SBC Examines Money Market Mutual Fund Reforms with SEC Chairman Mary Schapiro
At today’s Senate Banking Committee hearing, lawmakers examined the money market mutual fund (MMF) industry with Securities and Exchange Commission (SEC) Chairman Mary Schapiro. Lawmakers on both sides touched on the 2010 MMF reforms, and expressed concern about MMF regulations for municipal and corporate financing activity. In addition, lawmakers also discussed the new SEC study on the MMF industry that supports Schapiro’s arguments for additional regulation due to funds’ susceptibility to runs, citing how MMFs have been rescued from financial trouble by their sponsors more than 300 times since the 1970s.
The SEC will not release the study to the public, but Schapiro did say that she will provide the study to the Committee “in the next few weeks.”
Testimony
In her testimony and during the question and answer session, Schapiro said she was concerned about the systemic risk inherent in money market funds and the potential for a destabilizing run on the funds. She also discussed the lack of a level playing field between institutional investors and retail investors and small businesses, arguing that institutional investors tend to be early redeemers “who can commit resources to watch their investments carefully and who have access to technology to redeem quickly. This can provide an advantage over retail investors who are not able to monitor the fund’s portfolio as closely.”
While discussing the benefits behind the 2010 reforms, Schapiro said she still believes “that more needs to be done, as the incentive to run remains.” She identified several features of MMFs that contribute to the susceptibility to runs such as: 1) The $1.00 share price, which “has fostered an expectation of safety,” and contributes to a rush to redeem due to investors loss in confidence if the fund breaks a dollar; 2) Investors have an incentive to redeem at the first sign of problems in a MMF; and 3) The potential for the fund to sell securities at fire sale prices due to the amount of investors looking to redeem at the same time.
In her testimony, Schapiro identified two particular reforms that are worth considering. The first option would require MMFs to buy and sell their shares based on the market value of the funds’ assets. That is, to use “floating” net asset values (NAV). A second option would allow money market funds to maintain a stable value, but would require the funds to maintain a capital buffer to support the funds’ values, possibly combined with limited restrictions or fees on redemptions. While the capital buffer “would not necessarily be big enough to absorb losses from all credit events,” the buffer instead “would absorb the relatively small mark-to-market losses that occur in a fund’s portfolio day to day, including when a fund is under stress.”
Schapiro concluded that the public will have the opportunity to comment if the Commission were to propose further reforms, and the proposal “will also include a discussion of their benefits, costs, and economic implications.”
Question & Answer
2010 Reforms and Analysis
Senate Banking Chairman Tim Johnson (D-S.D.) asked Schapiro whether the SEC has conducted an analysis on the 2010 reforms, and which reforms have been most helpful. Schapiro said the SEC has studied the 2010 amendments “carefully,” adding the liquidity requirements (10 percent daily and 30 percent weekly liquidity) have been “most helpful in meeting redemptions.” Schapiro went on to say that the reforms “have served their purpose quite well,” but stated that the reforms do not solve the potential for an MMF to be unable to absorb the loss and experience a run from a credit event.
Schapiro added that if any proposal is released, the SEC will provide an analysis of the 2010 reforms, including reasons why the SEC believes additional reforms are necessary.
Sen. Robert Menendez (D-N.J.) asked whether the SEC is going to release the impact of the 2010 changes before moving on to the next set of reforms, adding “I think some of us would like to know what in essence those 2010 changes did before you move onto a next set of reforms to get a sense here of the impact.” Schapiro said she would be happy to provide a response for the record.
Cost-Benefit Analysis
Johnson asked whether Schapiro would agree that additional reforms, such as a floating NAV, capital buffers, and/or redemption restrictions, may cause investors to shift assets out of MMFs. Schapiro said the SEC, in a proposed release, would identify and analyze operational and administrative costs, competitive and opportunity costs, and weigh the costs to the overall benefits of the reforms. She said she believed that the costs would be “outweighed” by the benefits of forestalling another devastating credit event. The damage to investors’ confidence, frozen funds, short term credit freeze, including the costs to small businesses and individuals who are unable to access accounts to make payments need to be taken into account, she added.
