Editor’s note: On Wednesday, July 23, the SEC approved final money market reform rules, which have introduced a floating NAV and retention gates during times of market stress. VIEW SEC PRESS RELEASE
On July 23, traders, fund managers and other big buy-siders will be tuning in to an announcement from a Federal agency that may have far-reaching effects on how money is allocated in the U.S.
This time it is not the FOMC that has their attention, but rather the Securities and Exchange Commission, which will be voting on money market reform. At issue is whether the commission will require institutional money market funds to adopt a floating net asset value and/or institute liquidity fees or so-called “redemption gates” during times of extreme market stress.
At the height the financial crisis of 2008, a large money market fund, the Reserve Primary fund, “broke the buck,” meaning the value of its investment income failed to cover expenses, usually due to a loss or default on investments in the fund’s portfolio. In the case of Reserve Primary, the fund’s exposure to securities held by Lehman Brothers, the investment bank that filed for bankruptcy in September 2008, caused the fund’s NAV to fall to 94 cents (generally, money market funds hold the NAV constant at $1.00).
Since money market funds were large purchasers of the commercial paper corporate America uses to finance its operations, that market ground to a halt as well, creating serious problems for the real economy. It took an emergency action by the Federal Reserve – an unlimited guarantee on deposits – to avoid a catastrophe.
Section 120 of the Dodd-Frank Act gave the Financial Stability Oversight Council (FSOC) the authority to recommend that the SEC adopt money market reforms, but was not specific as to the scope or framework of such reforms.
For more on the FSOC, visit the FSOC page in MarketsReformWiki.
The SEC came close to proposing money market rules in August 2012 but, after a period of intense lobbying by the industry, three of the five commissioners under then-chairman Mary Schapiro said they would not support the rules as proposed. Schapiro resigned from the commission a few months later.
Rules were finally proposed in June 2013. The SEC received over 1200 letters, most of which urged the commission not to institute a floating NAV.
For more on the SEC proposed rule, click here.
The money market is a fully established ecosystem, and one that is safe, secure and liquid, most of the time. During times of market stress, however, nothing beats cold, hard cash, and funds invested in money markets can become vulnerable. Let us hope that the unintended consequences of the SEC’s final rules are not worse than the existing system.