CHAIRMAN WHITE'S OPENING STATEMENT AT SEC OPEN MEETING

FROM: U.S. SECURITEIS AND EXCHANGE COMMISSION
Opening Statement at the SEC Open Meeting

by

Chairman Mary Jo White

U.S. Securities and Exchange Commission

Washington, D.C.
June 5, 2013
This is an open meeting of the Securities and Exchange Commission on June 5, 2013.

Today, the Commission will consider proposals that would reform the way money market funds operate in order to make them less susceptible to runs.

As many people know, money market funds are investment vehicles that hold a pool of high-quality, short-term securities. In the early 1980s, the Commission provided money market funds with an exemption making them distinct from mutual funds and certain other investment products. That exemptive rule (Rule 2a-7) allowed these funds generally to maintain a stable share price of $1.00 instead of changing their share prices according to the market value of the securities held by the fund.

The industry has changed substantially since that time. Money market funds are now a significant piece of the nation's financial system. Over the years, money market funds have become a popular investment product for both retail and institutional investors. They also have become an important provider of short-term financing to corporations, banks and governments. All told, money market funds hold nearly $3 trillion in assets, the majority of which are in institutional funds.

While money market funds have thus long served as an important investment vehicle, the financial crisis of 2008 highlighted the susceptibility of these products to runs. In September of that year - at the height of the financial crisis - a money market fund called the Reserve Primary Fund "broke the buck" - a term used when the value of a fund drops and investors are no longer able to get back the full dollar they put in.

Within the same week of that occurrence, investors pulled approximately $300 billion from other institutional prime money market funds. The contagion effect was rapid. The short term credit market dried up, and corporations had trouble borrowing to run their businesses. This reaction contributed to the significant disruption that already was consuming the financial system.

To stop this run, the government stepped in with unprecedented support in the form of the Treasury temporary money market fund guarantee program and Federal Reserve liquidity facilities.

In the aftermath of that experience, the Commission - in 2010 - adopted a series of reforms that increased the resiliency of money market funds. But, as the Commission stated at that time, those reforms were only a first step. Today's proposal takes the critical additional step of addressing the stable value pricing of institutional prime funds - at the heart of the 2008 run - and proposing methods to stop a money market fund run before such a run becomes a systemically destabilizing event.

It has been a journey to get to this point. Commission staff has spent literally years studying different reform alternatives and performing extensive economic analysis in arriving at these recommendations.

These proposals are important in and of themselves and because they advance the public debate that will shape the final rules to address one of the most prominent events arising from the financial crisis.

Today's proposal contains two alternative reforms that could be adopted separately or combined into a single reform package to address run risk in money market funds.

Floating NAV

The first proposed alternative would require that all institutional prime money market funds operate with a floating net asset value (NAV). That is, they could no longer value their entire portfolio at amortized cost and they could not round their share prices to the nearest penny. The set "dollar" would be replaced by a share price that actually fluctuates, reflecting the changing values in these money market funds.

This floating NAV proposal specifically targets the funds where the problems during the financial crisis occurred: institutional, prime money market funds.

Retail and government money market funds - which have not historically faced runs in even the worst of times - would be exempt from the proposed floating NAV requirement.

This approach would thus preserve the stable value fund product for those retail investors who have found it to be convenient and beneficial. It also would allow municipal and corporate investors to have access to government money market funds - a stable value product - if they need it, although it would be a product that holds federal government securities as opposed to the higher-yielding investments of a prime fund.

We are soliciting commenters' views regarding the impact of targeting the floating NAV reform to institutional prime funds and whether government and retail money market funds also should operate with a floating NAV, as well as commenters' views regarding whether today's proposal would effectively differentiate retail funds from institutional funds by imposing a $1 million redemption limit. These and other important questions are specifically posed in the proposal.

I believe the floating NAV reform proposal is important for a number of reasons:
First, by eliminating the ability of early redeemers to receive $1.00 - even when the fund has experienced a loss and its shares are worth somewhat less - this proposal should reduce incentives for shareholders to redeem from institutional prime money market funds in times of stress.
Second, the proposal increases transparency and highlights investment risk because shareholders would experience price changes as an institutional prime money market fund's value fluctuates.
And, third, the proposal is targeted, by focusing reform on the segment of the market that experienced the run in the financial crisis.
Fees & Gates

The second proposed alternative seeks to directly counter potentially harmful redemption behavior during times of stress.

