U.S. GOVERNMENT PUBLISHING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Publishing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

22–172 PDF 2016

S. HRG. 114–388 

IMPROVING COMMUNITIES’ AND BUSINESSES’ 

ACCESS TO CAPITAL AND ECONOMIC DEVELOPMENT 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

SECURITIES, INSURANCE, AND INVESTMENT 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED FOURTEENTH CONGRESS 

SECOND SESSION 

ON 

EXAMINING HOW BUSINESS DEVELOPMENT COMPANIES, COMMERCIAL 

REAL ESTATE FINANCE, AND MARKET MUTUAL FUNDS PROVIDE ACCESS TO CAPITAL AND ECONOMIC DEVELOPMENT FOR COMMUNITIES 

AND BUSINESSES 

MAY 19, 2016 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.fdsys.gov/ 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

RICHARD C. SHELBY, Alabama, Chairman 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

DEAN HELLER, Nevada 

TIM SCOTT, South Carolina 

BEN SASSE, Nebraska 

TOM COTTON, Arkansas 

MIKE ROUNDS, South Dakota 

JERRY MORAN, Kansas 

SHERROD BROWN, Ohio 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

JOE DONNELLY, Indiana 

WILLIAM D. DUHNKE III, Staff Director and Counsel 

MARK POWDEN, Democratic Staff Director 

DAWN RATLIFF, Chief Clerk 

TROY CORNELL, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT

MIKE CRAPO, Idaho, Chairman 

MARK R. WARNER, Virginia, Ranking Democratic Member 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

TIM SCOTT, South Carolina 

BEN SASSE, Nebraska 

JERRY MORAN, Kansas 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

ELIZABETH WARREN, Massachusetts 

JOE DONNELLY, Indiana 

GREGG RICHARD, Subcommittee Staff Director 

MILAN DALAL, Democratic Subcommittee Staff Director 

(II)

C O N T E N T S 

THURSDAY, MAY 19, 2016 

Page 

Opening statement of Chairman Crapo ................................................................. 1 

Prepared statement .......................................................................................... 27 

Opening statements, comments, or prepared statements of: 

Senator Warner ................................................................................................ 2 

Senator Toomey ................................................................................................ 4 

Senator Menendez ............................................................................................ 5 

WITNESSES 

Ron G. Crane, Idaho State Treasurer .................................................................... 7 

Prepared statement .......................................................................................... 27 

Michael J. Arougheti, Cochairman of the Board of Directors, Ares Capital 

Corporation, on behalf of the Small Business Investor Alliance ...................... 9 

Prepared statement .......................................................................................... 43 

Responses to written questions of: 

Chairman Crapo ........................................................................................ 103 

Stephen W. Hall, Legal Director and Securities Specialist, Better Markets, 

Inc. ......................................................................................................................... 11 

Prepared statement .......................................................................................... 65 

Responses to written questions of: 

Senator Brown ........................................................................................... 108 

Drew Fung, Managing Director and Head of Debt Investment Group, Clarion 

Partners, on behalf of the Commercial Real Estate Finance Council ............. 13 

Prepared statement .......................................................................................... 71 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Statement from Lynn Fitch, Treasurer, State of Mississippi, submitted by 

Chairman Crapo ................................................................................................... 114 

Letter from Richard Johns, Executive Director, Structured Finance Industry 

Group, submitted by Chairman Crapo ............................................................... 116 

Letter from Thomas C. Deas, Jr., Chairman, National Association of Corporate Treasurers, submitted by Chairman Crapo ........................................... 117 

Letter from Michael Frerichs, Illinois State Treasurer, submitted by Chairman Crapo ............................................................................................................ 119 

Letter from Tom Salomone, 2016 President, National Association of REALTORS®, submitted by Chairman Crapo ............................................................. 120 

Letter from Jim Baker, Deputy Director of Research, UNITE HERE, submitted by Chairman Crapo ................................................................................. 121 

Statement from the Mortgage Bankers Association, submitted by Chairman 

Crapo ..................................................................................................................... 124 

Statement from the State Financial Officers Foundation, submitted by Chairman Crapo ............................................................................................................ 128 

Letter from J. Christian Bollwage, Mayor, City of Elizabeth, New Jersey, 

submitted by Senator Menendez ......................................................................... 136 

Letter from Joseph N. DiVincenzo, Jr., Essex County Executive, submitted 

by Senator Menendez ........................................................................................... 137 

Letter from John G. Donnadio, Executive Director, New Jersey Association 

of Counties, submitted by Senator Menendez ................................................... 138 

Letter from Abraham Antun, County Administrator, Hudson County, New 

Jersey, submitted by Senator Menendez ............................................................ 140 

(III)

(1) 

IMPROVING COMMUNITIES’ AND BUSINESSES’ 

ACCESS TO CAPITAL AND ECONOMIC DEVELOPMENT 

THURSDAY, MAY 19, 2016 

U.S. SENATE, 

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND

INVESTMENT, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Subcommittee met at 10:06 a.m., in room SD–538, Dirksen 

Senate Office Building, Hon. Mike Crapo, Chairman of the Subcommittee, presiding. 

OPENING STATEMENT OF CHAIRMAN MIKE CRAPO 

Chairman CRAPO. This hearing will come to order. 

This morning, the Subcommittee on Securities, Insurance, and 

Investment is holding a hearing on ‘‘Improving Communities’ and 

Businesses’ Access to Capital and Economic Development’’. We 

want to welcome all of our witnesses here today as well as the 

Members of the Committee. 

I will state at the outset we have a series of votes scheduled at 

11:15, so we are probably going to be moving through pretty fast 

today. I will just give the Senators and the witnesses advance 

warning of that. And we have had a request from just a couple of 

our Members to give an opening statement as well as the Chairman and Ranking Member, so I have agreed to that as well, and 

we will proceed with opening statements by myself, Senator Warner, Senator Toomey, and then Senator Menendez. And then we 

will move to the witnesses. 

Today’s hearing will provide insights into how business development companies, commercial real estate finance, and money market mutual funds provide access to capital and economic development for communities and businesses. 

There is a growing chorus that pending and existing Federal 

rules and statutory limitations are restricting access to capital and 

restraining economic growth. 

Because it is important for Congress to understand the factors 

that are impacting local communities and businesses, I welcome a 

discussion about specific proposals that would improve the current 

regulatory framework while maintaining proper safeguards. 

The House Financial Services Committee has already examined 

proposals to modernize the regulations for business development 

2 

companies and to adjust the risk retention rules for commercial 

real estate loans. 

Senators Toomey and Menendez have introduced legislation to 

restore the stable share price for institutional, nongovernment 

money market funds. 

I look forward to hearing from our witnesses on these legislative 

proposals and learning what specific factors, including Federal regulations, are negatively impacting lending and borrowing in local 

communities, for example: 

How a pending regulatory effective date will impact commercial real estate financing since almost $100 billion of loans in commercial mortgage-backed securities are set to mature in 2017, up from 

$52 billion this year. 

What will be the impact on State treasurers to invest and use 

money market mutual funds when several types of these funds will 

be required to switch from a stable to a floating net asset value in 

October? 

What statutory changes can be made to allow business development companies to increase investments in small and middle-market companies and enable investors to invest alongside with them 

and still provide adequate investor protections? 

These and a number of other questions I believe will be dealt 

with today as we discuss these issues, and I will conclude with that 

and turn to Senator Warner. 

STATEMENT OF SENATOR MARK R. WARNER 

Senator WARNER. Well, thank you, Mr. Chairman, and I apologize for being late. I wish I knew somebody who was involved in 

Virginia government to get that traffic moving. 

[Laughter.] 

Senator WARNER. I want to thank you for holding this hearing 

on the need to improve access to capital for businesses and communities. There is, I think, generally a bipartisan interest that we 

need to do more in this area, but in a way that is both responsible 

to avoid harm to investors and the financial system. 

I am particularly interested in the legislation to enhance business development company lending. BDCs, as we all know, were 

originally created by Congress to spur investment in small and 

middle-market companies, and since the crisis, actually we saw in 

the Wall Street Journal in 2014 that small business lending from 

the ten largest banks was down 38 percent compared to 2006. 

Clearly, there is a void that other lenders must fill. 

