The Money Market Reform (MMR) rules being enacted by the SEC have left me feeling a little like we have a cure that is worse than the disease. The SEC generally does a fair job in weighing the costs versus the benefits of enacting regulations (I am stretching a little here) but this one just doesn’t feel right, so I decided to do a little research to see what made this rule change seem so different from prior SEC rule changes.
In 2010, we saw the legislative hangover of the 2008 financial crisis manifest itself in the “Dodd Frank Wall Street Reform and Consumer Protection Act”. Out of the Dodd Frank legislation we got a new governmental agency called the Financial Stability Oversight Council, or more commonly referred to as FSOC. FSOC is the “big dog” when it comes to overseeing risks to the US financial system. With virtually an unlimited budget, it reports to congress and can issue “recommendations” to a financial regulatory agency (oh, like maybe the SEC) and that financial regulatory agency is obliged to implement. The FSOC reports to Congress on the implementation or failure to implement such recommendations.
During the financial crisis in 2008, one (yes, just one) money market fund, Reserve Primary Fund, broke the buck. That is, it had to lower its daily per share value to something less than $1.00. It ultimately paid out 99.1 cents per share, but by “breaking the buck” it essentially put itself out of business. Only one other true money market fund had done this before, Community Bankers US Government Fund broke the buck in 1994, ultimately paying out 96 cents per share. I mention these only to point out historically the rarity of a money market fund breaking the buck.
After the financial crisis of 2008 and the failure of Reserve Primary Fund, the SEC knew it had to make some reforms around money market funds. So in January, 2010, the SEC adopted new rules designed to strengthen the regulatory requirements governing money market funds. The new rules were intended to increase the resilience of money market funds to economic stresses and reduce risks of runs on the funds by tightening maturity and credit quality standards and imposing new liquidity requirements. These new rules were drafted after receiving a lot of input from the industry via comments letters and expert testimony. The SEC and the industry knew that this approach would achieve the safeguards needed without disrupting the industry by inflicting a floating NAV. Normally, this would have been the end of the story.
Apparently, the FSOC folks did not think the SEC reforms were strong enough, as they did not address “structural vulnerabilities” of money market funds that leave them susceptible to destabilizing runs. FSOC called for additional reforms to address the structural vulnerabilities in 2010, 2011 and 2012. In 2012, SEC Chairman Schapiro announced that the SEC would not proceed with a vote to publish a notice of proposed rulemaking to solicit public comment on potential structural reforms of money market funds. This was the SEC’s public notification that they were not going to follow FSOC’s “recommendations.” Uh oh. Not supposed to do that. Chairman Schapiro was actually in favor of the structural reforms( no big surprise as SEC Chairman has one of the 10 seats on the FSOC board) but could not get a majority of the commissioners to go along, and so that brings us to back to the “big dog”.
At this point, FSOC took over and using their authority under Dodd Frank, ordered the SEC to move forward with the comment period on the proposed recommendations for structural reforms.
SEC said no, FSOC said yes, and so in October we get floating NAVs, fees and gates, a huge disruption in money market funds as well a cost to the industry that will reach into the billions. So now it makes sense. Sort of. I guess only time will tell if the cost of this antidote will be worth it.
And one more thing. I am not a conspiracy theorist by any means, but government MM funds (defined as 99.5% of its assets invested in cash, U.S. government securities, and/or repurchase agreements that are collateralized by U.S. government securities) are exempt from most of these reforms, and business is really booming for them.
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L. Burton Keller was a principal founder of the company in 1985 and currently focuses on strategic initiatives for the company. Mr. Keller is a former member of the Bank, Trust and Retirement Advisory Committee of the Investment Company Institute. He has served on numerous committees and task force groups with the ICI over the last 17 years including Co-chair of the Dividend Distribution Task Force.