Sen. Jack Reed (D-R.I.) asked whether the SEC has taken the time to assess the impact the potential reforms could have on municipalities. Schapiro said the SEC has held frequent discussions, including roundtables, with state and local governments concerned about MMF reforms.
Sen. Mark Warner (D-Va.) told Schapiro that “we need to be really cautious about this because I think the costs are potentially very real and very large for municipalities, for school districts, for local government and there’s been a lot of general talk about that today.” He asked her whether the SEC has compiled analysis on the costs to local governments from further regulation. Schapiro said the SEC release, if there is one, will discuss the costs to local and state governments and will seek additional comment and input. “We recognize this is not a costless proposition by any means,” she said.
Systemically Important
Ranking Member Richard Shelby (R-Ala.) asked Schapiro whether the Financial Stability Oversight Council (FSOC) has designated any MMF or MMF activities as systemically important. Schapiro said MMFs were discussed at length as a potential systemic risk in the FSOC’s annual report, but said the FSOC has not designated any funds or fund activity as systemically important.
Reed asked Schapiro whether it was possible for the FSOC to designate the largest funds as systemically important if the SEC does not come out with proposed rules. Schapiro said this was possible, but noted the potential risk of some funds receiving a designation as systemically risky.
In a follow up question, Reed asked whether the SEC has considered stress testing the sponsors in their capacity to support various MMFs. Currently, the SEC conducts stress tests on the portfolios, not the sponsors, Schapiro said.
Warner said he viewed the largest MMFs as “probably the safest in terms of shoring up if they get into this gray area, and it really is the smallest ones, the ones on the fringes that may be providing the most threat to the system.” He asked Schapiro for her thoughts on stress testing the sponsor’s capacity to provide capital to a fund.
Schapiro said she thought this was an “interesting idea.” She added that if there is going to be capital support, “it should be specific capital support. Investor’s should not be left to wonder whether it will be available.”
Warner also asked Schapiro whether the SEC was looking at alternative reform options, such as liquidity requirements. Schapiro said President Obama’s working group laid out a number of options that the SEC has looked at, and is willing to continue to discuss those alternatives with interested parties. However, Schapiro mentioned how “we have to get at the structural weakness,” adding that she was not sure liquidity requirements will be sufficient.
SEC MMF Report
Shelby asked Schapiro to discuss the new report and inquired as to whether the Committee would be able to see the report since it is not available publicly. Schapiro said the SEC produced a “tabulation, not a study,” on occasions where sponsors provided support to the fund. She added that the 300 figure is a conservative estimate since the SEC staff only recorded the number of times sponsors provided notice to the SEC of the support given to the fund. She mentioned that the Moody’s report, as well as other reports, had different numbers and that this divergence could be due to the use of different baselines.
Sen. Pat Toomey (R-Pa.) pressed Schapiro to explain the study further, and inquired as to whether those organizations and/or agency’s that have written similar reports are using the same definition of “support” and asked Schapiro what the SEC’s definition was.
Schapiro said previous reports “may not be” using the same definition of support. She added that the 300 figure is a conservative evaluation pulled from instances where sponsors came to the SEC seeking authority to violate affiliate transaction rules by making a contribution to the fund. She noted that the study did not count renewals or other types of potential contributions to the fund.
Toomey was not convinced, saying the report was hard to understand “as support is defined in so many ways.”
In concluding his remarks, Toomey found it “extraordinary” that Schapiro is portraying the industry as “extremely vulnerable” given how MMFs have thrived for decades. He then criticized Schapiro for using the report to justify increased regulation when the Committee has not had a chance to look at the data. “And now, without having had a chance to look at this data that you cite, and citing the very characteristics that have been in place from the very first day of this industry, you’re telling us that this is a very vulnerable industry and there’s great threats of a run and using that to justify regulations that I think threaten the very existence of this industry.”
Sen. Mike Crapo (R-Idaho) referenced a report from James Engel, Professor at Georgetown University, and said it was important to distinguish between a “destabilizing run and an orderly walk.” He asked whether the SEC was focusing on this distinction.
Schapiro said the reforms take the distinction into account. She added that the SEC is concerned with the “propensity to run,” and noted her disagreement with Engel’s findings.
