Tuesday, November 13, 2012

FSOC Recommends Money Market Fund Reforms for Public Comment While Urging SEC to Act

The Financial Stability Oversight Council voted unanimously to seek public comment on a set of alternative structural reforms of money market funds. FSOC is proposing three alternative reforms: 1) a floating NAV under which money market funds would be required to use mark-to-market valuation to set share prices, like other mutual funds; 2) a capital buffer of up to one percent combined with a requirement that a small percentage of shareholder funds could be redeemed on a delayed basis; and 3) a capital buffer of 3 percent combined with other measures that together could reduce the size of the requited buffer. FSOC Chair, Treasury Secretary Tim Geithner, recognized that, in addition to these three options, there is a range of proposals by the industry and by academics and FSOC wants to hear comments on those options as well. The comment period is 60 days.

Secretary Geithner said that the basic vulnerabilities and design of money market funds tended to exacerbate the financial crisis of 2008. Currently, regulators do not have a sufficient degree of comfort that regulations are in place to guard against these vulnerabilities. While acknowledging the efficacy of the SEC’s 2010 reform of money market fund regulations, the FSOC Chair said that the 2010 reforms did not go far enough,

FSOC has proposed a set of recommendations, he noted, in order to provide public comment on which the SEC can move forward to further money market fund reform. If at any point the SEC has a majority to go forward, said the Secretary, FSOC would suspend its work and let the SEC go forward. Indeed, FSOC would prefer for the SEC to take this back and move forward.

SEC Chair Mary Schapiro said that she asked FSOC to address the structural weaknesses of money market funds and is very pleased that FSOC is acting to protect investors and the financial system. The FSOC recommendations represent meaningful structural reform options, she noted.

The SEC Chair noted that FSOC is committed, along with the SEC, to take the necessary action and make the tough calls. Of the three proposed recommendations, she said that the floating NAV is the simplest option and the option most consistent with the SEC’s approach to investment products. But, at the same time, she said that the SEC was also open to a stable NAV with added protections against panicked redemptions. In 2008, she said, a broad-based run on prime money market funds panicked investors and reduced short-term funding for municipalities.

Public input will be very important, emphasized the SEC Chair, and the Commission looks forward to it. The SEC is best positioned to implement money market reforms, emphasized Chairman Schapiro, and so it is her understanding that if the  SEC moves forward with meaningful reform, FSOC would not issue a final recommendation to the SEC.

Echoing these comments, Fed Chair Ben Bernanke said that the SEC should make the ultimate regulations on money market reform. He noted that a run on prime money market funds added significantly to the distress of the financial crisis. Extraordinary federal intervention was needed, he said, with powers that are no longer available. The SEC’s 2010 reforms were useful but only as first step, he noted, since they did not address the fixed NAV issue, which maintains the incentive for first movers to propagate a run. Thus, the basic run issue has not been solved and money market funds remain a systemic risk to the financial markets.

CFTC Chair Gary Gensler views FSOC’ s role as advisory and supports the proposal to seek broad public input on the reform alternatives. He said that the key to money market fund reform is finding the appropriate balance. On the one hand, there is a run risk, but on the other is the fear that the proposed alternative reforms may change the product that so many US investors rely upon.  The CFTC Chair has a keen appreciation of the importance of money market funds to municipal governments and to the markets; and he does not want the reforms to diminish money market funds as an investment product.

But first movers exacerbate market forces in bear markets. Chairman Gensler said that the SEC’s 2010 reforms were an important step in enhancing portfolio quality, liquidity and transparency, but that there is still an invective to run first.


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