Institutions fighting money market proposals

An attempt by the Securities and Exchange Commission to put more safeguards on money market funds is generating caution and resistance from lobbyists for pension funds and institutional money managers concerned the move will make the funds a less viable investment option.

“We believe cash management is a distinct investment category, different from other fixed-income strategies,” wrote BlackRock Inc.'s Barbara Novick and Richard Hoerner in the firm's comment letter to the SEC. Ms. Novick is vice chairwoman and head of government relations for BlackRock; Mr. Hoerner is managing director and head of global cash management.

“Money market funds are important to a large number of institutional investors,” including pension funds, where their cash equivalent function can help meet investment policy guidelines, Ms. Novick said in an interview.

The proposed reforms, and the largely negative reaction to them, are also attracting attention on Capitol Hill. One day after the Sept. 17 comment letter deadline, the House Financial Services Committee will hold a hearing to address concerns raised by plan sponsor groups and money managers that the SEC's proposed cure could be worse than any potential problem.

As many as half of all defined contribution and defined benefit plans use money market funds for stability, liquidity and a low-cost diversified way to access commercial paper and government securities.

Plan executives worry that further regulation would alter the fundamental characteristics of the funds, while adding administrative and compliance headaches, plan sponsor lobbyists say.

In a survey and conversations with clients investing in its money market funds, BlackRock officials found other investors worried about negative impacts the SEC's proposed changes could have on zero-loss tolerance policies, or accounting and tax guidelines.

One key proposed change would make prime institutional money market funds have a net asset value that would float on a daily basis, as opposed to the current stable share price. Another option would be to keep the stable share price, but let the money market funds impose a 2% liquidity fee or redemption gates to temporarily suspend redemptions if a fund falls below 15% liquidity. A third option would be some combination of the two approaches.

Other proposals, made by the SEC in June, would require structural changes and add requirements on disclosure and stress-testing, among other steps. When the comment period ends Sept. 17, SEC staff is expected to face a mountain of letters to sift through before making final recommendations to the commission. Efforts to increase regulation of money market funds stems from the 2008 default of the Reserve Primary Fund related to Lehman Brothers losses. By falling below the $1 per share price, the fund “broke the buck,” which spooked investors and caused a wide market run.

While there is a lot of money at stake for money managers, pension plan executives are trying not to get lost in the shuffle, said Jan Jacobson, senior counsel for retirement policy at the American Benefits Council, Washington, which represents employers and service providers. “We hope that the commission takes into consideration the potential effects on qualified retirement plans — both defined contribution and defined benefit — of any changes that they're contemplating.”

To distinguish between institutional and retail investors in the funds, SEC officials are proposing to define retail funds as those limiting daily redemptions to $1 million. According to Investment Company Institute figures as of Sept. 4, institutional investors represent roughly two-thirds of money market customers, with $1.7 trillion in the funds vs. $934 billion from retail investors.

“The SEC has said all along they always worry about the institutional side because of its size and reaction time,” said Timothy Cameron, New York-based managing director and head of the asset management group at the Securities Industry and Financial Markets Association, which represents money managers, securities firms and banks.

Pension executives want their funds to be considered retail customers, especially if the final rule shifts to a floating NAV, which would make tracking redemptions an administrative challenge, especially for DC plan participants.

“The real difficult challenge that everyone is facing now is how to you distinguish between the two,” said Mr. Cameron of SIFMA. “It's not necessarily easy to define what exactly institutional or retail is.” But “one thing that everyone is in agreement on is that nobody should be subject to both” a floating NAV and liquidity fees and gates.

If the reforms are focused on institutional prime funds that many observers predict will be made to float, “we are at this place where the ability of the institutional investor to take a risk is being muted somewhat,” said Mr. Cameron.

Some of the biggest names in money management and money market funds — including Fidelity Investments, Federated Investors Inc. and Vanguard Group, and their trade group, the ICI — are mounting a vigorous campaign to limit the amount of change. A June 3 client communication from BlackRock about the reform proposals said: “We have been deeply engaged in detailed and constructive discussions with the SEC, the Financial Stability Oversight Council and money market fund industry participants on how best to strengthen MMFs.”

“At this stage, these are just proposals,” the BlackRock letter stressed. “It is premature to draw any conclusions as to what will be included in the final rule.”

The asset management industry already proved itself a worthy opponent on the issue in 2012 when then-SEC Chairwoman Mary Schapiro's bid for additional structural reforms failed, prompting the Financial Stability Oversight Council to get involved and prod the SEC back to rule-making.

Joining money managers in the fight this time are plan sponsor lobbyists, who worry the new proposals could cause a major re-evaluation of portfolios and plan menus. A potentially big fiduciary issue for plan executives is a proposed requirement that sponsors hold back shares if the NAV falls below $1. “It simply is not clear that an ERISA fiduciary could allow the plan's assets to be invested under these conditions,” said James Klein, president of the American Benefits Council.

Not everyone is holding up a stop sign to the SEC. New York Federal Reserve Bank President William Dudley has devoted several speeches to supporting the SEC's proposed changes, arguing reforms made in 2010 did not remove the risk of runs on money market funds. He cites data from the U.S. Treasury's Office of Financial Research showing 105 money market funds with more than $1 trillion in aggregate assets were at risk of breaking the buck in 2012.

The perceived risks to investors and market stability was great enough to prompt all 12 Federal Reserve Bank presidents to write the SEC urging further reforms last week. They did not like the option of a constant NAV with liquidity fees and redemption gates because it “could create an incentive for investors to run even earlier,” they wrote in a joint letter Sept. 12. But they made a strong case for the “floating NAV” option, which they argued could make gains and losses more apparent to investors “and reduce the incentive to "run'.”

Money managers don't see it that way. While they see some purpose in redemption fees and gates, changing to a floating NAV would “be enormously harmful and result in departures of institutional investors,” wrote Arnold & Porter LLP partner John D. Hawke on behalf of Federated Investors in a preliminary comment letter. n