WASHINGTON — Moving money market funds to a floating net-asset value would “help remove the perception” that MMF’s are risk-free and reduce investor incentives to flee distressed funds, but might be difficult to accomplish and lead to unintended consequences, the President’s Working Group on Financial Markets said in a report released Thursday.
The long-delayed report, which was originally due to be released Sept. 15, 2009, details a number of options for money market fund reforms and addresses vulnerabilities that contributed to the financial crisis in 2008 and led to an unprecedented $50 billion federal liquidity backstop for the funds.
The report recommends that the Financial Stability Oversight Council established by the Dodd Frank Wall Street Reform and Consumer Protection Act consider the options, but doesn’t strongly endorse any of them.
For instance, it notes that switching to a floating NAV “would have potential benefits,” but warns they would have to be “weighed carefully against the risks that such a change would entail.”
The potential downside in moving to a floating NAV include: reductions in MMFs’ capacity to provide short-term credit due to lower investor demand; a shift of assets to less regulated or unregulated fund substitutes such as offshore MMFs, enhanced cash funds, and other stable-value vehicles, and unpredictable investor responses as MMF NAVs begin to fluctuate more frequently, the report said.
Currently, the Securities and Exchange Commission’s Rule 2a-7 on money market funds requires funds to maintain a stable net-asset value of $1 per share. But the industry nearly collapsed after the Reserve Primary Fund “broke the buck” — dropped below $1 per share — in September 2008, when Lehman Brothers bonds it owned defaulted following that firm’s collapse, and fund investors rushed to sell their shares.
The report noted changes to 2a-7 that the SEC adopted in February improved fund transparency, credit quality and liquidity, but said that more needs to be done — something that SEC officials already have acknowledged.
The report also suggested that policymakers could allow a two-tiered system of MMFs: stable NAV funds, which could be subject to enhanced protections such as bank regulations and possibly reserved for retail investors, and floating NAV funds, which would have to comply with certain but not all Rule 2a-7 restrictions. The floating NAV funds presumably would offer higher yields.
“Because this two-tier system would permit stable NAV funds to continue to be available, it would reduce the likelihood of a substantial decline in demand for MMFs and large-scale shifts of assets toward unregulated vehicles,” the report said. “At the same time, the forms of protection encompassed by such a system would mitigate the risks associated with stable NAV funds. It would also avoid problems that might be encountered in transitioning the entire MMF industry to a floating NAV.”
Industry participants have welcomed the most recent SEC rule changes but said they would oppose any move to establish a floating NAV.
Other options include: a private emergency liquidity facility; insurance for MMFs that could be private, public or a mix of the two; a requirement that the funds distribute large redemptions “in kind” rather than in cash; regulating stable NAV funds as special purpose banks; and enhanced constraints on unregulated MMF substitutes.
Investment Company Institute president Paul Schott Stevens said in a statement that the industry group looks forward to working with “regulators and policymakers to develop ideas that will strengthen MFFs against any future crisis.”