The SEC has requested comment on the various money market fund reform options discussed in the recently issued report by the President’s Working Group on Financial Markets (PWG). The PWG prepared a report analyzing various reform options to address systemic risk and reduce the susceptibility of money market fund runs in response to the Treasury Department’s proposal in its publication, Financial Regulatory Reform: A New Foundation. The SEC requests comments on or before January 10, 2011.
The SEC adopted new rules in February 2010 to provide better protection for money market fund investors during times of market stresses. At that time, the SEC also raised questions as to whether further, more fundamental changes were necessary to the current regulatory structure of money market funds. In its recent report, the PWG expressed support for the new SEC rules, but stated that the new rules were not sufficient to address the systemic risk posed by potential runs on money market funds. The PWG report discusses a number of possible further reforms, and requests that these options be examined by the newly established Financial Stability Oversight Council with assistance by the SEC, including through the recent SEC request for comment. Following the comment period, there will be a series of meetings with stakeholders, regulators, experts and other interested persons.
Money Market Fund Reform Options
The SEC requests comment on the following options discussed in the PWG report, which either individually or in combination might mitigate systemic risk with respect to money market funds:
- Moving to floating net asset value rather than the current stable net asset value.
- Establishing private emergency liquidity facilities for money market funds if funds need extra liquidity to meet redemptions.
- Requiring mandatory redemptions in-kind for large investors.
- Establishing some type of insurance for money market funds whether private, public or a combination thereof.
- Creating a two-tiered system of money market funds – one with a floating net asset value and the other with a stable net asset value. Only the stable net value funds would have enhanced protections.
- Creating a two-tiered system of money market funds – one with a floating net asset value and the other with a stable net value. The stable net asset value money market funds would be reserved for retail investors.
- Regulating stable net asset value money market funds as special purpose banks, thereby giving money market funds access to government insurance.
- Tightening constraints on unregulated, privately offered money market fund substitutes, such as offshore money market funds, enhanced cash funds and other stable value funds.
Some of these options could be adopted by the SEC under its existing authority, such as moving to a floating net asset value or some type of two-tiered structure. Other options, such as regulating money market funds as special purpose vehicles or tightening constraints on unregulated money market fund substitutes, would require legislation and action by multiple government agencies and the money market fund industry. Still other options may require the creation of new private entities, such as those involving liquidity facilities or private insurance.
Although the PWG report argues that each of the identified options can mitigate systemic risks associated with money market funds, it acknowledges that each option has its disadvantages, including policy and operational challenges, as well as potential unintended consequences. For example, the PWG report notes that a private liquidity facility (the Investment Company Institute is known to have been working on a private liquidity facility proposal over the past year) could distort incentives to investment advisers and cause them to invest funds in riskier assets because of the perceived protection provided by the liquidity facility. This option also presents capacity, pricing and other operational issues. The same sort of distortion of incentives for investment advisers also exists with the government insurance and special purpose bank options. Also, large capital infusions would be necessary to capitalize special purpose banks, making this option very disruptive and expensive for the money market industry. These options seem much less likely at the current time to be adopted, because the federal government has signaled to the industry and Congress that it does not want to provide further financial support to money market funds
Of the remaining options, any of the floating rate net asset value options could disrupt the availability of short-term financing available to the markets and cause assets to shift to less regulated or unregulated money market type substitutes. The shifting of assets may also cause net asset values in floating rate funds to be more volatile. The two-tiered options could cause investor confusion and pose difficulties in ensuring that investors are appropriately directed to funds in which they are qualified to invest, in addition to other operational problems. Any of the floating rate net asset value options certainly would be among the most disruptive and costly to the money market fund industry of the remaining options mentioned in the PWG report. Requiring mandatory redemptions could present potential cherry-picking and investor fairness issues and other operational issues for investment advisers. There is also no certainty that mandating redemptions in kind will be effective in avoiding runs on money market funds.
The SEC requests that comments specifically address the effectiveness of the options in mitigating systemic risks associated with money market funds. The SEC is also interested in hearing about the options’ potential impact on money market fund investors, fund managers, issuers of short-term debt and other stakeholders. Commenters may also address other concerns relevant to money market reform, including approaches for lessening systemic risk not identified in the PWG Report. The SEC urges submittals of empirical data and other information in support of their comments.
The SEC request for comment, which includes a copy of the PWG Report, can be found at http://www.sec.gov/rules/other/2010/ic-29497.pdf.