ICI Report on Money Market Mutual Funds March 2009.pdf - Report of the Money Market Working Group Submitted to the Board of Governors of the Investment

ICI Report on Money Market Mutual Funds March 2009.pdf -...

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Unformatted text preview: Report of the Money Market Working Group Submitted to the Board of Governors of the Investment Company Institute march 17, 2009 The Investment Company Institute is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts (UITs). ICI seeks to encourage adherence to high ethical standards, promote public understanding, and otherwise advance the interests of funds, their shareholders, directors, and advisers. Members of ICI manage total assets of $9.88 trillion and serve over 93 million shareholders.   To: John V. Murphy Chairman, Board of Governors of the Investment Company Institute From: John J. Brennan Chairman, Money Market Working Group Date: March 17, 2009 Re: Report of the Money Market Working Group I am pleased to submit the Report of the Money Market Working Group to the Investment Company Institute’s Board of Governors for its consideration and action. Since the formal establishment of the Working Group in November 2008, we have conducted a wide-ranging study of the money market, of money market funds and other participants in that market, and of recent market circumstances, the findings of which are set forth in detail in our Report. Drawing on the difficult experience of the last year and a half, we also have developed a series of recommendations designed, among other things, to make money market funds more resilient in the face of extreme market conditions such as those encountered in September 2008. We believe our recommendations respond directly to weaknesses in current money market fund regulation, identify additional reforms that will improve the safety and oversight of money market funds, and will position responsible government agencies to oversee the orderly functioning of the money market more effectively. Many of our recommendations are of a nature that money market funds can and should implement them immediately on a voluntary basis, pending appropriate rulemaking by the Securities and Exchange Commission. Fund complexes represented on the Working Group have signaled their readiness to implement these recommendations voluntarily, and we recommend that the Board approve them and urge their swift voluntary adoption by all of the Institute’s money market fund members. It should be the goal of all money market funds to substantially implement these recommendations by September 18, 2009, when authorization for the Treasury Temporary Guarantee Program for Money Market Funds expires. This will provide additional assurance to money market fund investors and help facilitate an orderly transition out of the Guarantee Program. i Report of the Money Market Working Group         Our Report also discusses a variety of reforms proposed by others that would fundamentally alter the existing regulatory or business model of money market funds. We do not believe that such reforms are necessary or practicable. They also would, we believe, have significant adverse consequences for the money market at large and for investors in that market. On a personal note, it has been a great pleasure for me to lead this effort. The Board should be aware of the remarkable dedication of all the members of and advisers to the Working Group, as well as of the ICI staff, that produced the Report. cc: ii Board of Governors, Investment Company Institute Paul Schott Stevens Investment Company Institute Money Market Working Group John J. Brennan Chairman of the Working Group Chairman of The Vanguard Group, Inc. James H. Bodurtha Independent Director BlackRock Funds Richard S. Davis Managing Director BlackRock, Inc. Mark R. Fetting Chairman and CEO Legg Mason, Inc. Martin L. Flanagan President and CEO Invesco Ltd. George C. W. Gatch President and CEO J.P. Morgan Funds J.P. Morgan Asset Management John W. McGonigle Vice Chairman and Director Federated Investors, Inc. James A. McNamara President and CEO Goldman Sachs Mutual Funds Goldman Sachs Asset Management Randall W. Merk Executive Vice President Charles Schwab & Co., Inc. President of Schwab Funds Paul Schott Stevens President and CEO Investment Company Institute Michael Wilens Head of Asset Management Fidelity Investments iii Advisers to the Money Market Working Group Mary Colby Deborah Cunningham Managing Director, Head of Municipal Research Senior Vice President, Senior Portfolio Manager Charles Schwab Investment Management Federated Investments, Inc. John T. Donohue Dave Fishman Chief Investment Officer: Global Liquidity Managing Director Co-Head Global Liquidity Management J.P. Morgan Asset Management Goldman Sachs Asset Management David R. Glocke Richard K. Hoerner Principal Managing Director The Vanguard Group, Inc. BlackRock, Inc. Karen Dunn Kelley Kevin Kennedy Chief Executive Officer Portfolio Manager Worldwide Fixed Income Western Asset Management Invesco Ltd. iv Mary J. Miller Charles Morrison Director of Fixed Income Head of Fixed Income Money Markets T. Rowe Price Associates, Inc. Fidelity Investments Table of Contents Executive Summary......................................................................................................................................................................... 1 The Growth of Money Market Funds.................................................................................................................................. 1 The Credit Crisis. ....................................................................................................................................................................... 2 Recommendations......................................................................................................................................................................3 Others’ Suggestions for Money Market Reform............................................................................................................ 7 1. Introduction and Methodology . ..................................................................................................................................... 9 1.1 Introduction.......................................................................................................................................................................... 9 1.2 Methodology........................................................................................................................................................................ 9 1.3 Structure of the Report. ..................................................................................................................................................10 2. The U.S. Money Market......................................................................................................................................................... 13 2.1 Structure of the U.S. Money Market.......................................................................................................................... 13 2.2 Money Market Funds as Financial Intermediaries................................................................................................18 3. The Market for Money Market Funds.......................................................................................................................... 21 3.1 Early Development of Money Market Funds........................................................................................................... 21 3.2 Characteristics of Money Market Funds. ................................................................................................................ 23 3.3 Retail Demand for Money Market Funds. ............................................................................................................... 24 3.4 Institutional Demand for Money Market Funds.................................................................................................... 27 4. Regulatory Features of Money Market Funds........................................................................................................ 31 4.1 Investment Company Act Protections. ..................................................................................................................... 31 4.1.1 Oversight and Accountability .......................................................................................................................... 31 4.1.2 Fund Disclosure..................................................................................................................................................... 32 4.1.3 Custody of Fund Assets .................................................................................................................................... 34 4.1.4 Prohibitions on Affiliated Transactions ....................................................................................................... 34 4.1.5 Limitations on the Fund’s Capital Structure and Its Use of Leverage .............................................. 35 4.1.6 Daily Valuation of Fund Shares . ..................................................................................................................... 35 4.2 Rule 2a-7 Protections...................................................................................................................................................... 36 4.2.1 Strong Risk-Limiting Provisions....................................................................................................................... 37 4.3 Historical Success of Money Market Fund Regulation....................................................................................... 38 v Report of the Money Market Working Group 5. Cash Management Alternatives to Money Market Funds. ..............................................................................41 5.1 Domestic Cash Pools...................................................................................................................................................... 