Other
Shelby asked Schapiro whether she considers MMFs to be shadow banks, and inquired about the Federal Reserve’s activity with the SEC on MMF reforms. Schapiro said she is not a fan of the term “shadow bank,” but also indicated to the Committee that the Federal Reserve has been active with the SEC in conversations about potential MMF reforms.
Crapo inquired about the recent International Organization of Securities Commissions (IOSCO) MMF report and asked who at the SEC provided input to the report. Schapiro said the paper “was published prematurely, quite honestly, before the SEC — through a genuine screw-up in the process at IOSCO — was able to register that there was not a majority of the commission’s support.”
Panel II Testimony
In her testimony, Nancy Kopp, State Treasurer of Maryland, discussed the importance of MMFs to states and the negative consequences for states if capitalization requirements and other restrictions are proposed. She added that a floating NAV “would increase accounting work tremendously because it would require the daily booking of the mark-to-market value of each fund.” In light of the economic situation in most states, she said “it is difficult to see how states would be able to appropriate funds for more accountants to do this work, which in the end, would be of no value to the overarching issue as to whether it would prevent a run on these funds.”
In his testimony, Paul Stevens, President and CEO of the Investment Company Institute, said “any additional reforms must preserve the fundamental characteristics of money market funds – such as a stable NAV and ready liquidity – and ensure a continued robust and competitive money market fund industry.” He added that regulators continue to view money market fund reform “through the outdated lens of 2008,” adding the suggested changes “would destroy money market funds, at great cost to investors, state and local governments and the economy.”
In his testimony, Christopher Donahue, President, CEO, and Director at Federated Investors, Inc., dispelled a few myths regarding MMFs “that purport to justify the need for further reforms.” In addition, Donahue discussed the European debt crisis and how no MMFs had trouble meeting redemption requests during the summer of 2011 “and there was no impact on the overall [MMF] market.” Turning to the 2008 financial crisis, Donahue said “no reform of MMFs can prevent shareholders from seeking a safe haven during such a complete loss of investor confidence. Efforts to eliminate all risks from MMFs will not prevent a future crisis; they will only eliminate MMFs.” In concluding his remarks, Donahue said the reforms currently under consideration “are fundamentally at odds with the nature of money market funds and the needs of their shareholders.” He recommended the SEC instead conduct a thorough study of the 2010 reforms and the effects of the Dodd-Frank Act before proceeding further.
In his testimony, Bradley Fox, Vice President and Treasurer at Safeway, Inc., discussed the benefits of money market funds, but warned that “the changes to money market mutual fund regulation would fundamentally alter the product so that it no longer remains a viable investment option.” He added that a floating NAV for MMFs “would result in a significant accounting burden for companies across American investing in this product,” since most treasury workstations do not have the accounting systems to track NAVs, nor do they have the time and effort required to record the gains and losses on each investment.
In his testimony, David Scharfstein, Professor of Finance at Harvard Business School, said the SEC’s 2010 reforms “are a potentially useful first step in enhancing money market fund stability, but more reforms are needed to reduce risk in the financial system. Requiring capital buffers large enough to meaningfully reduce portfolio and run risk is a desirable next step in MMF reform.” Scharfstein went on to defend potential SEC reforms further in his testimony.
Panel II Q&A
With the exception of Scharfstein, panelists defended the current structure of MMFs and disagreed with Schapiro’s support for a floating NAV, citing operational issues and the inherent difficulty of monitoring a floating NAV.
Scharfstein said he was in favor of additional capital requirements as a way to reduce the potential for another taxpayer bailout. Pressed by Shelby on what the suggested figure would be, Scharfstein said “I think if you had a subordinated share class, you know on the order of 3 percent, I don’t see that as being particularly difficult to do, or particularly costly.”
Donahue disagreed saying “that just won’t work. The math doesn’t work.” Donahue went on to explain the mathematics to refute Scharfstein’s figure.
Toomey said he was surprised by the argument that having a fixed NAV is “somehow unfair to investors because investors don’t really understand, and they think that this is really akin to a bank deposit and a guaranteed thing.”
Nancy Kopp, Treasurer for the State of Maryland, said “we do read the prospectus and we know it’s an investment. It’s not a savings account. And the reforms of 2010 and the experience of 2008 I think have brought that home very clearly. So I think… treating us like children is really not appropriate.”
