New US Money Market Funds rules point a way for EU solution
THE U.S. Securities and Exchange Commission introduced a new code of rules that govern money market funds on July 23th that respond to industry and investor concerns while addressing key questions of moral hazard and completing a period of delicate negotiations between industry, regulators and politicians.
The outcome was hailed by one of the five SEC Commissioners, Dan Gallagher, one of the prime movers of the package, and whose input forced changes in the US regime, which are still at the heart of EU Commission proposals for the EU MMF industry, notably a 3% capital buffer.
Dan Gallagher
Dan Gallagher

EU regulators and politicians have been watching the US moves, which now provide a template for Europe in some respects, although EU industry sources have warned against a kneejerk copying of the US proposals.

SEC Commissioner Gallagher himself warned against this in a statement ahead of a visit to Europe in the wake of the release of the rules, to discuss the rules with policymakers there.

In an interview on the July 23th rule changes with Finance Dublin, Commissioner Gallagher referring to the EU debate says “In many ways you are where we were in 2012. At that stage the debate on money market funds reform was bogged down in a crossfire of conflicting proposals, the most significant of which is demands for a capital buffer for funds, alongside other reform measures, which include 'gates and fees' reform, and, VNAV reform (the replacement of Constant NAV (CNAV) funds with marked-to-market funds which are allowed to break par ($1) value).

Discussions initially centred around removing the capital buffer question from the agenda. As Gallagher explains it, once this was agreed between Democratic and Republican legislators who united on the issue in a common cause, the way forward was paved for a solution.

“The imperative in my mind is to get the capital buffer off the table so you can have a meaningful discussion about reform, as we have had since 2012,” he said.

EU and US politicans and regulators have been seeking to strengthen the money market funds industry, which was at the centre of the financial crisis, being the subject, in the US, of a $65.5 billion bailout in September 2008 of the Reserve Primary Fund by the Treasury and the Fed.

Various elements in the US and European reforms feature - notably, the capital buffer, rules on minimum liquidity, as well as ‘fees and gates’ proposals that refer to the ability of promoters to impose bans on cash withdrawals in the case of a run, and, at the heart of EU-US concerns, proposals to move to variable NAVs (VNAVS) from Constant ($1) NAVs (CNAVs).

The US rules, introducing the concept of variable NAVS to money market funds for the first time (after a two year preparatory period) will only apply to an estimated 25% of the funds in MMFs, because of an exemption on funds in Treasurys and sovereign bonds along with prime CNAV funds that are sold to retail investors.

Europe does not have such a market structure, with the result that VNAVs are regarded by most industry observers as spelling doom for the EU industry. Indeed, certain doom is predicted if a capital buffer (3% is proposed) is brought in. Industry spokesmen have pointed out that a capital buffer would have the opposite effect from what is intended, increasing the instability of funds (quoted here in a report of a seminar on the Central Bank of Ireland’s website).

The European Commission in September 2013 unveiled proposals to reform money market funds that are more severe than the rules passed by the SEC.

The proposals proved contentious with strong opposition to the proposals with reform postponed most likely until Autumn 2014. In a note on the amendments, Arthur Cox partners said that if the EU were to just copy the SEC rules ‘it could wipe out the entire CNAV money market fund industry in the EU.’ ‘If the SEC had been faced with an investor profile similar to that in the EU, it would not have adopted today’s proposal for prime institutional CNAV funds.’

They also expressed a fear that 'one of the ironies of the decision of the SEC is ‘that some in the European Commission who have up to now ignored developments in the SEC and argued that the EU must pursue its own course on money market fund reform may cite today’s decision of the SEC as a rejection of CNAV money market funds and that today’s decision of the SEC vindicates the proposals of the European Commission on money market fund reform. Such an interpretation would be utterly misleading.’

See also: Finance Dublin editorial comment.
This article appeared in the August 2014 edition.