The debate over money fund reform continues to escalate as more firms express views challenging the recommendations of the Financial Stability Oversight Council (FSOC), with the last comment coming from Charles Schwab Investment Management [profile].
In a letter to the committee written by CSIM president Marie Chandoha, the firm expressed concerns about the FSOC process, arguing that the SEC is the only regulator with authority over money market fund reform.
At one part, Chandoha writes:
We continue to believe that a blanket shift of the entire money market fund industry from a stable NAV product to a floating NAV product would imperil the industry, deprive individual investors of a critically important cash management option, disrupt the larger economy, and potentially destabilize the financial system itself.
The CSIM president also suggests a modified alternative to the floating NAV, which she described in the following way:
Our alternative proposal allows investors to remain in a prime stable NAV fund if they own a sufficiently small percentage of the fund and thus pose minimal risk to the fund. But it takes the decision out of the hands of shareholders who own a larger percentage of the fund. Shareholders would not be permitted to own more than 0.1% of a prime stable NAV fund. We think this option strikes the balance for which a regulator should strive: leaving the decision about which type of fund to invest in up to the investor in most circumstances, but dictating in which type of fund an investor can invest when the shareholder’s concentration in the fund poses a measurable risk to the stability of the fund.
Highlights from Chandoha’s 15-page letter to the FSOC are presented below:
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Overview
Schwab has been an active participant in the debate over money market fund regulation since 2009. We were supportive of the 2010 amendments to Rule 2a-7, the rule that governs the funds, which we believe substantially strengthened money market funds, made them more transparent to investors, and reduced the risk of runs.
Since 2010, money market funds have shown their resiliency in the face of a variety of challenging market conditions, including the US debt ceiling crisis of 2011 and the ongoing EuroZone crisis. No fund has broken the buck, and all funds have shown stability and strength. Schwab continues to believe fundamentally that the 2010 reforms are working.
We continue to believe that a blanket shift of the entire money market fund industry from a stable NAV product to a floating NAV product would imperil the industry, deprive individual investors of a critically important cash management option, disrupt the larger economy, and potentially destabilize the financial system itself. But a more targeted approach, one that applies a floating NAV to the types of money market funds most susceptible to runs and the types of investors most likely to trigger runs, is an option worth considering.
We believe such a solution could address the concerns of regulators by targeting reform at the sector of the money market fund industry most likely to initiate a potentially destabilizing run, but do so without wreaking havoc on a $2.7 trillion product that is enormously popular with individual investors and plays a critically important role in the financial system and in the broader economy.
Concerns with FSOC Process
Schwab believes strongly that the SEC is the proper authority for the promulgation of rules related to money market funds.
Given that all signs point to another attempt by the regulatory agency of jurisdiction to promulgate a rule in 2013, we believe that the Council should not consider any further action on money market fund reform until such time as the SEC has completed its ongoing work.
Concerns With Council’s Proposed Recommendations
Alternative One: Floating Net Asset Value
A broad requirement that all funds float their NAVs would lead to a flight to less regulated products or to banks. This, in turn, would increase demand deposit insurance requirements at recipient banks, increase bank capital obligations, and, ultimately, increase systemic risk by concentrating assets in a small number of very large, very complex institutions. An across-the-board floating NAV proposal would also severely limit the cash management options available to individual investors and to the thousands of businesses, non-profit organizations, educational institutions, municipalities and states that rely on the short-term markets to fund operations.
For these reasons, we oppose a broadly-applied floating NAV as regulatory overreach. However, …requiring certain types of funds with particular investor characteristics to have a floating NAV is an idea we support.
Alternatives Two and Three: NAV Buffer with and without Minimum Balance at Risk
Our most significant concern is that (NAV Buffers) represent a move from the regulation of money market funds as securities products to the regulation of money market funds as bank-like products. For too long, money market funds have been labeled part of the “shadow banking” world. Nothing could be further from the truth. Money market funds are not banks. Rather, they offer an alternative to bank products and, indeed, provide a number of advantages.
Money market funds are investment products and should be regulated as such. Companies offering money market funds are required, via a robust disclosure regime, to be fully transparent with investors that the funds have risk and are not guaranteed by the government. We urge regulators to reject bank-like reforms.
In addition to our concerns about NAV buffers, we also have strong objections to the concept of a Minimum Balance at Risk, which we believe to be simply unworkable for individual investors.
The implementation of a minimum balance at risk proposal would destroy the convenience and flexibility that is a hallmark of the product. Investors would not be able to withdraw all their money at once and would likely be confused as to how much of their money would be available for withdrawal at any given time.
Individual investors in this context present almost no run risk at all, yet significant portions of their assets would be unavailable. It would be nearly impossible for these investors to use such a product to manage their cash in any efficient or reasonable way. It is not clear to us that any individual investor would want to use money market funds with these restrictions in place. In addition, it is not clear to us that holding back a certain percentage of a client’s funds would reduce run risk.
Schwab Alternative Proposal: Modified Floating NAV
Our alternative proposal allows investors to remain in a prime stable NAV fund if they own a sufficiently small percentage of the fund and thus pose minimal risk to the fund. But it takes the decision out of the hands of shareholders who own a larger percentage of the fund. Shareholders would not be permitted to own more than 0.1% of a prime stable NAV fund. We think this option strikes the balance for which a regulator should strive: leaving the decision about which type of fund to invest in up to the investor in most circumstances, but dictating in which type of fund an investor can invest when the shareholder’s concentration in the fund poses a measurable risk to the stability of the fund.
Any prime fund that allows a single shareholder to own more than 0.1% of the total assets of the fund would be designated a “Prime Variable NAV Money Market Fund.” Such a fund must “float” its NAV and report the share price at the end of each trading day.
“Non-prime” funds – Treasury, Government and Municipal money funds – should be permitted to retain their stable $1 per share pricing and be open to any investor.
We believe our proposal meets the Council’s goal by greatly reducing the first-mover advantage in the Prime Variable NAV Fund and by removing from Prime Constant NAV funds the shareholders most likely to cause a destabilizing run.
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