Frequently Asked Questions About ICI’s Money Market Working Group

Contents:

I. Money Market Working Group: Who, What, Where, and Why
II. The Report’s Recommendations
III. Other Proposals for Money Market Funds
IV. Money Market Funds and the Financial System
V. Money Market Funds and the Treasury Guarantee Program
VI. Money Market Working Group: Members and Advisers

I. Money Market Working Group: Who, What, Where, and Why

What is the Money Market Working Group?

The Money Market Working Group is a panel of industry leaders that was tasked in November 2008 with finding ways to strengthen the money market and money market funds. Established by the Executive Committee of the Board of Governors of the Investment Company Institute, the Money Market Working Group submitted its report to ICI’s Board on March 17, 2009.

On March 17, the ICI’s Board of Governors passed a resolution strongly endorsing the recommendations of the Working Group and urging all ICI money market fund members to take actions to implement those recommended practices that can be done without regulatory action as soon as possible, but no later than September 18, 2009.

Why did ICI form the Money Market Working Group?

The money market plays a vital role in the nation’s economy as a source of financing for U.S. businesses, financial institutions, consumers, and municipalities. In September and October 2008, a time of considerable financial turmoil, money market funds came under intense pressure. Following the bankruptcy of Lehman Brothers, one fund saw its share price, also known as net asset value (NAV), fall below the $1.00 level that money market funds strive to maintain. During this period, the Federal Reserve and the Department of the Treasury took unprecedented actions to keep the money market liquid and functioning.

ICI’s Executive Committee—as well as the industry as a whole—recognized this crisis as an opportunity to assess the regulations that govern the industry’s operations and the more stringent practices adopted by some money market funds that go beyond those regulations. The Money Market Working Group was formed to develop recommendations to improve the functioning of the money market and, in particular, the operation and regulation of money markets funds.

Are money market funds in trouble? Should I be worried?

No. Money market funds are governed very effectively by the Securities and Exchange Commission, both as mutual funds generally and pursuant to a carefully crafted rule under the Investment Company Act of 1940 (Rule 2a-7) that strictly limits the risks these funds can take. Since that role was adopted in 1983, money market assets have grown from about $180 billion to $3.9 trillion as of January 2009. Indeed, until September 2008, only once had a money market fund failed to repay the full principal amount to its shareholders’ investments.

II. The Report’s Recommendations

How did the Money Market Working Group produce this report?

The Money Market Working Group considered many ideas and consulted with a diverse group: institutional investors, sweep product providers, financial advisors to individual investors, a major consulting firm that works with corporations and financial institutions, U.S. and European regulators, counterpart trade associations in Europe and the United Kingdom, and academics.

How many recommendations are in the report?

The report offers 24 recommendations to make money market funds (already a very strong financial product) even stronger. The recommendations do so by addressing liquidity, maturity, credit quality, client concentration, and disclosure. They also give fund boards the necessary authority to assure fair treatment of all shareholders in the event of extreme redemption requests.

What is meant by liquidity, and what does the report recommend on the matter?

The liquidity of a security refers to the speed at which that security can be sold for approximately the price at which it is valued by the fund. The report recommends that money market funds should have, for the first time, mandated daily and weekly minimum liquidity standards. Taxable money market funds would be required to hold 5 percent of their assets in cash, U.S. Treasury securities, or other securities or repurchase agreements where the proceeds are accessible within one day. All money market funds would be required to hold 20 percent of assets in securities accessible within seven days. These minimum requirements would be supplemented by “stress testing” for the fund’s individual portfolio holdings and shareholder base to determine whether higher liquidity levels are needed.

What is meant by maturity, and what does the report recommend on the matter?

Maturity means the date by which an issuer (company, municipality, or government agency that issues fixed-income securities, such as bonds or money market instruments) promises to repay a security’s face value. The report recommends reducing the current dollar-weighted average maturity limitation for money market funds from 90 days to 75 days and establishing a new calculation that will further tighten maturities.

What is meant by credit quality, and what does the report recommend on the matter?

Credit quality refers to the amount of credit risk in a security held by the portfolio. In particular, credit risk for a bond issuer means the possibility that the issuer may not be able to pay interest and repay its debt. The report recommends requiring money market funds to establish a “new products” or similar committee to review and approve new investment structures before the fund invests in them. It also encourages money market funds and their advisers to follow best practices for determining minimal credit risks.

What is meant by client concentration, and what does the report recommend on the matter?

Client concentration refers to the number or type of investors holding shares of a fund. A money market fund’s ability to maintain sufficient liquidity (as discussed above) is closely related to the composition and diversification of its shareholder base. A fund with a few shareholders with large accounts seeking maximum yield, for example, could be more likely to face sudden redemption pressures than would a fund with many small accounts held by retail investors. The report recommends that money market funds adopt “know your customer” procedures and suggests that funds be required to provide monthly website disclosure to the public about client concentration levels and the risks involved.

What is meant by disclosure, and what does the report recommend on the matter?

Disclosure refers to a fund’s provision of important information to investors and regulators. The report recommends that money market funds be required to provide monthly website disclosure about portfolio holdings, among other steps to improve overall risk disclosure.

Will all of these recommendations get adopted by mutual funds and regulators?

Many of the recommendations are of a nature that money market funds can and should implement them immediately on a voluntary basis, pending appropriate rulemaking by the SEC. It should be the goal of all money market funds to substantially implement these recommendations by September 18, 2009.

What happens if some money market funds implement some of these recommendations, but not others?

ICI is notifying the SEC about these recommendations and will ask the Commission to advise money market funds that they must disclose whether or not they have voluntarily implemented the new standards.

If all of the Money Market Working Group’s recommendations get implemented, will that guarantee the performance of money market funds?

