Money Market Mutual Funds: Stress Testing & New Regulatory Requirements

Jeremy Berkowitz is Vice President in NERA’s Global Securities and Finance Practice. This post is based on a NERA publication authored by Dr. Berkowitz, Patrick E. Conroy, and Jordan Milev.

In July 2014, the Securities and Exchange Commission (SEC) adopted a package of reforms to the regulatory framework governing money market mutual funds. The SEC believes the new rules will enhance the safety and soundness of the money market fund industry during periods of market distress, when redemptions in some funds may increase substantially. [1]

The new rules require institutional prime (general purpose) and institutional municipal money market mutual funds to price and transact at a “floating” net asset value (NAV), permit certain money market mutual funds to charge liquidity fees, and allow the use of redemption gates to temporarily halt withdrawals during periods of stress.

Financial Market Utilities: Is the System Safer?

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication.

It has been two and a half years since the Financial Stability Oversight Council (FSOC) designated select financial market utilities (FMUs) as “systemically important.” These entities’ respective primary supervisory agencies have since increased scrutiny of these organizations’ operations and issued rules to enhance their resilience.

As a result, systemically important FMUs (SIFMUs) have been challenged by a significant increase in regulatory on-site presence, data requests, and overall supervisory expectations. Further, they are now subject to heightened and often entirely new regulatory requirements. Given the breadth and evolving nature of these requirements, regulators have prioritized compliance with requirements deemed most critical to the safety and soundness of financial markets. These include certain areas within corporate governance and risk management such as liquidity risk management, participant default management, and recovery and wind-down planning.


FSOC: Are Asset Managers’ Products and Activities Creating Systemic Risk?

The following post comes to us from Debevoise & Plimpton LLP and is based on a Debevoise & Plimpton Client Update.

In connection with its ongoing evaluation of the asset management industry, the U.S. Financial Stability Oversight Council (the “FSOC”) recently issued a notice seeking public comment (the “Notice”) on whether asset management products and activities may pose potential risks to U.S. financial stability. [1] Specifically, the FSOC seeks comment on the systemic risks posed by: (1) liquidity and redemption practices; (2) use of leverage; (3) operational functions; and (4) resolution, i.e., the extent to which the failure or closure of an asset manager, investment vehicle or an affiliate could have an adverse impact on financial markets or the economy. Comments on the Notice must be submitted by February 23, 2015; and we are working with several clients to prepare and submit such comments. This post summarizes some of the FSOC’s key concerns and questions outlined in the Notice.


Asset Manager SIFI Designation: Enter SEC

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication.

Asset managers who tuned in to last month’s Financial Stability Oversight Council’s (“Council”) conference regarding the industry’s potential systemic importance heard no surprises. The US Treasury Department and regulators did not defend the September 2013 report by the Office of Financial Research (“OFR Report”) which had suggested that the industry’s activities as a whole were systemically important. [1] Rather, officials continued to emphasize that they hold no predisposition toward designation. It was left to academics at the conference to argue that asset managers could pose systemic risk.


An Informed Approach to Issues Facing the Mutual Fund Industry

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at the Mutual Fund Directors Forum’s 2014 Policy Conference; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

As a practicing securities lawyer for more than thirty years, I have in the past advised boards of directors, including mutual fund boards, and I am well acquainted with the important work that you do. I also understand the essential role that independent directors play in ensuring good corporate governance. As fiduciaries, you play a critical role in setting the appropriate tone at the top and overseeing the funds’ business. Thus, I commend the Mutual Fund Directors Forum’s efforts in providing a platform for independent mutual fund directors to share ideas and best practices. Improving fund governance is vital to investor protection and maintaining the integrity of our financial markets.


Nonbank SIFIs: No Solace for US Asset Managers

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication.

Ever since the Treasury Department’s Office of Financial Research (“OFR”) released its report on Asset Management and Financial Stability in September 2013 (“OFR Report” or “Report”), the industry has vigorously opposed its central conclusion that the activities of the asset management industry as a whole make it systemically important and may pose a risk to US financial stability.

Several members of Congress have also voiced concern with the OFR Report’s findings, particularly during recent Congressional hearings, as have commissioners of the Securities and Exchange Commission (“SEC”). Further complicating matters, a senior official of the Office of the Comptroller of the Currency (“OCC”) recently expressed alarm about banks working with alternative asset managers or shadow banks on “weak” leveraged lending deals.


FSOC Proposes the First Three Nonbank SIFIs

The following post comes to us from Charles Horn, partner focusing on banking and financial services matters at Morrison & Foerster LLP, and is based on a Morrison & Foerster client alert by Mr. Horn and Jay G. Baris.

