Tags: SEC | money funds | proposal | NAV

SEC Issues New Money Funds Regulations for Comment

By    |   Wednesday, 05 Jun 2013 02:59 PM

The Securities and Exchange Commission (SEC) met Wednesday and voted unanimously to propose for comment its long-awaited proposed rule to reduce the systemic risk that could be posed by runs on money market mutual funds (MMMFs) such as the one that occurred at the Reserve Fund in the fall of 2008.

By taking this action, the SEC seeks to respond to the demand from the Financial Stability Oversight Council (FSOC) that it act to reduce the risk MMMFs pose to the financial system.

The FSOC has threatened to take action on its own if the SEC fails to act, but it accepted the assertion by the SEC that it had the necessary expertise to act, and the FSOC has essentially been saying, right, so do it. Last year, a stalemate developed between then-Chairman Mary Schapiro and several commissioners, and current Chairman Mary Jo White is seeking to demonstrate, and Congress is clearly expecting, that she can break the stalemate and move the SEC forward toward completion of the regulatory agenda mandated by the Dodd-Frank and Jumpstart Our Business Startups (JOBS) Acts.

This article will describe the proposal, discuss the positions of the commissioners and conclude by mentioning some important issues that will continue to lurk in the background.

Description of the Proposal

At this early point, the most useful description of the proposal is contained in the opening remarks of White. She explained that under an SEC exemption, money funds have been allowed to maintain a floating net asset value (NAV) of $1 instead of changing the value as the valuations of the underlying securities change.

She went on to review the circumstances of the 2008 run on the Reserve Fund, the response by the Commission by a series of reforms in 2010. Critics and the FSOC have charged that these reforms were inadequate; White described them in her statement as a "first step."

This complex proposal consists of two components. First, it would require that NAVs of prime institutional funds float, while stable NAVs would remain for retail funds that invest in government securities, rather than the higher-yielding commercial paper that makes up the portfolios of institutional investors. The Commission touts this idea as a way of distinguishing between the two major classes of investors so as to preserve the value of these products for the target audiences.

Second, the proposal would allow fund management companies to impose fees and gates as means of managing redemptions to discourage first movers from pulling funds out at the first sign of trouble in order to get out before the buck breaks, thus imposing costs on slower redeemers and helping to fuel a run. Non-government funds would be required to act by imposing a 2 percent liquidity fee if the fund's weekly liquid assets fall below 15 percent of total assets unless the board determined that this step would not be in the best interest of the fund, subject to the board's fiduciary duty to investors. (N.B.: I hope the proposal commenters will talk about how this would likely work out. On the surface, it appears to be a boon to the capable lawyers who serve the industry.)

After taking this step, the board would also be empowered to erect a gate against redemptions for 30 days, which the SEC hopes would enable the fund to rebuild its reserves and would remove the incentive for potential first movers to run.

As I was following the meeting, it seemed obvious that the two features should be combined, but they are being offered as alternatives or as a combination, and the reasons for this become evident when one considers the respective positions expressed by the commissioners.

In addition, the proposal provides some significant reforms — tightening diversification requirements, enhancing disclosure requirements regarding risk and risk management and strengthening stress testing. It would also improve reporting on unregistered private funds that could become alternatives that could vitiate the utility of the reforms. (It will be interesting to see how commenters will assess the adequacy of these reforms.)

Positions of the Commissioners

The remarks of the individual commissioners were more useful and more revealing of their thinking than usual. Among the most senior commissioners, White said little about her position except that she believes the proposal implements effective reforms and decreases the risk of a repetition of the 2008 events.

It would appear that she has a tremendous stake in producing a final rule and would be likely to support any rule that can achieve a majority. Since she sets the agenda for the SEC, no rule she does not support would be brought before the Commission.

Commissioner Elisse Walter stated that her preference would be to combine the two options into one proposal. She also called for comment on the effect of the proposed exemption of retail funds from the floating NAV mandate, because not all retail funds would qualify for the exemption.

It is useful to discuss the three other commissioners as a group, for at least two reasons.

First, as a group they called for a staff study, delivered last November, that provided economic analyses that were essential in informing this proposal and breaking the stalemate. Second, the fact that they do not agree as to the relative utility of the two options in the proposal is the reason they are presented for consideration separately or together.

Commissioner Luis Aguilar stated that the 2010 reforms would not be adequate, thus disposing of this argument, which heretofore has formed the basis of much industry opposition. He stated clearly that the three commissioners who requested the staff report insist that the rule be based on data and analysis, rather than "unexamined and questionable propositions." He further stressed the need to consider how retail investors might behave and the need to subject unregistered funds to regulations that would prevent their use as a means of escaping this regime and contributing to systemic risk.

Finally, he called for a balance between reducing systemic risk and preserving the utility of the funds for investors. He did not express a preference for adopting either of the options separately or combining them.

Commissioner Troy Paredes squarely raised the question, what are we solving for, and can the proposed solution be implemented at an acceptable cost. He found that the floating NAV would be expensive to administer and would not remove the incentive for first movers to redeem, so he dismissed this option. This is why the options are being offered both separately and together. It is Paredes who is the leading proponent of using fees and gates to deter and halt runs and to convey to investors the message that money funds should not be considered risk-free.

Commissioner Daniel Gallagher's remarks were especially useful for his rendition of the circumstances that led to the stalemate. Gallagher was also the only commissioner to address the elephant in the auditorium, which is the controversy over whether money funds should be required to hold capital. Gallagher dismissed this idea as one that would have required either so much capital as to destroy the utility of the product or so little as to offer merely a false sense of security.

He concluded by expressing hope that this proposal will enable the SEC to move on to other issues, such as finally removing reference to credit ratings from its regulations.


There was no discussion of the proclivity of money funds to concentrate their investments in securities of "too big to fail" banks, thus combining the systemic risk posed by risky megabanks with that of the money funds themselves.

Perhaps rather than dismissing the capital option, it would have been better to have allowed the funds to compete on this basis, with the help of analysis by specialized money fund raters.

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The Securities and Exchange Commission (SEC) met Wednesday and voted unanimously to propose for comment its long-awaited proposed rule to reduce the systemic risk that could be posed by runs on money market mutual funds (MMMFs) such as the one that occurred at the Reserve Fund in the fall of 2008.
SEC,money funds,proposal,NAV
Wednesday, 05 Jun 2013 02:59 PM
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