Money market funds are never guaranteed, but the recommendations should help them better manage scenarios such as extreme redemption pressure.

How much are these recommendations going to cost investors?

The report recommends requiring funds to be invested in securities with higher credit quality and more liquidity. Thus, their returns could be somewhat lower with these changes. However, the Working Group believes that these restrictions better protect shares of a given fund and money market fund shareholders more generally.

Are these recommendations just for U.S. money market funds?

The Working Group consulted with international counterparts and regulators in putting together this report and recommendations. The fund industry hopes to continue to work with the SEC and international bodies to ensure a best-practice, minimum standard for money market funds that look like U.S. money market funds (constant, stable NAV, and with risk-limiting protections for credit quality, diversification, maturity, and liquidity).

III. Other Proposals for Money Market Funds

Why does the report reject some other suggestions for money market funds?

The report discusses reforms proposed by others that would fundamentally alter the existing regulatory or business model of money market funds. The Working Group does not believe that such reforms are necessary or practicable. They also could have significant adverse consequences for the money market at large and for investors.

Shouldn’t money market funds be regulated like banks?

Money market funds are not banks. Banks use leverage; hold long-term, nontransparent investments, such as mortgages or business loans; and have substantial off–balance sheet commitments. Banks are required to hold capital to protect depositors, the Federal Deposit Insurance Corporation, and other creditors from losses. Money market funds are highly restricted by SEC regulation on the maturity and credit quality of their securities, and the report’s recommendations would further restrict holdings. Finally, capital requirements can protect against one-off losses from securities in a fund’s portfolio, but provide little protection against broad market events such as those experienced in the fall of 2008.

Why does the report oppose insurance for money market funds?

Some type of federal backstop would be required for an insurance scheme to be credible, and government insurance is a very blunt policy tool that ultimately creates its own market distortions. For example, an unlimited federal insurance guarantee for money market funds could draw large sums of money from traditional banks and other cash pools, causing significant disruption to the banking system.

Why does the report oppose requiring money market funds to “float” their share price, rather than allowing them to maintain a fixed NAV at $1.00?

The $1.00 NAV is a fundamental characteristic of money market funds, and the Working Group concluded that investors would be far less likely to use the product without it. Floating the NAV would not relieve market pressures on funds. In fact, in recent months, other products that use a floating NAV experienced similar redemption and market stress problems as fixed-NAV money market funds. Ingrained institutional motivations and legal, tax, and accounting factors all drive the demand for stable-NAV products. If money market funds were barred from offering a stable NAV, investors would continue to seek such a product and would turn to cash pools that are less regulated than money market funds.

IV. Money Market Funds and the Financial System

Where does the report stand on the risks that market funds may present to the financial system as a whole?

The Working Group acknowledges that the money market as a whole is systemically important, but notes that no single money market fund is large enough to pose a systemic risk. The Working Group’s recommendations will protect investors and the money market by increasing the resiliency of money market funds, especially in extreme financial circumstances. The Working Group also proposes developing a reporting regimen for all institutional investors in the money market to enhance regulatory authority and knowledge of market conditions.

V. Money Market Funds and the Treasury Guarantee Program

What does the Report say about the Treasury Guarantee Program for Money Market Funds? Will this program become permanent? 

The Temporary Guarantee Program was established during the market crisis of September 2008 and was authorized for one year. At that time, there was a need for such a temporary government program and, together with other measures taken to stabilize the market, it worked well to restore liquidity and raise investor confidence. The report recommends that the Temporary Guarantee Program be extended until September 18, 2009, and then be allowed to expire, as scheduled. The report’s recommendations will increase the resiliency of money market funds and thus allow the products to exist without the need for a federal insurance program.

How do you know the industry won’t ask for another extension in September if the markets are still facing turmoil?

The Working Group can’t predict the future, but is confident that implementing these proposals immediately and across the board will prepare funds and investors for that program’s expiration.

VI. Money Market Working Group: Members and Advisers

Members

• John J. Brennan, Chairman, The Vanguard Group, Inc.
• James H. Bodurtha, Independent Director, BlackRock Funds
• Richard S. Davis, Managing Director, BlackRock, Inc.
• Mark R. Fetting, Chairman and CEO, Legg Mason, Inc.
• Martin L. Flanagan, President and CEO, Invesco Ltd.
• George C. W. Gatch, President and CEO, J.P. Morgan Funds, J.P. Morgan Asset Management
• John W. McGonigle, Vice Chairman and Director, Federated Investors, Inc.
• James A. McNamara, President and CEO, Goldman Sachs Mutual Funds, Goldman Sachs Asset Management
• Randall W. Merk, Executive Vice President, Charles Schwab & Co., Inc., and President, Schwab Funds
• Paul Schott Stevens, President and CEO, Investment Company Institute
• Michael Wilens, Head of Asset Management, Fidelity Investments

Advisers

• Mary Colby, Managing Director, Head of Municipal Research, Charles Schwab Investment Management
• Deborah Cunningham, Senior Vice President, Senior Portfolio Manager, Federated Investments, Inc.
• John T. Donohue, Chief Investment Officer: Global Liquidity, J.P. Morgan Asset Management
• Dave Fishman, Managing Director, Co-Head Global Liquidity Management, Goldman Sachs Asset Management
• David R. Glocke, Principal, The Vanguard Group, Inc.
• Richard K. Hoerner, Managing Director, BlackRock, Inc.
• Karen Dunn Kelley, Chief Executive Officer, Worldwide Fixed Income, Invesco Ltd.
• Kevin Kennedy, Portfolio Manager, Western Asset Management
• Mary J. Miller, Director of Fixed Income, T. Rowe Price Associates, Inc.
• Charles Morrison, Head of Fixed Income Money Markets, Fidelity Investments

March 2009