I do have to say in terms of the legislation we are going to be 

looking at, I harbor some reservations about the House bill since 

it allows these BDCs to invest further in financial services’ assets 

as opposed to the more traditional funding of what I would call 

more the ‘‘real economy.’’ And I am also concerned about the proposal to codify an exemption to owner registered investment adviser. But I do remain open on the question of how we can better 

use BDCs. 

On the commercial real estate risk retention, I think it is important to remember why we have risk retention rules in the first 

place. In the aftermath of the crisis, many financial institutions 

practiced an ‘‘originate to distribute’’ model with mortgage-backed 

3 

securities displaying little regard for the quality of the underlying 

asset. This practice saddled investors with highly rate but lowquality assets, spurring large losses. 

We know on the residential side we started with a 5-percent risk 

retention rule. I know there are some questions we are going to be 

looking at today about potentially lowering those risk retention 

rules’ requirements for certain types of CMBS. I think it is open 

to that, but I believe it is important to maintain the principle of 

aligning incentives between the sponsors of securitization and the 

investors. 

I know I have got a couple of my colleagues here who are involved with the legislation dealing with money market funds. In 

2014, the SEC came up with what I believe was a compromise in 

terms of rules, changing the treatment of institutional—and I 

stress ‘‘institutional’’—prime money market mutual funds by requiring a floating NAV. 

Some of these changes have been controversial, and with market 

participants, including municipalities, municipalities in my own 

State, raising concerns about the effect of a floating NAV and the 

effects that will have on the demand for municipality securities. 

In evaluating this rule, though, I think it is helpful for us to revisit the financial crisis and what precipitated the much-needed reform from the SEC. Again, we could go back and reexamine what 

happened back in 2008 with the Reserve Primary Fund that ended 

up from Lehman breaking the buck and the runs on the industry 

at that point. Clearly, there were efforts put in place, temporary at 

that point, to try to guard against further erosion of an instrument 

that many municipalities used for liquidity. 

I would agree that money market funds are an important cash 

management tool, but it is important that we never again return 

to the situation where taxpayers must step in to bail out a private 

entity. That is why the President’s Working Group on Financial 

Reform, the FSOC, and many Senators urge this panel for the SEC 

to act in terms of reforming the money market industry. There 

were a series of proposals that the SEC considered. I believe that 

where they came down in terms of the floating NAV actually seems 

to be pretty much in a good spot. 

Today we are discussing legislation that would undo some of 

those safeguards applied to that one-third of the industry within 

the institutional investors. I remain open to hearing the arguments, but obviously I have a series of grave concerns on this topic. 

So, again, Mr. Chairman, I think these are three serious pieces 

of legislation. They are to some a little bit arcane, but obviously all 

key to the smooth functioning of our financial markets, and I look 

forward again to hearing particularly from our colleagues Senator 

Toomey and Senator Menendez because I know they feel quite 

strongly on this legislation. 

Thank you. 

Chairman CRAPO. Thank you, Senator Warner, and I appreciate 

your thoughts, our working relationship, and will work with you on 

these issues. 

Senator Toomey. 

4 

STATEMENT OF SENATOR PATRICK J. TOOMEY 

Senator TOOMEY. Thank you, Mr. Chairman and Senator Warner. Thanks for having this hearing. 

I think it is clear that the American economy has been underperforming for a number of years now. There are many contributing 

factors, but one of them, in my view, is the overregulation that has 

been inflicted on the economy, including in the financial services 

space. 

At today’s hearing we are going to look at and examine two 

somewhat narrow but, nevertheless, important aspects of ways in 

which excessive regulation can be harmful to economic growth. 

Money market funds are a critical source of short-term financing 

in our communities. They are attractive to investors and issuers 

because they are low cost, they are extremely efficient, they are 

very liquid, and they are very stable. They offer modest returns, 

but they offer also very low risk, and that is a suitable combination 

for many. 

The financial crisis absolutely stressed the financial system. We 

had hundreds of banks and dozens of insurance companies that 

failed. Money market funds went through that period, and yet only 

one broke the buck. And investors in that fund recovered 99.1 cents 

for every dollar they had invested. 

Whatever one thinks of the taxpayer guarantees that were imposed during the crisis, the fact is taxpayers never ended up having to shell out a penny for investors in these funds. 

Nevertheless, in 2010, the SEC imposed a wave of very, very significant regulations on money market funds, including stringent liquidity requirements, shorter maturities on assets. And then in 

2014, without any evidence that the 2010 regulations were inadequate, the SEC, nevertheless, imposed a new set of regulations, 

including stress testing, diversification requirements, additional 

disclosures, and requiring prime and tax-exempt institutional 

money market funds to abandon the $1 stable NAV. 

This is problematic for several reasons which we will discuss 

today. I am grateful to Senators Menendez, Crapo, and Manchin 

for joining me in legislation that would allow funds to elect a status 

which would enable money market funds to use the amortized cost 

and penny rounding accounting, therefore, maintain a stable NAV. 

In that respect, and in that respect alone, we would revert back to 

the way the money markets operated from 1971 to 2015 with virtually zero losses for anyone during that entire period of time. 

By the way, our legislation would leave in place all of the extensive 2010 and 2014 regulations, and as a condition of having a stable net asset value, our legislation explicitly prohibits the Federal 

Government from stepping in with any form of bailout and requires 

that all investors in the fund would be aware of that legal requirement. 

Also, let me briefly, Mr. Chairman, mention the BDC issue which 

we will discuss today. There is an alarming statistic that I would 

start with, which is that the total number of small businesses in 

America declined between 2009 and 2014. I am not sure that there 

is another 5-year period in recent history in which that has happened. But it has happened, and part of the reason is the reason 

is the difficulty of accessing financing, conventional financing espeVerDate Nov 24 2008 11:12 Dec 20, 2016 Jkt 046629 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\05-19 IMPROVING COMMUNITIES AND BUSINESSES ACCESS TO C
5 

cially, and bank financing. Business development companies have 

stepped in to fill that void in many cases, including the cases in 

my State of Pennsylvania. Pittsburgh Glass is a great story where 

a business development fund operated by Franklin Square Capital 

provided $180 million, and they did it for one reason: because for 

Pittsburgh Glass, it was the best financing option available to 

them. 

The House Banking Committee, the Financial Services Committee, has passed legislation that would modernize BDC regulation, and I think it is very constructive legislation. It would allow 

a modest increase in the leveraging that is available. It would 

streamline some of their issuing requirements. And I hope this 

Committee will take up substantively similar legislation, and I am 

grateful for the fact that we will be able to discuss it today. 

Chairman CRAPO. Thank you very much, Senator Toomey. 

Senator Menendez. 

STATEMENT OF SENATOR ROBERT MENENDEZ 

Senator MENENDEZ. Thank you, Mr. Chairman, for the opportunity. Like many of my colleagues who were formerly State and 

local public officials, I have always been concerned about ensuring 

access to capital markets for State and local governments, for housing and transportation authorities, for small businesses, universities, hospitals. And money market funds facilitate that access by 

investing in short-term municipal debt and holding it to maturity. 

In fact, money market funds are the largest investors in shortterm municipal bonds and hold nearly $6 billion of municipal bonds 

in New Jersey. At the end of 2015, money market funds were estimated to hold over $245 billion in municipal debt issuances. 

Now, I have heard from elected officials across my State of New 

Jersey, including the mayor of Elizabeth, the Hudson County business administrator, the Essex County executive, and the New Jersey Association of Counties that represent all 21 counties in the 

State, that access to the capital markets that they depend on to get 

the lowest-cost financing for affordable housing, for public infrastructure, and schools appears to be at risk due to unintended consequences of the SEC rule requiring that tax-exempt and prime 

money market funds must change their method of calculating their 

net asset value from fixed to floating. 

And, Mr. Chairman, I would ask to submit all of those letters for 

the record. 

Chairman CRAPO. Without objection. 

Senator MENENDEZ. Thank you. 

In addition, I continue to hear from investors and fund managers, including local government officials in my State of New Jersey, who are charged with cash management or municipal finance. 

They are concerned that instead of making money market funds 

safer, the floating NAV reporting will significantly reduce the viability of the product as a tool to invest money on a short-term 

basis. 

