On Wednesday, new Securities and Exchange Commission Commissioner Daniel Gallagher gave a speech entitled, "SEC Reform After Dodd-Frank and the Financial Crisis" at the U.S. Chamber of Commerce, questioning the need for additional and immediate money fund regulation. He says, "A very high profile event in the crisis separate from the bailout of Bear Stearns and AIG, but intimately tied up with the problem of too-big-to-fail, was the breaking of the buck by the Reserve Primary Fund, representing only the second time in history that investors have lost money in a money market mutual fund. Despite the fact that the Dodd-Frank Act did not address money market funds, these funds have emerged as an issue in the past month or so. Indeed, in an early November speech, the Chairman explicitly stated her intent to "issue a proposal in very short order" Since then, I have spent a considerable amount of time during my first 26 business days as a Commissioner focused on this important issue. And, based on what I have learned to date, I have questions about many of the currently discussed reform options."
Gallagher explains, "Before I comment on some of the specific proposals currently on the table, I want to step back for a moment and express my more general concerns with the push towards rulemaking in this area. In particular, I want to make sure that we keep in mind two important and related questions as we proceed. First, for what specific problems or risks are we trying to solve? And second, do we have the necessary data that will allow us to regulate in a meaningful and effective way? Let me address the first question. As I said earlier, I do not believe that it should be -- nor can it be -- the goal of the Commission to ensure that securities products are risk-free. Of course we must strive to prevent fraudulent and manipulative practices. But when the risks of an entirely legal investment are adequately disclosed, it is not the Commission's job to forestall the possibility of loss. To put a finer point on it, in light of the extensive disclosures regarding the possibility of loss, money market funds should not be treated by investors or by regulators as providing the surety of federally insured demand deposits."
He continues, "So what is prompting this urgency to reform money market funds? What are the particular risks that money market funds, as currently constituted, pose to investors and to the capital markets? What problem are we solving here? I'll admit that I just posed a bit of a trick question. We cannot know what risks money market funds pose unless -- and this brings me to my second point -- we have a clearer understanding of the effects of the Commission's 2010 money market reforms. For some reason, much of the discussion surrounding the current need for money market reform sweeps aside the fact that the Commission has already responded to the 2008 crisis by making significant changes to Rule 2a-7. Notably, those amendments only became effective in May 2010. Without an adequate understanding of the current state of play, we are handicapped in our effort to define existing risks and measure their magnitude. Nor can we simply hand-wave and speak vaguely of addressing "systemic risk" or some other kind of protean problem. The risks and issues justifying a rulemaking must be specifically and thoughtfully defined in relation to the Commission's mission. As a reminder, the Commission’s mandate is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. We are not expected to regulate with other goals in mind."
Gallagher comments, "Given my belief that any rulemaking in this space could be premature, and possibly unnecessary, I thought I'd spend just a few minutes on the current proposals being bandied about. Although I am keeping an open mind about all options in this space, and am fully aware that the devil is in the details of many of these proposals, I do have some initial reactions. First, I am hesitant about any form of so-called "capital" requirement, whether it takes the form of a "buffer" or of an actual capital requirement similar to those imposed on banks. Although I am not opposed to a bank-like capital requirement in principle, it is my understanding that the level of capital that would be required to legitimately backstop the funds would effectively end the industry. And I have doubts that a smaller capital buffer that accrues over time would be sufficient to protect investors and funds in an actual crisis. I am concerned that it could simply create the illusion of protection, and further obscure the well-disclosed risk of investing in money market funds."
He continues, "I will note, however, that at least one industry participant has suggested the possibility of a stand-alone redemption fee. Although the details of the imposition of such a fee would need to be carefully considered, this suggestion avoids my worries about capital requirements. This minimal approach does not set up false expectations of capital protection, externalizes the costs of redemptions, and could be part of an orderly process to wind down funds when necessary. And, a meaningful redemption fee may cause a healthy process of self-selection among investors that could cull out those more likely to "run" in a time of stress. But despite my initial positive reaction to the notion of a redemption fee standing alone, grafting the fee onto a capital buffer regime will not assuage my concerns with such a capital requirement. Indeed, a combined approach retains all the problems of any capital solution, unless something significant is done to manage investor expectations regarding the level of protection provided."
Gallagher goes on, "Second, I acknowledge that a move to a floating NAV would work a profound change to the money market fund industry as we recognize it today. This proposal has its ardent supporters and its impassioned critics. I believe that it is an important option to keep on the table and to subject to further study and consideration. For example, it would be important to understand the effect of such a change on the commercial paper market and bank deposits."
He adds, "Finally, I should make explicit what I hope you have already gleaned from my statements thus far. If the Commission moves forward with a proposal, the option of doing nothing until we have seriously analyzed the impact of last year's reforms must be given serious consideration. By pre-judging the outcome of this rulemaking -- that something, anything must be done as soon as possible, never mind the consequences -- the Commission runs the danger of skewing its analysis of any proposed regulatory changes. Any analysis we undertake will necessarily be flawed if we lack a rigorous sense of the current baseline against which to measure the effects of any proposed changes. Moreover, we have a legal obligation to thoroughly consider all reasonable alternatives, and that includes the alternative of doing nothing beyond those significant changes the Commission has undertaken just last year."
