Late last Wednesday, SEC Chair person Mary Shapiro announced that the SEC was dropping its proposals to add additional regulation to money market funds. Ms. Shapiro acknowledged that she could not obtain support from a majority of the SEC commissioners. The money market fund sponsors are celebrating.
The celebration may be short lived. In her announcement, Ms. Shapiro provided lengthy explanation regarding why additional regulation and restrictions were needed. Perhaps more importantly, she urged other regulators to pick up the additional regulation because of the SEC’s inability to advance what she thinks is necessary. In Ms. Shapiro’s words:
I — together with many other regulators and commentators from both political parties and various political philosophies — consider the structural reform of money markets one of the pieces of unfinished business from the financial crisis. … [The SEC’s failure to] vote to propose reform now provides the needed clarity for other policymakers as they consider ways to address the systemic risks posed by money market funds. I urge them to act with the same determination that the staff of the SEC has displayed over the past two years.”
The Federal Reserve and/or the Treasury Department now might pose additional restrictions on money market funds. This new authority could be substantiated by broad new authority provided under Dodd-Frank, although this possibility has not yet been tested.
The SEC had two alternatives that it desired. Ms. Shapiro explained these two alternatives in this week’s announcement as follows:
We were considering alternative proposals that would address these two structural issues in different ways.
The two alternatives:
First, that money market funds float the NAV and use mark-to-market valuation like every other mutual fund. This would underscore for investors that money market funds are investment products and that any expectation of a guarantee is unwarranted. In such a scenario, investment losses in money market fund portfolios could be both absorbed and reflected in the price – as would gains for that matter. Similarly, while the incentive to run may not be reduced entirely, the “cliff” effect of redeeming at $1.00, or getting stuck with a loss and no immediate access to one’s assets would no longer exist.
Second, and alternatively, a tailored capital buffer of less than 1% of fund assets, adjusted to reflect the risk characteristics of the money market fund. This capital buffer would be used to absorb the day-to-day variations in the value of a money market fund’s holdings. To supplement that capital buffer in times of stress, it would be combined with a minimum balance at risk requirement. That requirement would enable investors to redeem up to 97% of their assets in the normal course as they do today. However, it would require a 30-day holdback of the final 3% of a shareholder’s investment in a money market fund. That holdback would take a so-called “first-loss” position and could be used to provide extra capital to a money market fund that suffered losses greater than its capital buffer during that 30-day period. The result is that remaining investors would not be harmed by a redeeming investor’s full withdrawal and the incentive to redeem fully and quickly at the first sign of trouble would be diminished.”
Each of these proposals would have further decreased money market yields. But, prior SEC additional restrictions already caused the yields on money market funds to be lower. In 2010, with the support of much of the money market fund industry, the SEC enacted new rules aimed at making the funds more stable. The new rules required funds to shorten the average maturity of holdings and meet liquidity minimums.
Money market funds are already making so little yield that it does not make any sense to accept additional risk. The yield advantage of money market funds over government-insured bank alternatives has largely disappeared, and is inconsequential in any event. Whether or not additional regulation occurs, there is currently little reason to use a money market fund.