Under this alternative, non-government money market funds would be required to impose a 2 percent liquidity fee if the fund's level of weekly liquid assets fell below 15 percent of its total assets, unless the fund's board determined that it was not in the best interest of the fund. That determination would be subject to the board's fiduciary duty, and we believe it would be a high hurdle. After falling below the 15 percent weekly liquid assets threshold, the fund's board would also be able to temporarily suspend redemptions in the fund for up to 30 days - or "gate" the fund.

This "fees and gates" alternative potentially could enhance our regulation in several ways:
First, it could more equitably allocate liquidity risk by assigning liquidity costs in times of stress (when liquidity is expensive) to redeeming shareholders - the ones who create the liquidity costs and disruption.
Second, this alternative would provide new tools to allow funds to better manage redemptions in times of stress, and thereby potentially prevent harmful contagion effects on investors, other funds, and the broader markets. If the beginning of a run or significantly heightened redemptions occur, they would no longer continue unchecked, potentially spiraling into a crisis. The imposition of liquidity fees or gates would be an available tool to directly counteract a run.
And, third, this approach also is targeted, focusing the potential limitations on a money market fund investor's experience to times of stress when unfettered liquidity can have real costs.
The two alternative approaches in today's proposal target the common goal of reducing the incentive to redeem in times of stress, albeit in different ways. Accordingly, the proposal requests comment on whether a better reform approach would be to combine the two alternatives into a single reform package - requiring that prime institutional funds have a floating NAV and be able to impose fees and gates in times of stress, and that retail funds be able to impose fees and gates. We specifically solicit and I am interested in commenters' views on this combined approach.

Greater Diversification, Disclosure and Reporting

Importantly, the staff's recommendations also contain a number of other significant reform proposals - tightening diversification requirements, enhancing disclosure requirements, strengthening stress testing and improving reporting on both money market funds and unregistered liquidity funds that could serve as alternatives to money market funds for some investors. These proposed reforms should further enhance the resiliency and transparency of this important product and are significant complements to the other proposals.

Today's proposal is the product of very hard work by all those who have sought to meaningfully reform this investment product that is such a critical piece of the nation's financial fabric.

There have been important and thoughtful comments throughout this process, including suggestions and recommendations from investors, the industry, and fellow regulators. We have given them all very careful consideration and they have proven invaluable to us formulating the important proposals we are voting on today.

In this regard I especially would like to thank all of my fellow Commissioners for their contributions and the spirit of cooperation in which we worked leading up to today's meeting.

I want to reiterate that our goal is to implement an effective reform that decreases the susceptibility of money market funds to run risk and prevents money market fund events similar to those that occurred in 2008 from repeating themselves. With this goal in mind, I very much look forward to the comments and am very pleased that, with my fellow Commissioners, we are moving this reform process forward.

Before I ask Norm Champ, Director of the Division of Investment Management, to discuss the proposed reforms, I would like to thank Norm and his team: Diane Blizzard, Sarah ten Siethoff, Thoreau Bartmann, Brian Johnson, Adam Bolter, Amanda Wagner, Kay Vobis, Jaime Eichen, and Megan Monroe for their tireless work on this rulemaking.

This rulemaking was a true team effort between the Division of Investment Management and the Division of Risk, Strategy and Financial Innovation, so I want to also express my gratitude for the work of Craig Lewis, Kathleen Hanley, Jennifer Marietta-Westberg, Woodrow Johnson, Jennifer Bethel, Virginia Meany, Dan Hiltgen, and Mila Sherman. I also would like to acknowledge the critical work and analysis included in the staff's economic study published late last year, which was highly influential in developing today's proposed reforms.

Thanks as well to Anne Small, Meridith Mitchell, Lori Price, Cathy Ahn, Jill Felker, and Kevin Christy from the Office of the General Counsel; Jim Burns, David Blass, Haime Workie, and Natasha Greiner from the Division of Trading and Markets; and Paul Beswick, Rachel Mincin, and Jeff Minton from the Office of the Chief Accountant.