In response to these concerns by county and local officials, I am 

pleased to have joined Senator Toomey in cosponsoring the Consumer Financial Choice and Capital Markets Protection Act in an 

effort to preserve money market funds both as a critical cash manVerDate Nov 24 2008 11:12 Dec 20, 2016 Jkt 046629 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\05-19 IMPROVING COMMUNITIES AND BUSINESSES ACCESS TO C
6 

agement tool for State and local government officials and as a 

source of liquidity and capital to meet the public infrastructure and 

investment needs of communities in New Jersey and throughout 

the country. 

I have heard concerns that investors are leaving both prime and 

tax-exempt money market funds in anticipation of the October 14, 

2016, implementation date. And since 2014, several tax-exempt 

money market funds invested in critical New Jersey State and local 

debt issuances to support housing, education, infrastructure, and 

health care facilities have closed or announced plans to close. 

The fact of the matter is if investors leave these funds and there 

is less demand for municipal securities, the borrowing costs for 

State and local governments will go up. And it is not just them 

that will feel the effect. State and local governments provide very 

often a key role in facilitating low-cost financing for nonprofit organizations undertaking vital projects in our State. 

So, Mr. Chairman, let me just close by saying I sat on this Committee when we did Dodd-Frank; I was a fierce defender of it; I was 

someone who authored several provisions of it; and I have fought 

those who want to slay it. But I do not think the SEC always gets 

it right, and I do not think they got it right this time, and that is 

why I am pleased to join in the legislation. 

Chairman CRAPO. Thank you, Senator Menendez. 

Before we move to the witnesses, I would ask unanimous consent 

that the following statements and letters be made a part of the 

record. These have been submitted to the Committee by the institutions and individuals noted: the State Financial Officers Foundation, the Illinois State treasurer, the Mississippi State treasurer, 

the National Association of Corporate Treasurers, the National Association of Realtors, the Mortgage Bankers Association, the Structured Finance Industry Group, and United Here. Without objection, 

they will be made a part of the record. 

Do any other Senators want to submit a statement for the 

record? 

[No response.] 

Chairman CRAPO. All right. With that, we will move to the witnesses. Again, we welcome all of our witnesses here. Although we 

have a bit of a tight timeframe, I think we will have plenty of time 

to get through and discuss these issues, and I will tell the witnesses at the beginning now, if we do not have time for all of the 

Senators—and some of the Senators will not even be able to make 

it because they have got other intervening commitments—we do 

have a practice of submitting questions following the hearing and 

asking for you to respond to those as well. 

Our first witness today is the Honorable Ron Crane, who is the 

Idaho State treasurer. Prior to being elected the State treasurer in 

1998, Ron served as a State legislator for 16 years and in that capacity as a member of the House of Representatives. I served with 

him in the Idaho Legislature, and he is a very good friend of mine. 

And, Ron, I appreciate you bringing some of Idaho’s common sense 

here to Congress and hope you will leave some with us. 

Our second witness is Mr. Michael Arougheti, the cochairman of 

the board of directors and executive vice president of Ares Capital 

Corporation, on behalf of the Small Business Investor Alliance. 

7 

Our third witness is Mr. Stephen Hall, the legal director and securities specialist of Better Markets, and we appreciate having you 

here with us. 

And our fourth witness is Mr. Drew Fung, the managing director 

and head of the Debt Investment Group of Clarion Partners, on behalf of the Commercial Real Estate Finance Council. 

Gentlemen, we welcome you all. You will see a little timer in 

front of you. We do have your written testimony, and we actually 

do read it and study it very carefully. We ask you to try to keep 

your oral comments to the 5 minutes, as you will see on the timer, 

and then we will get into some good questions and answers. 

With that, Mr. Crane. 

STATEMENT OF RON G. CRANE, IDAHO STATE TREASURER 

Mr. CRANE. Mr. Chairman, Members of the Subcommittee, thank 

you for inviting me to participate in this hearing. I serve as the 

chief financial officer for the State of Idaho and oversee investment 

portfolios of about $4.4 billion. In addition, my office oversees a 

number of debt management functions, including the issuance of 

tax anticipation notes annually 

I want to thank you, Mr. Chairman, as well as Senators Toomey 

and Menendez, for sponsoring Senate bill 1802, the Consumer Financial Choice and Capital Markets Protection Act. This bipartisan 

legislation will improve access to capital and economic development 

by preserving the stable-value money market funds for public infrastructure financing and the investment needs of Governments and 

business. 

Following the financial market crisis of 2008, the Securities and 

Exchange Commission adopted a number of reforms to the regulation of money market funds that helped to improve their liquidity 

and transparency while reducing interest rate and credit risk in 

the funds. However, one of those requirements is having significant 

unintended consequences. Any fund which is available to investors 

who are not so-called natural persons will be required to transact 

using a fluctuating or floating NAV instead of a stable $1 per 

share. This means two things. 

First, because the implementation deadline for the floating NAV 

requirement is fast approaching, a great deal of money is leaving 

tax-exempt and prime funds right now. 

Second, the funds can no longer use that money to provide financing to Governments and other organizations such as hospitals 

and businesses. 

I am going to focus my comments mostly on the impact on taxexempt funds, but it is there for prime funds, too. 

For more than three decades, stable-value, tax-exempt money 

market funds have been a stable source of short-term financing for 

cash-flow as well as important funding for public infrastructure 

and economic development. In Idaho, tax-exempt money market 

funds provide over $600 million in financing for the tax anticipation notes issued by my office, as well as for projects funded by the 

Idaho Health Facilities Authority and the Idaho Housing and Finance Association. 

Money market funds are the lowest-cost form of borrowing for us. 

As recently as the end of last year, a health care facility in Idaho 

8 

was able to pay 7 basis points for financing issued by the Idaho 

Health Facilities. 

Even if you add the cost of credit enhancement and other fees, 

that financing is significantly less than the 120 basis points they 

might have to pay for a bank loan or 250 basis points or more that 

they might have to pay on a long-term bond. 

Unfortunately, the floating NAV requirement, which takes effect 

in October, is forcing investors to leave and causing tax-exempt 

money market funds to liquidate at a much higher rate than the 

SEC expected. It is simple. All the non-natural persons have to 

leave. 

A survey by Treasury Strategies shows that at least 40 percent 

of fund assets are at risk solely because of the floating NAV requirement, and the indirect impacts are likely to make that significantly higher. Just this year, fund sponsors have announced that 

they have or will be closing 17 tax-exempt money market funds totaling $14.3 billion in assets as a result of the SEC’s requirement. 

This is reducing our choice for funding sources and driving up the 

cost of financing. 

I also want to mention the impact it is having on my ability to 

invest and manage Idaho’s cash. Prime money market funds remain an important cash management tool for approximately 50 

percent of the State and local governments’ cash that is invested 

outside of local government investment pools. Since Government 

entities will no longer be permitted to invest in stable-value prime 

money market funds, this will limit our investment options to bank 

deposits and money market funds that invest solely in U.S. Government securities. This means that at the same time as our financing costs are going up, our investment income is going down, 

and taxpayers have to fill in the gap. 

Senate bill 1802 offers a reasonable solution. It enables State 

and local governments and other non-natural persons to continue 

to invest in stable-value money market funds across the municipal, 

prime and Government spectrum. At the same time, it leaves all 

of the other money market reforms adopted by the SEC intact. 

Senate bill 1802 is consistent with the decision of the Government Accounting Standards Board, GASB, to restore the stable 

NAV for local government investment pools and the recent decision 

by the European Union regulators to preserve the stable-value 

money market fund in Europe. 

Many of my State treasurer colleagues actively support Senate 

bill 1802, including the treasurer from Illinois, Treasurer Frerichs; 

the treasurer of Massachusetts, Treasurer Goldberg; the treasurers 

of Alabama and Mississippi; and Treasurer Perdue from West Virginia. Their statements, as well as those of many other individuals 

and organizations representing State and local governments and 

Main Street issuers and investors, can be found on the Web site 

of the Coalition for Investor Choice, Protectorinvestorchoice.com. 

Again, thank you, Mr. Chairman, for the opportunity to testify 

on this important issue, and I will be happy to answer any questions that you or Members of the Subcommittee may have. 

Chairman CRAPO. Thank you, Mr. Crane. 

Mr. Arougheti. 

