The Securities and Exchange Commission is weeks away from issuing a proposal to reform money market funds — and likely months away from a final rule — but critics are already warning that new regulations could undermine the savings vehicles, limiting an important product for investment advisers' client portfolios.
In the spring, the SEC is ex-pected to propose a rule designed to avoid a situation like the one in 2008 when the net asset value of the Reserve Primary Fund fell to less than the traditional $1, prompting investors to stampede for the exits.
One part of the proposal is likely to recommend a capital buffer — financed through corporate cash, stock or debt offerings, or shareholder fees — combined with re-demption restrictions. The other part will recommend letting the funds' NAV float.
The SEC will take comments on both parts, and the five commissioners will choose one of the two options.
Even before the comment period, the financial industry is launching pre-emptive attacks on the emerging reform outline, which was first reported last week by The Wall Street Journal. Opponents called it a formula to end the stability and liquidity that make the funds popular money management tools for investors and companies.
“It will certainly provide a constraint on what brokers and advisers can do with clients' cash,” said Jeffrey T. Brown, senior vice president for legislative and regulatory affairs at Charles Schwab & Co. Inc. “There is a need to build a firewall against these changes that we believe are not in the best interest of investors.”
The proposals might not be good for financial advisers' wallets, either.
If the number of money funds decreases, so will the number of agreements that the funds sign with brokerage firms to provide their product in exchange for fees, according to James Angel, associate professor of finance at Georgetown University.
“That means that [advisers will] probably see 12(b)-1 fee revenue from money market funds dry up — or if not totally dry up, at least become a little bit less attractive,” he said.
The redemption restrictions probably would limit investors' ability to take money out of the funds on short notice, with 95% being available immediately and the other 5% available after 30 days.
That would create administrative hassles and force brokerage firms to rethink money funds, according to skeptics.
“It would be more difficult to attach a money fund to a sweep brokerage account,” according to a recent research report from Keefe Bruyette & Woods Inc.
Taken together, the changes could fundamentally alter the $2.6 trillion money market industry, according to a study from
Fidelity Investments.
POTENTIAL EXODUS
“Adopting rules requiring money market mutual funds to float their net asset values or impose liquidity restrictions on shareholders — two ideas that are currently under consideration — could spark retail and institutional investors to pull significant amounts of assets out of money market mutual funds, leading to unintended consequences for the financial markets and the U.S. economy,” Fidelity said in the report, which was sent to the SEC on Feb. 3.
The report included a poll showing that 52% of retail investors would reduce the amount of money they kept in money market funds or stop using them altogether if there were even a 3% restriction on redemptions. The online survey of 2,206 Fidelity clients was conducted in early December.
Investment advisers will be concerned about the reforms, if they undermine liquidity and raise costs, according to Dan Barry, managing director of government relations and public policy at the Financial Planning Association.
On the other hand, the SEC proposals could strengthen money funds as a
financial planning tool, he said.
“The upside is that well-crafted reform will give confidence that the funds won't break the buck,” Mr. Barry said.
Resistance also is building on Capitol Hill.
“I think that money market funds are under attack,” Sen. Patrick Toomey, R-Pa., a member of the Senate Banking Committee, told an audience last week at the U.S. Chamber of Commerce, which is helping lead the charge against money fund reform.
The potential SEC regulations “threaten the viability of the product itself,” he said. “We should push back aggressively.”
Mr. Toomey argues that the Reserve Primary Fund's breaking of the buck was an isolated case in the otherwise safe money fund market.
Like many Republicans skeptical of SEC rule making, he plans to demand a thorough cost-benefit analysis.
“I want to see how they've done that and challenge their methodology,” Mr. Toomey said. “If necessary, I wouldn't rule out legislation that would push back.”
The SEC maintains that it is trying to protect investors by preventing another Reserve Primary Fund situation, which required intervention by the Treasury Department to thaw frozen credit markets.
FOLLOW-UP
The SEC said that the upcoming reform proposals are a planned follow-up to changes to money market rules imposed in 2010.
Those changes included requiring money funds, which typically invest in short-term debt, to use safer assets; requiring them to invest in instruments providing 10% daily liquidity and 30% weekly liquidity; and shortening fund maturities.
“As a second step, the chairman is advocating structural reforms to money market funds to address their susceptibility to runs and provide a buffer against losses,” SEC spokesman John Nester said in a statement.
Money fund defenders point out that they have weathered the European debt crisis and a downgrade of the U.S. debt rating without any breaking the buck. They say that the 2010 reforms are sufficient.
Paul Schott Stevens, president and chief executive of the Investment Company Institute, told the chamber audience that prime money market funds held an estimated $643 billion in daily and weekly assets as of May 30, which helped them smoothly manage $172 billion in withdrawals between June and August.
“This is a very different industry than we saw in 2008,” Mr. Stevens said. “Regulations should take that into account.”
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