The Securities and Exchange Commission’s proposal to strengthen money market funds (MMFs) against investor runs may have been scuttled last summer, but the Financial Stability Oversight Council has continued the fight. And now it has the influential support of perhaps the entire Federal Reserve System.
On Tuesday the Federal Reserve Bank of Boston submitted a comment letter on behalf of all 12 regional Federal Reserve banks that gave full-throated support to the proposal issued November 13, 2012 by the FSOC. The FSOC’s proposals mostly echoed the SEC’s earlier proposals – one not supported by three of five commissioners – and offered three options to reduce the MMF risks.
One option is to do away with the current fixed-rate net-asset-value (NAV) regime and make a floating-rate NAV; the idea is that if investors understand that share prices can fluctuate, they may be less likely to flee when the price drops. Another option is to keep the fixed-rate NAV but impose a 3percent buffer to absorb losses when prices fluctuate. The third option couples a smaller NAV buffer with requiring a minimum balance at risk from investors for a specified period after a redemption.
The Federal Reserve has long supported tighter MMF regulation. Fed officials, Fed governor Daniel Tarullo among them, consider MMF shadow banking entities that work outside regulatory frameworks and a threat to the financial system.
The regional Feds’ support, to the dismay of the MMF industry and some corporates, increases the likelihood that at least some of these measures will come to fruition. Heath Tarbert, a partner at Weil, Gotshal & Manges, said the FSOC issued its “proposed recommendations” seeking public comment under Section 120 of the Dodd-Frank Act, the “naming and shaming” provision that gives FSOC authority to force regulators to revisit an issue. Under the same authority the FSOC will present its recommendations – further shaped by public comment – to the SEC, which must either reject them with an official explanation or proceed with a similar rule.
Tarbert said the support by the regional Feds significantly adds to the credibility of FSOC’s recommendations. “The regional banks are considered to be nonpolitical. Their presidents are chosen by each bank’s board, whose directors represent the local banking communities as well as the commercial interests of the region,” Mr. Tarbert said. “When they speak people listen, including members of Congress and their staffs.”
He added that it is rare that the regional reserve banks formally weigh in on regulatory matters, and all 12 signed the Boston Fed’s letter. “It makes it that much more difficult for the SEC to reject the FSOC recommendations on the basis that MMFs present no genuine systemic risk concerns,” Mr. Tarbert said.
Regulators including FSOC have expressed concern that runs on MMFs could destabilize banks and nonbank financial companies, which MMFs lend to with funds collected from large institutions. In fact, the Federal Reserve Bank of New York published a paper addressing this issue earlier in February called “Money Market Funds Intermediation, Bank Instability, and Contagion.”
The MMF industry, on the other hand, argues that regulators have already taken sufficient measures to strengthen the fund against runs. Corporates, too, are concerned about the impact of FSOC’s recommendations.
David Neshat, treasurer at Cambridge, MA-based Akamai Technologies, a cloud platform provider, said the floating NAV introduces the risk of losing principal, which may run against at least some corporate investment policies. The buffer proposal is problematic, he said, because it will most likely reduce MMFs’ yield, which is currently at historical lows. And the MBR is contrary to MMFs’ promise of same day liquidity.
“MMFs play a significant role in the short-term borrowing market … I’m afraid any of these reforms could harm the future of MMFs, which will have its own implications,” Neshat said.
Comments on the FSOC’s proposed recommendations are due Feb.15.