9 

STATEMENT OF MICHAEL J. AROUGHETI, COCHAIRMAN OF 

THE BOARD OF DIRECTORS, ARES CAPITAL CORPORATION, 

ON BEHALF OF THE SMALL BUSINESS INVESTOR ALLIANCE 

Mr. AROUGHETI. Chairman Crapo, Ranking Member Warner, and 

Members of the Subcommittee, thank you. I am Michael Arougheti, 

and I am the cochairman of the board of directors of Ares Capital 

Corporation, an SEC-registered business development company, or 

BDC, and we are one of the largest nonbank providers of capital 

to small- and medium-sized businesses in the U.S., or as we like 

to call them, SMEs, which we believe are the backbone of the U.S. 

economy. 

I appreciate the opportunity to testify today on behalf of the 

Small Business Investor Alliance, the SBIA, a trade association 

which represents a majority of the Nation’s BDCs. SBIA’s BDC 

member provide vital capital to small- and medium-sized businesses nationwide, resulting in job creation and corollary economic 

growth. 

Ares Capital Corporation is publicly traded on the Nasdaq and 

is currently the largest publicly traded BDC by both market capitalization and assets. And since our IPO in 2004, we have invested 

more than $20 billion in over 650 transactions involving hundreds 

of SMEs in America, and in the process we have created tens of 

thousands of new jobs and provided capital to growing businesses 

that were unable to access capital through commercial banks or 

other traditional financing sources. 

Congress created BDCs in 1980 in a period similar to what we 

saw following the Great Recession. Specifically, Congress created 

BDCs to enhance capital access to SMEs. Uniquely, though, the 

BDC model gives ordinary investors the opportunity to finance 

these small companies themselves, effectively funding Main Street. 

BDCs make direct investments in smaller, developing American 

businesses, providing access to capital for companies that may not 

be able to access capital from banks. Yet despite what we believe 

is an outdated regulatory regime, which has been in place since the 

early 1980s, the number of BDCs has grown, and this growth accelerated following the economic downturn after the 2008 and 2009 

recession, where BDCs came in to address the unique needs of 

these small companies that were starved for capital. Currently, 

there are over 80 BDCs in the United States, and BDC loan balances have more than tripled since 2008. 

While the scope of BDCs’ investments may vary, all BDCs share 

a common investment objective and a common purpose of improving capital access to small- and medium-sized companies. Today 

the middle-market sector of the economy is responsible for onethird of private sector GDP, and BDCs have grown as commercial 

banks have withdrawn from lending to this sector. 

BDCs now find themselves at the forefront of the effort to address the unmet capital needs of these companies. But the dramatic decline in bank financing for middle-market loans is not a 

new issue; it is a long-term trend. Middle-market borrowers have 

historically depended on smaller regional banks for financing, and 

the number of these banks has been shrinking since the 1990s. In 

order to continue to provide sufficient access to capital for smalland medium-sized companies, modernization of the BDC regulaVerDate Nov 24 2008 11:12 Dec 20, 2016 Jkt 046629 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\05-19 IMPROVING COMMUNITIES AND BUSINESSES ACCESS TO C
10 

tions is essential. Indeed, modernization will permit BDCs to 

meaningfully grow and serve these SME clients. 

SBIA’s BDC members have invested in numerous SMEs throughout the United States. According to AdvantageData, as of March 

31, 2016, BDC aggregate loan commitments in the U.S. equaled 

over $82 billion. To provide an example of the types of investments 

that we make, Ares Capital Corporation invested in OTG Management, which was a founder-owned operator of full-service restaurants and shops within large airports across the country. Recently, OTG was awarded a contract to build out and operate the 

food and beverage concession at JetBlue’s new Terminal 5 at JFK 

International Airport and needed to raise capital to complete the 

construction plan. However, OTG was unable to access financing 

from traditional sources. It was a small company with a limited operating history, and at the time the only providers of that capital 

were BDCs. Ares stepped in to fill the voice and provided OTG 

with much-needed capital as well as management support and expertise to help that business continue to grow. 

Ares has also helped fund the growth of many minority ownedand-operated businesses, including ADF Restaurants, which is the 

second largest Pizza Hut franchisee in the country, with over 250 

locations in the Northeast. 

Similarly, Main Street Corporation, an SBIA member BDC based 

in Houston, has funded two of the fastest-growing tech companies 

in Eugene, Oregon; the largest privately owned jewelry chain store 

in the Rocky Mountain region; and the leading fixed based operator 

at the Indianapolis airport. 

BDCs are heavily regulated by the SEC and, appropriately, the 

activities of BDCs are fully transparent to regulators, investors, 

and portfolio companies. Specifically, publicly traded BDCs are subject to the disclosure requirements of the Securities Act of 1933 and 

the act of 1934 and are also subject to additional regulations imposed by the Investment Company Act of 1940. These disclosure 

and other regulatory requirements are extensive and include, 

among other things, a requirement that BDCs publish a quarterly 

summary of each investment held by a BDC and the fair value of 

those investments, which I believe is a significantly greater degree 

of transparency than we find in other financial services models. 

So while we certainly believe in the importance of appropriate 

regulation, many of the challenges faced by BDCs in increasing the 

amount of capital that they can lend and deploy are a consequence 

of where BDCs sit within the regulatory framework. BDCs are 

more akin to operating companies such as banks and other commercial lenders, yet we are regulated as mutual funds. 

So recognizing some of these challenges, the House Financial 

Services Committee recently passed H.R. 3868, the Small Business 

Credit Availability Act, with a strong bipartisan vote of 53–4. And 

I believe that this bill was specifically designed to modernize the 

BDC sector precisely to enhance our ability to provide capital to 

growing SMEs as banks continue to retreat from the sector, at the 

same time ensuring significant and appropriate investor protections specifically requested by the SEC. 

Currently, most BDCs maintain an average leverage ratio of 0.5 

to 0.75, reflecting a desire and a practical need to maintain adeVerDate Nov 24 2008 11:12 Dec 20, 2016 Jkt 046629 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\05-19 IMPROVING COMMUNITIES AND BUSINESSES ACCESS TO C
11 

quate cushion in the unprecedented and unlikely event of a sudden 

and steep drop in asset values. The maintenance of this cushion 

has the unintended effect of reducing the ability of BDCs sometimes to raise and invest capital, thereby frustrating the original 

intent of Congress to provide capital to small- and mid-sized businesses. 

H.R. 3868, in addressing this specific issue, would permit a modest increase in leverage from 1:1 to 2:1, much less than the typical 

10:1 ratio found in traditional banking institutions and on par with 

the 2:1 ratio under the current SBIC Debenture Program, but without Government guarantee or implied taxpayer subsidy. Importantly, the legislation also includes significant investor safeguards 

for accessing additional leverage, including a shareholder vote or 

independent board of directors vote within a 12-month cooling-off 

period. 

The legislation also includes other reforms. These include: allowing for the issuance of multiple classes of institutional preferred 

stock; permitting BDCs to own registered investment advisers; and 

allowing for additional investments in financial corporations. With 

respect to this last point, let me be clear that the modest amendments being proposed do not increase a BDC’s ability to invest in 

securities of private equity funds, hedge funds, CLOs, or other private investment funds. 

So, in closing, we believe that the time is right to modernize regulations governing BDCs and to pass legislation, which would allow 

BDCs to increase capital flows to America’s SMEs, spur economic 

growth, and create jobs. And it is clear that the banks have left 

this space and are unlikely to return. 

SMEs are the engine of our economy, and, unfortunately, many 

traditional sources of capital are no longer available to them. This 

bill, in my judgment, represents a strong and necessary effort to 

modernize the BDC sector so that it can maintain and grow its participation in a growing small and middle market without reducing 

investor protections. 

I apologize for going over. I am happy to answer questions about 

the bill or any other matters, and on behalf of the SBIA and the 

BDC industry, I want to thank the Committee for its commitment 

to increasing capital for growing businesses, and especially its interest in the contribution of BDCs to the overall economy and job 

growth. 

Thank you. 

Chairman CRAPO. Thank you, Mr. Arougheti. 

Mr. Hall. 

STATEMENT OF STEPHEN W. HALL, LEGAL DIRECTOR AND 

SECURITIES SPECIALIST, BETTER MARKETS, INC. 

Mr. HALL. Good morning, Chairman Crapo, Ranking Member 

Warner, and Members of the Subcommittee. Thank you very much 

for the opportunity to testify today. I am Stephen Hall, and I serve 

as the legal director and securities specialist for Better Markets, 

which is a nonprofit, nonpartisan organization that promotes the 

public interest in our financial markets. 

