Regulators and industry participants continue to battle over what kinds of reforms should be made to money market funds. Tuesday, the Securities and Exchange Commission held a roundtable on money market funds and systemic risk in which several panelists talked about the merits of various proposals aimed at preventing money market funds from breaking the buck in the future, as they did in late 2008.
On Sept. 15 of that year, The Reserve Primary Fund, a $62 billion money market fund, broke the buck when its $785 million position in Lehman Brothers debt went to $0. From Sept. 10 to Oct. 1 of 2008, investors redeemed $396 billion from prime money market funds, according to the Investment Company Institute.
“I think everyone agrees that 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,” said SEC Chairman Mary Schapiro, in her opening remarks.
One of the reform proposals on the table is a floating NAV for money market funds, a proposal that has drawn a lot of criticism from the mutual fund industry.
Paul Tucker, deputy governor of financial stability for the Bank of England, voiced support for this option. We’re in an environment where people want safety, security, liquidity and return, but “it is impossible to deliver that.”
If the industry went to a floating NAV, the psychology of the investor base would change, as they’d no longer think of money funds as completely safe, but this is something they could easily get used to, Tucker said.
But retail investors are in these products for the stable NAV, and that’s the way the instruments are marketed, said David Certner, legislative counsel and director of legislative policy for government relations and advocacy for the AARP. It would take a while for advisors to explain the change and for investors to understand that they’re now not guaranteed.
Travis Barker, chair of the Institutional Money Market Funds Association, said that changing the pricing structure would not address the key issue of money market funds—the risk of a run. Hawke echoed the concerns surrounding liquidity, saying that with the floating NAV scenario, investors would still run for the doors at the first sign of the NAV declining.
Another option, which has been proposed by the ICI, is the creation of a private bank to provide a liquidity backstop for money market funds in case of a future market crisis. It would be structured as a commercial bank, which would build up capital over time. It would have access to the discount window and use commercial paper as collateral, said Brian Reid, chief economist of the ICI. Advisors seem to back this proposal, with some caveats.
But Tucker said the option poses some big questions surrounding who should have direct access to the Federal Reserve’s discount window. “If money market funds are doing this, what’s to stop other parts of our economy from doing this?” he asked.
Reid responded by saying that the intent is not to give special treatment to the money fund industry; the effort is intended as a way to bring the industry together and commit the capital needed should a liquidity problem come about. “This is fundamentally one of a market problem, not an industry problem,” he said. “This is a problem of liquidity that transcends the industry.”
According to Reid, the Federal Reserve would not regulate the money fund industry, just the particular bank that has access to the discount window. He tried to quell concerns by reiterating that the Federal Reserve would only be needed if the industry were to see a similar liquidity situation to 2008, a rare occurrence. “At the end of the day, liquidity support to the markets have been a last ditch effort.”
But FDIC Chairman Sheila Bair said a better approach would be to try to eliminate systemic risk, rather than institutionalize it, like the government did with the bailouts.
Robert Brown of Fidelity also said it’s not a credit issue, but one of liquidity. Fidelity supports a NAV buffer, which would be funded over time by withholding a small portion of the income paid to shareholders. For example, Brown said Fidelity’s largest institutional fund currently holds 62 percent of 30-day liquidity. He said an appropriate level for funds would be 50 percent of 30-day liquidity.
The final proposal discussed during the panel was similar to the buffer option, but the buffer would come from third parties or the sponsors of the fund, said Rene Stulz, Everett D. Reese chair of banking and monetary economics at The Ohio State University. It would be replenished quickly; the fixed NAV would be converted to a floating NAV if the buffer was depleted, and it would be securitized.