US Money Market Reforms: The Unintended Harmful Effects
Less than two years after the Dodd-Frank Act instituted numerous reforms to money market funds (MMFs), some American regulators, led by US Securities and Exchange Commission (SEC) chairman Mary Schapiro, want to add more and corporate treasurers and chief financial officers (CFOs) are crying foul. Additional reforms, they say, would leave them no choice but to exit money funds, increase bank deposits and raise borrowing costs.
“We strongly believe that the implementation of additional regulation on MMFs will have major unintended harmful consequences that will result from decreased investor interest in this investment vehicle,” says Jim Gilligan, certified treasury professional (CTP), assistant treasurer of Great Plains Energy (GPE) in Kansas City, Missouri.
In public comments Schapiro has weighed eliminating the stable net asset value (NAV) in favour of a floating NAV, subjecting corporate investors in MMFs to a redemption holdback and requiring fund companies to raise reserve capital. The goal of these proposals would be to prevent a run on MMFs similar to the one that occurred during the 2008 financial crisis. To that end, they would supplement measures already in Dodd-Frank designed to bring greater transparency to MMFs.
In addition to Schapiro’s comments, the Federal Reserve Bank of New York recently released a staff report supporting a redemption holdback. Although the SEC has not issued a formal proposal, it seems clear that Schapiro is determined to do so as soon as she can find additional backing on the SEC board of commissioners.
On 17 May, Gilligan, in his capacity as a member of the Association for Financial Professionals (AFP) board of directors, testified before the House Republican Study Committee Financial Services Working Group on MMFs. Gilligan voiced many corporate treasurers’ concerns on the three rule changes that the SEC is rumoured to be considering putting forward.
In his testimony, Gilligan explained that treasury and finance professionals direct the investment of corporate cash and pension assets for their organisations and must consider all available investment options to protect principal, ensure liquidity and maximise returns. “They are responsible for observing business conditions that affect their organisations and making assumptions on how those conditions will change in both the short and intermediate term,” he says. “They must also make critical business decisions – including those concerning corporate borrowing and business investment – based on those observations and assumptions.”
Gilligan notes that AFP members largely support the rules enacted in Dodd-Frank to improve MMFs following the 2008 financial crisis and are even open to amending them further to encourage transparency for investors. However, he was clear that the current rules have not received ample time to succeed and that more changes could destabilise the MMF industry.
In an interview with AFP following his testimony, Gilligan argued that there really haven’t been any recent issues with MMFs that justify the changes being proposed. “People on our side, in corporate America, do not understand what the urgency is that is being communicated from the SEC to regulate these funds,” he says. “Rules were just put into effect last year, so it seems that at least a couple of years would be logical in my mind to let the dust settle on what the impact of those rules might be.”
Corporate Paper Shrivels?
GPE provides electricity to more than 800,000 customers in Missouri and Kansas and has spent about US$3.5bn over the past five years on infrastructure improvements and new facilities. In order to finance these activities, GPE operates two commercial paper programmes that have a combined available capacity of more than US$1bn. By selling commercial paper, GPE benefits from reduced interest payments on borrowed funds.
“I’m the only one on the GRC [AFP’s Government Relations Committee] that is an issuer of commercial paper,” he says. “So the proposed changes to the MMF rules impact GPE from a liquidity standpoint and as a financing alternative. Specifically, what I think would happen for my company if these [changes] pass… there is a good possibility that the MMF product as it is known now will disappear, or investor interest will be diminished to lower levels than what it is today.”
One of GPE’s concerns is that the investor pool of commercial paper will be wiped out as MMFs disappear. “Sellers of commercial paper such as my company will have fewer investors looking for it,” he says. “As we are not the highest rated company for commercial paper, we think we would be squeezed out of the commercial paper market entirely. This would force us to use alternate forms of financing and we would be pushed into drawing upon our revolving credit facilities.”
If GPE is forced to revert back to borrowing under one of its three revolving credit facilities, it would mean significantly higher costs and more difficult operations for the organisation. “In order to borrow the least cost funds under a revolver, the company must provide at least three business days’ notice to the administrative bank, borrow a minimum of US$5m – with any additional funds in increments of US$1m only – and maintain the borrowing outstanding for 30 days,” Gilligan said in his testimony. “The cost for such borrowings would be based on the floating LIBOR [London Interbank Offered Rate] plus a spread dependent upon our credit rating. At current market rates the interest cost would be in the range of 1.75% to 2% – approximately two to four times the cost of issuing commercial paper.”
Institutional investors are strongly opposed to the floating NAV. Corporate treasurers view MMFs in a similar way to bank accounts that earn interest, and instituting a floating NAV makes MMFs more costly and lowers returns. Gilligan told Congress that corporate investors would also react quickly when the NAV fell below US$1, redeeming their investments as soon as possible and possibly creating a run even when there is no real threat.
“The most onerous of the three changes is the floating NAV,” he said. “A MMF is the equivalent to a bank account in a corporate’s mind. So the thought that you’re going to have an NAV that could drop below a dollar just changes the thought process. It’s no longer like a bank account; it’s an investment, which is what the SEC really wants – to change investors’ mind-set. But investors are not going to want to stay invested in these money markets if the NAV falls below one dollar.”
Additionally, mandating limited redemptions of MMFs through a 30-day hold on a percentage of the investments would create operational constraints on investors and make MMFs unsuitable for daily use. Redemption holds would limit access to funds when organisations need to pay expenses and would also result in higher redemption holdbacks than mandated if transactions are made daily.
Gilligan says that it is common for corporates to “sweep” excess funds into a MMF at the end of the day and earn a small amount of interest overnight. But factoring in a limited redemption provision creates major issues. “Say I put US$1m into a MMF. If I’ve got to hold back 5% of that, then tomorrow I’ve got to leave US$50,000 in there. And the next day, if I roll another US$1m back in, I have to leave another US$50,000. So now I have US$100,000 in there, so that is effectively 10%, not 5%,” he argues.
AFP members do not believe it is necessary to require MMFs to create a mandatory reserve. Gilligan notes that it does represent the most feasible method to provide additional liquidity since it eliminates the negative impacts of a floating NAV or redemption holdback provision. “However, requiring MMFs to have a capital buffer will lower yield, make the investment less attractive, and have no effect on prohibiting a run. We believe further consideration and thought is still necessary before implementing this rule change,” he said.
|AFP Liquidity Survey: Corporates Overwhelmingly Dislike MMF Changes
Only 23% of respondents indicate the potential reform would have no bearing on their willingness to invest in MMFs.