UK: PWG Issues Report on Money Market Fund Reform Options

The President's Working Group on Financial Markets ("PWG") on October 21, 2010 released its long-awaited report on "Money Market Fund Reform Options" (the "Report").1 The Report states that the large scale redemptions of MMF shares in September 2008 underscored the vulnerability of the financial system to systemic risk because the cash needs of MMFs seeking to meet redemptions exacerbated strains in short-term funding markets, which in turn threatened the broader economy. The Report acknowledges that the SEC's adoption of amendments to the regulatory structure governing MMFs earlier this year was an important "first-step" in making MMFs more resilient and less risky.2 However, the Report recommends that more be done to address systemic risks and the structural vulnerabilities of MMFs to "runs." To that end, the Report presents the following possible reform options for consideration by the Financial Stability Oversight Council ("FSOC") that was recently established by the Dodd-Frank Wall Street Reform and Consumer Protection Act:3

  • floating net asset values;
  • privately sponsored emergency liquidity vehicles;
  • mandatory redemptions in-kind;
  • insurance for MMFs;
  • a two-tier system providing enhanced protections for stable net asset value ("NAV") MMFs;
  • a two-tier system reserving stable NAV MMFs solely for retail investors;
  • regulating stable NAV MMFs as special purpose banks; and
  • enhancing constraints on unregulated MMF substitutes.

Although the Report discusses various reform options for the FSOC to consider, it does not recommend any particular reform. Many had expected the Report to propose that MMFs adopt floating NAVs—a proposal strongly resisted by the mutual fund industry and issuers of short-term debt, among others.4 Not only does the Report acknowledge several concerns with the floating NAV option, but the Report also speaks favorably about an industry-supported plan to provide MMFs with access to a privately sponsored emergency liquidity vehicle.

Floating Net Asset Values

The Report suggests that requiring MMFs to adopt floating NAVs could lessen investor perception that MMFs are "risk-free" vehicles (since experiencing losses would become more routine), thereby reducing the likelihood of runs in the event of a loss. The Report also states that, because share prices for redemption requests in a floating NAV fund would be established after the requests are received, losses to the fund would be realized by all shareholders, rather than only by those who remain in the fund. The Report states that this sharing of losses could reduce incentives to redeem shares when the risk of capital loss is rumored.

The Report acknowledges that eliminating the ability of MMFs to maintain a stable NAV would be "a dramatic change for a nearly $3 trillion asset-management sector that has been built around the stable $1 share price." The Report addresses the perceived disadvantages of a floating NAV requirement at some length. For example, the Report states that requiring floating NAVs could reduce demand for MMFs or cause investors to shift their assets to other investment vehicles, such as offshore MMFs or enhanced cash funds. The Report observes that because MMFs are significant providers of credit, such a reduction in assets could cause an abrupt and significant tightening of short-term debt markets. Moreover, since MMF substitutes are both subject to less regulation and just as susceptible to runs, the Report points out that imposing a floating NAV requirement may merely transfer the systemic risk to different and less transparent investment vehicles.

The Report also highlights problems and risks with the implementation of any floating NAV requirement. For example, MMF investors could preemptively redeem shares prior to the implementation of a floating NAV requirement to avoid potential losses. Additionally, the Report notes that because funds will no longer be able to use amortized cost to maintain a stable NAV, the benefits perceived by investment advisers of complying with Rule 2a-7 under the Investment Company Act of 1940 (as amended, "ICA") may be lost or become vague, causing risk management practices, as required by Rule 2a-7, to possibly deteriorate.5

Private Emergency Liquidity Vehicles

In 2008, when MMFs were experiencing heavy capital outflows, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (as created by the Federal Reserve Board, "AMLF") helped funds to meet redemptions by extending credit to banks and bank holding companies to finance their purchases of asset-backed commercial paper from MMFs. Noting the success of this program, the Report states that a liquidity protection system is necessary to strengthen MMFs against the risk of similar crises in the future. The Report notes further that a private liquidity vehicle, as opposed to a publicly-supported system like the AMLF, could have several benefits, including:

  • increased ability of MMFs to withstand large redemptions without selling illiquid securities at a discount;
  • efficiency gains experienced through risk pooling;
  • increased flexibility in managing liquidity risks; and
  • internalization of the costs of liquidity protection.

