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ICI Floats Idea of Money Fund Liquidity Facility

Would be State-Chartered and Adhere to Banking Laws

PHOENIX -- The money market fund industry and the Investment Company Institute are dead-set against a floating net asset value.

To show the Securities and Exchange Commission just how vigorously it opposes the idea of a floating NAV, the ICI is working on creating a state-chartered liquidity facility for prime money market funds.

"This facility would provide a second buffer to assist prime money market funds in meeting redemptions," said ICI President and CEO Paul Schott Stevens, at the ICI's Mutual Funds and Investment Management Conference here last week.

Stevens said the ICI's Money Market Working Group, chaired by Vanguard Chairman Emeritus John J. Brennan, has been working on the idea of a liquidity facility since it submitted its initial report to the SEC a year ago.

"After it issued its report last March, the ICI's Money Market Working Group began to explore additional ideas for providing liquidity for money market funds to meet redemptions when liquidity has dried up in the markets," Stevens said. "We have responded to an idea advanced in the Treasury Department's June 2009 whitepaper on financial regulatory reform, which called for exploring measures to require money market funds 'to obtain access to reliable emergency liquidity facilities from private sources.'"

Stevens said the ICI has been actively engaged in a task force sponsored by the Federal Reserve Bank of New York that seeks to strengthen money market tri-party repurchase agreements. Also included in the task force are regulators, clearing banks, cash borrowers and lenders, including money market funds.

"The goal is to improve the clearance and settlement arrangements and credit and liquidity risk management practices of market participants, while also providing greater transparency into this market for regulators," Stevens said.

He said a dedicated liquidity facility would likely be "a state-chartered bank or trust company, organized and capitalized by the prime money market fund industry and managed and governed in accordance with applicable banking laws."

The facility would be dedicated to providing additional liquidity to prime money market funds in the event of severe market conditions, he said.

"We have discussed this facility with regulators and other policymakers, and we recognize that there are significant hurdles we must clear in order to create such an institution," Stevens said. "I can't give you an exact time table on when-or even if-this liquidity facility might be launched."

In January, the SEC adopted several amendments to Rule 2a-7 governing money market funds that aim to reduce risks by increasing credit quality, improving liquidity, shortening maturity limits and requiring the disclosure of a funds' "shadow" NAV. The Commission fell short of requiring a floating NAV, but said it may still consider such a move in the future, as well as eliminating the new 60-day disclosure delay on holdings and the use of credit ratings agencies.

Under the new liquidity standards, money market funds are required to hold enhanced cash reserves in order to meet daily liquidity requirements of 10% of assets in cash or in cash equivalents, and weekly liquidity requirements of 30%. The rules also require funds to have "know-your-customer" procedures that would enable them to hold enough liquid securities to handle large redemption requests.

Stevens said assets in prime money funds currently stand at $1.8 trillion. Under the SEC's new requirements, prime money market funds would be required to hold, at a minimum, $540 billion in assets that are liquid within seven days, $180 billion of which must be redeemable on any given day.

A liquidity facility would provide a second buffer to assist prime money funds in meeting redemptions in excess of these new requirements, he said.

Fundamental Changes

The President's Working Group on Financial Markets is nearing completion on a report that seeks a "fundamental structural change in the money fund industry," said SEC Commissioner Luis Aguilar in a speech immediately following Stevens'.

"In particular, the staff is examining the merits of a floating, mark-to-market NAV for money market funds, rather than the stable $1 price," Aguilar said. "Other ideas under consideration include real-time disclosure of the shadow price; mandatory redemptions-in-kind for large redemptions, such as by institutional investors; a private liquidity facility to provide liquidity to money market funds in times of stress; and a possible 'two-tiered' system of money market funds, with a stable NAV only for money market funds subject to greater risk-limiting conditions and possible liquidity facility requirements, among others."

Stevens said the ICI adamantly opposes the floating NAV idea and added that such a move would "destroy money market funds as we know them."

The group's pending report raises a lot of difficult questions, particularly in the institutional money fund space, said Robert Plaze, associate director of the SEC's Division of Investment Management. Plaze joked that the discussions at the President's Working Group would give Stevens indigestion.

Peter Crane, president and publisher of Crane Data LLC and Money Fund Intelligence, said he assumes such a liquidity facility would be modeled after the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) run by the Federal Reserve Bank of Boston. That facility was created to provide liquidity after The Reserve's Primary Fund "broke the buck" in September 2008. The AMLF program expired last month.

"The fact that Paul Stevens came out with the idea for the liquidity facility shows how serious this issue is," Crane said. "The President's Working Group was tasked with choosing between a liquidity facility and a floating NAV, and the industry is hoping for the liquidity facility."

Karrie McMillan, general counsel for the ICI, emphasized that the ICI hasn't filed a formal proposal yet. In order for such a facility to work, it would need the proper scale and would have to have all prime money funds participating, McMillan said. This facility would transact at amortized cost, hold securities until maturity and wouldn't sell into a depressed market, she said.

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