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Advisors Back Liquidity Bank Proposal For Money Market Funds, With Some Caveats

Creation of a private bank to provide a liquidity backstop for money market funds is one of many solutions being bandied about to ensure the integrity of money market funds in a future market crisis. Financial advisors generally support such a solution, saying it would build investor confidence and reassure existing investors. Still, there are some concerns over how the plan would be carried out.

The mutual fund industy is calling for the creation of a private bank to provide a liquidity backstop for money market funds in case of a future market crisis. Such a move is not supported by regulators, who have been pushing other solutions including abolishing the funds' stable $1 net asset value.

Financial advisors like the idea of a backstop solution , however, saying it would build investor confidence and reassure existing investors. Still, there are some concerns among FAs over how the plan would be carried out.

The Investment Company Institute sent a letter to the Securities and Exchange Commission Monday pushing for the liquidity facility as the best solution for propping up money market funds. Under the ICI proposal, fund companies would finance a private bank with $350 million in assets, which would grow to $24 billion after 10 years.

The letter responds to the President’s Working Group on Financial Markets report, filed on Nov. 3, which outlines several options for addressing the problems that lead to the collapse of money market funds in 2008. The comment deadline on that report was Monday. While no advisors or broker/dealers commented during this round, they did comment to the SEC during a previous round of money market fund rule changes last year. At that time, both Wells Fargo and Waddell & Reed supported the creation of a backstop remedy for money market funds.

“I like it as long as there are certain rules attached to it that don’t encourage excessive risk,” said Greg Ghodsi, senior vice president of investments at Raymond James’ 360 Wealth Management Group. “I have never had so many calls about money market funds in my entire career,” Ghodsi said, referring to the period in 2008. “To have people petrified about putting money into a money market, that was scary.”

On Sept. 15, 2008, 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, ICI said. Over the first 11 months of 2010, investors redeemed about $225 billion from money market funds, according to Morningstar.

With the new backstop, financial advisors would be able to tell investors that their investments in money market funds are safe.

“Anything you can do to give investors more confidence is definitely a good thing,” said G. Andrew Ahrens, a partner at Ahrens Investment Partners. The banks are competing as the place to hold assets, and the backstop would encourage investors to keep their assets in money market funds, Ahrens said.

“Any time there’s any semblance of a guarantee, we like it, and so do our clients,” said Jane King, an advisor with Wellesley, Mass.-based Fairfield Financial Advisors. “The word ‘guarantee’ probably rolls off the tongue of advisors recommending the funds.”

But King said the SEC needs to iron out what the quid pro quo is to be a member of the liquidity facility. There needs to be criteria and rules for what the funds can invest in.

Under the ICI’s proposal, those money market funds that invest in high-quality, short-term money market instruments, including commercial paper, would participate in the facility. It would be funded through initial contributions from fund sponsors as well as ongoing member fees, the ICI said. If a member fund is not able to meet investor redemptions, the bank would buy high-quality, short-term securities from the fund to meet redemptions and keep a stable $1 net asset value.

Ahrens believes the managers that take more risk should pay more of a premium to be a member.

Ghodsi also feels there should be provisions for which types of money market funds can be backstopped. A more risky manager shouldn’t be able to offer a 2 percent return and gain a competitive advantage over a more conservative fund manager that offers 1 percent returns.

“As long as they’re all playing in the same sandbox—the safe part of the sand box,” he said.

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