Speech by SEC Commissioner:
Remarks at the Open Meeting of the U.S. Securities & Exchange Commission Regarding Money Market Fund Reform
Commissioner Troy A. Paredes
U.S. Securities and Exchange Commission
June 24, 2009
Thank you, Chairman Schapiro.
Money market funds serve an essential function for investors and our capital markets more generally. The fundamental purpose of money market funds is to provide an element of stability — namely, a $1 per share stable net asset value — while allowing investors the opportunity to earn higher returns on their money than, say, bank products yield. Investing in a money market fund is not riskless; but it is this marginal risk that generates the reward of higher returns.
Money market funds are one of the most popular investment options for both retail and institutional investors. Evidencing their success, there currently are over 750 money market funds registered with the SEC, holding in the aggregate around $3.8 trillion in assets.1
Not only are money market funds a valuable investment vehicle for investors, but money market funds provide an important source of financing in the economy. Companies look to money markets to finance short-term needs; money market funds are important purchasers of commercial paper. At the end of May 2009, there was approximately $1.14 trillion in outstanding commercial paper eligible for money market funds to invest in, with a mix of approximately $1.1 trillion of “First Tier” securities and $53 billion of “Second Tier” securities.2
Under the Investment Company Act, when the SEC must consider whether a rulemaking “is consistent with the public interest,” we are obligated to consider, “in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation.”3 Keeping with this statutory mandate, we should consider the impact the proposed amendments to Rule 2a-7 could have on issuers of commercial paper. Not only are we required to consider such impacts, but it is prudent for us to do so to ensure that we have a thorough understanding of the potential consequences of our rulemaking.
As I mentioned a moment ago, a defining feature of money market funds is their stable net asset value. In practical terms, this means that investors can expect to receive a dollar back for every dollar invested. A fund’s stable net asset value, however, is not guaranteed. Rather, there is at least some risk that the net asset value could drop below $1.00 — that is, that a fund could “break the buck” — in which case, a “dollar in” means something less than a “dollar out.” In the over 30-year period before the recent credit crisis, only one money market fund actually had ever broken the buck. However, last year, money market funds came under particular strain.
The goal of better ensuring the $1 stable net asset value of money market funds leads us to propose changes to Rule 2a-7.
The proposal goes to great lengths to reduce the risk that money market funds will break the buck. The proposed Rule 2a-7 amendments, for example, shorten portfolio maturities and impose new liquidity requirements. The amendments also would permit money market funds that have broken a buck to suspend redemptions to facilitate orderly liquidation.
Although I support the proposal, I do have significant reservations about two features of the Commission’s release.
First, the proposal eliminates entirely Second Tier securities as a category of investment for money market funds. Currently, a maximum of five percent of a money market fund’s assets may be invested in Second Tier securities. Under the proposal, this would be reduced to zero percent. Yet I am not aware of any evidence showing a causal link between Second Tier securities and the stresses money market funds came under last year. Indeed, the release itself does not suggest any such link.
Second, in proposing certain portfolio disclosures, the release discusses and seeks comment on the possibility of requiring money market funds to disclose their market-based net asset value per share. This so-called “shadow NAV” may differ from a fund’s amortized cost net asset value — that is, the $1 NAV a fund is required to maintain. The release also seeks comment on whether to go beyond requiring disclosure of a “shadow NAV” to require that a fund’s net asset value actually float. A floating NAV based on the market value of the securities a fund holds would be a major departure from the longstanding stable $1 NAV.
I look forward to considering all the comments we receive, and I am particularly interested in comments that address these two areas. Accordingly, I have the following questions for commenters:
Concerning Second Tier securities: How might the proposal impact the ability of Second Tier issuers to raise capital and what alternative financing options might companies seek if money market funds are no longer able to invest in Second Tier securities? To what extent and in what ways might eliminating Second Tier securities from a money market fund’s eligible investments impact fund diversification and, accordingly, fund portfolio risk? To what extent might the elimination of Second Tier securities impede competition by undercutting the ability of certain funds to compete by offering investors a higher yield? What are the pros and cons of instead reducing Second Tier securities from a maximum of five percent of a fund’s portfolio to some lower threshold, such as three percent? Are there other “middle ground” options that we should consider instead of eliminating Second Tier securities from money market funds entirely?
Concerning a “shadow” or floating NAV: Might disclosure of a fund’s market-based net asset value spur redemptions if investors see that the NAV has fallen? If a shadow NAV is publicly disclosed, might investors “rush to be first” by redeeming if the shadow NAV falls below a dollar, such as to $.998, if only out of concern that other investors will redeem? Might such redemptions put pressure on a fund to break the buck when investors otherwise would not have redeemed if the shadow NAV were not disclosed? Similarly, if a fund’s floating NAV falls, might investors redeem to avoid getting out at a still lower price? If money market funds have a floating NAV, to what extent might investors turn from money market funds to alternative investment options? Would the disclosure of the $1 amortized-cost NAV and the market-based shadow NAV confuse investors, especially retail investors?
Finally, the release raises the possibility of further embedding credit ratings into Rule 2a-7 by considering whether a money market fund board should designate three or more NRSROs that the fund would rely on for determining whether the fund is permitted to invest in a particular security. In addition to the two areas I have highlighted, I also am keenly interested in comments on the role of credit ratings under Rule 2a-7.
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I would like to join my colleagues in thanking the staff for its swift work on this proposal. In particular, from the Division of Investment Management, I would like to single out Diane Blizzard and Penelope Saltzman; and from the Office of Economic Analysis, I would like to recognize Amy Edwards, Woodrow Johnson, and Chuck Dale.
1 See Investment Company Institute, Money Market Mutual Fund Assets (June 4, 2009), available at www.ici.org/highlights/mm_06_04_09.
2 See http://www.federalreserve.gov/releases/cp/outstandings.htm.
3 See Section 2(c) of the Investment Company Act; see also National Securities Markets Improvement Act of 1996 (NSMIA), Public Law 104-290, 110 Stat. 3416.