And now I'll turn the meeting over to Norm Champ to provide a fuller explanation of the proposed reforms we are considering today.

SEC COMMISSIONERS ATTACK CHAIRMAN'S STATEMENT ON MONEY MARKET REFORM

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION
Statement on the Regulation of Money Market Funds
by Commissioner Daniel M. Gallagher; Commissioner Troy A. Paredes
U.S. Securities and Exchange Commission
Washington, D.C.
August 28, 2012
We were dismayed by the Chairman’s August 22, 2012, statement on the proposal she advanced to restructure money market funds. The current discourse about the Commission’s regulation of money market funds is rife with misunderstandings and misconceptions. This joint statement is intended as one step in setting the record straight. Our colleague, Commissioner Luis Aguilar, has already responded separately, and we respect the views presented in his response. We also commend Commissioner Aguilar for his efforts to engage in a constructive dialogue on money market fund reform.

The Chairman has recommended that the Commission approve a regulatory proposal that would have altered several fundamental features of money market funds. After careful consideration, we determined that the changes the Chairman advocated were not supported by the requisite data and analysis, were unlikely to be effective in achieving their primary purpose, and would impose significant costs on issuers and investors while potentially introducing new risks into the nation’s financial system.

As an initial matter, the Chairman’s statement creates the misimpression that three Commissioners — a majority of the Commission — are not concerned with, or are somehow dismissive of, the goal of strengthening money market funds. This is wholly inaccurate.

The truth is that we have carefully considered many alternatives, including the Chairman’s preferred alternatives of a "floating NAV" and a capital buffer coupled with a holdback restriction, and we are convinced that the Commission can do better. Our view of the complex issues involved has been informed by the input of a range of market participants, including the many retail and institutional investors who have implored the Commission not to deprive them of the choice to invest in money market funds, as well as the interests of states, municipalities, and businesses that rely on money market funds as a key source of financing. We have also considered various pronouncements by other regulators on the topic.

Our decision not to support the Chairman’s proposal, based on the data and analysis currently available to us, has also been informed by our concern that neither of the Chairman’s restructuring alternatives would in fact achieve the goal of stemming a run on money market funds, particularly during a period of widespread financial crisis such as the nation experienced in 2008. The Reserve Primary Fund did not "break the buck" in a vacuum, but rather in the midst of a financial crisis of historic proportions.

Since the Commission adopted Rule 2a-7, the principal rule that governs money market funds, the Commission on multiple occasions has reviewed the efficacy of the rule and has adopted amendments to make improvements. Most recently, in 2010, the Commission adopted changes to Rule 2a-7 that have improved the liquidity and transparency of money market funds and decreased the credit risk of their portfolios with the objective of making such funds more resilient.

We want to emphasize that, just as the Chairman’s proposal reflects the Chairman’s good faith view as to what is best, our inability to support her proposal reflects what we believe is best for investors, issuers, the financial system, and the nation’s economy at this time. In our judgment, the Chairman’s proposal is flawed because it is premised on an incomplete perspective on the 2008 financial crisis — the effects of which both of us confronted directly at the SEC at the time and continue to grapple with today — and on the drivers of a financial run occurring in the midst of a crisis. Although there is a great deal to say about this, we will touch on just two points in this statement.

First, the Commission’s 2010 money market fund reforms have not been shown to be ineffective in enabling money market funds to satisfy large redemptions and to remain resilient in the face of a sharp increase in withdrawals. In fact, the empirical evidence we have so far, such as the performance of money market funds during the ongoing Eurozone crisis and the U.S. debt ceiling impasse and downgrade in 2011, suggests just the opposite — that money market funds can meet substantial redemption requests, in large part, we have heard, because of the 2010 reforms. Second, the necessary analysis has not been conducted to demonstrate that a floating NAV or capital buffer coupled with a holdback restriction would be effective in a crisis. Indeed, both alternatives disregard the predominant incentive of investors in a crisis to flee risk and move to safety. Reason indicates that such behavior — the "flight to quality" — is likely to overwhelm the buffer proposed by the Chairman and swamp the effect of a holdback. As for the floating NAV proposal, even if there is no stable $1.00 NAV — i.e., even if, by definition, there is no "buck" to break — investors will still have an incentive to flee from risk during a crisis period such as 2008, because investors who redeem sooner rather than later during a period of financial distress will get out at a higher valuation. Thus, if neither the floating NAV proposal nor the capital-buffer-with-holdback proposal will solve the money market fund run problem, then neither proposal will foreclose the possibility that policymakers might once again face the prospect of supporting the commercial paper market in response to a widespread financial crisis.

