The Securities and Exchange Commission will issue a proposal within the next couple months to protect money market funds from the kind of default that forced one of them to break the buck during the financial crisis, SEC Chairman Mary Schapiro said today.
The agency is developing a rule to require that the vehicles have a source of capital to draw on during emergencies. This so-called capital buffer would help a fund respond to an investor stampede for the exit such as the one that caused the Reserve Primary Fund in 2008 to fall below the $1 net asset value that money markets promise.
"It could mitigate the incentive for investors to run since there would be dedicated resources to address any losses in the fund," Ms. Schapiro told the annual meeting of the Securities Industry and Financial Markets Association in New York. "A sudden market or interest rate fluctuation would not have the potential dramatic 'break the buck' effect that it could have today."
"Much of the SEC staff's energy, working jointly with staff from other [Financial Stabiilty Oversight Council] member agencies, is focused on developing a meaningful capital buffer reform proposal," Ms. Schapiro said. Redemption restrictions also could be part of the proposal.
The agency has not made a decision on the type of structure such a pool of money would take. It could be accumulated by the money market's sponsor, from the fund's shareholders or from the market, through debt or equity offerings.
In February 2010, the SEC tightened credit standards for money funds and imposed a liquidity requirement. Ms. Schapiro, however, said that more needs to be done.
"A money market fund's $1 stable NAV is brittle," she said. "Notwithstanding their generally strong record, there is 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."
Last fall, the President's Working Group released a money fund report. That was followed by a money market round table in May at the SEC. The best ideas that emerged, according to Ms. Schapiro, were the notion of a capital buffer and a proposal for a floating NAV.
The latter, while still on the table, presents problems, Ms. Schapiro said.
"While floating NAVs would reinforce what money market funds are — an investment — and what they are not — a guaranteed product — this option poses challenges for policymakers, particularly in fostering an orderly transition from stable NAVs to floating NAVs.'
The Investment Company Institute breathed a sigh of relief that the SEC appears not to be pursuing the notion of a floating NAV.
"Any reforms must preserve the utility of money market funds for investors and avoid imposing costs that would make large numbers of advisers unwilling or unable to continue to sponsor these funds," ICI President and chief executive Paul Schott Stevens said in a statement. "We are also pleased that the Chairman recognizes the many challenges surrounding the proposal to float the NAV, including the impact on businesses, institutions, and retail investors."
Ms. Schapiro's preview of the money market proposal to SIFMA allows the industry to begin thinking through its response to a capital buffer.
"We cannot let this issue linger," Ms. Schapiro said. "Once the SEC issues any reform proposal, a critical step will be hearing from interested parties through the public-comment process. We want and need your input."