Today, we excerpt from "A Guide to Understanding How Money Market Funds Serve Investors," which was a supplement to our recent Money Fund Symposium Binder provided by Federated Investors' John McGonigle (who spoke on our "Regulatory Roundtable" session June 21). The Guide, which was written by Stephen Keen of Reed Smith LLP, explains in its introduction, "Federated Investors, Inc. has prepared this briefing book to help provide both the facts and the conceptual foundations needed to appraise how proposed structural reforms of money market funds will affect the more than 56 million Money Market Fund shareholders and, in turn, the capital markets."
It says, "The most important thing to understand is why there are more than 56 million money market fund investors. People use money market funds ("MMFs") because they need what a MMF does for them. This briefing book is intended as a primer on what a MMF is, how it works, how it satisfies the basic and important needs of investors for a stable value and ready access to their cash, and the history of MMF operations and regulations. The importance of the history of the MMF is that it is a Securities and Exchange Commission-enabled innovation that has become a fundamental vehicle for cash management for individuals, as well as an array of other investors such as corporate and personal trustees, businesses, state and local government entities, other government-sponsored enterprises, and pension plans. This innovation has led to the MMF becoming a critical component of the financial products and companies that, together, are the financial services industry providing services underlying the system that is our capital markets. While it is important to understand how the MMF fits into the financial services industry, we encourage you to also seek to listen to the shareholders ... the investors ... in MMFs who are the fund's primary beneficiaries. It is the efforts of the 56 million shareholders to satisfy their financial needs that ultimately drive the capital markets."
The piece tells us, "Section 1 begins by explaining how most MMFs have managed to preserve the value of their shareholders' investments, year-in and year-out, without any financial support from their sponsors or from the government. Using Federated's largest prime MMF as an example, this section explains: How the fund has provided for the past 23 years, without interruption or the intervention of its sponsor, daily liquidity to shareholders who purchase and redeem a billion shares a month. How the fund maintains a stable $1 net asset value per share (a stable "NAV") that is fair to its shareholders, who have earned billions more than they could have from other cash investment alternatives. Why shareholders rely on MMFs to meet their transactional, operational and strategic cash needs, and the enhanced levels of professional management, service and diversification these funds provide. The significant legal, tax, accounting and operational difficulties that changes in a share's price would create for these shareholders, if they were required to transact at a fluctuating NAV."
It continues, "Section 2 provides a history of money market fund regulation, including: The history of the Securities and Exchange Commission's ("Commission") interpretations and hearings that led to the exemption of MMFs from certain pricing standards of the Investment Company Act of 1940 (the "ICA"); The Federal Reserve's initial efforts to limit the appeal of MMFs to cash investors; and The Commission's adoption and extensive amendment of Rule 2a-7."
The Guide adds, "Section 4 reviews the impact of the recent financial crisis on MMFs. This section draws almost exclusively on the findings of the Financial Crisis Inquiry Commission and a report prepared by the Commission's Division of Risk, Strategy and Financial Innovation (the "Risk Fin Division") to show: MMFs did not contribute to the "bubble" in real estate financing that was the primary cause of the financial crisis; Prime MMFs absorbed, without any government assistance, the initial shocks from the collapse of the bubble in 2007; Prime MMFs were not otherwise affected by the financial crisis until its climax during the days following Lehman Brothers bankruptcy, which touched off an "extraordinary rush" to safety that spread to every corner of the global credit markets; and Cash began to flow back into prime MMFs within three weeks after Lehman Brothers bankruptcy and continued to do so during the remainder of the financial crisis."
It asks, "What steps are most critical for the Council to take to prepare for the possibility of a future financial crisis? The Council can best prepare for the next financial crisis by completing the regulatory program mandated by the DFA [Dodd-Frank Act]. As the Chairman acknowledged during her confirmation hearing, "complet[ing] these legislative mandates expeditiously must be an immediate imperative for the SEC." Completion of DFA's mandates is no less imperative for the other Council members. The fact that none of the DFA's provisions were directed at MMFs strongly indicates that Congress did not consider MMF reform a priority."
The Guide answers, "Perhaps the most important step would be for the Federal Reserve to comply with the mandate in Section 1101 that it "establish, by regulation, in consultation with the Secretary of the Treasury, the policies and procedures governing emergency lending [in compliance with Section 1101] for the purpose of providing liquidity to the financial system." Congress directed the Federal Reserve to undertake this rulemaking "[a]s soon as is practicable" after the date of enactment of the DFA, specifically to avoid bailouts of individual institutions and to avoid the ad hoc and inconsistent approach taken in 2008, which the FCIC concluded, "added to uncertainty and panic in the financial markets." Yet, more than two and a half years after the enactment of this congressional directive, no rules under this section have even been proposed. Given the critical role played by the Federal Reserve during a financial crisis, the policies and procedures adopted under Section 1101 should be a lynchpin for any plans to prepare for the next financial crisis. If the Council [FSOC] makes any recommendations to one of its members, it should begin by recommending that the Federal Reserve complete these policies and procedures so they may be factored into the policies adopted by the other members."
It adds, "In summary, this briefing book has demonstrated that: 1. Nearly all MMFs have provided their shareholders with a stable NAV without sponsor or government support; 2. Shareholders need a stable NAV for cash management; 3. MMFs were not affected until the very peak of the financial crisis, and then only for a brief period; 4. Confidence in MMFs was quickly restored during the financial crisis and the Commission acted promptly to further increase the resiliency of MMFs; 5. Current regulations minimize the risk of a fund breaking a dollar and charge the Board with preventing any dilution or other unfair results if their fund breaks a dollar; and 6. MMFs could not survive any of the reforms currently being considered in the FSOC Proposals."
Finally, the piece, which was written prior to the SEC issuing its latest MMF Reform proposals, says, "Federated must emphasize that it has not opposed legitimate enhancements to MMF regulations. Federated advocated for most of the reforms the Commission adopted in 2010. In addition, we have submitted a detailed proposal to the Commission to enhance the Board's oversight of events that might lead to wide-scale redemptions from a MMF, and to give the Board the ability to suspend redemptions for a brief period while it determines which course of action would best protect the fund's shareholders. The FSOC Proposals, however, that would make it nearly impossible for shareholders to use MMFs or for managers to operate them profitably, or both, are not "enhancements" to current regulations. The Commission should be allowed to perform its proper role by using its years of expertise in overseeing MMFs to develop (working with the industry) reform proposals consistent with its mission of protecting investors and promoting efficiency, competition, and capital formation."