Furthermore, we are concerned that the Chairman’s proposal would, at a minimum, severely compromise the utility and functioning of money market funds, which would inflict harm on retail and institutional investors who have come to rely on money market funds for investing and as a means of cash management and on states, municipalities, and businesses that borrow from money market funds. Such adverse outcomes would undercut the SEC’s mission.

There is no consensus of support among stakeholders for what the Chairman has offered. Instead, there is a serious debate over the appropriateness of those measures and the extent to which they would even achieve their primary objective. We agree with Commissioner Aguilar that even just proposing rule amendments that advance the Chairman’s alternatives at this time could have harmful consequences.

Although we cannot support the Chairman’s specific proposals, we are not opposed to further improvements to the Commission’s oversight and regulation of money market funds. But further action must be advanced on the basis of data and rigorous analysis showing that any such changes to our existing rules would be workable, would be effective in achieving their purpose, and would not unwisely disrupt the functioning of money market funds and short-term credit markets. Ultimately, there must be a reasonable basis to conclude that the benefits of any new initiatives justify their costs, a straightforward premise that the Chairman herself espoused when committing the SEC to a thoughtful standard of economic analysis earlier this year.

We believe we share a common goal with other members of the Commission and other financial regulators. We have urged that the Chairman take a different way forward for strengthening the resiliency of money market funds. This approach would (i) empower money market fund boards to impose "gates" on redemptions; (ii) mandate enhanced disclosure about the risks of investing in money market funds; and (iii) conduct a searching inquiry into, and a critical analysis of, the issues raised by the questions we pose below.

In particular, it would be useful to receive comment on a proposal that would permit money market fund boards, as they deem appropriate and consistent with their fiduciary obligations to investors and without having to seek an exemptive order from the Commission, to "gate" redemptions to stave off a run and to allow the fund manager time to mitigate the concerns of investors who otherwise may be inclined to redeem. The Commission’s 2010 amendments allowed boards to unilaterally suspend redemptions if the fund is put into liquidation. At that time, the Commission received input recommending that the Commission allow boards to impose a gate when they deemed appropriate, consistent with the boards’ fiduciary duties to the fund’s shareholders.

Discretionary gating directly responds, we believe, to run risk, both as to an individual fund and across multiple funds, as well as to the potential disparate treatment between retail and institutional investors. This should have the effect of addressing the conditions that gave rise to certain forms of governmental support in 2008, when money market funds had to sell portfolio assets to meet redemptions and scaled back their participation in short-term credit markets. These significant benefits of discretionary gating could be achieved by a straightforward amendment to the Commission’s rules to expand a money market fund board’s authority to impose gates, a change that would build on the 2010 reforms.

Such a proposal would, of course, require enhanced disclosures to investors that would clearly explain the liquidity and principal reduction risks that could accompany a fund board’s discretionary gating authority. Beyond that, we would recommend other disclosure enhancements that may be warranted to clear up any misunderstandings investors may have as to the riskiness of their money market fund holdings.

Regrettably, the Chairman dismissed this approach. Instead, the draft release presented to the Commission relegates gating to a limited discussion of options that are implied to be inferior to the Chairman’s preferred alternatives. Gating is never considered as a standalone proposal, but instead is coupled with a capital buffer.

