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Comment Letter Fact Sheet
Other Possible Reform Measures for Money Market Funds
On January 10, 2011, ICI filed a comment letter with the Securities and Exchange Commission addressing the proposals outlined in the President’s Working Group on Financial Markets (PWG) Report on Money Market Fund Reform Options.
We strongly support creation of a private emergency liquidity facility for “prime” money market funds, and we strongly oppose any requirement that money market funds be forced to adopt floating net asset values. Those positions are outlined in companion fact sheets.
This page addresses other options offered by the PWG Report. In general, ICI found that these proposals have drawbacks, ranging from potential detrimental impacts on money market funds, their issuers, and investors, to complicated regulatory, structural, and operational hurdles.
Mandatory Redemptions in Kind
The PWG report discusses the concept of requiring money market funds to pay certain large redemptions through the distribution of a proportionate amount of the fund’s securities to the redeeming shareholder. These “in-kind” redemptions currently are permitted, but due to operational and other reasons, are rarely invoked.
- Difficulties determining appropriate thresholds: Mandatory redemptions in kind, by their very nature, require regulation specifying the conditions or events that would trigger the requirement. These regulations would also need to specify the threshold level of redemptions to which the in-kind requirement would apply. Such thresholds are difficult to determine in advance, and would condition investors to redeem shares in advance of the trigger event.
- Investors’ efforts to avoid mandatory redemptions in kind: Investors would likely work around mandatory redemption in kind requirements—for example, by carefully allocating investments among multiple funds in amounts below the anticipated thresholds. As funds enter periods of net redemptions, however, investors intending to be below the threshold may seek to redeem shares in order to stay below the threshold or to avoid having to monitor the size of their positions in a shrinking fund. Those redemptions would in turn place additional downward pressure on the market.
- Investors’ efforts to avoid mandatory redemptions in kind: As funds enter periods of net redemptions investors intending to be below the threshold may seek to redeem shares in order to stay below the threshold or to avoid having to monitor the size of their positions in a shrinking fund. Those redemptions would in turn place additional downward pressure on the market.
- Market pressures exacerbated by redemptions in kind: Investors who receive redemptions in kind but need immediate liquidity will have no option but to sell the securities received into a falling market, likely causing further dislocations. Potentially, all money market funds holding these securities could be required to mark down their value, placing additional pressure on the value of all such funds’ shares and further destabilizing the market.
- Operational hurdles: Redeeming money market securities in kind presents valuation and operational problems for both the fund and its shareholders.
- For more, see page 42 of the letter.
Insurance Programs for Money Market Funds
ICI has serious concerns about the feasibility and desirability of an insurance program for money market funds.
- Pure federal insurance: A permanent federal insurance program—whether unlimited or partial—raises deep concerns about market distortions, particularly for banks.
- Pure private insurance: Extensive discussions with insurance industry experts indicate that private, unlimited “break-the-dollar” insurance is not feasible, due to the risks of contagion, and the financial crisis’s impact on confidence in private insurers.
- Hybrid insurance programs: A federal backstop would boost confidence by market participants in the program. However, capital for the private insurance portion, even when that insurance is limited, would be extremely difficult to obtain.
- For more, see page 46 of the letter.
A Two-Tier System with Enhanced Protections for Stable NAV Money Market Funds
Another option would be allow two types of money market funds to be regulated under Rule 2a-7. Stable net asset value (NAV) money market funds would continue to maintain stable $1.00 NAVs, but they would be subject to “enhanced protections,” which might include “some combination of tighter regulation (such as higher liquidity standards) and required access to an external liquidity backstop.”
- The PWG report is vague regarding what “enhanced protections” it envisions. More details would be necessary before ICI could determine whether to endorse or reject the approach.
- If “enhanced protections” made the product less attractive to investors, this approach would not address systemic risks.
- The PWG report contends that under a two-tier system, investors who choose floating NAV funds presumably would be less risk-averse and more tolerant of NAV changes than the shareholders of stable NAV funds. This assumes that investors would fully appreciate the differences between the two types of funds.
- In any case, recent experience has shown that floating the NAV of a money market fund would not lessen the incentive for investors to redeem shares rapidly in periods of market turmoil.
- For more, see page 50 of the letter.
A Two-Tier System of Money Market Funds, with Stable NAV Money Market Funds Reserved for Retail Investors
This approach would distinguish stable NAV and floating NAV funds by investor type. Under this option, stable NAV money market funds could be made available only to “retail” investors, while “institutional” investors would be restricted to floating NAV funds or alternative products.
- Because many institutional investors may be particularly unwilling to switch to floating NAV money market funds, a prohibition on sales of stable NAV funds to such investors may have many of the same unintended consequences as a requirement that all money market funds adopt floating NAVs.
- A floating NAV product is not likely to deter institutional investors from exiting quickly in a crisis, and thus putting stress on securities held by both “retail” stable NAV funds and “institutional” floating NAV funds.
- There are important areas of overlap between retail and institutional investors that can make drawing a bright line between types of investors quite challenging and therefore inconsistent across the industry.
- For more, see page 51 of the letter.
Regulating Stable NAV Money Market Funds as Special Purpose Banks
The PWG report raises the possibility of requiring bank-like regulation of money market funds that maintain a stable NAV.
- Regulating money market funds under bank regulations poses significant implementation issues.
- It is not clear whether the business model for money market funds would remain viable as a special purpose bank.
- If bank-like regulation is viewed as a means to provide deposit insurance to money market funds, such insurance would distort financial markets and create significant amounts of moral hazard.
- We are not aware of the evidence supporting the position that the bank structure and regulation is superior to that of mutual funds, or money market funds in particular.
- For more see page 53 of the letter.
Enhanced Constraints on Money Market Fund Substitutes
The PWG report discusses the possibility of imposing enhanced regulatory constraints on investments that could serve as alternatives to money market funds, particularly if other reforms greatly reduce the appeal of money market funds to many investors.
- Such reforms would likely do little to reduce systemic risk given the wide variety of alternative cash management products available to institutional investors, including offshore money funds and overnight sweep arrangements, many of which are largely beyond the jurisdictional reach of domestic regulators.
- For more, see page 57 of the letter.
For more information on regulatory developments on the reform of money market funds, please visit ICI's Money Market Funds Resource Center.