The presidents of the 12 Federal Reserve Banks have submitted a joint letter responding to the Securities and Exchange Commission's reform proposal on money market mutual funds (MMMFs).

The Reserve Bank presidents expressed support for the SEC's so-called "floating NAV" alternative - the proposal to require net asset values for MMMF shares to fluctuate with market conditions. But they voiced concerns about the alternative proposal, covering possible fees and "gates" applied to redemptions, saying they would not reduce the risks that MMMFs pose to financial stability.

In the letter (available at http://www.bostonfed.org/-/media/Documents/Press-Releases/PDF/pr091213-letter.pdf) the presidents:

• outline the risks to financial stability posed by MMMFs;
• discuss ways to further enhance the SEC’s floating NAV alternative;
• highlight how the SEC proposal addresses certain industry concerns with a floating NAV requirement;
• detail their concern surrounding liquidity fees and temporary redemption gates; and
• offer observations on, and support for, some other enhancements proposed by the SEC.

As currently structured, MMMFs permit redemptions and purchases at a constant NAV (generally $1), take credit risk, and have no mechanism to absorb losses. Investors therefore have an incentive to cash out - "run" - from a fund when they perceive market value to be less than the reported NAV. The result can be the kind of destabilization experienced during the financial crisis.

Under the floating NAV alternative, MMMFs would be required to process purchases and redemptions based on the current market-based value of the securities in a portfolio (rounded to the nearest 1/100th of a percent). The Reserve Bank presidents favor this option because, if properly implemented, it could make gains and losses a more regularly observable occurrence for investors and reduce the incentive to "run" .

Under the SEC's alternative proposal for liquidity fees and temporary redemption gates, MMMFs would continue to operate at a constant NAV, but would be required to charge a fee for redemptions once the fund's assets fell below a certain level (although the fund's board of directors could opt out). The fund's directors would also be permitted to temporarily "gate" the fund, meaning that investors would not be able to redeem their shares during that time. The Reserve Bank presidents are concerned that this could create an incentive for investors to run even earlier - "before the trigger is breached" - to avoid being subject to gates or fees.