Last Monday, the Investment Company Institute hosted its annual Mutual Funds and Investment Management Conference in Phoenix, Arizona, featured two keynotes with money funds as their main there, plus a panel on money market funds reform. (See last week's "News," "SEC Commissioner Walter Asks Fund Companies to Re-Engage at MFIMC" and "ICI's McMillan Says Plans for MMFs Outrageous, Time for SEC to Move On.") ICI's release on the panel explained, "Mutual fund industry experts and a representative from the Securities and Exchange Commission will discuss the current state of money market funds and the potential additional regulatory changes being pursued by the agency during the." ICI Senior Associate Counsel Jane Heinrichs moderated the panel that covered "expected SEC proposals to impose a floating net asset value (NAV) or capital requirements and redemption restrictions on money market funds and how the proposals would impact investors." Panelists included: Robert Plaze, Deputy Director, Division of Investment Management, SEC, Paul Atkins, CEO, Patomak Global Partners, Stephen Keen, Counsel, Reed Smith LLP, Simon Mendelson, Global Co-Head, Cash and Securities Lending, BlackRock Financial Management, and Lloyd Wennlund, Executive Vice President and Managing Director, Northern Trust Global Investors. Today, we finally got around to featuring comments from the panel (we're still transcribing), and we feature some quotes from the SEC's Bob Plaze today. (Look for more in coming days.)
After the ICI's Heinrich reviewed the current state of money funds, Plaze commented, "One of the things, with all of this [Form N-] MFP data that we have, we are able to do a great deal and we can look into portfolios. We can understand a lot more what's going on than ever before.... We can try to understand and look at that risk that particular fund managers and fund groups are willing to take ... in dealing with this low risk environment. The neat slide that I have showed what the average gross yield.... We can look in to each one of those and understand how they are acquiring this significantly higher yield.... What risks they are willing to take, etc.... Even within 2a-7, there is an opportunity to take additional risk, and those risks of course have consequences if the bets don't turn out the way they did. Which you saw in 2008 with Reserve Fund.... Their chickens ultimately came home to roost."
He continued, "It's a long way of saying that 2a-7, while narrowing the parameters of risk, still gives a great deal of room, since the ingenuity ... knows no bounds. These outliers are of concern to us because if an event happens with respect to one of these funds, the transmission to the rest of the fund industry is a concern. There's "neighborhood risk" to be concerned about, let's call it. If one fund makes a mistake and assumes too much risk and something happens, it's not going to be contained to that one fund. It's going to spread as we saw in 2008. That's what we're spending a lot of time watching these days."
Later during the panel, Plaze said, "Part of the problem with 2a-7 over the years [is that] we amend it to take care of the last problem.... We're always like generals fighting the last war; regulators fighting the last crisis. The tradeoff implicit in 2a-7 is we limit your risks and you're able to use amortized cost. The question is whether that's breaking down, whether it's really realistic for us to regulate for risks and risk assumptions, given the fact that you have an industry that's driven by yield.... Rulemaking is so much more difficult to do than it was before.... We can see the dynamics play out within fund groups and we can see the risks, [but] we don't always have very good tools to deal with those risks."
On the European concerns of last summer, Plaze commented, "Something changed with institutional investors, demonstrating their skittishness. There weren't losses. There was only the threat of losses, and we saw huge redemptions. While we changed the liquidity side of the balance sheet, something else has happened on the other side of the balance sheet with institutional investors and how quick they are to pull out large amounts of money.... If there were losses, what would have been the consequences?"
He explained, "The regulators were facing three choices coming out of 2008.... Make them all banks. Every time you use the word "shadow banking system".... Two, make them more like mutual funds.... I think the third is, we listened to the industry, we need to maintain the stable NAV. It's what clients, the investors, want. We are in some sense path dependent. We've done 30 years of stable NAV; floating NAV comes with some downsides also. [This option would] try to come up with a hybrid in order to put some bank-like protections in place for MMFs that would allow them to maintain the stable NAV and not lead them to the type of vulnerability to runs that we saw in 2008."
When asked about whether a floating NAV would even float, Plaze responded, "Obviously, they wouldn't float if you kept them at a dollar, so you would have to be talking about higher amounts.... These are issues and why that option might not be the optimal option.... If it really doesn't float, then investor behavior doesn't change. That's a weakness of the option."
Next, when asked whether the SEC has done any outreach or surveyed investors on a possible floating NAV, Plaze answered, "I would stipulate that they would not like it.... In some respects, what we're doing here is an exercise of taking costs that have been externalized and internalizing them and that's going to increase the cost of that product somehow. I don't know any investor, myself included, who would vote for that. At the same time, the idea is the sustainability of the product and the effect on the short-term markets is really what is at issue here."
