In advance of tomorrow’s meeting of the Financial Stability Oversight Council (Council), Secretary Geithner today sent a letter to the members of the Council regarding recent developments in the effort to reform the money market fund industry and address the threats those funds can pose to the stability of the financial system.
To download a copy of the letter, see [link]. To see the recommendations by the Council in the 2011 and 2012 Annual Reports, see [link] and [link]. For more information on the Financial Stability Oversight Council, please see FSOC.gov.
September 27, 2012
the Financial Stability Oversight Council,
Last month, the
Securities and Exchange Commission (SEC) announced that it would not proceed
with a vote to solicit public comment on potential structural reforms of money
market funds (MMFs). This comes after a long
and concerted effort by the SEC to develop reform options.
reforms to the MMF industry are essential for financial stability. MMFs are a significant source of short-term
funding for businesses, financial institutions, and governments. The funds provide an important
cash-management vehicle for both institutional and retail investors. However, the financial crisis of 2007–2008 demonstrated
that MMFs are susceptible to runs and can be a source of financial instability
with serious implications for broader financial markets and the economy. In the days after Lehman Brothers failed and
the Reserve Primary Fund, a $62 billion prime MMF, “broke the buck,” investors
redeemed more than $300 billion from prime MMFs. Commercial paper markets shut down for even
the highest quality issuers. Only
Treasury’s guarantee of more than $3 trillion of MMF shares, a series of
liquidity programs by the Federal Reserve, and support from many fund sponsors stopped
the run and helped MMFs meet their shareholders’ redemption requests in a
The SEC took
important steps in 2010 to improve the resilience of MMFs by amending Investment
Company Act Rule 2a-7 to strengthen the liquidity, credit-quality, maturity, and
disclosure requirements of MMFs. But the
effort toward reform should not stop there.
The 2010 reforms did not attempt to address two core characteristics of
MMFs that leave them susceptible to destabilizing runs: (1) the lack of
explicit loss-absorption capacity in the event of a drop in the value of a
portfolio security and (2) the “first-mover advantage” that provides an
incentive for investors to redeem their shares at the first indication of any
perceived threat to the fund’s value or liquidity.
President’s Working Group on Financial Markets and the Financial Stability
Oversight Council (Council) have consistently called for the SEC to pursue
additional reforms to address structural vulnerabilities in MMFs, including
unanimous recommendations in the Council’s 2011 and 2012 annual reports. The Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act) gives the Council both the responsibility and the
authority to take action to address risks to financial stability if an agency
fails to do so. Accordingly, I would
like the Council to consider taking a series of additional steps to address this
Path Forward to Protect
Investors and the Economy
As its Chairperson,
I urge the Council to use its authority under section 120 of the Dodd-Frank Act
to recommend that the SEC proceed with MMF reform. To do so, the Council should issue for public
comment a set of options for reform to support the recommendations in its
annual reports. The Council would
consider the comments and provide a final recommendation to the SEC, which, pursuant
to the Dodd-Frank Act, would be required to adopt the recommended standards or
explain in writing to the Council why it had failed to act. I have asked staff to begin drafting a formal
recommendation immediately and am hopeful that the Council will consider that
recommendation at its November meeting.
The proposed recommendation
should include the two reform alternatives put forward by Chairman Schapiro, request
comment on a third option as outlined below, and seek input on other
alternatives that might be as effective in addressing MMFs’ structural
Option one would entail floating the net asset values
(NAVs) of MMFs by removing the special exemption that allows them to utilize
amortized-cost accounting and rounding to maintain stable NAVs. Instead, MMFs would be required to use mark-to-market
valuation to set share prices, like other mutual funds. This would allow the value of investors’ shares
to track more closely the values of the underlying instruments held by MMFs and
eliminate the significance of share price variation in the future.
