The road to money market fund reform has been politically arduous. In August, Mary Schapiro, then the Chairwoman of the SEC, was forced to call off a vote on money market fund reform. Three of the five commissioners had indicated that they were not prepared to support the rules under consideration. Fortunately, two of the three dissenters have recently expressed receptivity to some reforms in certain circumstances.
To break through the impasse within the SEC, the commissioners should consider a compromise first proposed by Walt Bettinger, President and CEO of investment services firm Charles Schwab. That proposal would affect money market funds held by large institutions—such as pension funds and corporate treasuries—while leaving retail investors largely unaffected.
To understand this proposal, you need to understand how money market funds work. Money market funds are required to invest solely in short-term securities issued by high-quality corporations and governments. In exchange for these restrictions, money market funds are allowed to fix their share price—known as the net asset value, or NAV—at $1.00 per share, even if the true market value of their investments fluctuates slightly.
Regulators argue that this “stable NAV” makes money market funds vulnerable to runs. One rule supported by Chairwoman Schapiro would have required money market funds to adopt a fluctuating NAV. In other words, funds would have to calculate their NAV based on market prices, as is required of stock and bond mutual funds.
To see the regulators’ logic, imagine that you’re a corporate treasurer with a large investment in a money market fund. You begin to notice that some of the fund’s investments have declined slightly in value. If you act quickly, you can still sell your shares for $1.00 each. If you wait, the value of the fund’s investments could decline further, possibly requiring the fund to “break the buck”—that is, report an NAV less than $1.00.
Given this choice, you might very well decide to sell right away. Even worse, several of your colleagues running other corporate treasuries might also decide to sell their shares immediately—effectively triggering a run on that fund.
However, this dynamic mainly affects large institutional investors, which carefully monitor their holdings and can quickly redeem a large portion of a fund’s shares. By contrast, retail investors are likely to be unaware of any slight fluctuations and generally redeem much more slowly than large institutions. As a result, retail money market funds are much less susceptible to runs.
Therefore, I advocate that institutional money market funds should be required to adopt a fluctuating NAV. On the other hand, money market funds held solely by retail investors should be allowed to continue using a stable NAV at $1.00 per share.
Regulators will need to carefully establish rules which define money market funds as “retail” or “institutional.” I believe that funds with a maximum account size less than $1 or $2 million should qualify as “retail funds,” but regulators may also need to consider other factors, such as concentration of ownership.
In any case, these rules should be designed to ensure that individuals and small businesses can continue storing their cash in money market funds with a stable NAV. Such retail investors typically use money market funds as an alternative to bank deposits; a fluctuating NAV could lead many retail investors to flee money market funds entirely.
Driving retail investors out of money market funds would deprive high-quality corporate and municipal issuers of a critical source of short-term loans. And it is not clear whether the banking system has enough capital to support a huge influx of retail deposits from money market funds.
My proposal would also maintain the stable NAV for any money market funds—retail or institutional—which invest solely in securities issued or guaranteed by the U.S. government. Because the assets of such funds are highly safe, they are much less vulnerable to runs.
In short, regulators should require a fluctuating NAV for institutional money market funds that invest in non-government securities. This proposal would improve the stability of the financial system, while also protecting retail investors. This is the type of balanced solution that could break the deadlock at the SEC on money market fund reform.