At a speech last week, Mary Schapiro, chair of the Securities and Exchange Commission (SEC), reiterated her support for tighter regulation of money market funds. The reforms passed by the SEC in 2010 in response to the Reserve Primary Fund breaking the buck, such as the introduction of minimum requirements for liquidity, tighter limits on the inclusion of second-tier securities within funds, as well as shorter limits on maturities, "were just a first step," Schapiro said. "Because, despite changes in the assets they hold, money market funds remain susceptible to a sudden deterioration in quality of holdings and consequently, remain susceptible to runs."
Schapiro went on to say that the Reserve's collapse shouldn't be considered an isolated event. Indeed, during 2007 and 2008, more than 100 funds worked with their parent companies to gain capital infusions. Without such support, additional runs would have been likely, she said. Moreover, given the risk-averse nature of their investors, money funds remain vulnerable to outside shocks, from natural disasters to financial upheavals around the globe, Schapiro added.
To mitigate the risk, Schapiro said she supports moving to floating net asset values (NAVs). With this change, the funds' values could change, just as the values of other types of mutual funds fluctuate. The shift would "desensitize investors to the occasional drop in value" of the funds, Schapiro noted. Another option would be to impose capital requirements, along with limits or fees on redemptions. This would increase funds' abilities to absorb any losses, Schapiro said.
These ideas face steep opposition. Many in the industry have expressed concern about the potential disruption to the market if NAVs were allowed to float. In testimony last year before the House Committee on Financial Services, Paul Schott Stevens, president and CEO of the Investment Company Institute, said that any regulatory change should be guided by two principles. One was preserving "those features of money market funds (including the stable $1.00 per-share NAV) that have proven so valuable and attractive to investors." The other was avoiding costs that would undercut the willingness or ability of large numbers of investment advisers to continue to sponsor these funds.
At the same hearing, Scott Goebel, senior VP and general counsel with Fidelity Management and Research Company, said that moving to floating NAVs would prompt "shareholders to leave money market funds in large numbers." Instead, Goebel proposed requiring all funds to retain a portion of the yield shareholders otherwise would receive. This could be used to create a buffer that would grow over time. The buffer would absorb losses and ensure liquidity, by enabling the funds to sell securities at a loss, in the event they're faced with large numbers of redemptions.
Still, the idea of allowing NAVs to float has its backers. According to the Squam Lake Group, a group of 15 academics focused on reforming financial regulation, "the current stable-NAV model for prime money market funds exposes fund investors and systemically important borrowers to runs like those that occurred after the failure of Lehman in September 2008." To reduce this risk, funds should have either floating NAVs or buffers that can absorb losses up to a level to be set by regulators, the Group says.
What do you think? Would a move to floating NAVs make money market funds less vulnerable to runs? Or, would the change be so disruptive that the costs would outweigh any benefits of greater transparency?