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Treasury Notes

 Five Questions on the FSOC’s Proposed Recommendations for Money Market Mutual Fund Reform

By: Amias Gerety
11/27/2012

Earlier this month, the Financial Stability Oversight Council (the Council) voted unanimously to advance proposed recommendations for money market mutual fund (MMF) reform for public comment.  Here are five frequently asked questions about MMFs:

What are MMFs?

MMFs are mutual funds that offer individuals, businesses, and governments a means of pooled investing in money market instruments. MMFs are a significant source of short-term funding for businesses, financial institutions, and governments, as MMFs had approximately $2.9 trillion in assets under management as of September 30, 2012.  However, the 2007–2008 financial crisis demonstrated that MMFs are susceptible to runs that can have destabilizing implications for financial markets and the economy.

Why do MMFs need to be reformed?

In the days during September 2008, after Lehman Brothers Holdings, Inc. failed and an MMF “broke the buck,” investors redeemed more than $300 billion from prime MMFs, and commercial paper markets shut down for even the highest-quality issuers. Government intervention was needed to help stop the run on MMFs during the financial crisis.

While the Securities and Exchange Commission (SEC) took important steps in 2010 by adopting regulations to improve the resiliency of MMFs, these reforms did not address the structural vulnerabilities of MMFs that leave them susceptible to destabilizing runs.

This structural vulnerability to runs is driven by the “first-mover advantage,” which provides an incentive for investors to redeem their shares at the first indication of any perceived threat by allowing investors who redeem first to do so at the customary share price of $1.00, even if the fund’s assets are worth slightly less.  Because MMFs lack any explicit capacity to absorb losses in their portfolio holdings without depressing the market-based value of their shares, even a small threat to an MMF can start a run.

Why is the Financial Stability Oversight Council involved if they don’t regulate MMFs?

The broader financial regulatory community has focused substantial attention on MMFs and the risks they pose. 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 and financial markets.  However, as the SEC has not been able to move forward with MMF reform, Secretary Geithner urged the Council to take up these important reforms using the Council’s authority under Section 120 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Section 120 of the Dodd-Frank Act is an authority given to the Council to help it carry out its financial stability mission. It enables the Council to issue recommendations to primary financial regulatory agencies to apply “new or heightened standards and safeguards” for a financial activity or practice conducted by bank holding companies or nonbank financial companies under the agency’s jurisdiction.

What are the Financial Stability Oversight Council’s proposed recommendations for MMF reform?

The Council is proposing three alternatives, which are not mutually exclusive and could be implemented in combination:

1.     Floating net asset value, which would remove a special exemption under SEC rules that allows MMFs to maintain a stable net asset value per share and, in its place, would require that MMFs’ share prices reflect the actual market value of their portfolio holdings, consistent with requirements for other mutual funds.

2.     Stable NAV with a NAV buffer and minimum balance at risk, which would require MMFs to build a buffer of up to 1 percent of assets to absorb day-to-day fluctuations in value. This would be paired with a “minimum balance at risk,” which would require that a small amount of a shareholder’s investment be made available for redemption on a delayed basis and subject to first losses if a fund suffers losses that exceed its NAV buffer.

3.     Stable NAV with a NAV buffer and other measures, which would require MMFs to build a buffer of 3 percent of assets, and that could be combined with other measures to enhance the effectiveness of the buffer and potentially increase the resiliency of MMFs. To the extent that these other measures complement the NAV buffer and further reduce the vulnerabilities of MMFs, the size of the NAV buffer could be reduced. 

Additionally, the Council recognizes that there may be other reforms that could achieve similar outcomes, so the Council is seeking comment on other potential reforms of MMFs that meet the objectives of addressing the structural vulnerabilities inherent in MMFs and mitigating the risk of runs.

What happens now that these proposed recommendations have been released?

A 60-day public comment period began November 19, 2012, when the proposed recommendations were published in the Federal Register. During the comment period, all stakeholders – including institutional and individual investors, industry participants, municipalities, and other interested parties – are welcome to submit their comments. Once the public comment period closes on January 18, 2013, the Council will carefully consider the comments and plans to issue a final recommendation to the SEC. Under the Dodd-Frank Act, the SEC will be required to implement the recommended standards, or similar standards that the Council deems acceptable, or explain in writing within 90 days why it has determined not to follow the recommendation.

However, if the SEC moves forward with meaningful structural reforms of MMFs before the Council completes its Section 120 process, it is expected that the Council would not issue a final recommendation to the SEC.

Read more about the Council here.

Amias Gerety is the Deputy Assistant Secretary for the Financial Stability Oversight Council at the U.S. Department of the Treasury.

Posted in:  Financial Stability Oversight Council
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