Regulation: SEC infighting nobbles money market reform

Louise Bowman
Published on:

Industry lobbying pays off – for now; Other regulators might take up the baton

The increasingly ill-tempered battle of wills between the financial industry and its regulators erupted into a full-blown slanging match at the end of the summer when the SEC threw in the towel over further reform to the $2.5 trillion money market fund industry.

Money market funds have been at the centre of the financial crisis since its inception, thrust into the spotlight when the $62.5 billion Reserve Primary Fund broke the buck shortly after Lehman’s collapse in 2008. They have controversially been viewed as an integral part of the shadow banking sector that has so worried the regulators ever since.

But on August 22 SEC chairman Mary Schapiro announced that she was abandoning a two-and-a-half-year project to bring structural reform to these funds following the decision by three fellow commissioners (Luis Aguilar, Daniel Gallagher and Troy Paredes) to veto a proposal to do just that. Democrat Elise Walter supported the proposal. But Schapiro did not go down without a fight.

"I – together with many other regulators and commentators from both political parties and various political philosophies – consider the structural reform of money markets one of the pieces of unfinished business from the financial crisis," she said. "While as commissioners we each have our own views about the need to bolster money market funds, a proposal would have given the public the chance to weigh in with their views as well."

Gallagher and Parades expressed "dismay" at her remarks five days later, stating that "the current discourse about the Commission’s regulation of money market funds is rife with misunderstandings and misconceptions. The Chairman’s statement creates the misimpression that three Commissioners – a majority of the Commission – are not concerned with, or are somehow dismissive of, the goal of strengthening money market funds. This is wholly inaccurate."

Round one

This is a fight about whether money market fund reforms that the SEC introduced in 2010 are sufficient. The regulator introduced the first changes to rule 2a7 (which was published in 1983) in May 2010, tightening up the rules on credit quality, diversification, liquidity, maturity, portfolio stress testing and transparency. In her August 22 statement Schapiro emphasized: "The Commission made clear that the first round of reforms in 2010 were a first step and that additional structural reforms were expected to follow as a second step. In fact, I specifically said as much at the time."

But the money market industry has been emphatic in its dismissal of further regulation and insistence that the market is sufficiently regulated already.

Paul Schott Stevens, CEO of the Investment Company Institute, claims that the summer of 2011 (when there was an escalation of the eurozone crisis, the showdown over the US debt ceiling and the downgrade of US government long-term debt) put the existing reforms to the test. "From early June to early August 2011 investors withdrew 10% of their assets from prime money market funds – $172 billion in all," Stevens says. "During the debt ceiling crisis prime and government funds together saw an outflow of $114 billion in just four trading days. But this withdrawal had no discernible effects at all – either on the funds or the markets." He points out that between April and December the average mark-to-market price of the shares of prime money market funds with the greatest exposure to European financial institutions fell by nine-tenths of a basis point. "That’s nine one-thousandths of a penny," Stevens points out, helpfully. Schapiro has, however, testified to 300 examples of sponsors having to step in to stop money market funds breaking the buck.

Hold back

Schapiro’s proposals envisaged funds operating with either a floating NAV or a stable NAV with capital buffers and redemption limits. Redemption restriction would most likely have been implemented via a "holdback": investors would be required to hold a minimum account balance, which would be held back on full redemption for a waiting period and could even be subordinated to absorb losses ahead of other shareholders, acting as a contingent capital cushion.

SEC chairman Mary Schapiro
SEC chairman Mary Schapiro
This – not surprisingly – provoked outrage among fund managers. In March, BlackRock said that 43% of its clients dipped below the mooted minimum account balance at least once in 2011, and 10% did so more than five times in a year.

"Many clients go below the minimum account balance because of the nature of their business, which calls for a ramp-up of assets and then a redemption to zero," the asset manager explained. "In addition, many clients operate under guidelines that prohibit them from using funds with redemption restrictions – sweep accounts and collateral accounts must have access to 100% of their funds."

BlackRock concluded that Schapiro’s redemption restriction proposals would actually increase the risk of clients running in a financial crisis. "Many of them told us that with a portion of their balance held back for 30 days and subordinated they would choose to redeem much sooner – at the first sign of nervousness."