On November 13, 2012, stating that “[r]eforms to address the structural vulnerabilities of money market mutual funds … are essential to safeguard financial stability”, the Financial Stability Oversight Council (“FSOC”) voted unanimously to propose for public comment possible recommendations for money market fund reform. FSOC’s vote signals a growing impatience with the status quo and in effect rejects reform measures proposed by the money market fund industry such as implementing liquidity fees and/or temporary restrictions on redemptions during times of market stress.
Three months ago, the U.S. Securities and Exchange Commission Chairman Mary Schapiro announced that the SEC was unable to move forward with the staff’s money market fund reform proposal due to a lack of support from a majority of the SEC commissioners.1 Shortly thereafter, U.S. Treasury Secretary Timothy Geithner, who also serves as the Chairman of FSOC, urged FSOC to step in and take up money market fund reform.2 FSOC complied, and it did so quickly. Just 47 days after Secretary Geithner urged FSOC to act, it published for comment three recommendations to reform money market funds pursuant to its authority under Section 120 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).
According to the FSOC release, the proposed recommendations aim to “address the activities and practices of money market funds that make them vulnerable to destabilizing runs: (i) the lack of explicit loss-absorption capacity in the event of a drop in the value of a security held by an money market fund, and (ii) the first-mover advantage that provides an incentive for investors to redeem their shares at the first indication of any perceived threat to a money market fund’s value or liquidity.”3 However, FSOC itself asks whether the recommendations would if implemented in fact achieve the desired results.
Alternative One: Floating Net Asset Value
The first proposed recommendation would require money market funds to have a floating net asset value by removing the special exemption that currently allows money market funds to utilize amortized cost accounting and / or penny rounding to maintain a stable net asset value. Instead of a net asset value (“NAV”) per share fixed at $1.00, the NAV per share of a money market fund would reflect the actual market value of the underlying portfolio holdings, consistent with the requirements that apply to all other mutual funds. FSOC stated that the risk limiting provisions of Rule 2a-7 that govern the credit quality, maturity, liquidity, and diversification of money market funds’ portfolios would continue to apply to money market funds. Under this proposal, FSOC contemplates a phase-out period potentially lasting five years in which existing money market funds could transition from a stable NAV to a floating NAV. FSOC concedes that moving to a floating NAV would be a significant change for the multi-trillion dollar money market fund industry and may cause the industry’s assets under management to contract, thus lessening the availability of credit and potentially harming the economy.
Alternative Two: Stable NAV with NAV Buffer and “Minimum Balance at Risk”
The second proposed recommendation would permit money market funds to maintain a stable NAV but would require a risk-adjusted NAV buffer of up to one percent to absorb day-to-day fluctuations in the value of the funds’ portfolio securities. Cash, Treasury securities and Treasury repos (repurchase agreements collateralized with Treasury securities) would not require any NAV buffer, but other assets would, ranging from 0.75 percent for daily liquid assets (weekly liquid assets, for tax-exempt funds) to 1.00 percent for all other assets. The NAV buffer would be paired with a minimum balance at risk (“MBR”) requirement. The MBR would be equal to three percent of an investor’s highest account value in excess of $100,000 during the previous 30 days. If an investor decided to redeem his or her shares, the redemption proceeds for the MBR would be held back for 30 days. If a money market fund suffered losses that exceed its NAV buffer, the losses would be borne first by the MBRs of shareholders who have recently redeemed. In addition, a money market fund whose NAV buffer fell below the requirement would be required to limit its new investments to cash, Treasury securities, and Treasury repos until its NAV buffer was restored. A money market fund that completely exhausted its NAV buffer would be required either to suspend redemptions and liquidate or to operate as a floating-NAV money market fund indefinitely or until it restored its NAV buffer. These requirements would not apply to Treasury money market funds. The MBR requirement would not apply to investors with account balances below $100,000. The proposed recommendation contemplates several methods by which the NAV buffer could be raised, including from income from the fund itself and from the fund’s sponsor. It also proposes that one-half of the buffer be funded one year after the effective date of the rule, with the balance by the second anniversary of the effective date.
Alternative Three: Stable NAV with NAV Buffer and Other Measures
The final proposed recommendation combines the risk-adjusted NAV buffer described in the second proposed recommendation, but at three percent, with other measures such as more stringent investment diversification requirements, increased minimum liquidity levels, and more robust disclosure requirements. FSOC stated that it may consider decreasing the size of the NAV buffer under this option if it could be adequately demonstrated that more stringent investment diversification requirements, alone or with other measures, reduce the vulnerabilities of money market funds.
FSOC’s proposed recommendations, for the most part, are concepts familiar to the money market fund industry and its primary regulator, the SEC. The first two proposed recommendations, for example, track the proposals that were being considered by the SEC in August. FSOC stated that these proposed recommendations could be implemented on their own or in combination. FSOC also noted that other reform measures may be chosen instead.
Comments on the proposed recommendations are due 60 days after publication in the Federal Register. If FSOC issues final recommendations thereafter, the SEC is required, under the Dodd-Frank Act, either to implement the recommendations through its own rulemaking or, within 90 days, inform FSOC the reasons for not doing so. Recognizing that the SEC is best positioned to implement the money market fund reform, FSOC said that it would not issue final recommendations to the SEC if the SEC moves forward with “meaningful structural reform”4 in the interim. On the other hand, FSOC warned that its members are actively evaluating alternative authorities, including the option of designating the funds or their sponsors as "systemically important financial institutions" and subjecting them to enhanced prudential standards and supervision by the Federal Reserve, in the event that the SEC chooses not to impose the recommended measures in any final recommendation.
FSOC’s proposed recommendations are not the latest words on the topic of money market fund reform. Pressure for reform continues to build as regulators from around the world zero in on money market funds. Five days after FSOC published its proposed recommendations, the Financial Stability Board issued a report on global shadow banking in which it identified money market funds’ susceptibility to runs as a systemic risk.5 In particular, the Financial Stability Board endorsed the policy recommendation issued by the International Organization of Securities Commissions to move money market funds from a stable NAV to a floating NAV.
The pressure on money market funds and the money market fund industry is clearly mounting, and some kind of further regulatory action appears increasingly likely. Whether that action will effectively address the issues faced in 2008 is uncertain. Likewise, it remains to be seen whether regulatory action will make money market funds less attractive to investors, and thus cause the industry to shrink, with potentially negative economic repercussions. Nonetheless, the concern by global financial regulators about shadow banking helps to explain FSOC’s insistence on quick action, even in the face of uncertainty as to its effects.
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1 Chairman Schapiro’s statement is available at http://www.sec.gov/news/press/2012/2012-166.htm.
2 Secretary Geithner’s letter to the members of FSOC is available at http://www.treasury.gov/connect/blog/Documents/Sec.Geithner.Letter.To.FSOC.pdf.
3 FSOC’s Proposed Recommendations Regarding Money Market Mutual Fund Reform is available at http://www.treasury.gov/initiatives/fsoc/rulemaking/Pages/open-notices.aspx.
4 See page 15 of FSOC’s Proposed Recommendations Regarding Money Market Mutual Fund Reform.
5 The Financial Stability Board is a Basel-based group formed by G20 countries to coordinate the work of international regulatory authorities. Its report on global shadow banking is available at http://www.financialstabilityboard.org/publications/r_121118.pdf.