In a recent comment letter to the SEC, the Investment Company Institute (ICI) provided a detailed proposal for the creation of a private liquidity facility for prime money market funds, which the ICI stated is the most promising solution to bolster these funds in times of severe market stress. The ICI submitted its letter in response to the SEC's request for comment on the President's Working Group on Financial Markets (PWG) Report on Money Market Reform Options.

The PWG proposed various options for money market reform, including the creation of a private liquidity facility for money market funds. In its comment letter, the ICI stated that it favors this option over others and went on to describe a detailed plan for such a liquidity facility. Under the ICI's plan, the liquidity facility would be structured as a state-chartered bank or trust company regulated by state banking authorities and the Federal Reserve, and would be capitalized by initial contributions and ongoing fees. It would grow additional capacity by issuing time deposits (such as certificates of deposit) to third parties and when markets are operating normally, the facility would invest the proceeds of its sponsors' capital, the ICI stated. Like other banks, the liquidity facility would also have access to the Federal Reserve discount window.

The ICI proposed that an initial contribution from prime fund sponsors be based on prime money fund assets under management; the ICI's initial target is $350 million, with a minimum initial fee of $250,000 per individual firm. The ongoing commitment fee paid by participating funds would be three basis points of prime money fund assets per year. Some industry experts believe the ICI's three-basis-point proposal is high and could lead to greater consolidation in the industry because those advisors that do not want to absorb the fee may leave the market. The expense could be passed on to shareholders; however, this might adversely affect current yields.

Under the ICI's plan, all prime money market funds would be required to join the facility — those funds that decline to participate would be unable to use the amortized cost method of valuation and would be forced to convert to Treasury or government funds. In 10 years, the ICI aims for the liquidity facility to have raised $50 billion.

According to the ICI, the liquidity facility would not provide credit support, by buying distressed securities, for example. Therefore, had the liquidity facility existed in 2008, it would not have prevented the Reserve Primary Fund from "breaking the buck."

Rather, the ICI stated that the liquidity facility would strengthen prime money market funds by buying high-quality, short-term securities from such funds during times of market stress and illiquidity thereby allowing the funds to meet redemptions while maintaining a stable $1 net asset value (NAV). By its very existence, the liquidity facility would provide reassurance to investors, the ICI argues, and limit the risk that liquidity concerns in a single fund would spur redemptions in all prime money market funds.

Participating funds would be permitted to access their proportional amount of liquidity, the ICI stated; however, the liquidity facility's board of directors could provide more liquidity to a fund if necessary. The ICI outlined other conditions that would attach to a fund's ability to access liquidity, one condition being that the fund pay an additional fee.

In its comment letter, the ICI went on to express its opposition to other options proposed by the PWG, including: requiring money market funds to float their NAVs; imposing mandatory redemptions in kind; insurance programs for money market funds; a two-tier system with stable NAV money market funds reserved for retail investors; regulating stable NAV money market funds as special purpose banks; and imposing enhanced constraints on alternative investments to money market funds. More about the ICI's position regarding these options can be found in its comment letter at: http://www.ici.org/pdf/11_sec_pwg_com.pdf.

Aside from commenting on reform options discussed by the PWG, the ICI recommended in its letter that the SEC consider implementing a new rule requiring intermediaries, such as broker-dealers, to provide information to money market funds about their investors. This, the ICI asserted, would make it easier for funds to comply with "know your investor" procedures newly required by the SEC. If funds could better identify their investors, they could better evaluate their liquidity needs and thereby mitigate risk, the ICI went on to note.

Industry participants do not all agree that a liquidity facility structured in accordance with the ICI's plan is the best solution. We are following this issue and will keep you updated.

The PWG Report on Money Market Reform and the SEC's related request for comment can be found here: http://www.sec.gov/rules/other/2010/ic-29497.pdf.

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.