Financial advisers should begin preparing their clients for changes in the money market fund industry. Changes became almost inevitable when Treasury Secretary Timothy Geithner on Sept. 27 sent a letter to the Financial Stability Oversight Council urging it to consider issuing new rules for money market funds. The council can assert control over large money market funds by designating them “systemically important financial institutions.”
Mr. Geithner, whose department heads up the FSOC, took the action because the Securities and Ex-change Commission failed in its efforts to craft new rules for the funds, which regulators believe are necessary to prevent a run on them that might lead to another financial meltdown.
The financial crisis and the run on money market funds are forever intertwined. The September 2008 collapse of the Primary Reserve Fund — triggered by holdings in the failed Lehman Brothers Holdings Inc. — set off a run on money market funds, which contributed to the freeze in credit markets. The run was staved off by the federal government when it guaranteed the value of the shares temporarily and bought up assets at face value.
The FSOC was established by the 2010 Dodd-Frank financial reform law to be a superregulator that steps in when another regulator is unable to take action to address some issue that might threaten the nation's financial stability.
At the end of last month, money market funds had total assets of $2.4 trillion, suggesting that they are big enough that a run on them could trigger another financial crisis.
Mr. Geithner sent his letter to the FSOC because the five-member SEC could not achieve a consensus to support proposals to reform the money market fund industry put forward by Chairman Mary Schapiro.
These proposals called for money market funds either to float their net asset value and use mark-to-market valuation like other mutual funds or adopt a larger capital buffer to absorb the day-to-day variations in the value of a fund's holdings. The latter would be combined with a rule that would restrict shareholders from redeeming their full account value at any one time by imposing a 3% holdback.
The money market fund industry has opposed the proposals vigorously, saying either would greatly harm it and the economy.
Industry leaders have argued that a floating NAV would lead to more runs on funds, as occurred when the Reserve Fund's shares fell to 97 cents in the wake of the collapse of Lehman Brothers. The drop in the Reserve Fund's NAV — only the second time a money market fund has “broken the buck” — caused a run on other funds that was stemmed only by government intervention.
The industry also argues that changes in regulations since 2008 that require funds to hold more assets in easily traded securities have greatly diminished the possibility of a run on the funds. Noting that the funds withstood the buffeting of the European financial crisis, fund managers contend that another layer of regulation is unnecessary.
Now industry leaders will have to make their arguments against further reform again before the FSOC, which no doubt will be harder to persuade than three of the five SEC commissioners.
REVISIT THE MATTER
Perhaps the best outcome for money market funds is for the SEC to revisit the matter quickly and impose new regulations before the FSOC can act. One of the commissioners who voted against Ms. Schapiro's proposals already has said he would support a floating NAV.
Whether the final regulation comes from the SEC or the FSOC, investors almost certainly will find money market funds a less comfortable place than in the past to park money while seeking good investment opportunities.
Now is the time for advisers to begin to prepare their clients for the coming changes. At the very least, clients may have to accept a floating NAV.
Clients accept floating values on other mutual funds, as well as on stocks and bonds, so they may be persuaded to do so on money market funds. They also may have to accept some limits on how much and how quickly they can liquidate funds to take advantage of an opportunity.