For additional information on the hearing, please click here.
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At today’s Senate Banking Committee hearing, lawmakers examined the money market mutual fund (MMF) industry with Securities and Exchange Commission (SEC) Chairman Mary Schapiro. Lawmakers on both sides touched on the 2010 MMF reforms, and expressed concern about MMF regulations for municipal and corporate financing activity. In addition, lawmakers also discussed the new SEC study on the MMF industry that supports Schapiro’s arguments for additional regulation due to funds’ susceptibility to runs, citing how MMFs have been rescued from financial trouble by their sponsors more than 300 times since the 1970s.
The SEC will not release the study to the public, but Schapiro did say that she will provide the study to the Committee “in the next few weeks.”
Testimony
In her testimony and during the question and answer session, Schapiro said she was concerned about the systemic risk inherent in money market funds and the potential for a destabilizing run on the funds. She also discussed the lack of a level playing field between institutional investors and retail investors and small businesses, arguing that institutional investors tend to be early redeemers “who can commit resources to watch their investments carefully and who have access to technology to redeem quickly. This can provide an advantage over retail investors who are not able to monitor the fund’s portfolio as closely.”
While discussing the benefits behind the 2010 reforms, Schapiro said she still believes “that more needs to be done, as the incentive to run remains.” She identified several features of MMFs that contribute to the susceptibility to runs such as: 1) The $1.00 share price, which “has fostered an expectation of safety,” and contributes to a rush to redeem due to investors loss in confidence if the fund breaks a dollar; 2) Investors have an incentive to redeem at the first sign of problems in a MMF; and 3) The potential for the fund to sell securities at fire sale prices due to the amount of investors looking to redeem at the same time.
In her testimony, Schapiro identified two particular reforms that are worth considering. The first option would require MMFs to buy and sell their shares based on the market value of the funds’ assets. That is, to use “floating” net asset values (NAV). A second option would allow money market funds to maintain a stable value, but would require the funds to maintain a capital buffer to support the funds’ values, possibly combined with limited restrictions or fees on redemptions. While the capital buffer “would not necessarily be big enough to absorb losses from all credit events,” the buffer instead “would absorb the relatively small mark-to-market losses that occur in a fund’s portfolio day to day, including when a fund is under stress.”
Schapiro concluded that the public will have the opportunity to comment if the Commission were to propose further reforms, and the proposal “will also include a discussion of their benefits, costs, and economic implications.”
Question & Answer
2010 Reforms and Analysis
Senate Banking Chairman Tim Johnson (D-S.D.) asked Schapiro whether the SEC has conducted an analysis on the 2010 reforms, and which reforms have been most helpful. Schapiro said the SEC has studied the 2010 amendments “carefully,” adding the liquidity requirements (10 percent daily and 30 percent weekly liquidity) have been “most helpful in meeting redemptions.” Schapiro went on to say that the reforms “have served their purpose quite well,” but stated that the reforms do not solve the potential for an MMF to be unable to absorb the loss and experience a run from a credit event.
Schapiro added that if any proposal is released, the SEC will provide an analysis of the 2010 reforms, including reasons why the SEC believes additional reforms are necessary.
Sen. Robert Menendez (D-N.J.) asked whether the SEC is going to release the impact of the 2010 changes before moving on to the next set of reforms, adding “I think some of us would like to know what in essence those 2010 changes did before you move onto a next set of reforms to get a sense here of the impact.” Schapiro said she would be happy to provide a response for the record.
Cost-Benefit Analysis
Johnson asked whether Schapiro would agree that additional reforms, such as a floating NAV, capital buffers, and/or redemption restrictions, may cause investors to shift assets out of MMFs. Schapiro said the SEC, in a proposed release, would identify and analyze operational and administrative costs, competitive and opportunity costs, and weigh the costs to the overall benefits of the reforms. She said she believed that the costs would be “outweighed” by the benefits of forestalling another devastating credit event. The damage to investors’ confidence, frozen funds, short term credit freeze, including the costs to small businesses and individuals who are unable to access accounts to make payments need to be taken into account, she added.
Sen. Jack Reed (D-R.I.) asked whether the SEC has taken the time to assess the impact the potential reforms could have on municipalities. Schapiro said the SEC has held frequent discussions, including roundtables, with state and local governments concerned about MMF reforms.
