Speech by SEC Commissioner:
Statement on Proposing Release, Money Market Fund Reform
Commissioner Kathleen L. Casey
U.S. Securities and Exchange Commission
January 27, 2010
Thank you, Chairman Schapiro, and good morning. I also want to thank the staff for their work on this release. I know a tremendous amount of time and effort went into bringing it before the Commission today. And, of course, this is a very important topic.
With over $3.5 trillion in assets currently under management, money market funds have grown into significant providers of credit for businesses, governments, and other institutions. As we witnessed in 2008, however, a run on a single money market fund has the potential to impair short-term financing for borrowers, tie up the assets of fund investors, and place inordinate pressure on money market funds as a whole.
As one example of the dislocations in short-term credit markets and strains on businesses that obtain funding in those markets, during the week of September 15, 2008, investors withdrew approximately $300 billion from taxable prime money market funds, or 14 percent of the assets held in those funds. In the final two weeks of September 2008, funds reduced their holdings of top-rated commercial paper by $200.3 billion, or 29 percent. Without support from fund sponsors and a number of federal programs, we likely would have witnessed the failure of multiple money market funds, with further cascading consequences for investors and our capital markets alike. Notwithstanding the critical role money market funds have come to play, that position is a tenuous one if it requires sponsors, and taxpayers, to serve as their guarantors.
While I appreciate many of the reform proposals set forth in today's adopting release, such as the enhancements to liquidity and maturity, they simply do not go far enough. Some are good; others go in the wrong direction; and collectively, they do not address fundamental issues at the heart of rule 2a-7. Absent more fundamental changes to the rule and their structure, money market funds will remain susceptible to runs and we would be furthering the view that these funds are implicitly guaranteed or insured by the U.S. government.
Regrettably, my vote on the release today necessarily presumes that this is the only reform we will undertake despite discussion, as the Chairman has endorsed, of a more fundamental reevaluation of rule 2a-7 in the context of a second rulemaking later this year. Because I cannot be sure when or whether we will have an opportunity to address the underpinnings of the rule and because I believe these issues are of critical importance now, I cannot, in isolation, support the limited measures we are taking today.
To put it plainly, this space has grown too large for rule 2a-7, as currently conceived and as amended, to do its job adequately. I think our experience with the Reserve Fund and other funds is a wake up call that stable NAV money funds are susceptible to runs and we must more fundamentally rethink how they are regulated. If we are to address these concerns, one of two logical paths lies ahead: either money market funds will require recourse to dedicated liquidity facilities, in which case, in my view, they should be regulated as banks are, or they should move to a floating NAV, which would unyoke them from one another and allay fears that a decline in the value of one fund would lead to a run with the resultant choking of short-term credit markets and the tie-up of investor assets that we witnessed in 2008.
Indeed, I had hoped that the Commission today would take a more significant step in the direction of a floating rate NAV by embracing a shadow pricing regimen that would provide investors with closer-to-real-time information about the market values of investments in fund portfolios. As it stands, we will be providing shadow pricing information, but on a delayed basis. If part of the reason we are releasing information after so long a delay is because we fear that greater transparency may result in runs, then, once again, I must question the rule 2a-7 regulatory model as it currently exists. Nevertheless, I hope that, as investors evaluate the periodic reports they will begin to receive about the shadow pricing of their funds, we undertake the more structural reforms that are needed.
In addition to this broad concern and despite the many practical improvements the adopting release makes to the current rule, there is nevertheless another component of the rulemaking that goes in the wrong direction and precludes me from joining my colleagues today. That is, the rule further embeds the regulatory use of NRSRO ratings in the money market fund space.
Under the revised rule, fund boards will be required to designate at least four NRSROs that they must look to in evaluating the eligibility of portfolio securities under the rule and that they must determine, annually, issue ratings sufficiently reliable for that use. Despite the release's suggestion to the contrary, this approach does nothing to reduce inappropriate investor and regulatory reliance on credit ratings. And it is at odds with the lessons of the current crisis.
