Moving money market funds to a floating net-asset value would cause investors to flee the funds and ultimately deprive state and local governments of needed capital, several municipal market groups are warning in a letter to the Securities and Exchange Commission.
The three-page comment letter was sent to the SEC Monday as it begins to weigh the fund recommendations made by the President’s Working Group on Financial Markets in a report it issued in October.
The report said requiring funds to use a floating NAV would “help remove the perception” that they are risk-free and reduce investor incentives to flee distressed funds, though it might be difficult to accomplish and lead to unintended consequences.
But market groups strongly urged the SEC not to consider this option, arguing that a fixed NAV is the “hallmark” of money market funds.
A floating NAV, they warned, would ultimately harm state and local governments that both invest in such funds for cash-management purposes and issue short-term debt purchased by the funds.
“As investors in money market mutual funds … we are concerned about any changes that would alter the nature of these products and eliminate or impede our ability to purchase these securities,” said the letter, which was sent by the Government Finance Officers Association, the National Association of State Treasurers, the National League of Cities, and other muni issuer and borrower groups.
“Changing the NAV from fixed to floating would make [funds] far less attractive to investors, thereby limiting the availability for money market funds to purchase municipal securities,” the groups wrote. “Losing this vital investing power could lead to higher debt issuance costs for many state and local governments across the country.”
The groups warned that shrinking the market for funds would have “severe consequences” for state and local finances, and noted that money market funds are the largest investor in short-term municipal bonds, holding 65% of the $500 billion of such debt that is outstanding.
”The fixed NAV is the fundamental feature of money market funds, and changing its structure likely would eliminate the market for these products by forcing state and local governments, along with many other institutional investors, to divest their [fund] holdings,” they wrote.
“If the SEC were to adopt a floating NAV for [funds, the dozen or so organizations that signed the letter] expect that many, if not all, of their members would divest a significant percentage of their [funds] and would have to look at competing products that, in turn, could be more susceptible to market conditions, more difficult to account for and manage, and may pose market risk.”
Currently, the SEC’s Rule 2a-7 on money market funds requires funds to maintain a stable NAV of $1 per share.
But the industry nearly collapsed after the Reserve Primary Fund “broke the buck” — dropping below $1 per share — in September 2008, when the Lehman Brothers bonds it owned defaulted following that firm’s collapse, and fund investors rushed to sell their shares.
The October report noted changes to 2a-7 that the SEC adopted last February improved fund transparency, credit quality, and liquidity, but said that more needs to be done — something that SEC officials already have acknowledged.
In a separate letter, Vanguard said it also opposes the idea of a floating NAV, which “would require significant, and expensive, changes to operational and recordkeeping systems for both funds and investors.”
“Ironically, the imposition of a floating NAV might actually spark a run that regulators are trying to prevent, as investors may be more price sensitive to an NAV that fluctuates,” wrote William McNabb 3rd, Vanguard’s chairman and chief executive officer.
“Some investors have already reacted strongly to the concept of a floating NAV, commenting that, even if they could get comfortable with the new structure, the tax, accounting and operational challenges would be a 'nightmare.’ ”
The Investment Company Institute, which represents mutual and money market funds, planned to send a separate letter to the SEC late Monday also urging for continuation of a fixed NAV, among other issues, but it was not available at press time.
A spokeswoman said ICI would support a recommendation by the President’s Working Group on Financial Markets that a privately capitalized liquidity facility be established to make funds more resilient during times of stress with the least negative impact on the market.