The mutual fund industry’s argument that new money-market fund rules would hurt companies, states and cities that sell short-term debt has been contradicted in a new Securities and Exchange Commission study.
Should new rules shrink money funds, non-financial companies wouldn’t be significantly affected because they don’t lean heavily on the funds, while banks are well suited to find alternative funding, according to the report prepared by SEC staff for three commissioners. The report also said a reduction in demand by money funds wouldn’t necessarily cause a drop in demand for short-term debt.
“Given the supply of very short-term securities is likely to be limited to the same securities in which money funds currently invest, shifts in investor capital are likely to increase demand for these same assets, reducing the net effect on the short-term funding market,” the report said.
The SEC report, made public yesterday, undermines the case put forth by fund companies that a planned overhaul of money funds would hurt the U.S. economy by disrupting markets for short-term debt. Fund executives have been fighting efforts by regulators to impose changes the companies believe would destroy the attraction of the products that manage about $2.6 trillion and represent the largest collective buyer of commercial paper in the U.S.
Ianthe Zabel, a Washington-based spokeswoman for the Investment Company Institute, a trade association that has fought the proposed rules, declined to comment.
“These changes would destroy money-market funds, at great cost to investors, state and local governments and the economy,” ICI President Paul Schott Stevens said in written testimony before the Senate Banking Committee on June 21.
Regulators, including outgoing SEC Chairman Mary Schapiro, have worked to impose tighter restrictions on money funds since the September 2008 collapse of the $62.5 billion Reserve Primary Fund. Its failure, because it owned debt issued by Lehman Brothers Holdings Inc., set off a run by money-fund investors that helped freeze global credit markets.
The SEC created liquidity minimums, lowered maturity limits and required more disclosure in rules introduced in 2010. Schapiro also supported another round of changes that would have forced funds to choose between abandoning their traditional $1 share price or building capital buffers to absorb losses and imposing redemption restrictions to discourage runs.
Schapiro shelved her plan in August when commissioners Luis A. Aguilar, Troy A. Paredes and Daniel M. Gallagher signaled they would reject it, saying they wanted more study of the issue. The three then asked SEC staff to examine the 2008 crisis, the impact of 2010 reforms and the potential impact of further changes.
The Financial Stability Oversight Council, a panel of regulators headed by Treasury Secretary Timothy Geithner, on Nov. 13 began a process by which it will pressure SEC commissioners to reconsider Schapiro’s plan and other overhaul proposals.
The SEC paper, prepared by its division of risk, strategy and financial innovation, said the run on money funds in 2008 was due to many factors, including the Reserve Primary failure and the collapse of Lehman Brothers. It said 2010 changes had reduced risks posed by funds.
“Funds are more resilient now to both portfolio losses and investor redemptions than they were in 2008,” the report said.
Examining short-term debt markets and issuers, the report concluded that most companies had little to worry about from any potential drop in demand from money funds.
“Commercial paper financing by non-financial businesses is a small portion (1 percent) of their overall credit market instruments,” the report said.
While financial companies are more reliant on commercial paper, that dependence has declined “dramatically” since 2008, according to the report. In addition, financial companies are “by their nature, well suited to identify alternate mechanisms for short-term funding,” it said.
The report said municipal issuers have also already shifted away from money funds since 2008. At the same time, they have increased aggregate borrowing even as money funds have decreased municipal holdings by 40 percent.
“A decline in demand from money-market funds is unlikely to significantly reduce the ability of municipalities to fund their debt,” the report said.