We believe in capital formation as a means of generating economic growth and prosperity for all Americans. However, deregulaVerDate Nov 24 2008 11:12 Dec 20, 2016 Jkt 046629 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\05-19 IMPROVING COMMUNITIES AND BUSINESSES ACCESS TO C
12 

tion is the wrong way to achieve these goals. The bills at issue here 

today would actually undermine capital formation in two very important ways: 

First, they would expose investors to a greater risk of loss, eroding the confidence that is essential for thriving capital markets; 

Second, they would increase the likelihood of another financial 

crisis, which poses the single greatest threat to capital formation 

and economic growth in this country. 

The 2008 financial crisis proves the point. It destroyed millions 

of jobs, triggered a tidal wave of home foreclosures, and wiped out 

the savings of countless American households. The costs have been 

staggering, and they are still mounting. That includes $20 trillion 

in lost GDP and untold human suffering. 

The lesson is clear: Without effective regulatory safeguards, our 

financial system is vulnerable to crisis, which can inflict widespread damage on our entire economy, including businesses of all 

sizes. 

Turning to the individual bills, S. 1802 would allow all money 

market funds to maintain a fixed net asset value. This provision 

would repeal the SEC’s 2014 rule mandating that certain institutional money market funds adopt a floating net asset value. The 

bill is a step in the wrong direction. 

We know from the financial crisis that money market funds are 

susceptible to runs. When the Reserve Primary Fund broke the 

buck in September of 2008, a run ensued. It quickly spread to all 

prime money market funds, and it froze the credit markets. The 

run subsided only after Treasury took the unprecedented step of 

guaranteeing, for the first time in history, the entire money market 

fund industry. 

Floating the NAV is necessary to ensure that money market 

funds remain stable. It reduces an investor’s incentive to withdraw 

from a fund, the first sign of stress. It promotes fairness among investors, and it corrects the basic misconception that money market 

fund investments cannot lose value. This reform should be allowed 

to take effect, and it should not be repealed. 

H.R. 4620 would weaken the risk retention safeguards applicable 

to securitizations of commercial real estate loans. This, too, is a 

step in the wrong direction. The financial crisis again illustrates 

the point. Before the crisis, the originate to distribute model became pervasive in the residential mortgage market. A similar pattern took hold in commercial real estate where underwriting standards sank to meet demand for loans that could be securitized. 

When the crisis hit, the toll on these markets was huge. Risk retention requirements are among the most important reforms in this 

area. They help protect investors, and they inhibit the accumulation of systemic risk. 

H.R. 4620 would make two counterproductive changes in the risk 

retention rule. First, it would create a blanket exemption for the 

securitization of a single commercial real estate loan or a group of 

related loans. Second, it would dilute the criteria for qualified commercial real estate loans, which are also fully exempt from the risk 

retention rule. These changes will weaken important investor safeguards and systemic safeguards in a market prone to systemic risk. 

13 

Finally, H.R. 3868 would undermine multiple safeguards that 

govern the operation of business development companies. Two provisions raise especially strong concerns. One would allow BDCs to 

double their leverage. This change would expose retail investors to 

additional risk of loss. Another provision would allow BDCs to invest greater amounts in financial companies, thus diverting capital 

away from the businesses they were intended and designed to assist. These and other provisions in the bill are simply unwarranted. 

In conclusion, I want to thank you again for the opportunity to 

appear today at this hearing, and I look forward to your questions. 

Chairman CRAPO. Thank you, Mr. Hall. 

Mr. Fung. 

STATEMENT OF DREW FUNG, MANAGING DIRECTOR AND 

HEAD OF DEBT INVESTMENT GROUP, CLARION PARTNERS, 

ON BEHALF OF THE COMMERCIAL REAL ESTATE FINANCE 

COUNCIL 

Mr. FUNG. Thank you, Chairman Crapo, Ranking Member Warner, and Members of the Committee, for the opportunity to testify 

today. My name is Drew Fung. I am a managing director and the 

head of the Debt Investment Group at Clarion Partners, and I am 

here today testifying on behalf of the Commercial Real Estate Finance Council, or CREFC, where I am a member of the executive 

committee. 

CREFC is the collective voice of the $3.1 trillion commercial real 

estate finance industry. Our 300-plus membership includes balance 

sheet, agency, and CMBS lenders as well as loan and bond investors and servicing firms. Our industry plays a key role in financing 

properties of all types in all 50 States, including apartments, nursing homes, grocery stores, retail, just to name a few. 

So my testimony today will focus on commercial mortgage-backed 

securities, or CMBS, as they are commonly known. CMBS has been 

an essential financing tool in real estate for decades. But in recent 

years, there have been a plethora of new rules and regulations that 

have evolved that have dramatically undermined the viability of 

this important funding source. 

So a little bit of background. A conduit, commercial-backed security is a set of bonds that is collateralized by a pool of between 50 

and 100 individual commercial mortgages with each loan averaging 

around $14 million in size. Institutional investors buy these CMBS 

bonds, and the principal and interest payments due to them are 

funded by the cash-flows from the mortgaged properties. And the 

estimated size of the CMBS market today, $500 billion, give or 

take, so quite sizable. 

CMBS plays a key role in commercial real estate lending because 

it provides much-needed real estate debt capital to markets and 

properties, particularly in secondary and tertiary markets. 

Balance sheet lenders, such as community banks and insurance 

companies, do not have the capacity on their own to cover the full 

range of these needs. In fact, in 2015, CMBS provided over 20 percent of all commercial real estate financing, which is over $100 billion of mortgage capital flowing into the markets. CMBS provided 

34 percent of all commercial real estate loans to tertiary markets 

like Boise and Bloomington, and 24 percent of the financing that 

14 

was put in place in secondary markets like Richmond. No other 

lender source comes close to serving all these so-called Main Street 

markets to that extent. 

Earlier this year, the CMBS markets were roiled by volatility. 

Some days it was very near impossible to sell a CMBS bond. Other 

days the interest rates on bonds that may be bought or sold in the 

markets was moving up and down by 20 percent. This volatility 

has translated into CMBS borrowers paying nearly 100 basis 

points or 1 full percent more for a loan than they would have been 

required to pay for a loan originated maybe 9 months ago, and this 

is in an environment where nearly all the economic indicators have 

remained stable or improved and the delinquency rates in these securities have actually dropped. 

But the greater concern, though, is that the availability of CMBS 

capital to these borrowers could diminish over time if the growing 

liquidity issues are not addressed. Liquidity is essential to investors who buy these bonds, such as insurance companies, pension 

funds, and institutions that purchase CMBS bond. Excessive volatility and the resulting loss of liquidity threatens the viability of 

the CMBS business, thereby reducing borrowers’ access to the 

mortgages provided by the CMBS industry. 

So what role does the regulatory environment play here? Well, 

today bank-affiliated broker-dealers are the primary liquidity providers for the CMBS secondary market. They provide liquidity by 

maintaining an inventory of bonds that already are in circulation 

in the marketplace to sell to or buy from investors. So those are 

market-making activities, and these market-making activities are 

being burdened by increasing regulation and expanding obligations 

to hold more capital liquidity and cushion for these loans. 

There are eight new or revised accounting capital rules, liquidity 

rules, including the new Dodd-Frank risk retention rules, which 

will take effect in December, that are directly impacting CMBS 

right now, and there are four more on the way. 

Each of these new capital requirements increases the cost of 

issuing and holding CMBS for broker-dealers and, when taken together, poses a serious threat to the CMBS capital flows to borrowers on Main Street. So as new regulatory requirements are finalized and as rules already in place are reevaluated going forward, I think it is very important that the overall impact on the 

CMBS business and on the economy overall are factored into the 

evaluation. And it is actually my understanding that policymakers 

and regulators abroad have already begun to do this. 

In closing, a bill that is moving through the House, H.R. 4620, 

warrants serious consideration. It would improve three elements of 

the CMBS retention regulations, and contrary to what Mr. Hall 

said, I believe that by adjusting these three criteria for loans to be 

deemed qualified, we will actually improve the bond’s performance 

over time while allowing more borrowers access to a qualified loan. 

On a relative basis, nearly all residential loans made today qualify 

for the QRM exemption; whereas, conduit CMBS, commercial 

loans, only 4 percent of the loans qualify. 

