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SEC Will Seek Money Market Fund Reform Says Schapiro

Wednesday, November 9, 2011

Yoomi Lee | Bloomberg LawSEC Speech, Mary L. Schapiro, Remarks at SIFMA's 2001 Annual Meeting (Nov. 7, 2011) Securities and Exchange Commission (SEC) Chairman Mary L. Schapiro spoke at the Securities Industry and Financial Markets Association's (SIFMA) 2011 Annual Meeting regarding money market funds and the SEC's ongoing efforts in coordination with the Financial Stability Oversight Council (FSOC) to reform the structure of these investments. The SEC plans to revamp rules for money market funds to (1) improve market resiliency by reducing money market funds' susceptibility to runs, and (2) provide a greater cushion in the event of a poor credit decision or decrease in short-term liquidity. Although the SEC already has enacted significant reforms to protect the $2.6 trillion money market fund industry, Schapiro maintained that additional steps need to be taken to address the structural features that make money market funds vulnerable to runs.

Current Weaknesses

Schapiro discussed the structural flaws of money market funds that were exposed during the recent financial crisis. Money market funds, which are used by both retail and institutional investors, seek to maintain a stable $1.00 net asset value (NAV). As a result of the stable NAV, investors consider money market funds to be low risk and essentially use them as cash liquid accounts. During the financial crisis of 2008, however, a wide-scale run on institutional prime money market funds occurred and the sizeable redemptions and uncertainty about counterparties led money market fund managers to retreat from the commercial paper market. Investors withdrew approximately $310 billion from prime money market funds at the peak of the financial crisis and money market managers rushed to liquidate assets to meet the redemption demands of nervous investors. As such, the significant role of money market funds in the financial system became very apparent said Schapiro.

SEC's Recent Reforms

According to Schapiro, in February 2010, the SEC adopted significant reforms that have made a substantial difference. Such reforms include, tightening credit quality standards, shortening weighted average maturities, and imposing a liquidity requirement on money market funds. Moreover, Schapiro discussed new reporting requirements that (1) provide public transparency so investors can verify their money market funds' exposures, and (2) enables the SEC to better monitor trends in money market funds' holdings and risk profiles.

Additional Money Market Fund Reform is Necessary

Shapiro noted that the SEC's recent reforms have been valuable, as evidenced this past summer when money market funds remained resilient despite substantial redemptions and large changes in day-to-day flows. However, Schapiro claimed that there is still a lingering concern regarding how money market funds will stand up in a future financial crisis or whether a particular money market fund unexpectedly could default. To that end, Schapiro maintained that a money market fund's $1.00 stable NAV is brittle as these funds do not have a committed source of stability to draw upon, except for the discretionary support of their sponsors. Specifically, many investors treat the $1.00 NAV as an all-or-nothing proposition and run at the first sign of trouble. There is also no current legal requirement that sponsors support the funds or that funds have other financial back-up. Accordingly, Schapiro discussed two viable options to reform the structural features that make money market funds vulnerable based on a report released by the President's Working Group and the SEC's Roundtable on Money Market Funds and Systemic Risks: (1) floating NAVs, and (2) capital buffer. — Floating NAVs Schapiro explained that instituting floating NAVs would change money market funds dramatically, causing them to look like any other mutual fund. She further stated that a floating NAV would potentially deprive investors of access to a stable net asset value product that has met many of their needs. Removing such a popular product from the financial markets, Schapiro noted, poses challenges for policy makers. — Capital Buffer Further, Schapiro discussed that the SEC and other FSOC member agencies have been working jointly to develop a meaningful capital buffer reform proposal that would guarantee that a source of capital is available to funds in times of a financial crisis instead of the current discretionary sponsor support. A capital buffer also could be combined with redemption restrictions to address incentives to run said Schapiro. As such, a sudden market or interest rate fluctuation would not have the potential "break the buck" effect that it could have today and it would reduce the uncertainty surrounding money market funds. Finally, Schapiro noted that the SEC is examining the pros and cons of various sources of capital, which could potentially come from (1) the fund's sponsor; (2) the fund's shareholders; or (3) the market, through the issuance of debt of a subordinated equity class. Schapiro concluded that finding the right balance between establishing a capital buffer that offers meaningful protection against unexpected events without over-protecting the "prudent and efficient portfolio management of the fund" will be a continuing challenge. DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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