42 5.1.1 Enhanced Cash Funds......................................................................................................................................... 42 5.1.2 Short-Term Investment Funds and Securities Lending Pools............................................................... 42 5.1.3 Local Government Investment Pools. ........................................................................................................... 43 5.2 Overnight Sweep Arrangements ............................................................................................................................... 43 5.3 Offshore Money Funds. .................................................................................................................................................44 5.3.1 IMMFA Funds. ....................................................................................................................................................... 45 5.3.2 IMMFA Funds’ Neutral Tax Treatment.........................................................................................................46 6. Understanding Money Market Fund Developments in the Financial Crisis........................................... 47 6.1 Market Events Leading Up to September 15, 2008............................................................................................. 47 6.2 What Caused Bear Stearns to Fail?...........................................................................................................................50 6.3 Primary Fund—Background and Changing Investment Strategy. .................................................................. 53 6.4 Market Events—September 2008. ............................................................................................................................ 58 6.5 Primary Fund—Week of September 15, 2008....................................................................................................... 59 6.6 Events Following September 15-16, 2008...............................................................................................................60 6.6.1 Difficulties Experienced by Pooled Investment Vehicles. ..................................................................... 62 6.6.2 Government Actions...........................................................................................................................................64 6.7 Aftermath............................................................................................................................................................................ 66 7. Recommendations.................................................................................................................................................................... 69 7.1 Portfolio Liquidity Requirements................................................................................................................................ 72 7.1.1 Daily Liquidity Requirements .......................................................................................................................... 74 7.1.2 Weekly Liquidity Requirements...................................................................................................................... 74 7.1.3 Stress Testing. ....................................................................................................................................................... 75 7.2 Portfolio Maturity. ........................................................................................................................................................... 76 7.2.1 Portfolio Maturity Limits That Address Interest Rate Risk................................................................... 76 7.2.2 Portfolio Maturity Limits That Address Spread Risks. ........................................................................... 77 7.3 Enhance Credit Analysis ............................................................................................................................................... 78 7.3.1 New Products Committee................................................................................................................................. 79 7.3.2 Minimal Credit Risks...........................................................................................................................................80 7.3.3 Credit Ratings Requirement. .............................................................................................................................81 7.3.4 Designated NRSROs............................................................................................................................................ 82 7.4 Assessment of Client Risk. ........................................................................................................................................... 82 7.4.1 Shareholder Due Diligence/Know Your Client Procedures.................................................................. 83 7.4.2 Website Disclosure of Client Concentration..............................................................................................84 vi Table of Contents 7.5 Addressing the Possibility of a “Run”. ...................................................................................................................... 85 7.5.1 Authority to Temporarily Suspend Redemptions..................................................................................... 87 7.5.2 Rule Permitting a Fund to Suspend Redemptions Upon Liquidation.................................................90 7.6 Investor/Market Confusion About Money Market Funds..................................................................................91 7.6.1 Enhanced Risk Disclosure. .................................................................................................................................91 7.6.2 Website Disclosure of Monthly Portfolio Holdings................................................................................. 92 7.6.3 Anti-Fraud Rule to Address Investor and Market Confusion .............................................................. 94 7.7 Government Oversight................................................................................................................................................... 95 7.7.1 Nonpublic Reporting. .......................................................................................................................................... 96 7.7.2 SEC Staff Surveillance of Certain Money Market Fund Performance............................................... 96 7.8 Government Resources.................................................................................................................................................. 97 7.8.1 Rule 17a-9 Transactions..................................................................................................................................... 97 7.9 Government Programs. .................................................................................................................................................. 98 7.9.1 Extension of Treasury Guarantee Program................................................................................................. 98 7.9.2 Amortized Cost No-Action Letter.................................................................................................................. 99 7.10 Forward-Looking Enhancements. .......................................................................................................................... 100 7.10.1 Second Tier Securities. .................................................................................................................................. 100 7.10.2 Board Oversight................................................................................................................................................. 101 8. Others’ Suggestions for Money Market Fund Reform ................................................................................... 103 8.1 Floating NAVs and Bank-Like Regulation. ............................................................................................................. 104 8.1.1 Floating NAV ....................................................................................................................................................... 105 8.1.1.1 Reducing Systemic Risk. ................................................................................................................. 105 8.1.1.2 Implications for Investors. ............................................................................................................. 107 8.1.1.3 Alternative Investments and Implications for Markets. ....................................................... 111 8.1.2 Insurance Programs for Money Market Funds......................................................................................... 112 8.1.2.1 Pure Federal Insurance. ................................................................................................................... 112 8.1.2.2 Pure Private Insurance. .................................................................................................................... 113 8.1.2.3 Hybrid Insurance Programs............................................................................................................ 114 8.1.3 Capital Reserves for Funds and Capital Requirements for Advisers................................................ 114 8.1.3.1 Capital Reserve for Money Market Funds. ............................................................................... 115 8.1.3.2 Capital Requirements for Advisers of Money Market Funds............................................. 116 8.2 Other Proposals...................................................................................
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