The Financial Stability Oversight Council issued a significant report, including three major (and non-exclusive) recommendations for material changes in the manner in which money market funds (“MMFs”) operate, all with the intended purpose of forestalling a run on MMFs of a type that may trigger a market crash. FSOC’s summary of the three proposals is as follows:
Alternative One: Floating Net Asset Value. Require MMFs to have a floating net asset value (“NAV”) per share by removing the special exemption that currently allows MMFs to utilize amortized cost accounting and / or penny rounding to maintain a stable NAV. The value of MMFs’ shares would not be fixed at $1.00 and would reflect the actual market value of the underlying portfolio holdings, consistent with the requirements that apply to all other mutual funds.
Alternative Two: Stable NAV with NAV Buffer and “Minimum Balance at Risk.” Require MMFs to have an NAV buffer with a tailored amount of assets of up to 1 percent to absorb day-to-day fluctuations in the value of the funds’ portfolio securities and allow the funds to maintain a stable NAV. The NAV buffer would have an appropriate transition period and could be raised through various methods. The NAV buffer would be paired with a requirement that 3 percent of a shareholder’s highest account value in excess of $100,000 during the previous 30 days – a minimum balance at risk (MBR) – be made available for redemption on a delayed basis. Most redemptions would be unaffected by this requirement, but redemptions of an investor’s MBR itself would be delayed for 30 days. In the event that an MMF suffers losses that exceed its NAV buffer, the losses would be borne first by the MBRs of shareholders who have recently redeemed, creating a disincentive to redeem and providing protection for shareholders who remain in the fund. These requirements would not apply to Treasury MMFs, and the MBR requirement would not apply to investors with account balances below $100,000.
Alternative Three: Stable NAV with NAV Buffer and Other Measures. Require MMFs to have a risk-based NAV buffer of 3 percent to provide explicit loss-absorption capacity that could be combined with other measures to enhance the effectiveness of the buffer and potentially increase the resiliency of MMFs. Other measures could include more stringent investment diversification requirements, increased minimum liquidity levels, and more robust disclosure requirements. The NAV buffer would have an appropriate transition period and could be raised through various methods. To the extent that it can be adequately demonstrated that more stringent investment diversification requirements, alone or in combination with other measures, complement the NAV buffer and further reduce the vulnerabilities of MMFs, the Council could include these measures in its final recommendation and would reduce the size of the NAV buffer required under this alternative accordingly.
In addition to providing the above recommendations, the report provides (i) an overview of the regulations that apply to MMFs, (ii) a summary of the recent changes that have been made to those regulations and (iii) a discussion of the role that MMFs played in triggering the financial crisis.
Lofchie Comment: The issuance of the FSOC recommendations follows disagreement among the SEC Commissioners, that came to a head this summer as to whether the SEC should issue a rule proposal regarding the operation of MMFs. At that time a majority of the SEC Commissioners took the view that more study was needed before rule proposals were issued. The issuance of this report will obviously put significant pressure on the SEC to act with respect to them.
All three of the proposals really work major changes in the operation of MMFs. The first proposal is the simplest: it arguably does away with the notion of a MMF and says that the NAV of a MMF shall rise and fall each day with its underlying assets, just as is the case for every other type of mutual fund. The second alternative exposes large investors in money market funds to limits on their ability to withdraw their assets and in fact provides a disincentive to withdraw money by imposing losses first on those who withdrew their money recently. (One negative reaction that I have to this proposal is that it punishes those investors who are alert to a problem by creating a disincentive to monitor the safety of their investments.) An example of how this proposal would work is on page 42 of the report. The third alternative essentially creates a level of quasi-equity that would be at risk of loss in the event of a run on the MMF. (In some sense, one might think of this making a MMF more like a bank; the ordinary investors in the MMF are more akin to depositors, and there is level of risk absorbtion below the depositors. The level of capital required would be less than is required of a bank, but the allowed investments of the MMF would be more limited than those permitted to a bank.)
It would seem inevitable that there be a major change in the way that MMFs are regulated, given wide acknowledgment of the role that such funds played in the financial crisis. What is odd, and disappointing, is that so much regulatory energy has been diverted to the creation of rules regarding matters that had pretty much nothing to do with the financial crisis. That said, notwithstanding the amount of time that has passed since the financial crisis, I wonder how much “macro” level consideration has been given to the effect of these proposals (for better or worse) on the financial markets. To take two open questions: (i) will these proposals draw money out of MMFs and into banks? (ii) will those proposals draw money out of public MMFs subject to such regulations and into private or non-U.S. MMFs? In any case, the report does ask for comments on many questions.
Anyways, as far as the way the markets work and the economy functions, this report is big stuff.
Link here to the press release announcing the report.
Link here to FSOC’s Proposed Reccomendations Regarding Money Market Funds.
Link here to FSOC’s 2012 Annual Report, which contains extensive discussion of Money Market Funds.