Money Market Reform Fight Not Over Yet

Despite a setback at the SEC, U.S. regulators are still committed to imposing more regulation on a popular holding place for corporate cash.
Vincent RyanAugust 29, 2012

Corporate treasurers who invest in money-market funds and were opposing further regulatory reform of the short-term cash vehicles should hold off on cheering. Last week’s failure by Securities and Exchange Commission chair Mary Schapiro to push through her proposals for additional safety measures is not the last word from regulators in an area some deem systemically risky to financial markets.

“Between now and the end of the year, there will be nothing happening with money-market fund regulations,” says Lance Pan, director of research for Capital Advisors, an investment advisory. “But regulators — the Treasury Department, the Federal Reserve, and Schapiro — are fully committed to doing something.”

Last week, confronted by opposition from other commissioners, Schapiro called off an SEC vote on proposed new regulations for money-market funds. The proposal would have required funds to adopt a “floating” net asset value, meaning a fund’s NAV would rise and fall daily; forced money funds to accumulate a capital reserve to cushion against losses; and required investors seeking to redeem their shares to wait 30 days to get back 3% to 5% of their principal.

Those rules would have made money fund investing less attractive to corporations, some say, because among other effects they would have lowered yields and forced companies to change the accounting for these investments. In a survey of its clients published last March by ICD, a provider of risk-management analytics tools, treasurers said they would withdraw up to 41% of their money fund holdings if the rules were enacted.

But money-market funds could still turn into less appealing investments if regulators take other kinds of actions or get behind a different set of rules. For example, the Financial Stability Oversight Committee (FSOC) — a supervisory body created by the Dodd-Frank law — could deem MMF asset managers systemically important financial institutions, allowing the Federal Reserve to impose new capital and liquidity requirements on funds and force the SEC (money markets’ primary regulator) to revisit the issue, says Tory Hazard, CFO and chief operating officer of ICD.

But the FSOC is unlikely to do so before the U.S. Presidential election. The committee includes a host of Presidential appointees, including Ben Bernanke, Timothy Geithner, and Schapiro, and they won’t have the time or appetite to “push forth an FSOC designation prior to the election,” says Hazard. And if there is a change in Presidential administrations, he adds, most likely the issue would go away. “We still haven’t heard any real arguments on how money-market funds are systemically risky.”

Longer-term scenarios include the SEC considering reforms that would be more acceptable to the commissioners who opposed Schapiro’s proposal last week. For example, two SEC commissioners who were set to block Schapiro’s initiative disclosed Tuesday that they would support a rule permitting the boards of money-market funds to “gate” redemptions: in other words, stop investors from redeeming shares to stave off a run on a fund. Boards would be able to do so without prior regulatory approval, as was required during the financial crisis.

“We are not opposed to further improvements to the Commission’s oversight and regulation of money market funds,” said SEC commissioners Daniel Gallagher and Troy Paredes in a statement posted Tuesday on the SEC’s web site. “But further action must be advanced on the basis of data and rigorous analysis showing that any such changes to our existing rules would be workable . . . and would not unwisely disrupt the functioning of money market funds and short-term credit markets.”

Money-market funds came under fire in the wake of the collapse of the Primary Reserve Fund in 2008. That fund’s NAV dropped below $1 per share, forcing the U.S. Treasury to step in and insure the holdings of all MMFs to prevent market panic.

As a result, in 2010 the SEC’s so-called 2a-7 rules established new standards for a fund’s portfolio liquidity, weighted average maturity, and asset quality. They also required funds to disclose their holdings on their web sites.

The additional transparency and liquidity of fund holdings would prevent another run on money-market funds, say opponents of any further reforms. Indeed, Hazard points out, if the 2010 regulations had been in place, investors and regulators would have seen that the Primary Reserve Fund was investing in high-risk securities and customers of other, more conservatively managed funds would have been less inclined to redeem their shares, because they would have had access to detailed information on their own funds’ securities portfolios.

The removal of the near-term threat of further SEC regulation this year is not likely to directly cause corporate treasurers to move cash back into money-market funds, says Pan of Capital Advisors. But money-market funds could see inflows if the Federal Deposit Insurance Corp.’s guarantee on noninterest-bearing transaction accounts expires at year-end, even though yields on MMFs are extremely low. Treasurers have very few places to put cash to work, he emphasizes.

“It’s just easier for them to go back to money markets, but it’s not a long-term solution for anybody,” says Pan. “We’re in a very, very difficult time in the cycle where rates are very low, the regulatory environment is still unraveling, and the economy still needs more help from the government, which means even lower yields.”

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