The Federal Reserve Bank of New York has voiced its support for regulation that would require money market funds to hold a portion of investors’ money for 30 days in order to stave off a potential run. In a staff report
released Thursday, the New York Fed said this requirement would make the financial system safer and fairer, reduce systemic risk and protect small investors that do not redeem quickly in crises.
The measure demands that a “small fraction” of MMF investors’ balances, called the minimum balance at risk (MBR), be set aside to absorb losses should the fund be liquidated. While most regular transactions in the fund would not be affected, redemptions of the MBR would be postponed for 30 days.
The New York Fed noted that investors currently have a strong incentive to run if they find themselves invested in a troubled fund, because those that are the first to leave get their money back at 100 cents on the dollar. The MBR proposal provides a disincentive to run because it would keep investors partially tied to the fund long enough to share in any definite losses or costs arising from their redemptions. Small investors could be exempted from holding a minimum balance because they would be less likely to withdraw funds at the first hint of trouble.
The report also contends that MBRs could help to stabilize the MMF industry, as investors would have more incentive to identify potential problems long before losses occur. Additionally, by discouraging investors from redeeming shares in a troubled MMF, the New York Fed believes that the MBR would help avoid the need for fire sales of assets to raise cash, thus reducing the risk of contagion.
New York Fed President William Dudley called further reform of MMFs “essential for our nation’s stability,” and threw his full support behind the SEC’s proposals for new rules. “I strongly endorse their adoption,” he said.
AFP continues to view any kind of hold as a “non-starter” for corporates, noted Brian Kalish, AFP's finance practice lead. “Our members would actually prefer a variable NAV rather than receive less than 100 percent of their money in a timely fashion, not that they want a variable NAV,” he said.
Jim Gilligan, CTP, assistant treasurer of Great Plains Energy Inc. and a member of the AFP board of directors, argues that instituting a 30-day hold on a portion of investments would create operational constraints on investors and make MMFs unsuitable for daily use. Redemption holds limit access to funds when organizations need to pay expenses and would also result in higher redemption holdbacks than mandated if transactions are made daily.
Gilligan recently told AFP that it is common for corporates to “sweep” excess funds into a MMF at the end of the day and earn a bit of interest overnight. But factoring in a limited redemption provision changes the game. “Say I put $1 million into a money- market fund. If I’ve got to hold back 5 percent of that, then tomorrow, I’ve got to leave $50,000 in there. And the next day, if I roll another $1 million back in there, I have to leave another $50,000. So now you have $100,000 in there, so there’s really 10 percent that’s in there, not 5 percent,” said Gilligan.