As the Securities and Exchange Commission (SEC) considers imposing further regulations on money market funds, those close to the $2.6 trillion industry say the revisions are unnecessary, could threaten the very existence of the 40-year-old business and would limit access to a vital source of funding for state and local governments.
On the securitization front, as ASR's Nora Colomer writes in the cover story for the magazine's July edition, these regulations can lead to the exit of money market funds from the ABCP market. These funds comprise at least 30% of the investor base of asset-backed commercial paper.
Under a new proposal, changes would require money markets to convert from a stable $1 net-asset value to a “floating” NAV. Alternatively, another change proposes that funds retain their stable NAVs, but have capital buffers and, possibly, redemption restrictions.
Industry insiders say the changes will put undue stress on money funds — especially on the heels of revisions already imposed in 2010.
Paul Schott Stevens, president and chief executive officer of the Investment Company Institute, called the changes “deeply flawed” and said they would “alter the fundamental characteristics of money market funds, thereby destroying their value to investors and the economy.”
“Money market funds have a decades-long track record as a steady, predictable mainstay of the financial marketplace and a key component of the American economy,” Stevens told ASR sister publication The Bond Buyer last week. “Were funds changed as some at the SEC propose, investor demand would precipitously decline.”
“This would have clear, adverse consequences to many parts of the market,” he added, and would disrupt the short-term municipal bond market because many state and local government entities rely on tax-exempt money market funds for funding.
“We believe the 2010 reforms were highly effective in bolstering the resilience of money market funds, including tax-exempt funds, during times of severe market turmoil such as we saw last summer,” Stevens continued. “Further regulation of the kind under consideration at the SEC is neither necessary nor appropriate.”
The issue will be the topic of a live-streamed presentation on Thursday from 2 to 4 p.m. Eastern Daylight Time. It will be moderated by Peter Wallison, a co-director of the Washington, D.C.-based American Enterprise Institute for Public Policy Research. Stevens is a scheduled participant.
Many market players agree that any new regulation would be damaging.
“We believe that the 2010 reforms have gone a long way in addressing what has been described as perceived risks posed by the money market fund industry,” said Pam Tynan, portfolio manager at Vanguard in Valley Forge, Pa., who manages the firm’s short-term tax-exempt fund.
Those regulations, some of whose final provisions were just implemented in late 2011, tightened holding requirements and liquidity standards. They require that funds conduct periodic stress tests and disclose holdings and their “shadow” NAV — the fund’s actual net “mark to market” NAV — every month, Tynan noted.
In a 15-page report called Money Market Mutual Fund 'Reform’: The Dangers of Acting Now, released last week, James J. Angel, associate finance professor at Georgetown University’s McDonough School of Business, said further reform could transform the industry in ways that would “severely damage municipal finance” and curtail the country’s economic recovery.
Angel said new regulations could shrink or eliminate the money market industry and lead to higher short-term borrowing costs for governments and businesses.
Money market funds continue to be an important tool for investors and for states and local governments across the country that are seeking to finance infrastructure and other projects.
“The regulations being proposed could strangle the municipal fund industry, and ultimately, harm local government’s ability to access short-term capital markets which are necessary to manage cash flow,” said Rick Calhoun, a first vice president at Crews & Associates in Little Rock.
Citing Angel’s paper, Tynan noted that 60% of the outstanding short-term debt of these municipalities is funded through the MMF industry alone.
“The current low interest-rate environment, along with continued support from MMFs, have provided some of the lowest funding costs in history,” Tynan said. “It is likely that municipal borrowers will have to continue to use cost-cutting and revenue-raising measures to address their fiscal problems, regardless of any additional MMF reforms, if implemented. That said, it will just be more difficult and more expensive without the demand from this important buyer base.”
Money market funds were created in the early 1970s as open-ended mutual funds that invested in short-term securities, such as U.S. Treasury bills and commercial paper.
Since 1983, money market funds have been governed by the SEC and regulated by Rule 2a-7 under the Investment Company Act of 1940, which strictly limits the risks these funds can take, according to ICI.
Currently, the funds are required to mainly buy the highest-rated debt that matures in 13 months or less, maintain a weighted average maturity of 60 days or less, avoid investing more than 5% in any one issuer — except for government securities and repurchase agreements — and seek to maintain a stable NAV of $1 per share.
Since their inception, only two funds failed to do so. Following the 2008 financial crisis and the bankruptcy of Lehman Brothers that September, the $60 billion Reserve Primary Fund “broke the buck” when its share price dropped to 99 cents per share and set off a run on other similar funds. The U.S. Treasury temporarily insured MMFs to stem redemptions, but Congress later banned the Treasury from repeating such bailouts.
In January 2010, the SEC changed the regulations governing money market funds to provide for more liquidity and disclosure of the potential risks associated with MMF investments.
Last week, in testimony before the Senate Banking Committee, SEC chairman Mary Schapiro laid out her case for additional regulation of the industry. She noted that governments that invest in such funds should be prepared to absorb losses, or avoid investing in MMFs altogether. She maintains that regulations passed in 2010 aren’t enough to prevent a repeat of 2008.
Federal Reserve officials have also suggested more regulation is needed and have threatened that if the SEC does not take the necessary actions, the Financial Stability Oversight Council may find that some funds threaten the stability of the U.S. financial system. In that case, they can be placed, along with other large financial firms, under Fed supervision and regulation.
But those in the fund industry say enough has been done to properly regulate the sector.
“There may be a small need for modest adjustments to regulations governing municipal money-market funds — especially after the financial meltdown in 2008 — but nothing as radical as what is currently being proposed,” Calhoun said.
It is the notion of a floating NAV under the new proposal that causes the industry the greatest concern.
“We believe that the floating NAV is a non-starter in terms of any potential further reform discussions,” Vanguard’s Tynan said. “Municipal MMFs already hold ample liquidity well above the 2010 liquidity requirements.”
Mike Krasner, managing editor of iMoneyNet Inc., a leading provider of money market information and analysis, is also a proponent of a stable NAV.
“Floating-NAV products, a.k.a bond funds, would cloud the issue without proof that the possibility of runs on fund assets by nervous investors in troubled markets would be averted,” he said. His firm has published the Money Fund Report, which tracks the performance and portfolio composition of more than 16,000 money market funds, since 1975.
“So far, the funds have held up well despite numerous negative media headlines,” Krasner said. “The rules ... seem to be accomplishing what they were intended to do.”
He said investors seek out money funds because of their stable NAVs, liquidity, safety, diversity and professional management.
“If the SEC takes away those features of money market funds that are most valued by investors, many investors may simply move to less regulated, less transparent cash pools, increasing systemic risk,” Stevens agreed.
Calhoun said some municipal professionals view the proposed regulations as an attempt to eventually “eliminate or restrict the very existence of tax-exempt financing.”
“These proposals will have negative consequences on local budgets and spending,” Calhoun said.
“Many state and local governments have been struggling to make ends meet,” Stevens pointed out. “There is little doubt that, if tax-exempt money market funds are taken out of the demand equation, the short-term municipal securities market will contract substantially.”
“We have already seen some fund providers exit the money-fund space, and consolidation will likely continue or accelerate if some ideas become reality,” said Krasner of iMoneyNet. “There will be fewer funds and less money around to fund short-term muni issues.”