Ever since the Reserve Primary Fund "broke the buck" in 2008, regulatory reform of money market funds (MMFs) has been an area of intense debate. Following the financial crisis and given the important and pervasive role played by MMFs in the US and global economies, regulators embarked on a two-step process of reforming the regulation of MMFs. In 2010, the SEC approved new regulations intended to address credit quality, liquidity, maturity, and transparency concerns. Since that time, the SEC, legislators, the Fed, and market participants have vigorously debated "step two," further regulatory measures aimed at reducing the risk of a run on MMFs and providing a cushion against losses. Are these further reforms necessary? Or have we done enough already?
Success of the 2010 Reforms
Fidelity, in a March 1, 2012
letter to the SEC, examines to what extent the 2010 reforms have reduced risk in MMFs by imposing more stringent constraints on portfolio liquidity, maturity, and quality, and through new requirements relating to disclosure, operations, and oversight. Fidelity's study finds that the 2010 reforms were successful in making MMFs less susceptible to runs, achieved a proper balance between costs and benefits, and played a vital role in helping MMFs navigate successfully the market volatility experienced in 2011. The data collected by Fidelity leads them to conclude that the 2010 reforms have been so effective no additional reforms are necessary or even advisable.
In the wake of these SEC actions in 2010, money market funds now hold investment portfolios with lower risk and greater transparency, characteristics that reduce the incentive of shareholders to redeem. Contrary to recent comments by some that mutual funds are living on borrowed time, we strongly believe that additional regulation of money market funds is neither necessary nor desirable.
Consequently, Fidelity urges caution in any further reform steps being considered by the SEC, warning that the unintended consequences could put the entire MMF industry in peril.
Additional reforms should be carefully considered prior to implementation to ensure that they are consistent with creating a stronger, more resilient product that serves the needs of short-term investors and borrowers, without imposing harmful, unintended consequences on financial markets or on the U.S. economy.
Further Reforms
Notwithstanding the apparent efficacy of the 2010 MMF reform measures, many regulators and legislators feel that MMFs could still become a source of systemic risk because of their susceptibility to sudden shareholder redemptions. This has led to many alternative reform suggestions, some mutually exclusive and some that may be used in concert. Many of these proposals go to the very heart of the current MMF structure, and threaten to change not just the fund products themselves, but the nature of the entire MMF industry. Among these proposals are imposing capital requirements, various types of redemption restrictions, and most controversial of all, freeing MMFs from the fixed $1 net asset value (NAV) in favor of a floating NAV. In an effort to make sense of the controversial and sometimes competing second step reforms, Blackrock has put together a
publication laying out what's been floated thus far, along with some critical analysis.
Like Fidelity, Blackrock is skeptical that further reform is necessary. They ask "have we done enough already?"
No discussion of MMF reform would be complete without consideration of the question: Have we done enough already? Some in the industry have argued that sufficient action has been taken and that the $2.66 trillion MMF industry is in a place of strength and stability today.
Blackrock argues that the 2010, coupled with the efforts that have been undertaken in the US and worldwide to strengthen the broader financial system have left the MMF industry stronger and less risky. Further, Blackrock makes the point that the global financial reforms have made the MMF industry less systematically important, obviating the need for additional measures to curtail the systematic risks posed by MMFs.
A frequently overlooked point is that in addition to changes to MMFs themselves, regulators have substantially limited the ability of financial institutions to rely on short-term funding in their capital structures. This has perhaps been the most significant regulatory change of all. The result has been a reduction in supply of some of the short-term instruments most used by money market funds. Between December 31, 2007 and September 30, 2011, commercial paper outstanding fell 44% and large bank time deposits declined by 30%. We believe the reduced reliance on short-term funding by financial institutions reduces the systemic importance of the money fund industry.
How Much Is Too Much?
The goal of regulators should be to impose only the amount and type of additional regulation necessary to reduce the systemic risk posed by MMFs without damaging their important role as a source of value to investors and funding to the short-term capital markets. Given the size and importance of the MMF industry, as regulators continue their work in the area, it is important that fund sponsors, investors, industry organizations, and corporate and municipal issuers of commercial paper to provide data and feedback on what has already been done, as well as rigorous examination and continue to examine critically any further proposed reforms.