So, in closing, although CREFC’s membership is not always unified in its public policy views given our different roles and interests 

in the sector, we are unanimous in our support for a stable CMBS 

15 

marketplace and our growing concern that the increasing lack of 

market liquidity threatens that stability. 

So thank you, Committee, for the opportunity to testify. CREFC 

looks forward to working with the Committee to address the liquidity concerns I have discussed today, and I would be happy to answer any questions. 

Chairman CRAPO. Thank you, Mr. Fung. 

I am going to take my question period at the end, so I am going 

to move first to Senator Warner, and then we will go to Senator 

Toomey and Senator Corker. Senator Warner. 

Senator WARNER. Very generous, Mr. Chairman. Thank you for 

that. I am going to try to run through these fairly quickly. 

On the BDCs, Mr. Arougheti, Mr. Hall, I do believe the business 

development companies play an important role in the middle markets. I think we have seen a lot of the banks move out of this 

space. I am sympathetic to expanding your market share and expanding your opportunities, but it seems like the legislation you 

are proposing is a bit of an overreach. You know, I would like you 

both to comment on the question. Not only are you looking to increase your leverage ratio from 1:1 to 2:1, which arguments could 

be made; but at the same time, you are also talking about increasing the percentage of the ability for these BDCs to invest in financial institutions, from 30 percent to 50 percent, and being able to 

actually buy registered investment advisors. 

It seems like one of the two—I would actually be more inclined 

to be supportive of increasing the leverage ratio, but why would it 

be in the best interest to both increase your risk profile both in 

terms of leverage and increase your ability to purchase more financial institutions in and itself, which was never part of the original 

intent of the BDCs? 

Mr. HALL. Thank you, Senator. A couple of points in response to 

your question. 

First of all, in our view, these are indeed—they represent an 

overhaul. They are not modest adjustments to the regulatory regime. They encompass fundamental aspects of BDC oversight, 

ranging from leverage, as you noted. They divert money from the 

companies that Congress intended them to serve. Their ownership 

of financial institutions is now going to be expanded significantly, 

and there are even corporate governance provisions and shareholder provisions that are material. 

Fundamentally, we come at this from two perspectives. One is: 

Is there really a need for these kinds of weakenings in the regulatory regime, number one? And, number two, even if there is some 

sense that adjustments are necessary, what are the consequences 

of doing do? And here, just as a threshold matter, the BDC community has actually been thriving over the last 10 to 12 years. Measured by assets under management, I believe they have grown by 

a factor of 10. 

At the same time, there are recent reports indicating that their 

current leverage levels, which are already preferential under the 

Investment Company Act, are posing pretty serious challenges to 

them. 

16 

It, therefore, strikes us as an inappropriate time to actually 

weaken oversight of these entities, especially where it runs directly 

counter to what Congress intended. 

Senator WARNER. I guess, Mr. Arougheti, what I would say is I 

fully agree with Mr. Hall. But, on the other hand, the notion of you 

are both looking for an increase in leverage and you are looking for 

further expansion into an area that was not where the original intent of the legislation was headed. 

Mr. AROUGHETI. I will try to tie all three of them together because I think there is a prevailing conception that each of those 

work hand in hand, and they actually do work independent of each 

other. 

I would just quickly say with regard to the leverage, while the 

BDC industry has been thriving, we are not capitalized well 

enough to meet the capital needs of the middle-market borrowers 

that we serve. And I think we could grow more to meet this need. 

Number two, as we talk about leverage and the concept of leverage in any financial institution, I think it is important to anchor 

on other financial services companies as we think about leverage. 

And as I referenced in our prepared remarks, the SBIC Debenture 

Program, which has been a very successful Government-sponsored 

program, currently allows for leverage up to 2:1. 

And then, third, with regard to Mr. Hall’s commentary on hearsay in the market about challenges of the leverage ratio, I think 

he is referring to a recent report that was published by the rating 

agencies that were highlighting not the risks of incremental leverage, but the very challenge that we are discussing today, which is, 

because of the leverage constraint, management teams who are 

managing BDCs are having difficulty growing, which I think 

speaks to the policy. 

With regard to the 30-percent basket, I think this is an issue 

that requires further discussion. This piece of legislation has been 

talked about collaboratively with the Commission, with the Democrats and the Republicans, for over 41⁄2 years, and the current legislation reflects, I think, some of the concerns that you have raised, 

which is why there is a prohibition and direction exclusion of investing in funds like private equity funds, hedge funds, CLOs, et 

cetera. 

But, importantly, there are many financial services companies as 

our economy continues to evolve that have mandates that are consistent with the policy mandate of a BDC. As an example, we have 

an investment in a small-ticket equipment leasing business that is 

providing a form of capital directly to the same middle-market borrowers that are borrowing from us—— 

Senator WARNER. Let me just—because my time is gone. I am 

sympathetic to potentially leverage. I am not sympathetic to both. 

I would simply make one quick comment, Mr. Fung, as well. You 

know, I can understand your concerns on CMBS. There are some 

of us on the Committee, Senator Corker and I, who believe strongly 

in risk retention. I would point out that there are major institutions who are being able to close deals operating under the new 

procedures. 

And, finally, Mr. Crane, since I am not going to get to you as 

well—and I know my colleagues feel strongly the other way, there 

17 

was a compromise here. The floating NAV, I think, did put across 

the notion that these are not—there are risks involved in money 

market funds, and I would simply point out that many of your colleagues in the money market industry were desperately interested 

in making sure they were not viewed as systemically important 

and subject to all the FSOC rules. I think if we were to go back 

from this reform, that might reopen that debate. 

Thank you, Mr. Chairman. 

Chairman CRAPO. Thank you, Senator Warner. 

Senator Toomey. 

Senator TOOMEY. Thank you, Mr. Chairman. 

Mr. Crane, do you have a preference between prime funds and 

Government funds for your investment purposes? 

Mr. CRANE. Mr. Chairman and Senator Toomey, I would tell you 

that I will draw greater yield from the money market funds than 

I will from the Government securities. 

Senator TOOMEY. And if prime funds became unattractive, unusable for you, it seems to me you have a few options: You could set 

up shop in-house and invest directly, which would be an extremely 

cumbersome process for which you may not be well suited. You 

could just deposit the money in a bank, although banks do not 

seem to want deposits these days. Or you could go with the Government fund, which you just said—is it true that all of those options offer you less yield or a higher cost or both? 

Mr. CRANE. Mr. Chairman and Senator Toomey, you are absolutely correct. We are in the cash management business because 

we have to keep our funds liquid for expenditure purposes at the 

ready. So we are looking for vehicles to invest in, but at the same 

time as being safe, we also want to maximize yield so that taxpayers are not making up the difference. Money market funds offer 

us that opportunity, and so they are a very good vehicle. In our case, I have about $4.4 billion under management; prob- ably $230 million of that is in money market funds. 

Senator TOOMEY. Thank you, Mr. Crane. 

Mr. Hall, in your testimony you state that floating the NAV, first 

and foremost, is because it reduces the incentive of any investor to 

expedite withdrawals from a stress money market fund in hopes of 

redeeming at the dollar price as opposed to something lower, and 

that ‘‘Eliminating this first mover advantage substantially reduces 

run risk.’’ 

We have operated since 1971 with the risk of a first mover advantage. The Reserve Fund is held up as the worst disaster that 

has ever occurred in the history of money market funds, and that 

disaster resulted in investors getting 99.1 cents for every dollar 

that they had invested. And then, subsequent to that, we had a 

huge wave of new regulations in 2010 and in 2014 which imposed 

new, more stringent liquidity requirements, diversification requirements, maturity shortening, stress tests, more disclosures, and, importantly, gates and fees which are designed precisely to reduce the 

risk of first mover advantage in an early run. 

My question is: What data do you have to share with me that 

indicates that that entire wave of new regulations imposed on what 

had been an extremely safe and secure product prior even to that 

wave of regulations, what data do you have that shows that the 

18 

new regulations are inadequate and we need to, in addition, have 

this floating NAV? 

Mr. HALL. Senator, the first point I would like to make is in reference to your sort of review of the history of the performance of 

the money market funds. It indeed is true that the breaking of the 

buck by the Reserve Primary Fund was the most significant, dramatic, headline-worthy breaking of the buck in history—and 

unique in a sense, but it was not unique in another sense, because 

studies indicate that on hundreds of occasions over the last couple 

of decades, money market funds have, in fact, teetered on collapse, 

and but for sponsorship support, they would have actually broken 

the buck. So there is more vulnerability here than many people 

seem to acknowledge. 

