While there are still just a handful of serious responses to the "President's Working Group Report on Money Market Fund Reform (Request for Comment)" on the SEC's website, one of them appeared yesterday written by former Prudential portfolio manager and money fund veteran Joseph Tully. Tully's interesting and original letter discusses several points, including shadow pricing more frequently, tactics to prevent runs, and a possible loan facility. The response, however, spends very little discussing the PWG's delineated options.
Tully, who served as Managing Director and head of Prudential's Fixed Income Management's Money Market Desk for 14 years, writes, "One of the lessons the money fund industry learned during the September 2008 run on money market funds (MMFs) was that the industry is only as strong as its weakest link. In that case, and as documented in the President's Report, the Reserve Fund broke its $1 NAV due to mark to market losses on its holdings of Lehman Brothers Holdings, Inc. The fund also did not have a strong sponsor with the financial capability and willingness to bail out the fund. As a result of this lesson, it is in the Commission's interest to promote the "best practices" within the industry, particularly when these best practices can be encouraged relatively easily through interpretive bulletins of SEC rule 2a-7, if not outright changes in the rule."
In a section entitled, "Shadow Price Daily," he says, "For example, in paragraph (c)(8)(ii)(A)(1) of rule 2a-7, the frequency of shadow pricing (the act of valuing the MMF at current market prices to determine the extent of the deviation from the MMF's amortized cost per share) is solely determined by the board of directors. Shadow pricing serves as a gauge to measure how the fund's NAV is faring against the changes in the market value of the fund's underlying securities. Shadow pricing on a more frequent basis would provide a fund's advisor and its board of directors with valuable information to make more timely adjustments to the underlying portfolio, thus reducing the possibility of the mark to market deviation growing to unmanageably large levels."
He explains, "Currently, all non-2a-7 mutual funds must be market priced daily. I see no reason why MMFs should not be held to that same standard but for shadow pricing. In other words, shadow pricing should be performed at least daily, but contrary to other mutual funds, the MMFs will still maintain their $1.00 NAV if their per share deviation remains below 1/2 of one percent. I believe any industry objections to such a change will be muted. While the current methods of money fund accounting were originally designed to reduce administrative costs, current industry arguments to maintain the $1 NAV primarily address tax considerations and ease of use for shareholders. Furthermore, during the 2008 financial crisis and its subsequent price volatility, MMFs should have been shadow pricing on a daily basis anyway, so the infrastructure should be in place and administrative costs should be minimal."
Regarding money funds' "Susceptibility To Runs," Tully comments, "The President's Report specifically commented on MMFs susceptibility to runs, the chief catalyst being the perception that the fund might suffer a loss. Shareholders therefore have an incentive to withdraw their funds early, thus precipitating a run on the MMF. Laggards then absorb a greater share of the previously unrealized losses in the portfolio. This analysis is certainly correct, but incomplete in my opinion. Institutional shareholders utilize money funds as depositories for their day-to day operating expenses, such as payroll. The prospect of a money fund breaking a dollar and being forced to liquidate would result in a freeze in money fund redemptions.... The recent revision to rule 22e-3, which permits money funds to postpone redemptions in order to facilitate orderly liquidation is a very welcome change in promoting shareholder fairness, but the heightened risk of a freeze may also precipitate even earlier withdrawals by institutional shareholders with limited alternative sources of liquidity."
He adds, "As detailed in the President's Report, none of the suggested avenues of money market reform offer simple, effective solutions without possible counterproductive consequences. However as a general rule and in a perfect world, those who reap the benefits should also pay for the accompanying risks."
Finally, Tully writes, "Another possible avenue of reform would allow shareholders to access to their funds during stressful market conditions, but to do so by allowing them to borrow against their money fund shares. Obviously, such a mechanism would only be implemented in cases of extreme stress, a disruptive level of redemption activity for a particular fund, and while the fund's share price has not yet fallen below $1 per share.... Shareholders looking to redeem shares would instead be able to seamlessly borrow against (for example) 90% of their money fund share value from a third party financial institution. The remaining 10% would represent the shareholder's remaining 'equity' in the money fund, and would be available to absorb capital losses, if any."
