We continue excerpting from the most important "Comments on Money Market Fund Reform" written to the Securities & Exchange Commission in response to their Dec 15 "Money Market Fund Reforms proposal. The latest is from Federated Hermes, who not only takes the record for the longest submission (at 115 pages), but who also published a second 45-page letter focused solely on the swing pricing proposal. CEO J. Christopher Donahue and Liquidity CIO Deborah Cunningham write, "This letter presents the comments of Federated Hermes, Inc., and its subsidiaries, in response to the rules regarding money market funds proposed by the Securities and Exchange Commission.... We have also submitted a separate comment letter focused on the Proposal's swing pricing requirements. We would also like to state, up-front, our endorsement of the comment letter submitted by the Investment Company Institute ('ICI') on the Proposal, with only minor differences regarding (i) the application of liquidity fees, (ii) availability of discretionary gates, and (iii) increases to the required daily and weekly liquidity requirements. We fully support the ICI's opposition to swing pricing and their support of a reverse distribution mechanism ('RDM'), as the most appropriate means to manage MMFs in a negative rate environment. As the ICI so rightly points out, MMFs are critically important for (i) over 50 million retail investors, as well as corporations, municipalities, and other institutional investors, who rely on the $5 trillion MMF industry as a low cost, efficient, transparent, cash management investment vehicle that offers market-based rates of return, and (ii) governments (federal, state and local), businesses, and financial institutions who utilize MMFs as an important source of financing."
They tell us, "Federated Hermes has managed MMFs since their inception and remains a leader in the management and distribution of MMFs around the globe. We take our position as an industry leader very seriously, not only because of our history successfully managing MMFs for over 45 years, but because of the critical role MMFs have played for stakeholders, including shareholders, issuers, and those that benefit from the activities of both the public and private sector entities that access the short-term funding markets. We have worked tirelessly over the years to defend and support MMFs, one of the SEC's greatest innovations and one of the best products ever created, against repeated challenges by regulators who seek to control all aspects of the short-term funding markets. It is in this light that we provide our response to the Proposal, as failure to adopt a measured response to the unprecedented events of March 2020 will have unnecessary and catastrophic consequences for stakeholders, including the short-term funding markets, and the overall economy."
The letter explains, "Federated Hermes appreciates the tremendous pressure being applied on the Commission with respect to MMFs. Central banks are once again singularly focused on eliminating the utility of MMFs and thereby regulating them out of existence. Former Federal Reserve ('Fed') Bank President Rosengren, a long-standing critic of MMFs, stated 'my personal preference would be not to have prime money market funds.' Ignoring not only the lack of any data supporting assertions that MMFs played a role in the events of March 2020, but also the dramatic reduction in size of the prime MMF universe after the SEC's 2014 amendments to Rule 2a-7, central banks continue to push a false narrative as to the role MMFs have in short-term funding markets and, specifically, the impact MMFs had on the market turmoil experienced in the Spring of 2020, resulting from the COVID-19 pandemic and government reactions to it."
It continues, "While global regulators have acknowledged that the Liquidity Crisis has placed a spotlight on the critical need to reform and enhance the resilience of short-term funding markets, such important market reforms have taken a backseat to the reform of MMFs, which 'reform' paradoxically would harm short-term markets by reducing liquidity and increasing costs to issuers relying on these markets for funding. Improving short-term funding markets, of which MMFs are but a very small participant, and addressing the root causes of the Liquidity Crisis, should be the priority, and any reform to MMFs, without consideration of the impact of changes to the short-term funding market, would be counterproductive."
Federated comments, "In determining not to apply swing pricing to MMFs in 2016, the SEC confirmed that a liquidity fee was the Commission's preferred approach for MMFs. That determination was correct in 2016 and remains correct today. Swing pricing eliminates a key tenet of MMFs; the ability to transact intraday and same day. Swing pricing would also encourage some investors to market time MMFs not only in stressed conditions, but at any regular interval where a MMF would ordinarily expect to have net redemptions (month-end, quarter-end, year-end, tax days, etc.) in excess of the Proposal's 'impact threshold' of 4% of a MMF's total assets that would trigger imposition of swing pricing, which according to the Commission's Notice accompanying the Proposal, occurs on approximately 5% of trading days. This is slightly more often than once per month, hardly a rare event, nor one that would be difficult for market timers to game.... [S]wing pricing would also serve as another 'bright line' for investors and would accelerate redemption requests in times of stress as some investors may look to game the system."
They say, "Certainly a properly calibrated, unencumbered, targeted liquidity fee remains a more appropriate liquidity management tool ('LMT') for MMFs as opposed to swing pricing which will encourage unnecessarily early redemptions, greatly diminish the already dramatically reduced size of the prime MMF market (if not eliminating it entirely), increase the risk of shareholders being treated unfairly (as the Proposal would permit a fund manager to utilize purchase and redemption assumptions in determining whether a swing pricing should be applied) and create new opportunities for market timing. We should not replace one improper bright line trigger with another."