Members of the mutual fund industry generally support the creation of a private liquidity system.6 However, the Report stresses that implementing such a system will be challenging and must be considered carefully in order not to distort incentives and favor certain market participants over others. The Report raises the following concerns:

  • whether voluntary participation in a liquidity facility would be more effective than mandatory participation;
  • whether the liquidity system has the capacity to functionally meet MMFs' needs in times of crisis;
  • whether there is a potential for conflicts of interest when liquidity is in short supply; and
  • how to curtail the "moral hazard" problem as advisers feel less pressure to personally maintain liquidity in their funds.

Mandatory Redemptions in Kind

The Report observes that large redemptions by one investor of a MMF tend to force other investors in the fund to bear the liquidity costs when the fund is forced to sell assets at an inopportune time. The Report states that requiring payments on redemptions to be paid in kind under such circumstances would shift liquidity costs to the redeeming investor. However, the Report observes that implementing an in-kind redemption program could be operationally problematic. For example, the Report notes that institutional investors may circumvent the program by structuring investments to "hover" below the in-kind limitations, and that providing a redeeming investor with a pro rata share of securities may not be possible if the fund's portfolio securities are not freely transferable.

Insurance for MMFs

The Report states that the success of the Treasury's Temporary Guarantee Program for Money Market Mutual Funds7 illustrates that insurance for shareholders can be useful in mitigating the risk of large capital outflows.8 The Report suggests that the implementation of an insurance program could help mitigate systemic risk, although it notes that the following issues could arise depending on the specific design of the insurance program:

  • Public, Private, or Hybrid Form of Insurance. Private insurers have historically encountered problems pricing financial events, and public insurance would require additional government oversight and administration.
  • Voluntary or Mandatory Participation. Although mandatory insurance would increase investor confidence, it would necessitate additional government intervention and administration.
  • Increased Moral Hazard Risks. The incentives for fund advisers to manage risk will shift to the insurers.
  • Pricing Challenges. If insurers do not accurately price securities relative to the risks associated with a MMF portfolio, moral hazard could increase. Also, under-priced insurance could lead to disturbing outflows from bank deposits, while over-priced insurance could reduce the relative investment appeal of MMFs.

Two-Tier Systems for MMFs

Two-Tier System with Enhanced Protections for Stable NAV MMFs

The Report suggests that, rather than requiring all MMFs to use a floating NAV, a two-tier regulatory program that allows both stable NAV funds and floating NAV funds might accommodate more investors with varying risk appetites, while still addressing systemic risk concerns. Under such a program, stable NAV MMFs would be subject to enhanced protections, such as insurance or private liquidity, while floating NAV funds would be subject to less stringent restrictions and would be allowed to bear greater credit and liquidity risks.

The Report states that, in contrast to other options, a two-tier system would mitigate the risk that MMF investors will shift investments to MMF substitutes, while gaining some of the benefits associated with a floating NAV system. The Report notes further that during times of crisis, investors may shift assets from floating NAV MMFs to stable value MMFs, which would be less disruptive to the credit markets. However, the Report states that a two-tier system contemplates investors who are sophisticated enough to understand the different risk profiles of the two tiers, and that if this assumption is incorrect, investors may still exit funds during a crisis, possibly impacting credit markets.

Two-Tier System with Stable NAV MMFs Reserved for Retail Investors

The Report suggests that another approach to mitigating risk would be to restrict investments in each type of MMF according to investor type—retail or institutional. The Report indicates that, because of their stake in the market and ability to monitor market conditions, institutional investors create greater risk of runs than do retail investors. As such, a two-tier system based on investor type could serve to protect retail funds and their customers from the effects of runs instigated by redemptions by institutional investors. The Report notes, however, that such a system would require a working definition of "institutional investor," and suggests that any regulatory structure would have to address the risk that investors will circumvent the threshold established to distinguish between retail and institutional investors.

The Report acknowledges that prohibiting institutional investments in stable NAV funds may have unintended consequences, such as providing a catalyst for investors to shift assets to MMF substitutes offshore or for institutional investors to shift assets to other investment vehicles, possibly disrupting short-term funding.

Regulating Stable NAV MMFs as Special Purpose Banks

Noting that MMFs and bank deposits are both subject to the risk of runs and are ostensibly conservative investments, the Report suggests that requiring stable NAV MMFs to reorganize as Special Purpose Banks ("SPBs") could be advantageous. The Report explains that, if stable value NAV MMFs were designated as SPBs, such vehicles would be subject to banking oversight and regulation, such as reserve requirements, capital buffers, liquidity backstops, and insurance coverage.