If we are to take seriously the findings of and recommendations regarding reducing reliance on, or eliminating the regulatory use of credit ratings, as has been emphasized by the Obama Administration, key members of Congress, the President's Working Group, the Financial Stability Forum (now the FSB), the International Organization of Securities Commissions, the G-30, and others, we need to be moving in the opposite direction of the path we are taking today.
Regulatory use of and references to ratings have long acted as a crutch rather than a safeguard for many investors, creating a false sense of comfort and protection and effectively encouraging their use as a substitute for due diligence - not only on the part of funds and investors, but regulators as well. Indeed, in characterizing ratings as a "floor," the revised rule affords the possibility that ratings might play an even more prominent role in rule 2a-7.
As I noted in my statement last June, in the years leading up to the events of September 2008, a number of money market funds held positions that were issued by structured investment vehicles ("SIVs"). For example, in October 2007, one large money market fund held $640 million of securities issued by a SIV that had gone into liquidation despite original ratings of AAA by the two largest rating agencies. There were fears throughout this period about the SIV holdings in the portfolios of other several leading fund companies. We know, too, that it took a long time for many of these funds to liquidate their exposure to these assets and, often, the fund sponsors had to come to their aid. These events demonstrate that the highest credit ratings held by many SIV securities were in many cases wholly undeserved. More importantly, they provide a cautionary tale for regulators about the dangers of reliance on ratings - especially in light of the potential "snowball effect" of widespread ratings downgrades that can further exacerbate the severity and breadth of their impact.
As a further point, I would like to discuss how the rule - and the release - is at war with itself on the use of ratings. Specifically, the release underscores that rule 2a-7 requires funds and advisers to engage in substantive credit analysis in evaluating securities for inclusion in a money fund's portfolio, irrespective of the ratings these securities may have received. Despite this minimum credit assessment requirement that has long been embedded in current rule 2a-7(c)(3)(i), we are providing a new and more exalted legitimacy for ratings by requiring boards to designate four NRSROs to which they must look in evaluating whether securities are "eligible" for inclusion in a portfolio.
The release describes these NRSROs as the only ones boards must look to in making these eligibility determinations under the rule. Boards, therefore, can ignore ratings issued by other NRSROs in making eligibility determinations - yet, it makes no sense that they would do so in evaluating the credit quality of portfolio investments if that other information is available. Thus, as much as anything, I believe the new requirement amounts to a confusing distraction from the real credit analysis that boards (and their designees) are obliged to engage in.
Even commenters seem to recognize that the designation process is susceptible to gaming. Indeed, the release points out that yearly reevaluations by boards are necessary as to whether the chosen NRSROs should continue to be "designated" for this regulatory purpose because funds might end up looking to NRSROs that routinely give higher ratings to securities to give themselves more wiggle room. In sum, I believe we are needlessly injecting further regulatory reliance on ratings and, as a result, I fear we are encouraging funds and investors to do the same thing. It also runs counter to the idea, outlined elsewhere in the rule, of moving away from ratings in the context of asset backed securities - where the NRSROs failed abysmally to capture the credit risks of the securities they rated.
As a final note on NRSROs, I would add that, if we were to move to a floating NAV, the rationale offered for maintaining their entrenchment - that is, that the weakest fund reaching for yield has the potential to cause a run on the entire fund industry - disappears. Greater transparency and clarity about the investment risks associated with a particular fund's holdings would be more readily apparent and distinguishable from other funds and, as a result, we should not have the same concerns that money market funds would succeed or fail as a body as a result of the performance of an outlier.
I look forward to continuing work with my colleagues to look for ways to reduce our regulatory reliance on ratings in the context of a more fundamental reassessment of how rule 2a-7 should operate. And, again, let me thank the staff, particularly in the Division of Investment Management, for their hard work and the time they spent with me on this release.