Sen. Mark Warner (D-Va.) told Schapiro that “we need to be really cautious about this because I think the costs are potentially very real and very large for municipalities, for school districts, for local government and there’s been a lot of general talk about that today.” He asked her whether the SEC has compiled analysis on the costs to local governments from further regulation. Schapiro said the SEC release, if there is one, will discuss the costs to local and state governments and will seek additional comment and input. “We recognize this is not a costless proposition by any means,” she said.
Systemically Important
Ranking Member Richard Shelby (R-Ala.) asked Schapiro whether the Financial Stability Oversight Council (FSOC) has designated any MMF or MMF activities as systemically important. Schapiro said MMFs were discussed at length as a potential systemic risk in the FSOC’s annual report, but said the FSOC has not designated any funds or fund activity as systemically important.
Reed asked Schapiro whether it was possible for the FSOC to designate the largest funds as systemically important if the SEC does not come out with proposed rules. Schapiro said this was possible, but noted the potential risk of some funds receiving a designation as systemically risky.
In a follow up question, Reed asked whether the SEC has considered stress testing the sponsors in their capacity to support various MMFs. Currently, the SEC conducts stress tests on the portfolios, not the sponsors, Schapiro said.
Warner said he viewed the largest MMFs as “probably the safest in terms of shoring up if they get into this gray area, and it really is the smallest ones, the ones on the fringes that may be providing the most threat to the system.” He asked Schapiro for her thoughts on stress testing the sponsor’s capacity to provide capital to a fund.
Schapiro said she thought this was an “interesting idea.” She added that if there is going to be capital support, “it should be specific capital support. Investor’s should not be left to wonder whether it will be available.”
Warner also asked Schapiro whether the SEC was looking at alternative reform options, such as liquidity requirements. Schapiro said President Obama’s working group laid out a number of options that the SEC has looked at, and is willing to continue to discuss those alternatives with interested parties. However, Schapiro mentioned how “we have to get at the structural weakness,” adding that she was not sure liquidity requirements will be sufficient.
SEC MMF Report
Shelby asked Schapiro to discuss the new report and inquired as to whether the Committee would be able to see the report since it is not available publicly. Schapiro said the SEC produced a “tabulation, not a study,” on occasions where sponsors provided support to the fund. She added that the 300 figure is a conservative estimate since the SEC staff only recorded the number of times sponsors provided notice to the SEC of the support given to the fund. She mentioned that the Moody’s report, as well as other reports, had different numbers and that this divergence could be due to the use of different baselines.
Sen. Pat Toomey (R-Pa.) pressed Schapiro to explain the study further, and inquired as to whether those organizations and/or agency’s that have written similar reports are using the same definition of “support” and asked Schapiro what the SEC’s definition was.
Schapiro said previous reports “may not be” using the same definition of support. She added that the 300 figure is a conservative evaluation pulled from instances where sponsors came to the SEC seeking authority to violate affiliate transaction rules by making a contribution to the fund. She noted that the study did not count renewals or other types of potential contributions to the fund.
Toomey was not convinced, saying the report was hard to understand “as support is defined in so many ways.”
In concluding his remarks, Toomey found it “extraordinary” that Schapiro is portraying the industry as “extremely vulnerable” given how MMFs have thrived for decades. He then criticized Schapiro for using the report to justify increased regulation when the Committee has not had a chance to look at the data. “And now, without having had a chance to look at this data that you cite, and citing the very characteristics that have been in place from the very first day of this industry, you’re telling us that this is a very vulnerable industry and there’s great threats of a run and using that to justify regulations that I think threaten the very existence of this industry.”
Sen. Mike Crapo (R-Idaho) referenced a report from James Engel, Professor at Georgetown University, and said it was important to distinguish between a “destabilizing run and an orderly walk.” He asked whether the SEC was focusing on this distinction.
Schapiro said the reforms take the distinction into account. She added that the SEC is concerned with the “propensity to run,” and noted her disagreement with Engel’s findings.
