Wed, 27 Jun 2012
Morningstar's Christine Benz and Miriam Sjoblom debrief investors on the floating NAV, capital buffer, and redemption restriction proposals for money market funds.
Christine Benz: Hi, I'm Christine Benz for Morningstar.
The Securities and Exchange Commission is considering a proposal that would change the way money market funds are regulated.
Joining me to discuss these proposals is Miriam Sjoblom. She is associate director of fund analysis for Morningstar.
Miriam, thank you so much for being here.
Miriam Sjoblom: Thanks for having me, Christine.
Benz: So, let's start with a little bit of stage-setting. Why is the SEC considering reforming the money market fund industry?
Sjoblom: Well, SEC Chairman Mary Schapiro has come out and said that the money market funds as they are structured today continue to pose systemic risk to the financial system, to the economy. And there were reforms enacted in 2010 that she says really haven't solved the problem of a crisis causing a run on money funds.
If you look back to 2008, that's what happened, when the Reserve Fund broke the buck following Lehman Monday. You saw people pulling money out of money market funds in droves.
Benz: So, ... money market funds are supposed to have this stable $1 net asset value. In the case of this Reserve Primary Fund that broke the buck, its net asset value actually dropped below $1, and that spurred a run-on-the-bank type of situation?
Sjoblom: That's correct.
Benz: So what is the SEC considering ,and how do they think that it would address some of these risk factors that are there for money market funds?
Sjoblom: Well, there are two main reforms on the table, it seems. The first is to eliminate that fixed $1 share price and switch to floating net asset value system where the net asset value of the funds would reflect the actual market value of the securities in them.
Benz: I think that that is something that investors watching this should be clear on: Even though [money market] funds typically do maintain that $1 per share NAV, the underlying securities can bob around a little bit more underneath that surface, and so the idea is to actually show investors to what extent that's happening. Sometimes they might actually jump above that $1 mark as well.
Sjoblom: Certainly. It can work both ways.
Benz: So they would float the NAV, and shareholders would be able to see on a daily basis ,or whatever it might be, what the real, actual NAV would be?
Sjoblom: Right. And some reports say if they were to show the actual NAV, it might be that you would have to go out several decimal points to even see the difference, yet still it could be another signal to investors of how good is my money market fund manager at managing risk.
Benz: Okay. So, the floating NAV is one part of their proposal. What else is on the table?
Sjoblom: Another one would be to have funds set aside a capital buffer similar to what banks are required to do to have capital reserves.
Benz: Then there is also a part of the proposal that relates to liquidity. I know that money market fund investors really value those daily redemptions that they are able to take out. What would this involve?
Sjoblom: This would be a restriction on investors pulling all their money out of a fund. They would have to leave some portion of it in for 30 days.
Benz: So, I know that the fund industry has pushed back quite hard, particularly ... on a few of these different aspects of the proposal. What is the fund industry putting forth... as arguments against these reforms? What are they saying? What are the key arguments?
Sjoblom: Well, they are saying for one that the reforms that were enacted in 2010 already went far enough to improving the ... overall credit quality of the portfolios. Funds after 2010 now have to maintain a certain amount of assets in liquid securities. They before didn't have a liquidity mandate. And it also shortened average maturities for these funds. So the weighted average maturity limit went from 90 days to 60 days.
So, they say enough has been done already. We don't need additional reform. Another argument is that investors really value that $1 stability, and if you take that away, money market funds become useless.
Benz: Leading up to this proposal being released this week, the SEC did issue a report outlining what’s going on in the money fund industry. And one striking statistic to many was that the SEC noted that within the fund industry, [there were] some 300 incidents where firms had stepped in and actually topped up, put in their own money into money market funds, to keep them from breaking the buck. What should investors make of that statistic, which on its surface, seems quite striking?
Sjoblom: It was 300 since the 1970s, and they specifically said that it was more than 100 in September 2008 alone, just to give you an idea for how severe the crisis was in September. But, on the one hand, investors might look at that 300 number, and say, well in the past fund sponsors have been willing to shore up those funds, if necessary. The risk to their business of allowing a fund to break the buck is too great, so they have stepped in, and that gives me comfort.
But on the other hand, investors should just know that parent companies aren't obligated to do this.
And the other factor that this introduces is the credit worthiness of the parent company as well. Even if the parent company does want to step in to save their own business, do they have the ability to do so?
Benz: And that's really a wildcard. It depends on whatever provider you are dealing with.
Sjoblom: Right. I'm kind of reminded of the monoline insurance business in the muni industry, where investors sort of depended on that AAA guarantee from an insurer ,and then we found out in many cases the underlying issuers were of much better quality than the insurers themselves.
Benz: Miriam, thank you so much for providing some context on this proposal. I know that there are literally many billions of dollars in money market funds, so investors will be staying tuned to this issue, and we will too. Thank you for joining me.
Sjoblom: Thank you.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.