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Geithner Pushes Hard For Money Market Fund Reforms

by Glen Shapiro,, New York

03 October 2012

Following the failure of the Securities and Exchange Commission (SEC) to act, the United States Treasury Secretary Timothy Geithner has written to the Financial Stability Oversight Council (FSOC) requesting that it should take action on potential structural reforms of money market funds (MMFs).

He professed that the instability of MMFs contributed to the 2008 financial crisis, and that, therefore, without their further reform, the US financial system “will remain vulnerable to runs and instability, which are harmful for retail and institutional investors, businesses that need a reliable source of funding, the MMF industry, and the financial system as a whole”.

Following opposition within the ranks of its Commissioners, the SEC’s Chairman Mary Schapiro had to abandon her proposals for additional regulation of MMFs in August this year. She and other US regulators, including the FSOC and the Federal Reserve, had already indicated their concern that further structural reforms to MMFs are a policy issue that has not been fully resolved following the financial crisis.

As a significant sector of the US financial industry with some USD2.7 trillion funds under management, Shapiro had stated that the purpose of the reform would be to improve market resiliency by “reducing MMFs susceptibility to runs, protect retail investors and lessen the need for future taxpayer bailouts.”

Geithner reiterated in his letter to the FSOC that, in his opinion, while the SEC took important steps in 2010 to improve their resilience by tightening credit quality standards, shortening weighted average maturities, and, for the first time, imposing a liquidity requirement on the funds, “further reforms to the MMF industry are essential for financial stability”.

“The 2010 reforms,” he added, “did not attempt to address two core characteristics of MMFs that leave them susceptible to destabilizing runs: the lack of explicit loss-absorption capacity in the event of a drop in the value of a portfolio security and the 'first-mover advantage' that provides an incentive for investors to redeem their shares at the first indication of any perceived threat to the fund’s value or liquidity.”

As the FSOC’s Chairman, Geithner urged it to use its authority under the Dodd-Frank Act to recommend that the SEC proceed with MMF reform. To do so, he wrote, the FSOC should issue for public comment a set of options for reform, consider the comments it receives and then provide a final recommendation to the SEC, which it would be required to adopt.

The proposed recommendation, he continued, should include the two reform alternatives put forward by Schapiro – floating the net asset values (NAVs) of MMFs by requiring them to use mark-to-market valuation to set share prices, like other mutual funds, or requiring them to hold a capital buffer of adequate size (likely to be less than 1%) to absorb fluctuations in the value of their holdings that are currently addressed by rounding of the NAV.

Another option could entail imposing capital and enhanced liquidity standards, potentially coupled with liquidity fees or temporary ‘gates’ on redemptions, while the FSOC would also seek input on other alternatives that might be as effective in addressing MMFs’ “structural vulnerabilities”.

In the meantime, Geithner recommended that the FSOC, in parallel, take active steps in the event the SEC is unwilling to act in a timely and effective manner, and pointed out that, also under the Dodd-Frank Act, it has the authority and the duty to designate any non-bank financial company that could pose a threat to US financial stability.

“The FSOC should closely evaluate the MMF industry to identify firms that meet this standard,” he insisted. “Designating MMFs or their sponsors or investment advisers would subject those firms to supervision by the Federal Reserve and would give the Federal Reserve broad authority to impose enhanced prudential standards, potentially including the options discussed above. Alternatively, the FSOC’s authority to designate systemically important payment, clearing or settlement activities under the Dodd-Frank Act could enable the application of heightened risk-management standards on an industry-wide basis.”

Geithner has asked staff to begin drafting a formal recommendation immediately, and was hopeful that the FSOC would consider that recommendation at its November meeting. It is intended that the FSOC will seek broad input from the full range of stakeholders on how best to design further MMF reforms.

On the other hand, the US regulators’ inability to carry forward further regulations for MMFs has appeared to satisfy the MMF sector itself, that has long argued that the SEC’s previous changes have already adequately protected the industry from future shocks.

In addition, the US Chamber of Commerce (USCC) issued a further statement on behalf of investors in MMFs that applauded the blocking action by the dissenting Commissioners who “want to study the performance of 2010 money market fund reforms before deciding if more regulations are necessary”.

David Hirschmann, president and CEO of the USCC’s Center for Capital Markets Competitiveness, noted that “businesses use money market funds to raise capital and manage cash flows. The FSOC needs to consider that it may destroy tools used by companies to grow and create jobs.”

He pointed out that it was “time for a different approach that begins with examining the significant reforms that have already been implemented, and if any additional changes are needed, focus on approaches that will strengthen rather than destroy a product those businesses and investors rely on.”

TAGS: investment | business | law | financial services | capital markets | investment funds | ministry of finance | legislation | United States | standards | regulation | services

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