SEC Seeks ‘Structural Reform’ of Money Funds
The U.S. Securities and Exchange Commission will soon propose revamping rules for money-market mutual funds, pushing the options of a floating net asset value and capital buffers, SEC Chairman Mary Schapiro said today.
“Money-market funds, while perhaps not the cause of the downward spiral of events, certainly exacerbated the financial breakdown,” Schapiro said in remarks prepared for a Securities Industry and Financial Markets Association conference in New York. The SEC is pursuing “further structural reform” in the $2.6 trillion industry, she said.
Regulators have been working to make U.S. money funds safer and more stable since the Sept. 16, 2008, collapse of the $62.5 billion Reserve Primary Fund. Spooked by the fund’s closure, investors withdrew about $310 billion from prime money funds that week, helping to freeze global credit markets. The Treasury and Federal Reserve stepped in with guarantees and other steps to stop the run.
“Our country should never again be in the position of having to choose between providing support to private market participants, including money-market funds, or risking a breakdown of the broader financial system,” Schapiro said.
Schapiro’s remarks served to narrow the options for reform from a longer list laid out by the President’s Working Group on Financial Markets, an advisory body to the Barack Obama Administration, in October 2010. Potential reforms now shelved include requiring an industry-financed liquidity backstop, regulating funds as special purpose banks and creating an insurance system for the funds.
The remaining options include the idea of forcing funds to adopt a floating share price, a concept industry leaders have said will destroy the attraction of money funds.
“Any reforms must preserve the utility of money-market funds for investors and avoid imposing costs that would make large numbers of advisers unwilling or unable to continue to sponsor these funds,” Paul Schott Stevens, president of the Investment Company Institute in Washington, said in an e-mailed statement after Schapiro’s speech.
Moving to a floating share price would require “dramatic” industry changes and pose a challenge to policy makers in managing the transition, Schapiro said.
Funds maintain a steady $1 level by recording holdings at their expected value at maturity and by rounding to the nearest 1 cent per share, at least once a day. That means a fund can ignore small fluctuations in the market price of holdings and suffer a loss of less than half a cent without “breaking the buck,” or falling below $1 a share.
Critics of the stable price, including former Fed Chairman Paul Volcker, have said this makes the funds more vulnerable to a run because small losses grow as a proportion of a fund’s assets when investors withdraw, giving holders an incentive to redeem their shares before others.
Schapiro today described the $1 share price as “brittle.”
The SEC’s staff has also been examining at least two capital buffer plans. The proposals would require individual funds to create cushions for absorbing potential losses on investments. One plan outlined by university economists known as the Squam Lake Group would require that funds raise cash equal to 1 percent to 3 percent of assets by selling subordinated shares.
A separate plan floated by Boston-based Fidelity Investments in May would build buffers gradually over a number of years by withholding returns. Schapiro didn’t comment on specific buffer proposals.
At a time of crisis, a capital buffer “could mitigate the incentive for investors to run since there would be dedicated resources to address any losses,” she said.
The SEC enacted several rule changes for money funds in 2010. These created minimum liquidity levels for the first time, reduced the maximum allowed average maturity for fund holdings and introduced new disclosure requirements.
“The SEC’s new money-market fund reforms were a critical first step,” Schapiro said.
The need for additional steps to “bolster the resiliency” of the funds is “pretty unanimous among all the federal financial regulators,” Schapiro said after her speech in an interview with television host Charlie Rose at the conference.
The SEC will make proposals “in very short order,” Schapiro said in her speech, without giving a date. Any proposal would be followed by a public comment period.
The Reserve Primary Fund ultimately lost about 2 percent of its assets on investments in debt issued by Lehman Brothers Holdings Inc. prior to that company’s bankruptcy. Reserve Primary’s closure denied shareholders access to their money for months after it became only the second money-market mutual fund to break the buck.
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