With a new chairman at the helm, the Securities and Exchange Commission on Wednesday will renew its effort to overhaul the $2.7 trillion money market industry, which was shaken during the 2008 financial crisis.
An effort to radically transform money market funds failed last year when then-Chairman Mary Schapiro could not muster a majority on the five-member commission. Democrat Luis Aguilar joined with the two Republicans to defeat her measure. But that hasn't stopped regulators, including new chief Mary Jo White, who believe money market funds remain vulnerable and could worsen a future financial crisis.
The money market fund issue is among the biggest and most controversial the SEC has taken up in years. No one outside the agency knows for sure what White will propose at the SEC's meeting starting at 10 a.m. ET.
Bend, Break Or Balk
Many regulators have favored a shift to a bend-but-don't-break structure. But the industry says investors want the security of knowing they're unlikely to lose money.
Aguilar has signaled he might back a modified plan. White, sworn in April 10, hasn't tipped her hand. In a May 1 speech before the Investment Company Institute, she said only, "Our goal is to preserve the economic benefits of the product while addressing potential redemption pressures and the susceptibility of these funds to runs, runs in which retail investors are especially likely to suffer losses.
The mutual fund industry, along with the U.S. Chamber of Commerce representing the businesses that use money market funds, have resisted sweeping change. They say investors would flee for less-regulated options, increasing systemic risks. They say regulations enacted in 2010 offer adequate protection.
"We think the SEC and regulators need to establish the need for further changes, and we haven't seen that yet," said ICI spokesman Mike McNamee.
For more than 40 years, individual and institutional investors have loved money market funds for their safety, stability and ease of moving in and out. Corporations and local and state governments use them to park cash.
Money market funds invest in short-term corporate debt — commercial paper — along with other short-term and highly liquid interest-bearing assets. They hold about a third of commercial paper and three quarters of short-term state and local government debt.
As the financial crisis unfolded in September 2008, the $64.8 billion Reserve Primary Fund, the oldest money market fund, held $785 million in Lehman Bros. debt that became worthless overnight when Lehman collapsed. The fund "broke the buck," meaning its net asset value fell below $1. Institutional investors led a run on money market funds. The commercial paper market dried up. Suddenly corporate America struggled to meet short-term financing needs such as making payroll and paying suppliers.
Until the Federal Reserve rode in with a bailout, it looked like the economy might grind to a halt.
Schapiro's plan called for abolishing the constant $1 NAV in favor of a floating NAV that could fall below a dollar. Like a mutual fund, a floating NAV implies the possibility of a loss of principal.
Her plan also called for a capital buffer that money market firms would keep to shore up a troubled fund and redemption restrictions that require funds to withhold part of investors' accounts if they tried to withdraw it all.
Some reports suggest White aims to apply the floating NAV idea just to prime money market funds that buy corporate debt — excluding funds that invest in Treasury, government or municipal debt. They experienced net inflows during the crisis.
Assuming the SEC votes Wednesday for a proposal, a comment period will follow with a final vote months away.
The industry contends floating NAVs won't stop another run. For example, ultrashort bond funds, which use floating NAVs, saw outflows of 15% during a four-week span in April 2008. The funds were down 60% by the end of the year, according to an ICI report.
Also, a floating NAV French money market fund lost 40% of its assets over three months in 2007.
Polls taken for Fidelity Investments and T. Rowe Price found that institutional and retail investors disliked floating NAVs. Most institutions said they would use money funds less or not at all.