However, the Report states that, although transforming stable value MMFs into SPBs is conceptually simple, there are several practical barriers and hurdles that add complexity to this reform option. The Report acknowledges that this option would require vast regulatory and legislative changes—not merely interagency coordination— and that significant considerations would include:

  • whether MMFs, which are not typically capital intensive, would be able to raise substantial equity to meet SPB capital requirements;
  • the probability of increased government liabilities, as deposit insurance requirements increase; and
  • whether the level of deposit insurance would protect institutional investors such that they are less likely to redeem their fund investments during times of crisis.

Enhanced Constraints on Unregulated MMF Substitutes

The Report acknowledges that many of the options discussed in the Report, while reducing the systemic risks to MMFs, could have the unintended consequence of causing investors to shift away from MMFs to unregulated investment vehicles. The Report notes that such MMF substitutes are often just as vulnerable to runs as registered MMFs, and that, to the extent investors move their assets to such funds, systemic risks will likely increase. Accordingly, the Report recommends that MMF reform include reform of MMF substitutes, and suggests specific regulatory changes, including:

  • prohibiting unregistered investment vehicles from maintaining stable NAVs;
  • amending Sections 3(c)(1) and 3(c)(7) of the ICA to make these registration exceptions from the definition of "investment company" unavailable to funds that seek to maintain stable NAVs; and
  • instituting banking and state insurance restrictions on funds and pools that seek to maintain a stable NAV but are exempt from registration under the ICA.

Conclusion

Recent events have shown that MMFs can be susceptible to runs. The SEC's new rules and rule amendments are designed to make MMFs more resilient and less risky. However, the PWG's Report emphasizes that the recent changes to the regulatory structure governing MMFs address only some of the features that make MMFs susceptible to runs. The Report concludes that more should be done to address systemic risks presented by MMFs and the structural vulnerabilities of MMFs to runs. The reform options presented by the Report will be submitted for consideration by the FSOC in the year ahead.

Footnotes

1. See "Report of the President's Working Group on Financial Markets: Money Market Fund Reform Options," available at http://treas.gov/press/releases/docs/10.21%20PWG%20Report%20Final.pdf. In 2009, the Department of the Treasury ("Treasury") had proposed that the PWG prepare a report on fundamental changes needed to address systemic risk and to reduce the susceptibility of money market mutual funds ("MMFs") to runs. See "Financial Regulatory Reform: A New Foundation," available at http://www.financialstability.gov/docs/regs/FinalReport_web.pdf.

2. For a summary discussing the SEC's changes to the regulation of MMFs, see "Amendments to the Regulatory Structure Governing Money Market Funds," DechertOnPoint (March 2010), available at http://www.dechert.com/library/FS_4_03-10_SEC_Adopts_Money_Market_Fund_Rule_Amendments.pdf.

3. To assist the FSOC with its analysis of these options, the SEC will solicit public comments on the Report.

4. See "Group of Thirty, Financial Reform: A Framework for Financial Stability" (2009), available at http://www.group30.org/pubs/reformreport.pdf . This publication criticizes MMFs, specifically expressing disapproval of the concept of amortized cost pricing. The report was a product of a study done by the G30, which at the time was led by Paul Volcker, now the chairman of the President's Economic Recovery Advisory Board and an advisor to the PWG.

5. Reacting to the Report's discussion of floating NAVs as a possible measure to address the structural vulnerabilities of MMFs to runs, the U.S. Chamber of Commerce issued a press release shortly after the Report was made publicly available, warning against instituting a floating NAV requirement or similar requirement that could harm MMFs. See "U.S. Chamber Warns Against Moves That Would Harm Money Market Funds: Removing Stable Pricing Would Harm Businesses, Investors, and Recovery" (Oct. 21, 2010), available at http://www.uschamber.com/press/releases/2010/october/us-chamber-warns-againstmoves-would-harm-money-market-funds.

6. See, e.g.,"ICI Weighs Creating Liquidity Facility for Money Funds" (March 9, 2010), available at http://www.ignites.com/c/55387/10562/weighs_creating_liquidity_facility_money_funds; see also "Statement with SEC Investment Advisory Committee Regarding Money Market Funds" (May 11, 2010),

7. In September 2008, the Treasury announced the establishment of a Temporary Guarantee Program for Money Market Mutual Funds to assist participating MMFs that broke the dollar to pay shareholders $1.00 per share upon liquidation. Under that program, MMFs were insured for up to $50 billion with assets from the Treasury's Exchange Stabilization Fund. The program expired in September 2009.

8. The Report states that capital redemptions from MMFs in the two days prior to the Treasury's Guarantee Program totaled about $200 billion, whereas in the two days after the program was announced outflows were only $22 billion.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.