SEC To Introduce Further Money Market Fund Reforms
Tuesday, May 01, 2012

In a speech to the Securities Industry and Financial Markets Association’s 2011 Annual Meeting, the Chairman of the United States Securities and Exchange Commission (SEC), Mary Schapiro, said that it will shortly propose further reforms to the regulation of money market funds.

She used her remarks to address a policy issue that, she indicated, had not been fully resolved following the financial crisis of 2008, relating to the SEC’s on-going efforts, in close coordination with the Financial Stability Oversight Council (FSOC), to pursue further structural reform of money market funds.

The purpose of the reform “would be to improve market resiliency by reducing money market funds’ susceptibility to runs and providing for a greater cushion in the case of a poor credit decision or decrease in short-term liquidity.” She confirmed that the financial crisis had revealed shortcomings in the functioning of the short-term credit market, which rapidly became frozen, and that the SEC had an obligation to evaluate and address weaknesses in that market in general, and in the USD2.6 trillion money market fund industry in particular.

Following the crisis, Schapiro explained that the SEC had enacted significant reforms to money market fund regulations in February 2010, by tightening credit quality standards, shortening weighted average maturities, and, for the first time, imposing a liquidity requirement on the funds.

As part of the reforms, the SEC had also adopted new reporting requirements that provided public transparency so that investors could see their money market funds’ exposures. Investors have also been given access to money market funds’ mark-to-market valuations, known as the “shadow net asset value (NAV).”

This information is reported on a monthly basis, with a 60-day lag to the public. The public shadow NAV information is expected, in part, to help educate investors to the fact that money market fund shares actually are interests in pools of investments that fluctuate in value, although those fluctuations generally are very small.

However, although the SEC’s existing money market fund reforms were a critical first step, Schapiro pointed out that there remains “a lingering concern about how money market funds will stand up in a significant financial crisis, or whether a particular money market fund holding unexpectedly could default, making matters worse.”

She therefore explained that the SEC – working with FSOC – are now focusing in particular on a capital buffer option, possibly combined with redemption restrictions, to serve as a cushion for money market funds in times of emergency, and floating NAVs (rather than a fixed and stable USD1.00 redemption value) that would ensure investors who use money market funds realize the costs that might be imposed during rare market events.

She was aware that forcing money market funds to float their NAVs would change them “very dramatically” as a result. “They would no longer look like a specialized product,” she added. “They would look like any other mutual fund, although with very short-term, high-quality portfolio holdings.”

In addition, she confirmed that “much of the SEC staff’s energy, working jointly with staff from other FSOC member agencies, is focused on developing a meaningful capital buffer reform proposal. A capital buffer could also, potentially, be combined with redemption restrictions in order to address incentives to run that may not be curtailed by a capital buffer alone.”

In assessing potential capital buffer structures, the SEC is examining the pros and cons of various sources of the capital. The capital in a money market fund could come from the fund’s sponsor, the fund’s shareholders or the market, through the issuance of debt or a subordinated equity class.”

In addition, the SEC is closely examining the appropriate size of any capital buffer. It is said that one challenge is how to establish a capital buffer that offers meaningful protection against unexpected events, without over-protecting and unnecessarily interfering with the prudent and efficient portfolio management of the fund.