The money market fund industry has come under heightened scrutiny since 2008 amid ongoing concerns that the current stable-NAV model for money market funds exposes funds to potential mass redemptions and poses significant systemic risk. The SEC adopted amendments to Rule 2a-7 under the Investment Company Act of 1940, as amended (“1940 Act”), effective May 2010 to require more conservative investment parameters related to credit quality, maturity and liquidity, as well as enhanced guidelines around risk oversight and transparency to investors. Additional money market reform proposals remain under active consideration by the SEC. It is unclear, however, what form any future regulation will take and whether the SEC will be able to successfully implement the money market proposals under consideration.
Industry commentators, including Andrew “Buddy” Donohue, the former head of the Division of Investment Management for the SEC, have suggested that the SEC may favor adopting a proposal in line with the so-called Squam Lake proposal. The Squam Lake Group, a group of 14 economists, has proposed to require money market funds to create capital buffers equal to between 1 and 3 percent of assets by establishing segregated accounts holding cash or cash equivalents. This plan would involve selling bonds or subordinated shares to a separate group of investors (such as the fund’s investment manager) who would lose money if the fund were to draw upon the capital buffer to cover investment losses. The proposed buffer is intended to lower the risk of destructive runs by significantly lowering the risk that a money market fund could “break the buck.” The Squam Lake Group has suggested that this plan will also better align the incentives of fund managers with the interests of the public in reducing systemic risk.
The SEC is also considering whether to impose a floating NAV on money market funds. Proponents of the floating NAV believe that pricing to market would reduce the incentive to redeem in the event of a loss and thereby lower the risk of a run on the fund. Opponents of the proposal believe that a floating NAV will lead to a significant reduction in the supply of short-term credit, an increase in systemic risks to the financial system because institutional investors will seek investment opportunities in alternative investments that are not similarly regulated, and adverse tax consequences. In her August 26, 2011 response to a recent letter from House Financial Services Committee Chairman Spencer Bachus and Subcommittee Chairman Scott Garrett that questioned the potential negative impact of a floating NAV on the long term viability of the money market mutual fund industry, SEC Chairman Mary Schapiro stated that the SEC continues to actively consider a floating NAV proposal. Chairman Schapiro’s letter can be found here.
Other proposals under consideration include a plan introduced by Fidelity, pursuant to which money market funds would build up a capital buffer over time by withholding a small portion of the income paid to shareholders, and a plan proposed by Paul Volcker, which would require money market funds to reorganize as special-purpose banks and be subject to bank regulatory and capital requirements. Under the Dodd-Frank Act, the Financial Stability Oversight Committee could also designate money market funds to be systemically important financial institutions (“SIFIs”), although this may prove unlikely until there is greater consensus on the appropriate criteria for SIFI designations.
The timing and form of possible new money market fund regulations remain uncertain. Some sources have suggested that the SEC could release a proposed rule for public comment as early as October. However, recent challenges to SEC rulemaking have increased scrutiny on the SEC’s cost-benefit analysis associated with rulemaking. Each of the proposals discussed above is likely to have significant associated costs, challenging the SEC’s ability to successfully implement these proposals absent a thorough cost-benefit analysis.