Fed Presidents are not going to let Money Market Funds off the hook A letter lands from the 12 Presidents of the Federal Reserve, led by consistent money market fund critic Eric Rosengren. Reform has been a marathon and they are going to run along behind the SEC waving a big stick until it is finished: First some carrot: We applaud the SEC Commissioners" and staff's continued efforts in this area. We believe the SEC is well-positioned to implement meaningful reforms that not only better protect investors but also address the risks to financial stability posed by MMMFs. And the Presidents like the first of three measures proposed for reform, to make Money Funds float their share price that they presently get to leave at a nice safe and secure sounding $1 per share (provide the SEC doesn't go easy on the $2.4tn industry): We welcome the inclusion of the floating NAV alternative in the current Proposal. We strongly support this alternative, especially if certain enhancements are undertaken. ... But they are not keen at all on the second option: We do not support the stand-by liquidity fees and temporary redemption gates alternative, as these mechanisms do not meaningfully reduce the risks that MMMFs pose to financial stability. ... The third is a mixed bag of better disclosure and diversification requirements that the presidents like. In case you had lost track, we are in year five of money market reform. The industry got its act together fast in 2009 after its flighty investors helped to spread panic and discord in the crisis when the $1 share price proved not so solid after all and the US government came to the rescue. Money fund sponsors came up with reforms and the SEC adopted them, pronto. Yet, perhaps surprisingly, the reforms did not address that thorny question of run risk inherent to the structure of the industry, one that has a product used much like a bank account, but regulated as a mutual fund. Discussions on what to do have pretty much gone in a variety of novel circles ever since. There have been capital buffers, (Buffering Stable-NAV Money Market Funds), liquidity gates, floating prices, ideas for government only investments, some sort of convoluted hold back system and threats of law suits. After all that, the SEC failed to get tougher proposals than the ones now on the table even to the comment stage last year when Commissioner Aguilar said he wouldn't support them. What followed was one for lovers of regulatory acronym tit-for-tat, but the SEC finally came out with the two proposals this year, the latter one an industry idea that in moments of trouble it could put in place to restrain institutional investors from dashing for the exit leaving dozy retail investors with losses. The regulator is also thinking about applying new rules only to retail funds used by customers with a balance under $1m, and to exclude government only funds, but the President's don't like those options either: A structural incentive would remain for investors in retail MMMFs that are exempt from the floating NAV requirement to be the first to redeem during times of stress. While retail investors did not en masse act on this incentive during the crisis, it seems imprudent to assume that their behavior in the future will be the same as in the past... We are also concerned that the $1 million redemption threshold may not fully exclude institutional investors from retail funds, as services might emerge to spread large cash balances across numerous MMMFs eligible for the retail exemption. Current government-only money funds might also be given an incentive to change their risk profile, as they can put 20 per cent of their holdings in non government securities. But their main complaint is that the temporary liquidity fees and gates still do not get rid of run risk. Because investors are unable to predict how other investors would react once a fund's WLA level begins to deteriorate, their safest option may be to run in advance of the fund breaching the trigger. Further, because of the relative homogeneity in many MMMFs" holdings, the imposition of a liquidity fee or redemption gate on one fund may incite runs on other funds which are not subject to such measures. They know the industry hates floating NAV, but they finish with the very big stick: We understand that among the many comment letters the SEC will receive on this Proposal, our position supporting the floating NAV alternative may well be in the minority, as it has been throughout this important debate... From a financial stability perspective, however, we believe that the floating NAV is the far better choice. This letter comes shortly after we learned that the Fed staff is now contemplating a fixed-rate, full-alotment reverse repo facility. Cardiff and Izzy previously explained the importance of the proposal. It's interesting to consider the proposal in combination with this letter. The new reverse repo facility, in times of stress, could act as a collateral backstop for money market funds in case there's another shadow banking run on the dealers, as in 2008. In "exchange," money market funds would have to accept to tighter regulatory scrutiny. This is all very speculative, but the combination would have a very Gorton-ian feel to it, no? By Dan McCrum and Cardiff Garcia Further Reading: SEC proposes radical money market reforms - FT Reform call on $2.7tn money market funds - FT US money funds thwart SEC reform plans - FT Les Miser-NAV-ables - FT Alphaville