Federated's letter continues, "Replacing one improper bright line trigger with another is exactly what some managers are proposing with respect to a mandatory liquidity fee. Mandatory liquidity fees, which include triggers (either single or double triggers), one of which is a fund's liquidity levels, will lead to increased redemptions, and once again convert usable liquidity into a floor. Moreover, those managers advocating for mandatory liquidity fees are also proposing a fixed liquidity fee or fees. A discretionary liquidity fee, with discretion in both the timing of implementation and amount, will (i) not serve as a trigger for redemptions, (ii) not impair a fund's ability to utilize its liquidity as intended, and (iii) prevent the imposition of a punitive fee. A discretionary model empowers a board, consistent with its fiduciary duty and in the best interest of the fund and the fund's shareholders, to implement, in instances involving material dilution, a liquidity fee which best approximates the cost of obtaining the actual liquidity in specific market circumstances."
It adds, "We very much appreciate that the Proposal has rejected, once again, many of the old, disproven, and discarded reform ideas which were tabled as part of the PWG Report. However, the need for 'more' or a 'package', so to speak, has resulted in a current Proposal which (i) introduces new ways to market time funds and treat investors unfairly, (ii) includes proposals which are neither supported by data nor the Commission's cost benefit analysis, (iii) is based upon a number of incorrect assumptions, (iv) ignores less onerous alternatives which would preserve, not eliminate, the utility of MMFs for investors and issuers, and (v) unjustifiably calls into question the integrity of the U.S. mutual fund governance system."
Federated complains, "The Proposal then goes beyond the events of the Liquidity Crisis and, as a matter of first impression, simultaneously introduces a prohibition on the use of a RDM to address a negative yield environment, putting at risk the four trillion dollars invested in U.S. Government MMFs. Notwithstanding that the interest rate environment continues an upward trajectory, and notwithstanding the repeated statements of the Fed on its intention not to introduce negative interest rates in the U.S., the proposed prohibition on the use of RDM and the requirement for financial intermediaries to confirm that they are capable to transact using a four-digit NAV would effectively kill off U.S. Government MMFs immediately -- even if a negative rate environment is never experienced. The Proposal cites only a concern that investors will not understand how RDM would operate -- ignoring the fact that the U.S. is a disclosure-based regulatory jurisdiction. Concerns regarding shareholder confusion can and should be addressed with the use of clear and concise, plain English disclosure. In a negative rate environment, investors will experience negative returns in their bank accounts or any other liquidity management product. Retaining the availability to invest in U.S. Government MMFs in a negative rate environment is critically important to investors."
They state, "Federated Hermes supports a data-driven approach to regulation which will enhance the safety and resilience of MMFs. Such an approach must include a full analysis of the short-term funding markets, not just MMFs, to ensure that the Proposal addresses the root causes of the Liquidity Crisis. Other than removing the improper linkage, the data simply does not support the Proposal. The underlying assumptions, the introduction of new market timing / arbitrage opportunities, the lack of credible supporting data, the disregard of more appropriate LMTs, and the implication that fund boards will fail to discharge their fiduciary duty are alarming."
Federated writes, "In this letter, we have endeavored to answer the questions set forth by the Commission and we remain eager to discuss any questions or comments which may arise. Ensuring that any final rules adopted (i) are supported by data and a fact-based cost benefit analysis, (ii) properly consider less onerous and equally effective alternatives, and (iii) enhance the safety and resilience of MMFs, is our top priority and a commitment we have made to our stakeholders."
Deep in the body of the letter, they also point out, "We note that while MMFs advised by global systemically important banks ('GSIBs') only represented approximately 28% of prime MMF assets, they were responsible for 56% of net redemptions from prime institutional MMFs, during March and April 2020. At the precise moment when those same GSIBs needed deposits to fund their balance sheet growth to cover record-breaking commercial borrower draw-downs on lines of credit, their institutional cash management clients shifted approximately $56 billion out of prime MMFs, and the GSIBs received the large inflows of deposits they needed. This looks less like an investor run than GSIBs working with their cash management clients to strategically shift accounts to meet the their balance sheet funding needs."
Federated's second comment letter written by Cunningham and Chief Risk Officer Michael Granito, says, "This letter presents the comments of Federated Hermes, Inc. and its subsidiaries with respect to the recent issuance by the Securities and Exchange Commission of a release proposing reforms to Rule 2a-7 that require, among other things, that all non-government and retail money market funds (i.e. institutional prime and tax-exempt money market funds, 'MMFs') use 'swing pricing' in some circumstances.... This letter will focus primarily on swing pricing as proposed. FHI has filed a separate comprehensive comment letter addressing other aspects of the Proposal. Federated Hermes is one of the largest investment management firms in the United States ... including $301 billion in registered money market fund assets and a total of $451 billion in cash management products.... Federated Hermes ... provides comprehensive investment management to more than 8,400 institutions and intermediaries including corporations, government entities, insurance companies, foundations and endowments, banks and broker/dealers."
It tells us, "Federated Hermes has managed money market funds since their inception and remains a leader in the management and distribution of MMFs around the world. With over 45 years of experience in managing MMFs, we have witnessed firsthand their embodiment of the SEC's statutory mandate of capital formation, efficiency and competition. Our prime, tax-exempt and government MMFs have materially improved the yield to shareholders and reduced the borrowing costs for municipal and corporate issuers. Throughout this long history we have steadfastly defended MMFs against unwarranted arguments for bank-like regulation or other amendments that would scuttle prime and tax-exempt funds, while supporting proposals to improve their resilience. We are at the precipice of another ill-conceived rulemaking. In this letter, Federated Hermes will demonstrate that the costs of the proposed swing pricing requirement for institutional prime and tax-exempt funds far outweigh the alleged benefits; and that the adoption of mandatory swing pricing, as proposed, would be arbitrary and capricious."
