As we wrote almost two weeks ago (see our Nov. 14 Crane Data News, "FSOC Approves Proposal to Recommend Money Fund Reforms to SEC"), the Financial Stability Oversight Council approved its "Proposed Recommendations Regarding Money Market Mutual Fund Reform." While no Comment Letters have been posted yet, we thought we would review the proposals themselves in more detail (for those that haven't had time to read the whole 73-page document). The FSOC writes on the "Proposed Recommendations," "The Council seeks comment on proposed recommendations to the SEC to address the structural vulnerabilities of MMFs discussed in Section IV. In particular, the Council aims to address the activities and practices of MMFs that make them vulnerable to destabilizing runs: (i) the lack of explicit loss-absorption capacity in the event of a drop in the value of a security held by an MMF, and (ii) the first-mover advantage that provides an incentive for investors to redeem their shares at the first indication of any perceived threat to an MMF's value or liquidity."
They explain, "In considering options for further reform, the Council notes three key features of MMFs that make them appealing to investors: the stability of principal associated with the funds' stable $1.00 per share NAV; liquidity through shares that can be redeemed on demand; and market-based yields that often exceed those of short-term Treasury securities and rates on FDIC-insured bank deposits. The activities and practices of MMFs that have made them appealing to investors also contribute to their vulnerability to runs. For example, both MMFs' reliance on rounding to maintain stable NAVs and the liquidity of MMF shares contribute to a first-mover advantage for redeeming investors. MMFs' practice of investing in short-term securities with interest-rate and credit risk to boost yields, without explicit loss-absorption capacity, makes them more vulnerable when losses do occur."
FSOC writes, "Therefore, reforms that would provide meaningful mitigation of the risks posed by MMFs would likely reduce their appeal to investors by altering one or more of their attractive features. The first proposed alternative would require funds to have a floating NAV by removing the valuation and pricing provisions in rule 2a-7 that currently allow funds to maintain a stable, rounded $1.00 NAV. Alternatives Two and Three would preserve, and potentially bolster, the principal stability that investors currently enjoy by preserving the stable NAV, but would likely reduce the higher yields and/or the liquidity that MMFs offer to investors. These reform alternatives, therefore, present trade-offs between stability, yield, and liquidity. Different MMF investors may have different preferences. Accordingly, it may be optimal to offer both floating NAV funds and stable NAV funds with enhanced protections and to allow investors to determine which they prefer. The Council seeks comment on the merits of adopting such a flexible approach as well as the merits of recommending a single structural reform alternative."
On the Floating NAV Proposal (Alternative I), they say, "This reform alternative would require MMFs to have a floating NAV instead of a stable NAV. The price per share would fluctuate based on small changes in the value of the MMF's portfolio, rather than remaining at $1.00 absent a break the buck event. As such, the value of MMFs' shares would reflect the market value of the underlying portfolio holdings, consistent with the valuation requirements that apply to all other mutual funds under the Investment Company Act.... [A] requirement that MMFs use floating NAVs could make investors less likely to redeem en masse when faced with the prospect of even modest losses by eliminating the "cliff effect" associated with breaking the buck. Regular fluctuations in MMF NAVs likely would cause investors to become accustomed to, and more tolerant of, fluctuations in NAVs. A floating NAV would also reduce the first-mover advantage that exists in MMFs today because investors would no longer be able to redeem their shares for $1.00 when the shares' market-based value is less than $1.00. This alternative does not contemplate requiring funds to have an NAV buffer."
FSOC continues, "Under this alternative, each floating-NAV MMF would re-price its shares to $100.00 per share (or initially sell them at that price) to be more sensitive to fluctuations in the value of the portfolio's underlying securities than under a $1.00 share price. For example, a 5 basis point loss would not move the share price of a floating-NAV MMF with a share price of $1.00.... To reduce potential disruptions and facilitate the transition to a floating NAV for investors and issuers, existing MMFs could be grandfathered and allowed to maintain a stable NAV for a phase-out period, potentially lasting five years.... This would discourage significant and sudden investor redemptions that could occur out of fear that a fund would force existing shareholders to incur a loss immediately upon the fund's transition to a floating NAV."
They describe the NAV Buffer and Minimum Balance at Risk Alternative as, "A second regulatory reform alternative would mandate that most MMFs: (i) maintain an NAV buffer, which would be a tailored amount of assets of up to 1 percent in excess of those needed for a fund to maintain its $1.00 share price and which would absorb day-to-day fluctuations in the value of the fund's portfolio securities; and (ii) require that 3 percent of any shareholder's highest account value in excess of $100,000 during the previous 30 days (the MBR) be available for redemption with a 30-day delay. The MBR requirement would have no effect on any redemptions that leave an investor's remaining balance at least as large as the MBR; only redemptions of the MBR itself would be delayed. In the event that an MMF suffers losses that exceed its NAV buffer, those losses would be borne first by the MBRs of shareholders who have recently redeemed. These requirements would not apply to Treasury MMFs, and investors with balances of less than $100,000 would not be subject to the MBR requirement."
FSOC adds, "The NAV buffer and the MBR would be designed to reduce MMFs' susceptibility to runs by allowing a fund to absorb day-to-day fluctuations in the value of its portfolio securities, providing a disincentive for shareholders to redeem in times of stress, and allocating more fairly the costs to the fund that can result when shareholders do redeem. This alternative would be designed to address the structural vulnerabilities of MMFs while also allowing them to continue to maintain a stable NAV under most conditions."
They write on the "NAV Buffer and Other Measures," "This alternative would incorporate a larger risk-based NAV buffer than Alternative Two, of 3 percent, that could be combined with other measures to enhance MMFs' loss-absorption capacity and mitigate the run vulnerabilities that would be addressed by the MBR in Alternative Two. To the extent that more stringent investment diversification requirements, alone or in combination with other measures, complement the NAV buffer and reduce MMFs' vulnerabilities, the Council could include them in its final recommendation. These measures could serve to reduce the size of the NAV buffer required under this alternative accordingly. The Council requests comment on how the other measures might be structured; how, if at all, they could complement the NAV buffer and reduce the vulnerabilities described in Section IV; and whether more stringent investment diversification requirements, alone or in combination with other measures, would increase MMFs’ resiliency sufficiently to warrant a smaller NAV buffer requirement."
Finally, FSOC adds, "The policy alternatives discussed in the proposed recommendations described above aim to address the structural vulnerabilities inherent in MMFs and reduce their susceptibility to runs. The alternatives are not mutually exclusive but could potentially be implemented in combination. For example, sponsors could manage funds that have floating NAVs as well as stable NAV funds with the appropriate enhanced structural protections. The Council recognizes that there may be other reforms it could consider that are not mentioned above that may mitigate risks to financial stability by providing a substantial reduction in the susceptibility of MMFs to runs. Accordingly, in addition to the request for feedback on the proposed recommendations above, the Council also solicits comment on other possible reforms of MMFs that the Council should consider for its final recommendation."
