Though Friday's deadline has now passed for Comments on the Financial Stability Oversight Council's Proposed Recommendations Regarding Money Market Mutual Fund Reform, comment letters continue to be posted. We'll be reading through them in coming days, and will continue excerpting from the relevant ones. Today, we quote from UBS's comment. Rob Sabatino and Keith Weller write, "UBS Global Asset Management (Americas) Inc. ("UBS Global AM") appreciates the opportunity to comment on the FSOC Proposal. We strongly oppose requiring a floating net asset value ("NAV") per share for money market funds ("money funds") and believe that all money funds that meet the requirements of Rule 2a-7 under the Investment Company Act of 1940, as amended ("1940 Act"), should be allowed to continue to maintain a stable NAV per share. We also do not support the other proposed recommendations that the Financial Stability Oversight Council (the "FSOC" or "Council") would make to the SEC. As described more fully below, we believe the FSOC Proposal to require money funds to float their NAVs will actually increase systemic risk by: (1) driving money into other financial products which generally do not have as well diversified issuer risk as money funds and (2) causing investors to gravitate toward higher yielding, short-term bond funds, which also have floating NAVs, increasing investors' interest rate and credit risk. We do not believe that floating the NAV of money funds will be effective in modifying investor behavior. We support changes to money funds that facilitate the orderly and equitable management of redemptions from money funds experiencing significant redemption activity."
The UBS letter explains, "As detailed below, we support the following alternative approach: enhancing disclosure in prospectuses and marketing materials; granting fund boards enhanced authority to suspend redemptions/gate, as tailored to a fund's particular circumstances in light of the facts prevailing at the time that the situation is being addressed; enhancing further the SEC's authority to monitor money funds; and further substantive amendments to Rule 2a-7. We supported the amendments to Rule 2a-7 and other related rules under the 1940 Act adopted by the SEC in 2010 that strengthened the transparency and regulation of money funds (the "2010 Amendments"). We believe that time will show that the 2010 Amendments struck the correct balance between the protection of investors and the promotion of efficiency, competition and capital formation in the US economy."
It continues, "Mandating that money funds have a floating NAV per share would remove much of the incentive for investors to invest in money fund shares and may well diminish substantially the size of the money fund business. Historically, money funds have offered both retail and institutional investors a means of achieving a market rate of return on a short-term investment without having to sacrifice stability of principal. The stable NAV per share allows investors the convenience of not having to track gains and losses on a short-term investment and facilitates investment processes, such as sweep account arrangements at broker-dealers and banks, helping to make sure that investors’ cash balances are fully invested. However, the $1.00 NAV per share does not and has never constituted or reflected a guarantee of the amount of the investment. Accordingly, the absence of a government guarantee and the fact that an investor may lose money by investing in a money fund are prominently displayed in fund disclosures, including on the cover page of the fund prospectus."
UBS adds, "In the FSOC Proposal, the Council stated that requiring money funds to 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 $1.00 NAV per share. However, it is important to note that not all prime money funds experienced mass redemptions after the Reserve Primary Fund broke the dollar share price in September 2008.... Moreover, according to a study conducted by the Investment Company Institute, floating NAV ultra-short bond funds experienced outflows in excess of 60 percent during the 2008 financial crisis from their peaks. In our experience, we found that floating NAV short-term funds managed by the UBS Global Asset Management Division were not less susceptible to redemption pressures than stable NAV money funds.... These facts strongly indicate that the stable NAV of money funds did not cause the reaction of investors who redeemed in the face of possible losses."
They write, "The FSOC Proposal also indicated that regular fluctuations in money funds' NAVs likely would cause investors to become accustomed to, and more tolerant of, fluctuations in NAVs. Money fund investments, by their very nature as short-term investments of the highest credit quality, do not ordinarily fluctuate in value on a day-to-day basis, certainly not to an extent that necessarily would cause investors to become accustomed to fluctuations. Given the minimal fluctuations in NAV, money fund shares would likely continue to trade at a $1.00 NAV per share. The Council stated in the FSOC Proposal that a floating NAV would also reduce the "first mover advantage" that exists in money funds 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. We suggest that a better approach to reduce the first mover advantage would be to empower money fund boards to impose redemption gating or other restrictions as necessary to prevent some investors from gaining an unfair advantage over other investors."
UBS tells FSOC, "The FSOC Proposal stated that a floating NAV "would remove uncertainty or confusion regarding who bears the risk of loss" in a money fund. Given the fact that the market value of short-term, high quality investments does not ordinarily fluctuate on a day-to-day basis to any meaningful extent, whether a floating NAV would achieve this goal is uncertain at best. The goal of ensuring that money fund investors understand the risks of investing is an important one with which UBS Global AM and others in the industry can readily agree. However, this goal can be far more effectively addressed through requiring enhanced disclosure in the prospectus, summary prospectus and marketing materials of every money fund."
They add, "As a practical matter, the proposed Buffer would be difficult, if not impossible, for most money fund sponsors to implement, given the economic realities of the money fund business. The historically low interest rates that currently are paid on short-term money fund securities have resulted in many prime money funds being unable to earn a return that is sufficient to cover fund expenses. In the face of this environment, many money fund sponsors have waived management and other fees and/or reimbursed fund expenses to enable funds to continue to operate and to keep fund expenses from reducing fund assets. This low interest rate environment, which has existed since the 2008 crisis and is likely to continue for the foreseeable future, has greatly reduced, if not eliminated, profitability from the money fund business for many sponsors and would make it difficult for any sponsor to fund a Buffer out of its own resources."
They explain, "The Buffer proposal is not a necessary or appropriate means of implementing money fund reform. The proposal purports to base the size of a fund's buffer on the level of risk presented by the money fund's portfolio holdings. However, the proposal significantly overstates the level of risk presented by a fund's portfolio and would result in too high a level of buffer being maintained. In the event a determination is made to move forward with the proposal, we propose below an alternative Buffer proposal. Assuming that a Buffer is to be required, the purpose of the Buffer should be to ensure that a money fund has on hand sufficient assets to pay $1.00 per share to redeeming shareholders without harming the interests of those shareholders who have not redeemed. To accomplish this goal, the size of the Buffer should be measured by the difference between the fund's current market based NAV and the $1.00 price at which money fund shares are redeemed.... In the event that a money fund's market-based NAV per share were to exceed $1.00, no Buffer would be required."
Finally, UBS writes, "The Risk Based NAV Buffer in Alternative Three represents a debatable effort to protect money funds from investment losses, so as to avoid the possibility of investor redemptions that could cause problems for the funds and, the proposal assumes, the financial system. As investment companies, money funds take investment risks and can lose money. These risks are an unavoidable part of operating any mutual fund and are required by the federal securities laws to be fully disclosed to investors. Investors in money funds, thus, unavoidably bear the risk of loss. To try to require a fund to maintain a NAV buffer for the purpose of offsetting any losses that might be realized is both a mistake and a losing proposition. A more realistic approach to addressing the risks of "runs" on money funds would be to incorporate the following concepts.... `Enhance further risk disclosures in money fund prospectuses and marketing materials to ensure that investors understand that, by holding fund shares, they are assuming the risk of loss.... Provide fund boards with the flexibility to temporarily suspend redemptions of fund shares (or, alternatively, to record redemption requests, but temporarily suspend the payment of redemption proceeds) in the event that a fund experiences events, whether through holding defaulted securities, experiencing an unanticipated high volume of redemptions or some combination of these and other events (such as market illiquidity), that threaten the ability of the fund to continue to maintain the $1.00 share price or to make payment upon redemptions."
