Risk Management

SEC Proposals Called Threat to Treasury Tool

Senate Banking committee opponents of money-market reforms proposed by SEC chief Mary Schapiro are concerned corporations could lose a crucial tool...
Vincent RyanJune 21, 2012

If the Securities and Exchange Commission piles further regulations on money-market funds, corporate treasurers may have to revamp how they invest short-term cash. But SEC chief Mary Schapiro believes the regulations imposed on money funds in 2010 didn’t do enough to lower the risk of shareholder “runs.”

In prepared remarks and testimony on Capitol Hill Thursday, Schapiro pushed new reforms to prevent a recurrence of the shareholder run on money funds that occurred in 2008 — a crisis that forced large-scale U.S. government intervention in the credit markets.

Schapiro’s proposals received a lukewarm reception from some members of the Senate Committee on Banking, Housing, & Urban Affairs, who are worried that more regulation could kill the industry. They are concerned corporations and governments could lose a crucial tool for cash management, and both government agencies and businesses might find short-term credit more expensive.

The SEC’s already-enacted rule changes dictate that, among other things, money-market funds hold a certain portion of their portfolio in highly liquid instruments. But the so-called 2a-7 regulations fail to remove money funds’ vulnerability to credit losses that cause a shareholder stampede to exit a fund. “The reforms were not designed to address the structural features of money-market funds that make them susceptible to runs,” Schapiro said in her prepared testimony.

Money-market funds are vulnerable to massive, quick withdrawals because shareholders have an incentive to redeem shares before others do when a loss appears imminent, Schapiro said in her prepared remarks.

After Lehman Brothers collapsed in 2008, the Reserve Primary Fund “broke the buck”: its per-share value, which is supposed to be fixed at $1, fell below that amount. Its shareholders requested $40 billion in redemptions from the $62 billion fund in two days. “An early redeeming shareholder will receive $1 for each share even if the fund has experienced a loss,” said Schapiro, and those redemptions “concentrate losses in the remaining shareholders of a fund that is now smaller.”

Institutional investors have an advantage over retail investors when a fund gets in trouble, something the SEC is particularly concerned about, said Schapiro. Institutions can commit resources to watch their investments and the technology to redeem shares quickly, she said. In the case of the Reserve Primary Fund, the late movers “were left waiting for a court proceeding to resolve a host of legal issues before they could regain access to their funds,” she said.

But money-market fund providers like Fidelity Investments say the 2008 run was more of a rapid reallocation of investor money from funds that held commercial-sector instruments to money funds that held only government-issued securities.

In addition, the higher levels of liquidity required by the new 2a-7 regulations enable funds to handle “large, unexpected redemptions in the rare instances they do occur,” said Fidelity Investments’s general counsel in a May letter commenting on a controversial report by the International Organization of Securities Commissions. The Fidelity executive, Scott C. Goebel, pointed out that money-market funds now have the ability to suspend redemptions in a fund, “thereby facilitating orderly liquidation.”

One of the reforms the SEC staff is exploring is requiring money funds to buy and sell their shares based on the actual market value of the funds’ assets, like mutual funds do. Schapiro said the stable $1 per-share price creates “misplaced expectations” of safety. Using a so-called floating net asset value (NAV) would accustom shareholders to fluctuations in share prices, she said, and make them “less likely to redeem en masse.”

The money-fund industry vehemently opposes a floating NAV, saying it could lead to massive outflows of investor money. A floating NAV would cause an increase in tax, accounting, and recordkeeping requirements for investors, Fidelity says. In addition, many state municipalities and insurance companies can only invest in money-market funds if they have a fixed NAV, and would find other places to invest their cash.

“Imposing a [fixed NAV] on money funds will create, rather than reduce, systemic risk by increasing concentration of short-term assets in the banking system,” said Goebel.

The other regulatory option, Schapiro said, is letting money-market funds keep the stable share value but require them to maintain a capital buffer. An SEC staff review found that since the 1970s, fund sponsors bailed out their money-market funds with capital injections more than 300 times. A capital buffer rule would merely make explicit the minimum amount of capital that is available to a fund, Schapiro argued. To guard against large credit losses that cause a fund to “break the buck,” a buffer would have to be combined with restrictions or fees on shareholder redemption, she said.

At Thursday’s Senate hearing, some senators challenged the notion that the money-fund industry needed additional regulation, saying it had stood up to the stress of the euro zone crisis, a recession in the United States, and a downgrade of U.S. government debt.

Money markets have been under scrutiny on and off since the financial crisis. Events a year ago helped reprise the debate: when financial markets came under stress last June, prime money funds faced $100 billion in withdrawals in three weeks. Although there was no disruption to the credit markets, about 6% of all prime fund assets were redeemed, and one fund lost 23% of its assets, Schapiro said.

The outflows occurred even though the funds involved experienced no credit losses.