Former independent director Dan Calabria has proposed a fix for the money market fund industry, and he’s shopping it around to others trying to find a viable solution, according to FII sister publication Fund Director Intelligence. The way to eradicate the threat that money funds will “break the buck,” as the Reserve Primary Fund did in September 2008, is to create industry-funded special-purpose insurance coverage that would support individual funds and the market as a whole, he said.
Calabria, a former independent director for AEGON Transamerica/IDEX Funds and Transamerica Income Shares, modeled his proposal on insurance provided to the industry and independent fund directors by ICI Mutual, though he is not working in collaboration with the company and existing coverage obviously would have to be tweaked to fit money funds. An ICI Mutual spokeswoman said the company does not comment on policy issues.
Under Calabaria’s proposal, if a fund’s net asset value were to fall below $1, the advisor would absorb the pre-determined deductible and then insurance would kick in—supported by both the primary insurer and reinsurers. “The advisor immediately forfeits its advisory fee from the money fund for a two-year period with those revenues paid into the insurance company’s reserve fund,” he said. “The annual ‘premium’ for that fund is increased relative to its total assets for a five-year period.” Should the same fund break the buck a second time, the fund board would be required to give notice of termination of the advisory contract and launch a search for a new advisor that also participates in the insurance program, Calabria said.
“There are other considerations to be resolved, but why not take the first step and remove a cloud over the industry and avoid another bureaucratic merry-go-round?” Calabria asked.
Around the same time Calabria unveiled his proposal in early September, Securities and Exchange Commission members Daniel Gallagher and Troy Paredes suggested a rule letting fund boards opt to “gate”—or temporarily halt—redemptions if a run threatens. Calabria said that a combination of his and the two Republican commissioners’ proposals would be an even better solution to the ongoing money fund conundrum. A spokeswoman for Paredes declined to comment, and calls to Gallagher were not returned.
Jeffrey Gordon, co-director of the Center for Law and Economic Studies at Columbia Law School, told FD that Calabria’s proposal, which he called “private insurance with some capital to control moral hazard,” is unlikely to gain traction because of the size of the money fund market and the typical behavior of insurance schemes during a crisis. “The problem with such a scheme is reserves/scale given an industry that has $1.5 trillion in prime assets, [which] is likely to get bigger after the ending of unlimited deposit insurance at banks as of year-end 2012,” Gordon said. “Note also that such private deposit insurance schemes are unlikely to perform well in a crisis, mostly because of the high correlation of events of insured losses. Break-the-buck events arise not only because of defaults on portfolio securities, but also because of losses from fire sale asset dispositions as funds attempt to raise cash....