Yesterday, the Forum submitted a letter commenting on the SEC's rule proposals amending Rule 2a-7, which governs money market mutual funds. As we summarized in our June 24, 2009 post, "SEC Proposes Money Market Reform Options," these proposed regulations would tighten restrictions on money funds and are aimed at increasing their stability and preventing the kind of sudden vulnerability they suffered last fall due to liquidity problems and market events. The proposals include recommendations for changes to tighten the risk limiting parts of Rule 2a-7, including credit quality, maturity, and liquidity. The proposed rules also seek to increase transparency of money market funds to both the Commission and investors, and lessen the effect when a particular fund breaks the buck and decides to liquidate.
Broadly speaking, the Forum expressed support for the proposed rule amendments that seek to tighten the credit quality, durational and liquidity limits placed on money market fund portfolios. The letter also expresses support for "the effort, implicit in the Commission’s proposals, to strike an appropriate balance between eliminating as much of that risk as possible while still permitting money market funds to provide an appropriate yield to their investors."
The thrust of the Forum's letter however, focuses on those aspects of the rule proposal that affect either the role of money market fund directors or the nature of money market funds. Certain aspects of the proposal run the risk of blurring the line between directors' oversight of money market funds and actual management of the funds themselves.
As is the case with other investment companies, the directors of money market funds play an essential role in protecting and advancing the interests of the funds' shareholders. In addition to protecting shareholders from conflicts of interest, directors provide oversight of many of the key activities of funds, including oversight of their funds’ portfolio management and returns. Importantly, however, directors generally oversee these activities by hiring qualified providers and experts, not by performing those tasks directly. In short, in order to be most effective, directors need to respect the difference between effective oversight and micromanagement. Regulatory provisions that deal directly with the role and duties of the directors also should respect this distinction.
The letter points out areas in the rule proposal that, if adopted, may pose a risk that the lines between oversight and management may become blurred.
1. Use of NRSROs
Separately, we support the concept of designating particular NRSROs that funds will use to monitor the credit ratings of securities in which they invest. However, as with other aspects of the rule, we believe that it would be preferable to have this function performed by the adviser subject to the board's oversight rather than directly by the board itself.
2. Maintenance of Appropriate Portfolio Liquidity
As we discussed in our July 7, 2009 post, "Money Market Fund Proposals: New Duties for Directors," the release proposes provisions that would require directors to determine whether the money market funds they oversee sell to “retail” or “institutional” investors. This determination would be made necessary by other rules in the proposal requiring funds selling to institutional investors to have twice the liquidity of funds sold primarily to retail investors. The Forum's letter requests:
if the Commission were to adopt the approach of classifying funds, we urge it not to assign the responsibility of doing so directly to boards. The information required to make this decision is uniquely within the operational responsibility of the adviser, and accordingly, if this decision is required the adviser or appropriate service provider should make that determination.
3. Suspension of Redemptions and Fund Liquidation
First, and most importantly, we note that, unlike some of the other matters discussed in this comment letter, the decisions to liquidate a fund and to suspend redemptions are properly within the board’s duties.
. . .
Second, we agree that permitting directors to suspend redemptions may help support an orderly liquidation of a fund.
. . .
[W]e encourage the Commission to propose and adopt rules permitting (but not requiring) directors of a fund that is liquidating to divide it into two tranches, one for shareholders who would like to redeem immediately at current market prices and one for shareholders who wish to hold onto the investment in hope of a higher recovery.
4. Ability to Transact at Prices other than the Stable Net Asset Value
Given that it is impossible to completely eliminate the risk that a money market fund will “break the buck,” we agree with the Commission’s proposal that all money market funds should have the capacity to effect transactions at prices of other than $1. Although the Commission proposes to make this mandatory by requiring that fund boards make an annual determination that their fund has this capability, boards lack the operational expertise to make this determination directly. A more effective solution would require the appropriate service provider to certify to the board on an annual basis that the fund has the capability to transact at prices other than $1/share. By imposing the requirement in this form, the Commission appropriately will give the board oversight responsibility.
5. Stress Testing
We agree with the Commission that all money market funds should engage in regular stress testing and that effective stress testing should identify, as accurately as possible, the combination of variables that could cause a fund to “break the buck.” We therefore support this proposal. However, as with many other provisions in Rule 2a-7, it is important that the rule carefully define the role of the board in stress testing, so as not to either unduly limit the board's oversight nor cause the board to micromanage the fund.
The Forum's comment letter also supports generally the disclosure reforms in the rule proposal, but expressed concern that any proposal to require money market funds to disclose a market-based net asset value per share would be more likely to be confusing than helpful to retail investors in money market funds.
Responding to the proposal's request for comment on floating NAV for mutual funds, the Forum stated that that the "rule amendments that the Commission proposes in the Release significantly reduce the need to consider more fundamental changes like a shift to a floating NAV," and the Forum "does not believe that there is a strong basis for the Commission to consider fundamental change to a product that has been highly successful and is clearly highly desired by both individual and institutional investors."
The full text of the Forum's comment letter on the Rule 2a-7 proposals is available at: http://www.mfdf.org/site/pages/documents/2a-7ReformCommentLetterIC-28807_000.pdf
- "SEC Publishes Money Market Reform Proposals," July 6, 2009
- "SEC Proposes Money Market Reform Options," June 24, 2009
- "Forum Comments on Potential Money Market Reforms," June 1, 2009