Before the Commission intervenes in a way that threatens to jeopardize a $2.5 trillion sector of the economy — one that has efficiently facilitated capital formation for governmental and corporate issuers, as well as proven to be an attractive investment for investors and means of cash management — it is only reasonable to ask that the Commission have the best possible understanding of what is likely to happen. We have consistently stressed that we should obtain the required data and undertake a rigorous analysis to determine whether any remaining risks associated with money market funds warrant fundamental structural changes like the ones the Chairman has urged. At present, we lack satisfactory answers to many crucial questions, including, but not limited to, the following:
During the peak of the financial crisis, in September 2008, investors redeemed assets from prime money market funds and, to a great extent, reinvested those assets into Treasury money market funds with the same structural features as prime money market funds. Do the sizeable inflows into Treasury money market funds during this period belie the claim that investors fled prime money market funds because of any structural flaws of money market funds? Did investors instead behave this way for another reason, such as a general aversion to risk or a "flight to quality" during the crisis? Did investors redeem from prime money market funds primarily in response to a single event, specifically the "breaking of the buck" by the Reserve Primary Fund? Or did other events, such as the failure and, in some cases government-sponsored rescue, of prominent financial institutions Lehman Brothers and AIG, as well as Fannie Mae, Freddie Mac, and Bear Stearns, contribute to the conditions that resulted in the run? If a money market fund were to break the buck outside a period of financial distress, would it cause a systemic problem, or only a problem limited to that particular fund?
What have been the effects of the money market fund regulatory reforms that the SEC promulgated in 2010? To what extent have those reforms improved the liquidity of money market funds? Reduced the credit risk of money market funds? Reduced the interest rate risk of money market funds? Has the increased transparency into the portfolio holdings of money market funds made funds less susceptible to runs? Has the establishment of an orderly wind-down procedure mitigated the risk of a run? If so, to what degree? What do the available data tell us about how money market funds performed following the implementation of the 2010 reforms, considering, for example, the performance of funds during the European sovereign debt crisis and the 2011 U.S. debt ceiling impasse and ratings downgrade? How would money market funds have performed during the events of September 2008 had the 2010 reforms been in place at the time?
If money market funds were to be fundamentally restructured and investors were then to shun such funds, to where would those assets migrate? What would be the implications of such a reallocation of capital for investors, financial institutions, systemic risk, and the overall economy?
If substantial assets were to flow out of money market funds, what impact would that have on the commercial paper market and the market for municipal debt? What would be the impact on corporate borrowers, municipalities, and states that sell their debt to money market funds?
A searching inquiry to answer these questions must be undertaken. Had the staff been directed to perform this crucial work when the Chairman first announced her views in November 2011, we might now have the information required to determine what further action is necessary.

Regulatory intervention into a $2.5 trillion industry — an industry that is integral to meeting the funding needs of major American institutions, both public and private — must not be done on the basis of incomplete data and analysis, including a less than up-to-date understanding of the efficacy of the Commission’s 2010 money market fund reforms. To date, no convincing evidence has been produced demonstrating that the fundamental restructuring of money market funds that the Chairman urges would be the appropriate means for addressing any remaining risks. To the contrary, what we have been shown tells us that the Chairman’s proposal risks effectively ending prime money market funds as we know them, a result that cannot be justified given the significant doubt that the Chairman’s alternatives would be effective in halting a run during another financial crisis and our present view that targeted reforms, such as the approach we outline above, would strike a better balance between costs and benefits.

The Chairman’s approach would deprive investors of two fundamental benefits of money market funds: stability and liquidity. Regarding the capital buffer, which would be mandated along with the holdback, we understand, based on the discussions we have had and our consideration of the Chairman’s proposal, that it could result in prime money market funds yielding to fund investors a return similar to that provided by Treasury money market funds. If this were to occur, one has to wonder why investors would invest in prime money market funds as opposed to investing in Treasury money market funds. In other words, the capital buffer, even by itself, would seem to risk substantially crowding out the prime money market fund sector at the expense of both corporate borrowers and investors.

We wish to stress that money market funds are squarely within the expertise and regulatory jurisdiction of the SEC. We do not intend to abdicate our responsibility to regulate money market funds, which would be unjustified and at the expense of our mission to oversee the securities markets. Accordingly, in the spirit of moving the agenda forward so that there can be constructive dialogue and engagement in this area, we ask that the Commission’s staff of economists conduct detailed research and analysis on money market funds, including the staff’s best efforts to answer the questions we have listed above, as well as others that are germane.

We look forward to reviewing the results of the work of the Commission staff in response to our request and to a constructive dialogue with the staff, our fellow Commissioners, and other regulators and stakeholders on what additional measures might warrant further consideration.