Other
Shelby asked Schapiro whether she considers MMFs to be shadow banks, and inquired about the Federal Reserve’s activity with the SEC on MMF reforms. Schapiro said she is not a fan of the term “shadow bank,” but also indicated to the Committee that the Federal Reserve has been active with the SEC in conversations about potential MMF reforms.
Crapo inquired about the recent International Organization of Securities Commissions (IOSCO) MMF report and asked who at the SEC provided input to the report. Schapiro said the paper “was published prematurely, quite honestly, before the SEC — through a genuine screw-up in the process at IOSCO — was able to register that there was not a majority of the commission’s support.”
Panel II Testimony
In her testimony, Nancy Kopp, State Treasurer of Maryland, discussed the importance of MMFs to states and the negative consequences for states if capitalization requirements and other restrictions are proposed. She added that a floating NAV “would increase accounting work tremendously because it would require the daily booking of the mark-to-market value of each fund.” In light of the economic situation in most states, she said “it is difficult to see how states would be able to appropriate funds for more accountants to do this work, which in the end, would be of no value to the overarching issue as to whether it would prevent a run on these funds.”
In his testimony, Paul Stevens, President and CEO of the Investment Company Institute, said “any additional reforms must preserve the fundamental characteristics of money market funds – such as a stable NAV and ready liquidity – and ensure a continued robust and competitive money market fund industry.” He added that regulators continue to view money market fund reform “through the outdated lens of 2008,” adding the suggested changes “would destroy money market funds, at great cost to investors, state and local governments and the economy.”
In his testimony, Christopher Donahue, President, CEO, and Director at Federated Investors, Inc., dispelled a few myths regarding MMFs “that purport to justify the need for further reforms.” In addition, Donahue discussed the European debt crisis and how no MMFs had trouble meeting redemption requests during the summer of 2011 “and there was no impact on the overall [MMF] market.” Turning to the 2008 financial crisis, Donahue said “no reform of MMFs can prevent shareholders from seeking a safe haven during such a complete loss of investor confidence. Efforts to eliminate all risks from MMFs will not prevent a future crisis; they will only eliminate MMFs.” In concluding his remarks, Donahue said the reforms currently under consideration “are fundamentally at odds with the nature of money market funds and the needs of their shareholders.” He recommended the SEC instead conduct a thorough study of the 2010 reforms and the effects of the Dodd-Frank Act before proceeding further.
In his testimony, Bradley Fox, Vice President and Treasurer at Safeway, Inc., discussed the benefits of money market funds, but warned that “the changes to money market mutual fund regulation would fundamentally alter the product so that it no longer remains a viable investment option.” He added that a floating NAV for MMFs “would result in a significant accounting burden for companies across American investing in this product,” since most treasury workstations do not have the accounting systems to track NAVs, nor do they have the time and effort required to record the gains and losses on each investment.
In his testimony, David Scharfstein, Professor of Finance at Harvard Business School, said the SEC’s 2010 reforms “are a potentially useful first step in enhancing money market fund stability, but more reforms are needed to reduce risk in the financial system. Requiring capital buffers large enough to meaningfully reduce portfolio and run risk is a desirable next step in MMF reform.” Scharfstein went on to defend potential SEC reforms further in his testimony.
Panel II Q&A
With the exception of Scharfstein, panelists defended the current structure of MMFs and disagreed with Schapiro’s support for a floating NAV, citing operational issues and the inherent difficulty of monitoring a floating NAV.
Scharfstein said he was in favor of additional capital requirements as a way to reduce the potential for another taxpayer bailout. Pressed by Shelby on what the suggested figure would be, Scharfstein said “I think if you had a subordinated share class, you know on the order of 3 percent, I don’t see that as being particularly difficult to do, or particularly costly.”
Donahue disagreed saying “that just won’t work. The math doesn’t work.” Donahue went on to explain the mathematics to refute Scharfstein’s figure.
Toomey said he was surprised by the argument that having a fixed NAV is “somehow unfair to investors because investors don’t really understand, and they think that this is really akin to a bank deposit and a guaranteed thing.”
Nancy Kopp, Treasurer for the State of Maryland, said “we do read the prospectus and we know it’s an investment. It’s not a savings account. And the reforms of 2010 and the experience of 2008 I think have brought that home very clearly. So I think… treating us like children is really not appropriate.”
For additional information on the hearing, please click here.