Option two would require MMFs to hold a capital
buffer of adequate size (likely less than 1 percent) to absorb fluctuations in the
value of their holdings that are currently addressed by rounding of the NAV. The buffer could be coupled with a “minimum
balance at risk” requirement, whereby each shareholder would have a minimum
account balance of at least 3 percent of that shareholder’s maximum balance
over the previous 30 days. Redemptions
of the minimum balance would be delayed for 30 days, and amounts held back
would be the first to absorb any losses by the fund in excess of its capital buffer.
This would complement the capital buffer
by adding loss-absorption capacity and directly counteract the first-mover
advantage that exacerbates the current structure’s vulnerability to runs.
Option three would entail imposing capital and enhanced liquidity standards, potentially
coupled with liquidity fees or temporary “gates” on redemptions that may be
imposed as an alternative to a minimum balance at risk requirement.
We should also
be open to alternative approaches that satisfy the critical objectives of
reducing the structural vulnerabilities inherent in MMFs and mitigating the
risk of runs. We should use this
opportunity to seek informed perspectives on the extent to which any mix of the
specific reforms described above or other reforms would achieve the same level
of protection for investors and the broader economy. The Council should engage with key
stakeholders as part of this overall process.
The proposal should
take into account the concern expressed that reform of MMFs may result in
outflows from MMFs to less-regulated parts of the cash-management industry. While investors should welcome enhanced
protections in MMFs, experience tells us that we cannot ignore the potential for
capital, in times of relative stability, to flow to less-regulated sectors with
fewer protections. Our objective should
be to propose reforms to MMFs that protect the stability of MMFs without
creating a competitive advantage for unregulated cash-management products.
Alternative Paths to Reform
The SEC, by virtue of its institutional expertise and
statutory authority, is best positioned to implement reforms to address the
risks that MMFs present to the economy. However,
while we pursue this path, the Council and its members should, in parallel,
take active steps in the event the SEC is unwilling to act in a timely and
Under Title I of the Dodd-Frank Act, the Council has the
authority and the duty to designate any nonbank financial company that could
pose a threat to U.S. financial stability.
The Council should closely evaluate the MMF industry to identify firms
that meet this standard. Designating
MMFs or their sponsors or investment advisers would subject those firms to
supervision by the Federal Reserve and would give the Federal Reserve broad
authority to impose enhanced prudential standards, potentially including the options
discussed above. Alternatively, the
Council’s authority to designate systemically important payment, clearing, or
settlement activities under Title VIII of the Dodd-Frank Act could enable the
application of heightened risk-management standards on an industry-wide
Other Council member agencies have the authority to take
action to address certain of the risks posed by MMFs and similar cash-management
products. For example, the bank
regulatory agencies should evaluate their authorities to impose capital
surcharges on regulated entities that sponsor MMFs, or restrict financial institutions’
ability to sponsor, borrow from, invest in, and provide credit to MMFs that do
not have structural protections. As
currently conducted, such activities can pose risks to financial institutions’
safety and soundness in a variety of ways, including the potential for MMFs to curtail funding for
financial firms abruptly in times of market stress and the implicit support
provided by firms that sponsor MMFs.
Additionally, the potentially destabilizing role of MMFs in the
tri-party repo market should be carefully assessed as part of the ongoing
efforts to improve the safety, soundness, and resiliency of that market.
I urge the members of the Council to accelerate their
evaluation of these alternatives. The members
of the Council should move ahead to consider how best to give effect to these
alternative paths as they consider public comments on reform options for the
Without further reform of MMFs, our financial system will
remain vulnerable to runs and instability, which are harmful for retail and
institutional investors, businesses that need a reliable source of funding, the
MMF industry, and the financial system as a whole. We will seek broad input from the full range
of stakeholders on how best to design further reforms.
Four years after the instability of MMFs contributed to the
worst financial crisis since the Great Depression, with the failure of the SEC
to act, the Council should now move forward with the tools provided by Congress.
Timothy F. Geithner