WASHINGTON — The Securities and Exchange Commission yesterday voted 4 to 1 to approve a series of changes to its Rule 2a-7 on money market funds aimed at boosting the resilience of funds during market crises, and promised to move forward with additional rules in the future.
The SEC also voted 3 to 2 to issue interpretive guidance requiring companies to weigh whether legislative, regulatory, or other actions related to climate change would require them to make certain disclosures in corporate filings with the SEC.
The agency approved the measure only after a heated and unusual politically charged debate between Democratic and Republican commissioners on the existence of climate change. However, the guidance drew support from several large investors, including state governments.
Some portfolio managers applauded the money market rule changes, saying they will improve transparency, credit quality, and liquidity. The Investment Company Institute also supported the proposals but said it would oppose any future effort to move away from a fixed $1.00 net asset value.
The extensive money market fund rule changes originally were proposed in June largely in response to a run on the Reserve Primary Fund, which “broke the buck,” or fell below a $1.00 net asset value, or NAV, in 2008, when Lehman Brothers bonds it owned defaulted following that firm’s collapse and fund investors rushed to sell their shares.
The rule changes address fund liquidity and disclosure requirements as well as their reliance on rating agencies. Notably, they include a requirement that funds enhance their disclosures by reporting on a delayed basis a “shadow” NAV, meaning the fund’s actual net “mark to market” NAV, rather than the stable $1.00 NAV at which fund shares are bought and sold.
“I believe this new disclosure will impose a discipline on fund managers to avoid taking undue risks that may result in the disclosure of a lower than expected shadow NAV,” SEC chairman Mary Schapiro said in opening remarks.
Even as the commission prepared to vote on the measures, Schapiro stressed that the SEC staff are considering additional reforms, some of which are controversial.
They include a floating, rather than a stable, $1.00 NAV, which the industry opposes; a private facility to provide liquidity to funds in times of stress; and a two-tiered system of money market funds, with a fixed NAV only for funds subject to “greater risk-limiting conditions” and possible liquidity facility requirements.
In addition, she said the additional changes could include options under discussion by President Obama’s working group on financial markets, which is being headed by Treasury Department officials.
The group is several weeks behind a self-imposed deadline for filing a report.
The rule changes drew some positive reactions, with the ICI worried about the SEC’s future proposals.
Paul Schott Stevens, ICI president and chief executive officer, said the group supports the measures the SEC approved yesterday, but will continue to “strongly” oppose any move to directly or indirectly require funds to abandon a fixed $1.00 NAV “that has been a defining feature of these funds.”
“Investors and issuers in the money market have filed extensive comments with the commission, and they have been almost unanimous in pointing out the serious damage that floating these funds’ NAV could inflict on investors, markets, and the economy,” Stevens said in a statement.
Mike Sebesta, director of liquidity management for StableRiver Capital Management, applauded the rule changes.
“I think it’s very positive for the industry,” he said. “It puts the industry at a safer spot improving credit quality, improving liquidity, and those are all very constructive for the industry.” He added that he believed most of the industry has already moved “very close” to these changes.
Kevin Bannerton, managing director at DB Advisors, said his firm is supportive of the new regulations, and is trying to implement at least some of the further improvements that Schapiro said the SEC would consider in the future — including real-time disclosure of funds’ shadow NAV.
Bannerton said DWS has already registered, but not yet launched, what may be the first variable NAV money market fund, designed to give institutional investors greater transparency and choice.
“We feel that a variable NAV would take this concept [shadow NAV] a step further and provide investors with daily transparency,” he said.
While the rule changes are intended to raise funds’ liquidity, they would also likely result in reducing what are already paltry yields, market participants said yesterday.
Money market funds coughed up more than $545 billion last year, according to ICI, with more than $100 billion coming out of tax-free money funds.
Disdain for yields flirting with zero is so rampant that investors are looking for other ways to approximate cash, Matt Fabian, managing director at Municipal Market Advisors, wrote in his latest weekly outlook.
“We note an increasing reliance by investors on cash alternative products in lieu of money market funds,” he wrote. “This will be an excellent environment for growth in cash alternatives like the floating NAV VRDO exchange-traded funds and/or shorter-duration high-grade mutual funds, which will increasingly compete with money funds for product.”
For instance, PowerShares manages an exchange-traded fund that buys short-term variable-rate debt obligations.
The ETF thus offers investors much the same product as tax-free money market funds except it is not restricted by Rule 2a-7 and its asset value floats every day. The fund has surged to more than $1.1 billion in assets.
At yesterday’s SEC meeting, Kathleen Casey, a Republican, was the only commissioner to vote against the changes, saying that they go “in the wrong direction.”
She was referring to rating agency provisions that she said would give nationally recognized statistical rating organizations, or NRSROs, “new and more exalted legitimacy” rather than decrease the reliance on their ratings in federal rules and regulations.
Rule 2a-7 generally requires that funds invest in securities rated double-A or higher, though they must perform an independent credit analysis of the assets that they purchase. The rule also allows them to invest in high-quality, unrated securities.
But Elisse Walter, a Democratic commissioner, who said she shares Casey’s concerns about the references to NRSROs, said that eliminating them would weaken investor protections. She said she was swayed by arguments that the references are needed in this particular rule.
Schapiro, who is politically independent, said she is sympathetic with Casey’s concerns as well, but noted that the SEC does not permit money market fund managers to use ratings as a shortcut around independent analyses of their credits.
Specifically, the proposal Casey objected to would require fund boards to annually designate at least four NRSROs whose ratings it considers reliable, permitting a fund to disregard ratings by NRSROs that the fund has not designated.
SEC staff said the provision would satisfy certain minimum rating requirements for funds while fostering NRSRO competition.
Meanwhile, the changes also would shorten the weighted average maturity of fund holdings to 60 from 90 days, restrict funds from investing in so-called second-tier securities, require fund managers to conduct periodic stress tests to ensure they can maintain a stable net-asset value, and require monthly disclosures of holdings to both the SEC and investors.
In addition, the changes would permit a fund that has “broken the buck” to suspend redemptions while it undertakes an “orderly liquidation” of assets. A firm breaks the buck when its NAV drops below $1.00 per share.
The money market fund rule changes are different in some key respects from the proposals released in June.
For instance, one provision to boost fund liquidity by requiring that at least 30% of both taxable and tax-exempt funds’ assets consist of cash, certain government securities, or securities that convert into cash within one week was altered from the original proposal that would have required 15% of retail money-market funds’ assets, or 30% of an institutional fund’s assets, to be convertible to cash within one week.
The ICI opposed the proposed provision, favoring instead a blanket 20% weekly liquidity minimum for all funds, arguing the “floor” could be adjusted upwards based on an individual fund’s liquidity needs.
However, SEC officials said that a 20% liquidity minimum was far too low based on the redemptions rates following Lehman’s collapse.
Meanwhile, the interpretive guidance on climate change that the SEC approved requires companies to weigh the impact of legislation and regulation, international accords, and the physical impacts of climate change when determining what to disclose in corporate filings with the SEC.
The guidance, long sought by investors, also says companies should consider indirect effects, such as changes in profits due to an decreased demand for goods that produce significant greenhouse gases.
“I do not believe that public companies today are doing the best job they possibly can do with respect to their current mandated disclosures,” Walter said.
The guidance comes as environmental groups are pushing for greater climate-change related disclosures for municipal bonds, though the SEC’s guidance did not apply to the municipal market.