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SEC to Rewrite Money Fund Rule 2a-7

'Urgent Discussions' Continue on Unfreezing Markets, Market Stability Regulator


NEW YORK - In the wake of the ongoing credit crisis and illiquid money market, much of it due to the failure of a single money market mutual fund, the Securities and Exchange Commission plans to overhaul Rule 2-a7. Separately, the Department of the Treasury is looking into creating a market stability regulator with omniscient powers across the "entire financial system."

"Money market funds have been stable throughout some of the most challenging environments," said Andrew J. Donohue, director of the SEC's division of investment management, addressing Investment Company Institute members here Monday. "The model is to be improved. The goals of stability, liquidity, income can sometimes be in conflict with one another."

In fact, Donohue told the audience at the ICI's Equity, Fixed Income & Derivatives Markets Conference, "There are three classes of money market fund investors: redeemers, purchasers and investors. It is easy in times of stress to focus on the needs of one and not the needs of all. Rule 2a-7 must be rethought, even though it has worked well for 37 years."

One possibility is to devise various types of money market mutual funds that accomplish these goals separately, Donohue said.

The SEC will also explore putting a cap on redemptions. "Institutional investors can move large blocks of money. This can work to the detriment of shareholders," Donohue explained. Certainly, one weakness in the current rule governing money market funds is that it has "no real focus on liquidity," he said.

Disclosure and risk are two other areas the SEC will review, seeking to provide "better and more timely information about money market funds and their holdings."

Finally, the SEC will look into whether a $1 NAV or a $10 NAV is a more efficient pricing model; ensuring that orderly securities lending continues in times of stress to provide additional liquidity; and whether the SEC's powers and oversight should extend to non-regulated cash management accounts, which have recently experienced the same investment and liquidity strains as money market funds, Donohue said.

Mutual fund executives can expect these and a wide range of other market-oriented regulations to restore order and safety to-and, most critically, faith in-trading and investing, speakers said.

Despite the overwhelming actions of the federal government to provide guarantees and absorb faulty debts, noted ICI President Paul Schott Stevens, "The crucial element-free and liquid trading in the money markets-remains elusive." Thus, the ICI will continue to work with the "public sector and private; buy side and sell; funds, banks and dealers-to find mechanisms to unfreeze these markets. We are continuing our urgent discussions with all responsible policy-makers," Stevens said.

The government's goal is not to usurp the free markets but to remove "the excesses of the past and restore equilibrium" through "balanced regulatory oversight," said Anthony Ryan, acting under secretary for domestic finance at the Treasury. The hope is to reengineer the capital markets and regulate them properly so that they can once again work competitively, innovatively and efficiently on their own, Ryan said.

In the wake of these actions and the $700 billion Emergency Economic Stabilization Act of 2008, "the financial landscape will be quite different," he predicted.

For starters, the President's Working Group on Financial Markets will release its recommendations on six areas at the heart of the financial crisis: mortgage origination, capital market discipline and liquidity, ratings on structured credit, risk management, adequate and updated regulatory policies and the OTC derivative market.

Possibly the biggest contribution from the Treasury, Ryan said, would be the creation of a market stability regulator that would provide transparency and disclosure.

"The market stability regulator would have the ability to evaluate capital, liquidity and margin practices across the entire financial system and their potential impact on overall financial stability," Ryan said.

The Treasury is also intent on updating "outdated 20th century laws and structure." he added.

"Given the diversity of market participants, the constant innovation undertaken by market practitioners, the growing complexity of financial instruments and the convergence of financial intermediaries and trading platforms-all within a global context-establishing a more robust, nimble regulatory structure is critical," the Treasury under secretary said.

"That being said, make no mistake, there is a great deal of work ahead of us," Ryan said. "It will take our collective best efforts and a good deal more time."

No Shutting Down

As to how the government was able to so quickly shore up money market funds with the $50 billion guarantee program, the $300 billion Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility and the potential $1.3 billion commercial paper repurchase plan to offset $500 billion in outflows from prime money market funds since last month- the ICI played a big role, Stevens informed fund executives.

As far back as a year ago, when the mortgage defaults first began to strain the capital markets, the ICI worked assiduously to educate the Fed about the pervasive and critical role the money market industry plays in the capital markets, Stevens said. "The $3.4 trillion in assets held by money market funds is vital fuel for the financial engines that drive the American economy," he said.

If the run on money market funds had not been stopped, the inability of those portfolio managers to participate in the money markets would simply have "shut down" the economy, Stevens said.

It is notable that while the recent run on money market funds totaled $239 billion in one week, retail and institutional investors have returned to the instruments, resulting in inflows in three of the past four weeks, Stevens said.

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