For Money Market Fund Reforms, the Answer Is Clear | Commentary
Before the August recess, the House Oversight and Government Reform Committee sent U.S. financial regulators questions regarding the influence of the Financial Stability Oversight Council on the Securities and Exchange Commission’s recent rule-making proposals on money market funds. The committee acted after the SEC released a 700-page document proposing amendments to the rules governing money market funds. We believe that aspects of the SEC’s proposal, which will affect 56 million Americans, are a response to pressure from the FSOC.
Specifically, Alternative One, a floating net asset value for prime money market funds, was among the three options the FSOC had earlier offered to the SEC. This concept could destroy money market funds, which for more than 40 years have been used by individuals, businesses, state/local governments and nonprofits for cash management and funding.
Alternative Two, which comes from the SEC itself, gives a fund’s board the option to impose redemption gates and/or fees to ensure that shareholders are protected in the event of a crisis. The SEC proposal provides these two alternatives for consideration and public comment. Now, as Congress looks to further hearings on money-market-fund regulation and the choice between the FSOC-driven Alternative One and the SEC’s Alternative Two, there are five key questions that I believe need to be asked.
Question 1: Which alternative preserves money market funds? This is the objective of the SEC, but the differences between the two are stark. A floating NAV:
1. will preclude the use of money market funds by many companies and public entities due to state regulations and investment policies.
2. will create unnecessary and unmanageable tax, accounting and administrative issues with significant costs.
3. may impact daily liquidity.
4. will cause a large portion of shareholders to exit the product.
In fact, the Senate Appropriations Committee in July stated its concerns that a floating NAV will change the nature of money market funds, tighten capital availability and increase costs.
Gating, on the other hand, maintains stable value and daily liquidity in all but the most extreme market conditions; creates no tax, accounting or administrative issues; and meets investor/issuer needs.
Question 2: Which alternative prevents runs? A floating NAV does not stop runs as shareholders will still exit a fund given credit concerns or fear of losses. Gating, however, provides the ability to employ a temporary suspension of redemptions during times of extreme stress at the discretion of the fund board, staunching the potential for a run and protecting all investors.
Question 3: Which alternative can be implemented cost effectively? A floating NAV will impose costly changes to accounting, tax, trading and settlement processes and systems. Gating will require more manageable operational changes because in the very rare instances of extreme market stress, it simply halts redemptions for a short period and will not reduce investor returns or increase borrowing costs.
Question 4: Which alternative promotes competition, capital formation and efficiency? This is integral to the SEC’s purview and particularly important in a fragile and slowly recovering economy. A floating NAV will increase borrowing costs and decrease issuers’ access to markets; channel money to large banks and less regulated vehicles; and ultimately drive providers of money market funds out of business. Gating will not disrupt the commercial paper and municipal borrowing markets and will maintain competition for cash management/funding services.
Question 5: Which alternative promotes investor protection? This is a cornerstone of the SEC’s responsibilities and here also the differences are clear. A floating NAV harms investors by eliminating a proven and popular cash management solution, adding to investor costs without reducing risk and creating uncertainty regarding redemption values. Gating directly mitigates the risk of runs and “first-mover advantage” and protects stability, daily liquidity and yield for shareholders.
The SEC has done an excellent job regulating the funds, and it is a big reason 56 million American investors, businesses, state/local governments and nonprofits depend on them every day. Gating is the only answer that meets the goals of the SEC and serves the interests of all users. It is a sensible and workable addition to the already robust rules that have governed money funds well for decades and the 2010 amendments, which further improved credit quality, maturity, liquidity and the transparency of funds.
More importantly, it is the only alternative that preserves money market funds and keeps them working for the American economy. And I hope Congress will make this clear to the SEC.
J. Christopher Donahue is president and CEO of Federated Investors Inc.