The most controversial idea regarding money market funds in the Obama administration’s financial regulatory reform plan has been temporarily put on a back burner by the Securities and Exchange Commission, or SEC.
The SEC has put on the table for public comment a series of proposals that it says should strengthen the rules governing money funds, make them better able to withstand tumultuous economic times and reduce the risk of runs on funds.
But the commission set aside the Treasury Department’s suggestion that money funds eliminate the $1 stable net asset value, or NAV. The commissioners clearly want to hear what the industry and the public think of the idea but are aware that it is extremely controversial and are pushing it to the sidelines for now.
“We think it would kill the product,” says Michael McNamee, spokesman for Washington, D.C.-based ICI, a national association of U.S. investment companies.
“As (ICI president Paul Stevens) said, this has been a core feature of the product since its inception. You put a dollar in, you get a dollar out and interest. If it’s going to be floating up and down, and you don’t know how much money you have on a given day without looking it up, if you have to get into complicated tax reporting because of the losses and gains throughout the year, then this is going to really diminish the appeal of the product.”
The Obama administration wants money fund regulations tightened to prevent a repeat of the September 2008 chaos that ensued when the net asset value of the $62 billion Reserve Primary Fund fell below $1, or “broke the buck.”
The fund had cut its NAV to $0.97 after taking a hit on its Lehman Brothers holdings. Lehman Brothers, a victim of the financial crisis, filed for bankruptcy. Panicked investors withdrew $27 billion from the fund in the course of two days.
McNamee says he thinks there is little enthusiasm for ending the $1 stable NAV and says letting it float won’t help anything.
“The idea of floating the NAV is that if it goes up and down, people get used to it, and it won’t trigger an event like breaking the buck. Well, there are funds that operate that way and they had runs. If you look at ultra-short bonds funds or enhanced yield funds — both very short bond funds — they have the same risk-limiting provisions as money market funds, and they don’t have the stable NAV. They were hit extremely hard by redemption pressure. The French have floating NAV money funds and they were hit extremely hard. There’s no less chance of a run.”
Among the proposed rule amendments that the commission is submitting for public comment:
- Require money market funds to have certain minimum percentages of their assets in cash or securities that can be readily converted to cash to pay redeeming investors.
- Shorten the weighted average maturity, or WAM, limits for money market fund portfolios from 90 days to 60 days.
- Limit money market funds to investing in only the highest quality securities. Eliminate their ability to invest in so-called second-tier securities.
- Require funds to stress test portfolios periodically to determine whether the fund can withstand market turbulence.
Shortening the maturities in money fund portfolios could mean less risk for the fund but smaller returns for the investor.
“I think that for the most part, shortening the weighted average maturity of a money fund would probably result in a slight decline in yields in a portfolio, but I don’t think it would be substantial,” says David Glocke, portfolio manager of taxable money market funds at Vanguard, in Valley Forge, Pa. “If you look at today’s environment, I think shortening the WAM might cost 2 to 3 basis points.”
Glocke says that stress testing is fairly common in portfolios and that it’s a strong plus for money market fund shareholders.
“Historically, a lot of the stress testing was more related to changes in credit environments or, in particular, stress related to changes in interest rates. But I think now we’ve all kind of started to adopt a new type of testing to account for stress in liquidity in portfolios.
“Here at Vanguard, we’ve increased the amount of high quality U.S. Treasury and agency securities in the fund to guard against illiquid conditions in the marketplace in general. That’s something that historically you hadn’t been so focused on and was a real problem over the course of the last two years.”
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