With respect to the underpinning of the floating NAV, I would 

simply say that the analysis, both economic analysis, regulatory 

analysis, that supports that measure is amply set forth in two 

sources. One is, of course, the SEC’s rule release. The other is the 

set of proposed recommendations that the Financial Stability Oversight Council developed. And one of the leading reforms that they 

recommended to the SEC was floating the NAV for all money market funds, not just a subset of those funds. 

So I would suggest that there is ample support for that move—— 

Senator TOOMEY. Well, there is no question there are people who 

agree with that, but I would question whether there is data that 

actually supports the necessity. I would point out the Government 

Accounting Standards Board has ruled that local government investment pools could continue to use the amortized cost accounting 

and the penny rounding. 

But let me just move on—I am running out of time—to a quick 

issue. Mr. Arougheti, is it the case that in the legislation, H.R. 

3868, any increase in leverage would be fully disclosed to investors? 

Mr. AROUGHETI. Yes, it would be fully disclosed. There are two 

provisions that would require a vote of the independent board of directors to move forward or a cooling-off period after that for shareholders to effectively vote with their feet if they were not comfortable being invested in a BDC that elected to—— 

Senator TOOMEY. OK. So investors would know that the BDC 

had a leverage of 2:1 ratio if the legislation permitted that. 

My question for Mr. Hall is: Isn’t it awfully paternalistic for the 

Government to say, ‘‘We are going to forbid you, Mr. Investor, from 

having this opportunity to take this leverage in this particular vehicle’’? Or is it your view that we should forbid leverage in other 

cases, too? For instance, it is my understanding that an ordinary 

investor could use a margin account and buy stock in a bank and 

achieve many, many multiples of leverage. Would you advocate 

eliminating margin for ordinary investors also? Or why are we singling out this particular vehicle as one that cannot exercise really 

what is a modest amount of additional leverage? 

Mr. HALL. I think the answer, Senator, lies in two sources. One 

is the 1980 statute that actually acknowledged or created the 

framework for these companies. They were created for a very specific purpose, and it was acknowledged at that time that their very 

business model that is one that caters to companies that are less 

creditworthy than others is inherently risky in certain respects. 

19 

The idea was to help the middle-tier and small-tier companies get 

capital that they could not otherwise get. 

The other thing is that the amendments that are being sought 

here, they are not as simple as just doubling leverage. It is actually 

more than that when you factor in the indirect increase in leverage 

that comes from the ability under this bill, if it is enacted, to expand investment into financial companies that are themselves leveraged. 

So to get to your question, it is not about being paternalistic at 

all. It is about respecting the judgments that have long been made 

about how to strike the right balance between helping these companies on the one hand and protecting investors on the other. And 

the history of securities regulation is replete with examples of limitations on the nature of the investor who is permitted to actually 

put their funds at risk through the accredited investor concept. 

There are loads of protections that can be characterized in some 

sense as paternalistic, but they are not. They are protecting investors, and they are in many cases safeguarding our system against 

systemic risk. 

Senator TOOMEY. I see I have run out of time and gone over, so 

thank you for the indulgence, Mr. Chairman. 

Chairman CRAPO. Thank you. 

Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Treasurer Crane, you pointed out in your testimony that, according to statistics released on April 20th by the SEC, gross yields on 

tax-exempt money market funds increases from 8 basis points in 

February to 35 basis points in March. With this significant jump 

in tax-exempt yields, how is this going to impact the ability of 

State and local governments to finance infrastructure and economic 

development projects? 

Mr. CRANE. Mr. Chairman and Senator Menendez, my guess is 

it is going to have a dramatic impact, and it is already having an 

impact on the markets. For example, in the State of Idaho, we have 

the Idaho Housing and Finance Association that provides low-income housing. We have the Idaho Health Facilities Authority that 

builds hospitals. Those bonds are sold to the money market funds. 

And if there are less money market funds, then the cost is going 

to go up, and the person that is going to pick that up is the taxpayer. 

Senator MENENDEZ. Let me ask you this: In your testimony you 

highlighted that the Government Accounting Standards Board 

acted to permit you to offer your local government investment pools 

with a stable unit price. Can you tell us a little bit about the Government Accounting Standards Board and its decision? 

Mr. CRANE. Well, Mr. Chairman and Senator Menendez, they 

recognized that the floating NAV was not good for accounting purposes as far as the LGIPs were concerned, and so they repealed 

that rule and allow us to amortize our costs and our increases from 

an accounting standpoint, and rightfully so. They recognized it was 

a mistake and reversed themselves. I think they did the right 

thing. 

Senator MENENDEZ. Let me ask you this: If State and local government are faced with impeded access to the capital markets 

20 

through the closure of tax-exempt money market funds, what other 

options exist for low-cost financing of critical community and infrastructure projects? 

Mr. CRANE. Mr. Chairman and Senator Menendez, I am not 

probably the best one to answer, but I can tell you that if you are 

going to go out and go into the bonding market and sell bonds, you 

are going to pay probably 120 basis points more, maybe 250 basis 

points more. You have got the banks that you can use. That is 

going to be a significant increase in cost. Or you can go out and 

bond for it, and it is going to be much more expensive than it currently is. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Chairman CRAPO. Thank you. 

Senator Corker. 

Senator CORKER. Thank you. Thanks for having this hearing, 

and I thank all of you for testifying. 

Mr. Arougheti, BDCs are something that in the past I have not 

spent a lot of time on. When you invest in these companies or provide capital, is it in the form of equity, mezzanine loans, direct 

loans? Is it all three of those? 

Mr. AROUGHETI. It is all three of those. The BDCs have the flexibility—and I think it is an important point to discuss—to make 

common equity investments, mezzanine investments, or senior 

loans, all with the goal of providing growth capital. As the capital 

markets have evolved and banks have left, it is actually the exact 

opposite of what Mr. Hall said. We are actually seeing larger companies come to the BDC market to access financing and more senior secured types of investments. 

The knock-on effect of that is when we are talking about access—— 

Senator CORKER. I have got 5 minutes. So the investors that invest—you know, it is a public company—is there any lockout or can 

they trade daily, they can get in and out of it? 

Mr. AROUGHETI. Daily trading. 

Senator CORKER. Yeah. And, you know, you all have operated for 

36 years with a 1:1 debt-to-equity ratio. It is modest, but it is doubling. What is actually driving—well, first of all, what kind of return on equity did your company have last year? 

Mr. AROUGHETI. About 10 percent. 

Senator CORKER. So with the additional debt, there will be some 

costs there. You could drive that up to 18 percent or so? 

Mr. AROUGHETI. I think it would be the opposite. So what I expect will happen with the increase—— 

Senator CORKER. Well, now, wait a minute. How could that—that 

is not possible. 

Mr. AROUGHETI. What would wind up happening is we would be 

investing in lower-yielding senior secured debt. The way the BDCs 

are structures now is if they invest in mezzanine or equity, the capital markets, be it bank or bond markets, will not actually leverage 

those assets. So the choice as a management team is invest in, 

quote-unquote, riskier illiquid assets with no leverage to drive a 

10-percent ROE or invest in higher-quality, lower-yielding senior 

securities with leverage to generate the same—— 

21 

Senator CORKER. So the additional leverage would allow you to 

be more involved in prime-type loans. Is that—— 

Mr. AROUGHETI. Yes, it would broaden the product set, and it 

would give us another tool to bring into the middle market, absolutely. 

Senator CORKER. And the interest in investing in financial institutions, what is driving that? That does seem, just for what it is 

worth, somewhat odd as it relates to this legislation? 

Mr. AROUGHETI. Yeah, I think it is a recognition that the face of 

the economy has changed in the 36 years since the legislation was 

passed, that financial services companies in and of themselves are 

a larger part of the GDP; they are job creators themselves. I think 

this is a relevant conversation. As I said, the legislation has tried 

to identify those types of financial instruments that cause concern. 

Senator CORKER. So if you were going to—if your ceiling was increased from 30 to 50 or whatever, as it relates to financial institutions, would you envision then—that would be more of an equity 

investment, would it not, not a lending type situation? 

