The SEC and the Fed and push for control (or the demise?) of money market funds.
The battle over money markets funds has been heating up recently. Both the Fed and the SEC in 2011 made the case for money market funds to move to floating net asset value regime vs. its current constant NAV (CNAV) set up — i.e., the buck. But are they really pushing for MMFs to be gone?
Since the financial crisis, regulators have been looking at ways to get more control over the shadow banking system. In particular, the Financial Stability Board, part of the Bank for International Settlements (the Basel people) has been zeroing in on key areas for review and regulation, which includes how banks interact with “shadow banking entities.” The main goal is to prevent lenders from taking excessive risk. Money market funds fall within this area of the shadow system, and the SEC and the Fed have recently been taking aim.
“MMMFs [money market mutual funds] started out investing in highly rated financial and nonfinancial company commercial paper (CP) and short-term Treasury securities,” wrote Kansas City Fed President Thomas M. Hoenig in a study entitled “Restructuring the Banking System to Improve Safety and Soundness.” “And then over the years [they] expanded to other money market instruments, such as asset-backed commercial paper (ABCP), and short-term repurchase agreements (repo).”
This expansion increased the risk of MMFs, Mr. Hoenig wrote. And like any other investment, the higher the risk, the bigger the decline can be which leads to “runs” on the investment. “Just like banks were subject to depositor runs that created liquidity crises before deposit insurance was available, virtually every step of the shadow banking process is dependent on uninsured investments in MMMFs and other MMI funds with NAVs of $1.”
To fix this he proposed floating NAV, which SEC Chairman Mary Schapiro also proposed in late 2011. Mr. Hoenig’s answer to critics that want to keep the $1 NAV is Regulation Q. “MMMFs were first introduced to evade interest rate ceilings on deposits, and the only remaining Regulation Q deposit rate ceiling – the prohibition of paying interest on business transactions deposits – was eliminated by the Dodd-Frank Act,” he wrote. Also, “some may be concerned that their deposits will be largely uninsured, but they were uninsured when invested in MMMFs.”
But the concept floating has been met with a lot of pushback, including protests from the Investment Company Institute (ICI), which suggests a floating NAV will destroy the attraction of money funds. And a recent informal survey on a JPMorgan treasury webinar bears this out, showing that two thirds of the 400 or so participants said they would not use MMFs that had a floating NAV.
One recent commentator, John D. Hawke, a partner in Arnold & Porter LLP, Washington recently wrote a piece wondering if he were paranoid or was someone “really trying to kill the money funds?” “One need not be paranoid to think that people at some government agencies really want to put MMFs out of business.”
And now many companies are starting to make their voices heard. On January 20 a group of 23 corporations and industry organizations wrote a letter to Chairman Schapiro voicing their concern about the prospects for MMFs. They tout their reliability and efficiency in short-term financing and also argue that more regulation can actually increase risk.
“Money market funds are a crucial instrument for businesses’ daily cash management and the efficient operation of the US economy. Throughout their 40-year history—a period which saw countless bank failures and substantial losses in other investment vehicles—money market funds have provided investors a variety of benefits, including enhanced diversification, robust credit analysis, high-quality, short-term assets, and preservation of capital. Moreover, money market funds provide significant administrative efficiencies and accounting and tax simplicity because of the stable $1.00 per share value,” the companies wrote. Companies included Alcoa, CVS Caremark, FMC Corporation, Johnson & Johnson, Kraft Foods and host of others.
Whether the powers that be are out to kill MMFs remains to be seen. Others with the NeuGroup universe have made similar suggestions, speculating that regulators want everything to go through banks or other prudentially supervised institutions. But banks appear to be struggling with their own liquidity problems; and they have not shown the greatest savvy when it comes to risk in recent history. Treasurers and their companies should keep making their voices heard and perhaps in the meantime, look for an MMF alternative if one can be found.