In a June 3, 2013 closed-door meeting, the Financial Stability Oversight Council (“FSOC”) voted to propose the designation of three financial services companies—American International Group (“AIG”), Prudential Financial and GE Capital—as the first systemically significant nonbank financial institutions (“nonbank SIFIs”) under section 113 of the Dodd-Frank Act.

The FSOC decision, announced by the Treasury Secretary, did not identify specific names, but all three companies publicly confirmed their proposed nonbank SIFI status. If these proposed designations become final, these three companies will become the first nonbank SIFIs to be subjected to stringent Federal Reserve Board oversight and supervision, as well as capital and other regulatory requirements, under Title I of the Dodd-Frank Act. In addition, these designations will bring to life the Dodd-Frank Act’s orderly liquidation authority that applies to systemically significant financial firms, in the event that one of these companies may fail or be in danger of failing in the future.

The FSOC’s action to begin the process of designating nonbank SIFIs has been long awaited—some would say long-overdue—and the identities of the three companies that have been proposed for SIFI designation come as no real surprise. Nonetheless, the FSOC’s action marks an important milestone in the implementation of the Dodd- Frank Act’s systemic regulation framework. While the actual significance of these designations likely will emerge more clearly in the coming weeks and months, the FSOC’s action brings into sharper focus the questions and challenges that the designated firms and their regulators will face.


Examining the Application of Title I of the Dodd-Frank Act

The following post comes to us from James R. Wigand, Director, Office of Complex Financial Institutions at the Federal Deposit Insurance Corporation, and is based on Director Wigand’s testimony before the U.S. House of Representatives Committee on Financial Services, available here.

Chairman McHenry, Ranking Member Green, and members of the Subcommittee, thank you for the opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC) on Sections 165 and 121 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Our testimony will focus on the FDIC’s role and progress in implementing Section 165, including the resolution plan requirements and the requirements for stress testing by certain financial institutions.

Section 165 of the Dodd-Frank Act

Resolution Plans

Under the Dodd-Frank Act, bankruptcy is the preferred resolution framework in the event of a systemic financial company’s failure. To make this prospect achievable, Title I of the Dodd-Frank Act requires that all large, systemic financial companies prepare resolution plans, or “living wills”, to demonstrate how the company would be resolved in a rapid and orderly manner under the Bankruptcy Code in the event of the company’s material financial distress or failure. This requirement enables both the firm and the firm’s regulators to understand and address the parts of the business that could create systemic consequences in a bankruptcy.

The FDIC intends to make the living will process under Title I of the Dodd-Frank Act both timely and meaningful. The living will process is a necessary and significant tool in ensuring that large financial institutions can be resolved through the bankruptcy system.


FSOC Designation: Consequences for Nonbank SIFIS

The following post comes to us from Arthur S. Long, partner and member of the financial institutions and securities regulation practice groups at Gibson, Dunn & Crutcher. This post is based on a Gibson Dunn memorandum by Mr. Long, Alexander G. Acree, Kimble C. Cannon, C.F. Muckenfuss III, and Colin C. Richard.

Treasury officials have recently suggested that the Financial Stability Oversight Council (FSOC) may soon designate the first round of systemically significant nonbank financial companies (Nonbank SIFIs). In March, Under Secretary for Domestic Finance Miller and Deputy Assistant Secretary for the FSOC Gerety stated that designations could occur “in the next few months.”

Moreover, the Board of Governors of the Federal Reserve System (Federal Reserve) recently finalized its rule on determining when a company is “predominantly engaged in financial activities,” thus making the company potentially subject to FSOC designation. The final rule is notable for stating that an investment firm that does not comply with the Merchant Banking Rule’s investment holding periods and routine management and operation limitations may nonetheless be determined, on a case- by-case basis, to be engaging in “financial activities.” In addition, the final rule rejected the argument that mutual funds — including money market mutual funds — are “not engaged in a financial activity” and therefore not capable of designation.


Challenges for the SEC’s Independence

Daniel M. Gallagher is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Gallagher’s remarks at the Practicing Law Institute’s SEC Speaks in 2013 Program, available here. The views expressed in the post are those of Commissioner Gallagher and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

On a number of occasions since returning to the SEC as a Commissioner, I’ve spoken about the Commission’s priorities, both in terms of what the Commission is doing and what it should be doing in order effectively to carry out its mandate to protect investors, ensure fair and efficient markets, and facilitate capital formation. Needless to say, the Commission does not operate in a vacuum, and for various reasons, it’s not always easy to execute those priorities as we see fit. The constant stream of external influences on the Commission’s work serves as a significant impediment to its ability to focus on the core mission, including the vital, basic “blocking and tackling” of securities regulation. Therefore, I’d like to talk about the Commission’s origin and role as an expert, independent agency — as well as the challenges to that independence — in what has become in recent years a difficult environment for independent agencies.


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