions."
BlackRock adds, "This solution provides an efficient and easily applied cost to redeeming investors and, given the Commission's own acknowledgment that the creation of a market impact factor will at best be only an estimation, we believe this prescribed fee would provide more robust protection to remaining investors with no need for a market impact estimation. The formulaic application of the framework would allow MMFs to continue providing same day liquidity. Fund providers could apply the redemption fee quickly after the close of the MMF, without need for extra time to compute estimations."
They write, "Additionally, in the unlikely event that negative interest rates occur in the U.S., we believe it should be more than sufficient for intermediaries to have policies and procedures in place to allow for manually processing redemptions at an FNAV. We are concerned that the Commission's proposal regarding an intermediary's readiness to support negative interest rates would require cost prohibitive changes to myriad systems. To avoid those changes, intermediaries may remove government and retail MMFs from their platform offerings and instead move their customers to alternative products such as bank deposits. We note there is precedence for intermediaries culling the funds they offer in response to regulatory change that would require them to undertake substantial operational and technology change. It was intermediaries' unwillingness to take on this same transformative work after the 2016 MMF reforms that led to the removal of institutional MMFs with FNAVs from certain intermediary platforms."
Finally, BlackRock comments, "Given that backdrop of ample existing transparency for MMFs, we do not believe that collecting more information that is not directly related to a specific reporting shortcoming evident in March 2020 is warranted.... We recommend that given the number of additional reporting points required now under Form N-MFP that the Commission extend the filing deadline for this form to 7 business days after month end. This 2-day extension would allow the additional information to be generated in a timely manner and would allow MMF sponsors to have proper oversight and controls in reviewing the data prior to filing."
