Published December 05, 2012
WASHINGTON – U.S. Securities and Exchange Commission economists have found that reforms adopted in 2010 have bolstered the $2.6 trillion money fund industry but would not have prevented the Reserve Primary Fund from "breaking the buck" during the financial crisis.
The SEC's findings were laid out in a new study released late on Wednesday that examines the 2008 financial crisis and the impact of reforms implemented as a response to those events.
During the crisis, heavy exposure to collapsed investment bank Lehman Brothers caused the net asset value (NAV) of the Reserve Primary Fund, a large money market fund, to fall below $1 per share, or "break the buck" in industry parlance.
"The findings indicate that funds are more resilient now to both portfolio losses and investor redemptions than they were in 2008," the report says.
"That being said, no fund would have been able to withstand the losses that The Reserve Primary Fund incurred in 2008 without breaking the buck, and nothing in the 2010 reforms would have prevented The Reserve Primary Fund's holding of Lehman Brothers debt."
The study was requested by SEC Democratic Commissioner Luis Aguilar and Republicans Troy Paredes and Dan Gallagher, all three of whom were reluctant to support any new reforms championed by SEC Chairman Mary Schapiro without additional economic analysis.
The study does not make any policy recommendations.
However, it does explore various explanations for redemption activity by investors during the financial crisis, and how any potential structural changes to money funds could affect investor behavior.
Since last year, Schapiro has been calling for a new round of reforms to the money market fund industry.
Although the SEC implemented numerous reforms in 2010, she has said those did not go far enough to prevent runs that could cause money market funds, ordinarily presumed to be risk-free investments, to drop below an industry target of $1 per share and thus lose money.
Those reforms at the time bolstered fund transparency, tightened credit quality standards, shortened the maturities of fund investments and imposed a new liquidity requirement.
Earlier this year, Schapiro circulated a draft proposal to SEC commissioners that contained several options for new measures. The leading option called for capital buffers coupled with redemption limits during periods of stress.
Another approach called for moving from a stable $1 per share net asset value to a floating NAV, so that investors would not get spooked by the prospect of funds breaking the buck.
But Schapiro faced staunch opposition from money market funds, as well as corporate treasurers, who said her proposal could effectively kill the industry.
Aguilar, Paredes and Gallagher were all wary of her call for more regulations without first studying the effects of the 2010 reforms, which were adopted in response to the Reserve Primary Fund incident.
The SEC voted to publicly release the economists' report on Wednesday after Aguilar issued a public comment earlier in the day announcing the study had been completed and delivered to commissioners.
He said in his statement he was glad the study more closely explores one of his primary concerns - that major structural changes to money funds could give rise to a migration by investors into instruments in an "unregulated market".
Those who prefer "yield over principal stability and low investment risk" could shift their money into floating NAV offshore money market funds or other instruments, the report said.
But non-financial commercial paper issuers would probably be largely unaffected by a decrease in demand from money market funds, and municipalities that use money market funds for short-term funding needs would also not likely feel a huge impact, the report said.
It is unclear exactly how the study will affect ongoing negotiations at the SEC over possible money market fund reforms.
Following the defeat of Schapiro's plan in August, the U.S. Financial Stability Oversight Council recently decided to take up the issue in an effort to pressure the SEC to come to a consensus on new reforms.
Last month, the FSOC rolled out a framework of new rules that largely mirror the plan championed by Schapiro.
It is collecting comments on the draft, which discusses the various regulatory approaches.
If the SEC refuses to act, then the FSOC could formally present its recommendations, which would force the SEC to agree to them, or reject them in writing within 90 days.
With Schapiro about to depart the agency on December 14, that will leave the SEC split between two Democrats and two Republicans, potentially making it harder to reach a consensus.
Aguilar has not publicly commented specifically about his views on either the capital buffer or floating NAV proposals.
Gallagher, however, has previously said he would be open to a floating NAV if it were coupled with rules allowing fund boards to impose liquidity "gates" on redemptions.
(Editing by Gerald E. McCormick, Tim Dobbyn, Leslie Adler and Edmund Klamann)