Floating NAV? Ready, Set, Reload
October 5, 2012
Well, that didn't take long.
One month after the Securities and Exchange Commission sidestepped a vote on whether to pursue significant additional structural changes in money market mutual funds, Treasury Secretary Timothy Geithner is rebooting the push-and appears to putting the baton back in the hands of SEC Chairman Mary Schapiro.
In a Sept. 27 letter to members of the Financial Stability Oversight Council, Geithner wrote that while the SEC took important steps in 2010 to improve the resilience of money funds by amending Investment Company Act Rule 2a-7, the 2010 reforms did not address two issues that leave money funds susceptible to destabilizing runs. These include:
(1) The lack of explicit means to absorb losses in the event of a drop in the value of securities in an investment portfolio; and,
(2) The "first-mover advantage" that provides an incentive for investors to redeem their shares at the first indication of any perceived threat to the fund's value or liquidity.
With that, Geithner prodded the SEC to resume its pursuit of reform, which had featured recommendations that limits be placed on redemptions, capital buffers be established to absorb losses and, most debated, the end to the hallmark feature of money market funds: the stable value of a share at a net value of $1 worth of assets in a fund.
"As its Chairperson, I urge the Council to use its authority under section 120 of the Dodd-Frank Act to recommend that the SEC proceed with MMF reform. To do so, the Council should issue for public comment a set of options for reform to support the recommendations in its annual reports. The Council would consider the comments and provide a final recommendation to the SEC, which, pursuant to the Dodd-Frank Act, would be required to adopt the recommended standards or explain in writing to the Council why it had failed to act. I have asked staff to begin drafting a formal recommendation immediately and am hopeful that the Council will consider that recommendation at its November meeting," Geithner said.
The options that Geithner wants to see considered include: floating the net values of assets in money funds by removing the special exemption that allows them to utilize amortized-cost accounting and rounding to maintain stable NAVs; require the funds to hold a capital buffer (likely less than 1% of assets) to absorb fluctuations in the value of their holdings that are currently addressed by rounding of the NAV; and imposing capital and enhanced liquidity standards, potentially coupled with liquidity fees or temporary "gates" on redemptions that may be imposed as an alternative to a minimum balance-at-risk requirement.
But what happens if the SEC should double fault on re-proposing the reforms?
Geithner wrote that while the SEC, by virtue of its institutional expertise and statutory authority, is best positioned to implement reforms to address the risks that money funds present to the economy, the Council and its members should, in parallel, take active steps in the event the SEC is unwilling to act in a timely and effective manner.
To be sure, the SEC is quietly laying the ground for compromise and passage of a new plan. In response to a request on Sept. 17 from three commissioners, SEC staff members began studying whether the rules could disrupt money market funds and short- term credit markets, Bloomberg News reported. The study could be completed within six weeks.
"People have to come back to the table and talk about the issue and be willing to put something out for public comment and debate," Schapiro said, in an interview. The SEC is "willing to engage with the industry and see if we can find a way forward."
And Geithner also has the backing of BlackRock, which reportedly released a new proposal last month backing the concept of redemption "gates" included in Geithner's letter, according to the report. Specifically, BlackRock suggested that funds be authorized to impose circuit breakers to limit runs, dubbed "standby liquidity fees" that would be triggered when a fund fell below a mark-to-market NAV of $.9975 or when its one-week liquidity, which represents the portion of a fund that can be paid out to clients in cash without selling securities, fell below 7.5%.
The firm also recommended that some of the SEC's 2010 changes, which tightened rules on asset quality, maturity and liquidity, be applied globally.
But Geithner's biggest backer may well turn out to be SEC member Daniel Gallagher, who helped derail efforts to tighten rules for money-market mutual funds. Gallagher said he would likely support a measure forcing the industry to abandon its marquee $1 share price.