Government guarantees for US money market funds expire in September: Is the industry ready? | Practical Law

Government guarantees for US money market funds expire in September: Is the industry ready? | Practical Law

Government guarantees for US money market funds expire in September: Is the industry ready?

Government guarantees for US money market funds expire in September: Is the industry ready?

by Nathan J Greene , Shearman & Sterling LLP
Published on 08 May 2009 • USA (National/Federal)
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With the Temporary Guarantee Program for Money Market Funds (which supports such funds against the risk of sudden increases in redemptions) due to expire in September, US regulators and the industry are looking for a framework under which the funds can smoothly transition out of the insurance programme without again panicking investors. This article explores some of the reform proposals.
After two large US money market funds collapsed in September 2008, many US money market funds experienced sharp spikes in shareholder redemptions. The resulting near panic was a reminder of the fact that money market funds are subject to "break-the-buck" risk (that is, they may not return to investors their expected dollar per share) when unexpectedly forced to liquidate assets to meet a concentrated run of redemptions.
(Money market funds are a closely regulated subset of the US mutual fund industry. They buy short-term, high-quality assets and regularly distribute any yields realised, thus allowing their shares to maintain a steady net asset value, typically US$1 per share. They are widely used as a savings vehicle and today represent almost US$4 trillion in investor assets.)
Following the disruptions of September 2008, the US Treasury quickly created the Temporary Guarantee Program for Money Market Funds, which guaranteed that fund shareholders who owned shares on 19 September 2008 would be protected if a money market fund liquidated. This program succeeded in calming investors and ending the run of redemptions, but it is set to expire in September 2009.
With that September deadline looming, US regulators and the money market fund industry are looking for a framework under which the funds can smoothly transition out of the insurance programme without again panicking investors. Many believe this requires structural change.
Current reform proposals generally fall into one of three categories:
  • Scrap money market funds in favour of bank money market accounts or something very much like them inside "special purpose banks".
  • Scrap money market funds in favour of floating, as opposed to steady US$1, net asset value (NAV) vehicles.
  • Fine-tune the present system.
The principal proposals have been made by the "Group of 30", an international committee of current and former senior bankers and regulators; the Investment Company Institute, the US mutual fund industry’s leading trade group; and by senior officials of the US Securities and Exchange Commission (SEC), as follows:
  • Group of 30. Under the Group of 30's proposal, money market funds that offer "bank-like services", including transaction account services, withdrawals, demand at par, and assurances of a steady US$1 NAV, would be required to reorganise as special purpose banks. The Group of 30 recommends that money market funds that do not offer bank-like services should offer an investment option with a floating NAV. Either approach would upend 30 plus years of practice.
  • Investment Company Institute (ICI). The ICI generally makes more modest recommendations, many of which can be implemented by funds voluntarily, including:
    • shortening asset maturity requirements;
    • maintaining specified liquidity cushions;
    • enhancing internal credit analysis procedures;
    • requiring money market funds to develop know your client procedures; and
    • developing increased disclosure requirements.
    More dramatically, the ICI has proposed rule-making to authorise money market fund directors to suspend redemptions and purchases by the money market fund for five days in the case of exigent circumstances.
  • Securities and Exchange Commission (SEC). SEC Chairman Mary L Shapiro testified in March before the US Senate Banking Committee that the SEC will focus on proposals to enhance the standards applicable to money market funds. In a speech given in April, SEC Division Director Andrew Donohue challenged the US$1 steady NAV because it is insensitive to changes in the value of money market fund portfolios and therefore signals risk only to the most sophisticated investors who are able to perform their own "shadow pricing" calculations. He suggested that a US$10 floating NAV could address this concern.
Each of the proposals above has aspects that represent meaningful change from the status quo. In some cases, they would alter the US money market fund industry beyond recognition. That such far-reaching changes are being discussed is testament in large part to the fact that economic events ranging far beyond money market funds have created a uniquely fluid policy environment.
Yet for industry watchers with long memories, some of the current proposals will be familiar, having been widely discussed in the late 1970s and early 1980s. It is perhaps not mere coincidence that those earlier proposals saw their heyday during the tenure of then-US Federal Reserve Chairman Paul Volcker and that today Mr Volcker chairs the Group of 30's Steering Committee responsible for its money market fund reform agenda described above.
For a more information about these matters, see US Money Market Fund Reform Initiatives: A $4 Trillion Question.