June 25, 2012

A new Investment Company Institute study points to just how complicated the operational impact of redemption restrictions on money market mutual funds might be, according to Joan Ohlbaum Swirsky, of counsel with Stradley Ronon Stevens & Young. The ICI report was released yesterday, on the eve of a Senate committee hearing on the mooted reforms, which the industry is battling. Securities and Exchange Commission Chairman Mary Schapiro appeared before the panel this morning.

The SEC, worried about systemic risk and runs on money funds, is scoping various potential proposals including a floating net asset value (NAV), capital requirements and redemption restrictions (Complianceintel.com, 4/10).

Restricting redemptions, ICI stated in its study, essentially involves holding in escrow a portion of a shareholder’s money market fund account on a continuing basis. That money would be used to absorb losses if a fund “breaks the buck,” or is unable to maintain a $1 NAV. Daily redemption restrictions could make money market funds useless, ICI stated. “The evidence of this paper indicates...that the costs of these changes could be prohibitive and that the industry would be unlikely to undertake them, particularly if the SEC’s changes result in shrinking the asset base of money market funds,” the industry group argued.

ICI studied the concept based on a 30-day holdback of 3% of all redemptions. That means that shareholders would not have access for 30 days to a portion of the account equal to 3% of the shareholder’s highest daily balance over the past 30 days. If a fund broke the buck within the 30-day period, a portion of that restricted balance would bear losses prior to other shares.

Swirsky said the report drives home the potential complexity of a redemption restriction. “It’s not only a holdback, but there’s an aging component daily,” she told CI. “The holdback has to be aged daily for that 30-day period. And you have to calculate how much of the holdback is subordinated. It’s really very complicated and I think it’s going to be difficult to communicate to shareholders. And one of the benefits of money market funds is simplicity.”

Swirsky noted that ICI pointed out in its report that it is opposed to redemption restrictions when liquidity is available. “So that means there’s room for an alternative that’s imposed only when liquidity is dried up. They’re leaving open that door,” she said.

Meanwhile, the Senate Banking, Housing and Urban Affairs Committee today questioned Schapiro on her thinking behind potential money market reforms. “Should the [Federal Reserve] be the primary regulator of money market funds?” asked Sen. Richard Shelby, R-Ala., the committee’s ranking member.

“I think the SEC is a fine regulator of money market funds,” Schapiro replied. “The complication is that their value doesn’t fluctuate like investment products can, should and do, because we have the fiction of the stable net asset value.”

Schapiro also responded to questions on a range of issues that have been raised over the course of the lengthy money fund debate, including whether the SEC has thoroughly analyzed its 2010 reforms to know whether more are needed, and whether any money funds have been designated systemically important.

Republican Sen. Patrick Toomey of Pennsylvania pressed Schapiro on whether she had backing from the Commission on the reforms. “Senator, I guess I wouldn’t say that,” she replied. “Clearly, they have not joined me in this testimony—the Commission as a whole hasn’t. I think that some would tell you that they still have open minds. But you are right, some of them have expressed their views that nothing more needs to be done.”