Thursday, August 23, 2012

SEC Chair Hints at Delay on New Structural Money Market Mutual Fund Reforms

SEC Chairman Mary L. Schapiro has issued a statement noting that significant money market mutual fund reforms are unlikely in the near term. The basis for the Chairman’s statement was her being informed that three Commissioners would not support a staff proposal for additional reforms. Said Chairman Schapiro, “I…consider the structural reform of money markets one of the pieces of unfinished business from the financial crisis.” The Chairman also observed that the staff proposal would have provided the Commission an opportunity to receive public comments on these reforms.

Chairman Schapiro noted that some commissioners suggested an alternative approach might be to issue a concept release on new money fund reforms. However, the Chairman appeared to reject this approach by suggesting that public comment on a proposal would be more valuable. According to Chairman Schapiro: “A concept release at this point does not advance the discussion. The public needs concrete proposals to react to.”

During the recent financial crisis, Reserve Primary Fund broke the buck (i.e., returned less than $1 NAV) largely due to a bad investment in Lehman Brothers commercial paper. Because of the perceived risk to the domestic economy if other money market funds failed, the Fed and Treasury created multiple facilities to support these funds. The SEC issued an interim temporary final rule to allow money market mutual funds to participate in the Treasury guarantee program (IC-28487). This extraordinary support for money market funds has now ended.

Chairman Schapiro’s statement cited two reasons for seeking new money fund reforms: (1) money market funds have difficulty absorbing losses above a certain size, and (2) money market fund investors tend to withdraw funds quickly in a crisis resulting in runs on these funds. Reforms previously being considered by the SEC included a floating NAV and mark-to-market valuation to remind investors that money market fund investments are not guaranteed. Alternatively, the SEC could require money funds to have a capital buffer that would be augmented by a minimum balance at risk requirement.

The Chairman’s statement also noted that no federal securities laws permit money market mutual funds. Rather, these funds exist due to Investment Company Act Rule 2a-7, which allows money funds to do business in exchange for limits on the types of investments these funds can make. The Chairman further observed that while many sponsors supported their money funds during the recent financial crisis, there is no legal requirement to provide support, nor is there a guarantee that sponsors will be able to provided support when it is most needed. The Chairman noted that Commission staff had logged 300 instances of sponsor support to money funds from the 1980s to the present.

The Commission began the reform process in 2010. Release No. IC-29132, among other things, revised the risk-limiting provisions of Rule 2a-7 and added a rule to allow the suspension of redemptions and to provide for the orderly liquidation of fund assets. Chairman Schapiro’s August 2012 statement observed that the 2010 reforms had been intended as a first step, to be followed by additional reforms.

In March 2011, the Commission proposed to amend Rule 2a-7 by removing references to credit ratings in favor of a new method of determining credit worthiness with resulting modifications of the terms “eligible security” and “first tier security,” and by revising the standards for monitoring securities ratings and for conducting stress tests. The proposing release observed that these amendments are similar to revisions the SEC had proposed in 2008 (Release No. 33-9193).

Additionally, Fed Chairman Ben S. Bernanke, has on several recent occasions noted the need for structural reforms of money market funds. For example, in an April 9, 2012 speech, Chairman Bernanke noted the connections between the still mostly unregulated shadow banking system and money market mutual funds. Chairman Bernanke also observed that additional money fund reforms are needed beyond those adopted by the SEC in 2010. Said Chairman Bernanke, “Additional steps to increase the resiliency of money market funds are important for the overall stability of our financial system and warrant serious consideration.”

Chairman Schapiro issued her statement little more than one week after the Federal Reserve Bank of Boston staff published a report noting that many money market mutual funds would have broken the buck without support from their sponsors during the financial crisis. The report identified 21 prime money market mutual funds that would have broken the buck without a single instance of sponsor support. The report also found 31 prime money funds would have failed without repeated sponsor support.