On Floating Net Asset Values of Money Market Funds: Will The Curtain Rise?

Abstract

Our recent participation at the Securities and Exchange Commission (“SEC”) roundtable discussion on money market funds and systemic risk gave us the impression that the government is moving closer to a policy draft on money market fund reform. Despite overwhelming complaints, the floating net asset value (“NAV”) approach remains a top choice for the regulators. The industry’s leading solution of a liquidity facility faces internal skepticism and possible failure in receiving government backstop liquidity. Although elegant and simple from a theoretical angle, the floating NAV approach requires the government to address asset flight risk, loss of short-term funding concerns, and the shift of systemic risk to the banking system. We propose that, should the government adopt such an approach, temporary liquidity and lending facilities are necessary to minimize market disruptions. We further propose a two-tier system with “risk-less” government funds receiving stable NAV treatment. Regardless of the policy outcome, corporate and institutional investors should choose funds less prone to run risk, remain calm during the transitional period, and formulate long-term plans based on likely paths before government decisions are handed down.

Introduction

On May 10, 2011, we were honored to participate in the Money Market Funds and Systemic Risk Roundtable discussion hosted by the SEC. Led by Chairman Mary Schapiro, the Roundtable consisted of all four SEC Commissioners, representatives of the Financial Stability Oversight Council (FSOC), and selected members of the money market fund industry, sponsors, investors and the academic community. Industry observers widely viewed the session as the last open debate before the SEC staff proposes rule changes on money market funds to the FSOC.
We left the Roundtable with the impression that the floating NAV approach remains a preferred option of the regulators. This approach, vehemently rejected by the fund industry and shareholders alike, was thought to have been tabled before. We felt compelled to reassess the issue, including the likelihood, timing, and potential ramifications of such regulatory actions. We also attempt to offer some general principles for corporate cash investors to deal with such dramatic challenges.
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