WASHINGTON — All 12 Federal Reserve Bank presidents on Tuesday endorsed efforts by regulators to reform the $2.9 trillion money market mutual fund industry.
In a joint comment letter to the Financial Stability Oversight Council, the Reserve Bank presidents said regulators were right to fix the structural vulnerabilities of money market mutual funds and agreed with the council's assessment that the funds' activities and practices could increase the risk of liquidity and credit problems of spreading across the financial system.
"Money market mutual funds have no explicit capacity to absorb losses in the event of a decrease in the value of assets held within the fund's portfolio," the Reserve Bank presidents said in the letter. "This structure gives rise to a risk of destabilizing money market mutual fund runs by creating a first mover advantage."
In November, the FSOC voted to release three proposed recommendations to reform the industry. The move by regulators — utilizing its authority under Dodd-Frank — was intended to break through a logjam at the Securities and Exchange Commission, where former Chairman Mary Shapiro had been unable to win board approval to move forward with the agency's own reform plan.
Regulators have remained concerned that money market mutual funds are vulnerable to runs, as seen during the financial crisis four years ago. The deadline for comments on the proposal ends Feb. 15.
In its proposal, the FSOC outlined three recommendations to address remaining structural vulnerabilities in the funds, built on earlier work done by the SEC.
For one, funds could be required to float their net asset values, an idea opposed by many in the mutual fund industry. Alternatively, funds could be required to hold a capital buffer in order to absorb losses, along with placing restrictions on how much investors can redeem shares at one time. A third alternative would require a fund to keep a buffer of 3% to help absorb losses and potentially use other measures to increase its resiliency.
At the time, the FSOC suggested that one or more of the recommendations could be adopted.
The Reserve Bank presidents agreed with such an approach, saying it would take more than just one method to address financial stability concerns.
"For example, a complex could offer both a floating NAV fund and separately a stable NAV fund with a capital buffer (and possibly coupled with a minimum balance at risk), from which investors could chose," they wrote.
In their letter, the Fed presidents weighed in on each recommendation. A floating NAV, for example, could address run risk by eliminating the "cliff effect" related to "breaking the buck" and "reducing the first mover advantage."
On the other hand, a 3% buffer could also address run risk, while also putting into a place a buffer that could absorb day-to-day fluctuations as well as minor losses. While they noted it wouldn't entirely eliminate the possibility of a "cliff effect," it would make it less likely to occur with fixed NAV shareholders protected by a loss absorbing buffer.
Alternatively, funds could have a stable NAV fund with a capital buffer and possibly with a minimum balance at risk, which would help reduce run risk and a cliff effect by providing loss absorption capacity, while also keeping fund shareholders' ability to make transactions at a constant NAV under ordinary circumstances.
"As currently structured, MMFs provide a stable price at which an investor may purchase or sell an interest in the MMF, but MMFs have no explicit loss absorption capacity. By allowing redemptions at a constant share price rather than at a share price reflecting the current market value of the underlying portfolio assets, MMFs give investors a financial incentive to redeem before others during times of stress," they wrote.
After the comment period closes on Friday, the FSOC will provide its recommendation to the SEC. The agency has 90 days to respond to the council either by agreeing to the recommendation, suggesting its own suitable alternative, or explaining in writing why it won't be following guidance by outside regulators. If the SEC agrees to proceed with its own separate rule writing process, the council will suspend its own undertaking and not issue a final recommendation.