Two sides are clamoring to be heard on the way forward for money market mutual funds.
The views about additional MMF regulation are passionate and generally fall into two camps: Yes, more regulation is needed, or no, more regulation is not needed. Most agree that the proposals being bandied about, namely a floating NAV, additional capital requirements and 30 day withholding of a portion of redemptions will have an overall adverse impact on the MMF industry. The expectation is that investors won’t tolerate the principle risk of the floating NAV or the liquidity and operational inconvenience of redemption withholding, and that fund managers can’t bear the cost of additional capital requirements. Consequently, it is reasonable to presume, as many are saying, that more regulations will mean less MMF’s (More means less).
However, no one expects the industry to completely disappear, so the question arises, “what will we be left with?” According to Sallie Krawcheck, writing recently in the Wall Street Journal, the former executive with Bank of American and Citigroup, said the industry will be left with a smaller, but more transparent and well-capitalized industry. “If industry growth is built on clients misunderstanding its underpinnings, and if industry profitability is built on inherent under-capitalization, then better to provide real transparency,” she wrote. As financial firms adjust to this new landscape, new products that are presumably more robust will eventually emerge. As Ms. Krawcheck noted, “This will allow investors to make informed choices and allow market forces and innovation to work their magic—perhaps producing new, more favorable cash solutions for investors and funding sources for corporations.” (Less means more)
Of course, MMF’s are a major source of inexpensive short-term financing for highly rated companies and a smaller MMF market could certainly hinder that. Tory Hazard, Chief Operating Officer with Institutional Cash Distributors (ICD), a major MMF portals used by institutional investors, has concerns over the CP market, “If the proposed rules go into effect, MMF’s become less desirable and [will] lose considerable assets,” he said. While some observers are predicting death to the industry, “we believe the MMF industry would live, however at 25 percent to 50 percent lower levels.” According to Crane Data, there is a little over $400bn of commercial paper owned in taxable US MMFs. That would mean a $100-$200bn reduction in MMF CP investments, or 8.5 percent to 19 percent of total US CP. Should Ms. Krawcheck’s prediction not come true, there will be a big hole left in the capital markets.
More Floating NAV Controversy. In her editorial, Ms. Krawcheck weighed in on the debate about the merits of a floating NAV pointing out that the MMF industry suffers from an implied expectation that any loss of value in a particular stable NAV fund would be covered by the fund company. Clearly it would be advantageous to lose this expectation that is not unreasonable given the commitment to $1 share price. But if the fund value is allowed to float, the fund now looks much more like a mutual fund where it is understood that valuations will change. “In short, if the industry wants to keep the guarantee as a ‘can-do’ rather than a ‘must-do,’ then a floating net asset value would go a very long way toward signaling that the investment principle is not guaranteed” Ms. Krawcheck noted.
ICD presents a counterview. But Mr. Hazard and several others question the benefits of a floating NAV. Some call it a “nuclear alternative,” (Barron’s) and others claim it wouldn’t prevent runs on the funds (a 2009 Investment Company Institute study showing that short-term bond funds suffered significant outflows in troubled markets). A floating NAV “fundamentally changes what MMFs were intended to be in the first place,” said Joan Swirsky at MMF specialist Stradley Ronon.
ICD also conducted its own research with a December 2010 survey to gauge client reaction to October 2010’s “President’s Working Group report on MMF Reform.” Of the more than 50 enterprise-level corporate treasury respondents, only 22 percent were receptive to a floating NAV.
It seems that currently the floating NAV naysayers outnumber the proponents in the marketplace. But a few more editorials from industry insiders such as Ms. Krawcheck could start to turn the tide.