The Derivative Project

Kudos Charles Schwab: Leadership on Money Market Reform

Kudos Charles Schwab: Leadership on Money Market Reform

Kudos Charles Schwab: Leadership on Money Market Reform

Systemic Risk, High Fees and Voluntary Recapture in Money Market Funds

Unbeknownst to most retirement investors, a quiet war has been waged between the broker-dealer industry and the Department of Treasury Financial Stability Oversight Council (FSOC) over money market mutual funds. The issue is the systemic risk money market mutual funds pose as interest rates rise. Moody’s downgraded the industry in December 2014, as The Derivative Project wrote December 13, 2014, “Money Markets: Suspend, File and Charge the Investor.”  The SEC has ruled on significant changes to the money market fund industry that will be adopted in 2016.

Retirement investors should not have their life savings at risk in systemically risky products, nor be responsible for fees that exceed the returns of packaging the product. In this low interest rate environment, money market funds are an obsolete product, as the costs to create the funds far exceed the benefit in increased yield to the consumer.

Most retirement investors have no idea of the systemic risks these funds pose or that the brokerage industry is poised, to take from the retirement investor, a piece of the interest rate gain, once rates rise.  One could argue this is a critical fiduciary breach that “advisors” are still placing their retirement investor funds in high fee, money market mutual funds that carry systemic risks, when better yielding FDIC insured sweep options are available. It is also of note that not one major media publication has warned retirement investors on the systemic risks these money market mutual funds pose, as interest rates rise.  This is just how the broker-dealer industry thrives, a media that prints the news the brokers want, in exchange for lucrative advertising revenues.

A Brief History of the Brokerage Industry and the Fight to Save this Obsolete Product at Costs to Retirement Investor

During the 2008 financial crisis the Reserve Fund, a money market mutual fund, was forced to take a bailout from taxpayer dollars. Here is a September 17, 2008 New York Times article on the Reserve Fund posing risks of losses to investors. Dodd Frank created the FSOC to investigate this money market fund bailout (among other risks) who recommended fundamental changes to the money market mutual fund structure, that brokerages fiercely fought, including Charles Schwab.

The Financial Stability Oversight Council held a public comment period on the systemic risk on money market funds and changes that the industry proposed to deal with such risk. The comments are worth a read for every retirement investor. Not one financial advisor, not one broker dealer, put the interests of the retirement investor over their own. Most advisors wrote en mass, “Our clients love them.”  Ask your “advisor” if he or she wrote the FSOC to protect your interests from systemic risks in money market funds.  If not, why not?

Here is a summary of the comments at

Here is the link to the Comments at the FSOC.

It is worth a read to review Charles_Schwab_FSOC_MMF_Comment_Letter against the FSOC proposed changes on money market mutual funds.

Here is a FSOC Advisor Comment to the Financial Stability Oversight Council on changes to money market funds.

Brief History on Money Market Reforms

2012 – Public Comment on Systemic Risks of Money Market Funds

The Derivative Project wrote to the SEC Investor Advisory Committee to urge the SEC to warn every retirement investor of the costs and systemic risks of these funds, September 26, 2012.

“It is abundantly clear our nation’s capital markets have been manipulated to create a product that delivers maximum return to the packagers of the “product”, while returning no incremental gain to the retirement investor, with very high risk, that is completely avoidable given currently available alternatives that offer a comparable or higher return.”

Charles Schwab responded to the SEC questions on the role of their “voluntary recapture program”.  In essence, once interest rates rise, Charles Schwab would recoup the fees that they have been waiving to support the on going use of a product that no longer had benefit to the consumer.

In its 2012 letter to the SEC, The Derivative Project highlighted a cash sweep option used by broker-dealer Fidelity, a choice to sweep to a FDIC insured bank, that eliminated the systemic risk, through FDIC insurance and paid an equivalent yield.

2015 – Systemic Risks are still Present in Money Market Funds as the Federal Reserve Increases Rates

Fast forward to 2015 and the Federal Reserve is hinting interest rates may rise.  One cannot forget, as Moody warned in 2014, there still exist many systemic risks, “unhealthy credits” in money market mutual funds.  What is a real fiduciary to do?

September 15, 2015 the Wall Street Journal wrote, “Will a Rate Rise Reach Money Fund Investors?”  Charles Schwab was prominently featured in this article that highlighted the fact consumers may be giving up some of their long anticipated gains back to Wall Street firms.  Here is a summary of money market rates for retail investors, however it is only prudent to double check which of the broker dealers’ and fund companies are posed to recoup expenses.

Consumers need the transparency to understand that the money market fund is an obsolete product in this unprecedented, low interest rate environment.  Consumers should not be forced to pay for the financial services’ industry ongoing use of a flawed product.

What is a Fiduciary to Do?  It is 2015 and Rates are Poised to Rise

Money market funds are organized under the Investment Company Act of 1940.  They are subject to a fiduciary duty to their shareholders.  As Congress, the White House and the Department of Labor debate the role of “advice” and fiduciary duty to retirement investors, it is no surprise that a leader has not emerged to confront the systemic risks posed in money market mutual funds, that also deliver low returns and too high fees to sustain the product in today’s interest rate environment.

Now, three years later, as rates are poised to rise, it appears Schwab is rethinking their April 2012 letter to the SEC and moving small retirement investors’ cash to a FDIC sweep-option, that The Derivative Project urged the SEC to highlight for every retirement investor, over 3 years ago.

As an “investment advisor” newsletter wrote last week, “Schwab alerts its RIA’s that it will liquidate client money market holdings by December 1.”

As this article reveals, Charles Schwab has changed its cash options: any amounts below $500,000 will be “swept” to Charles Schwab Bank, carrying FDIC insurance.  Schwab is in an enviable position compared to other broker-dealers, such as Fidelity, having a bank up and running to make an immediate switch to a FDIC sweep option that not only keeps the money in house, but provides the lucrative spread on deposits.

The “Schwab Bank Sweep Feature” is described at the Schwab website.  For the consumer, Charles Schwab has done the right thing, eliminating costly money market sweep options, which carry systemic risk and costly “voluntary recapture” programs, implemented as interest rates rise.  However, the consumer must now monitor any fees for the new FDIC sweep option and the rate of return they receive on the deposits from Charles Schwab Bank.

Will more broker dealers, “advisors” and money market mutual fund companies exercise their fiduciary duty and advise all consumers of the systemic risks still lurking in money market funds and the viable FDIC bank deposit alternatives to “voluntary recapture programs” as interest rates rise?   Charles Schwab knows this is a win for their bank, a win for the retirement investor and a winning marketing strategy, as capital markets change and evolve, given different economic scenarios.

However, buried in the fine print are the fees broker dealers are charging for such a sweep option to a FDIC insured account.  Questions to ask in the name of transparency for all retirement investors:

  • If my broker dealer uses a FDIC insured sweep account, what are the fees the broker is paying to the FDIC Program Bank, that I am responsible for?  What is the interest rate?
  • Is Charles Schwab Bank more competitive since they will not charge a “Program Bank” fee?  What is their interest rate?

It is all a mute point right now, until interest rates rise as most firms are paying .01%, before Program Bank fees. However, it pays to ask your broker what the “Program Fee” is, if you are in a FDIC sweep account.  However, as interest rates rise, it pays to be prepared to understand the new SEC rules of money markets in this interest rate environment, their risks and how to avoid money market fund systemic risks and “voluntary recapture” programs.