Mr. AROUGHETI. Each BDC is different, but when people are investing in financial services in that 30-percent basket, it does tend 

to be an equity investment. And back to my earlier comment, those 

in and of themselves are not leverageable. So I think the concern 

of leveraging leverage by investing in financial services companies 

is probably—— 

Senator CORKER. So an investor today in your company would 

have a year, there would be a cooling-off period. They can get out 

of the stock after this testimony if they decide, and then they 

would be investing in a company that they understand has got additional leverage and is probably going to be more focused toward 

using that money for lending, not for equity itself. Would that be 

a fair assumption? 

Mr. AROUGHETI. Yes, that is my view. 

Senator CORKER. Let me ask you, Mr. Fung, on the conduit lending, I have participated in that in the past and understand it somewhat. What is the 4-percent box you are talking about? What are 

the limitations on a qualified mortgage that make that box so 

small? 

Mr. FUNG. Well, the QCRE, qualified commercial real estate, 

loan box is smaller now because there are limitations on interestonly, there are limitations on loan-to-value. And what they are effecting is actually they are applying equally across all the different 

type of loans, including the absolute most safe, lower leverage, high 

debt service coverage loans. 

So this, frankly, is about a very modest change—— 

Senator CORKER. What I did not hear in your testimony was 

what the limiting factors are that are keeping the box so small. I 

am out of time, but can you quickly lay out what is causing only 

4 percent of the conduit loans to—— 

Mr. FUNG. To not qualify. 

Senator CORKER. That is right. 

Mr. FUNG. Yeah, basically those loans are not qualified because 

they have either too high loan-to-value or a debt service coverage 

ratio that might not meet this broad-brushed test. But it is about 

an overall credit picture of each loan, and so, you know, the one 

22 

or two factors that are being considered are probably not absolutely 

appropriate. 

Senator CORKER. Well, I would like to talk to you in more detail. 

You know, having had some experience, I will say conduit lending 

typically has had much—they have been far more aggressive, if you 

will, than life insurers and others. I mean, I think that is a fact. 

And so I would like to understand—— 

Mr. FUNG. That is true. 

Senator CORKER. You agree with that, right? 

Mr. FUNG. I do. 

Senator CORKER. So if you would, I would love for you to come 

into our office and explain. I am just having difficulties understanding what those limiting factors are, and I really would like to 

understand. 

Thank you all for your testimony and for being here today, and 

thank you, Mr. Chairman, for having this hearing. 

Chairman CRAPO. Thank you, Senator Corker. 

Senator Warren. 

Senator WARREN. Thank you, Mr. Chairman. Thank you for having this hearing today. Thank you all for being here. 

In 1980, Congress created these business development companies, or BDCs, as special investment vehicles with the goal of giving small businesses more access to capital. And Congress required 

BDCs to invest at least 70 percent of their money in small businesses. And as an incentive to attract investors to BDCs, Congress 

put a big carrot on the table and exempted BDCs from corporate 

income taxes. 

Now, I know a lot of BDCs focus on small business investments 

and fill a hole in the market. I know a lot of companies in Massachusetts and across the country get investment money from BDCs. 

But I am concerned that some of the largest BDCs have turned this 

into a raw deal for investors, and the bill before us today would 

take a bad deal and make it worse. 

Mr. Arougheti, you run the biggest BDC in the country, Ares 

Capital, and I took a look at some of the disclosures your company 

submitted to the SEC, and, frankly, I have got to say they are pretty shocking. Over the last decade, your management and incentive 

fees have risen by over 35 percent annually. They have nearly doubled every 2 years. Meanwhile, total returns to shareholders in 

that same time period have risen by only about 5 percent. And because of lousy numbers like these, institutional investors are bailing out of BDCs, leaving behind a lot of mom-and-pop investors 

who may not realize that they are getting fleeced. 

Mr. Arougheti, you have been pushing for legislation that would 

allow your company to borrow more money and increase your leverage. In fact, your company alone has spent $1.5 million lobbying 

on this issue in the last few years, and you say that is because you 

want to be able to invest in more small businesses. But it seems 

to me that is something of a misdirection. 

If you really want to have more money to invest, why don’t you 

lower your high fees and offer better returns to your investors? 

Then you get more money, and you can go invest it in small businesses. 

23 

Mr. AROUGHETI. Thank you for the question, Senator. I think 

when we talk about ROEs on entities that are required by law to 

distribute 90 to 100 percent of their income, it is not a corollary 

to look at other operating companies to talk about a 5-percent increase in shareholder value because effectively—— 

Senator WARREN. So you are saying that, in effect, you have doubled the return every couple of years to your investors? 

Mr. AROUGHETI. Right. The way I would encourage people to look 

at the math is you have to actually look at the reinvestment of 

those dividends because BDCs do not have—— 

Senator WARREN. So I have watched your fees nearly double 

every 2 years. What I am trying to get at is if you are saying the 

return is also doubling nearly every 2 years, then I do not get why 

the market has not just solved this? Why aren’t people flocking to 

you wanting to invest more money and you have got plenty of 

money—— 

Mr. AROUGHETI. Well, I think that they are, so—— 

Senator WARREN. ——to put into small businesses? 

Mr. AROUGHETI. I think that they are. We IPO’d in 2004 with an 

equity market capital—— 

Senator WARREN. Well, if you have got plenty of money, then 

why are you coming to Congress asking for a shift in the allocations so that you can attract even more money? 

Mr. AROUGHETI. Sure, so it is somewhat circular. So when 

we—— 

Senator WARREN. Yeah, it is. 

Mr. AROUGHETI. When we IPO’d in 2004, we had an equity mar- ket capitalization of $165 million and 11 people. Today we have an 

equity market capitalization of $4 billion and hundreds of people 

who are in local markets making middle-market loans. So—— 

Senator WARREN. And yet the institutional investors seem to be 

leaving you and leaving only the mom-and-pops behind. 

Mr. AROUGHETI. I do not think that that is true. Sixty percent 

of the investors in Ares Capital Corporate are large mutual fund 

complexes. There are actually some constrains that we—— 

Senator WARREN. You are saying that in the industry institutional investors are moving in to BDCs? 

Mr. AROUGHETI. Institutional investors are about 50 to 60 percent—— 

Senator WARREN. Are you saying they are moving in, what the 

slope looks like? 

Mr. AROUGHETI. Well, I think they are stable. I think that there 

are—— 

Senator WARREN. That is not the data I am seeing, but let me 

get to another issue here. I also want to focus on an aspect of the 

BDC bill that you are pushing. BDCs right now can invest up to 

30 percent of their money in things other than small businesses, 

including hedge funds or other financial firms. Ares has taken full 

advantage of this to funnel money into financial firms. At the end 

of last year, it had about 26 percent of its money in financial services companies. 

Now, this bill would let BDCs dedicate another 20 percent of 

their investments to financial companies rather than to small businesses, which means that BDCs could invest half of their money 

24 

in financial firms and still get all of the no-taxes break that was 

offered to get them to invest directly into small businesses. 

If the goal of this bill is to promote investment in small businesses that make things and provide services to their communities, 

then why does it allow BDCs to divert even more money, up to 50 

percent of their portfolio, away from small businesses and into 

other financial firms? 

Mr. AROUGHETI. Sure. So I will use Ares Capital Corporation as 

an example because you referenced 26 percent of our balance sheet 

in financial services firms. Back to my comments earlier about 

transparency, if you were to look at our filed financial statements, 

you would actually see that those are not financial services firms, 

but it is an investment in two joint ventures that we have with a 

large insurance company, a large specialty finance company that 

make middle market loans. 

Senator WARREN. Look, let us be clear. We are talking—sorry. 

We are talking about an amendment here that says that you can 

go up to 50 percent of your investments, not in small businesses, 

and still get all the tax breaks that Congress created so that you 

would invest in small businesses. 

I am out of time here, but I have got to say I am very concerned 

about the business model that big BDCs like Ares are using, essentially imposing private equity-like fees on mom-and-pop investors 

without any of the same kind of potential upside. And I am very 

concerned about aspects of this bill which would allow firms like 

Ares to borrow a whole lot more money, divert billions of dollars 

away from small businesses to hedge funds and other financial institutions, and collect even more management fees, all while preserving special tax breaks and not doing anything to help either 

small businesses or BDC investors. 

As this bill is currently written, it is a giveaway to BDC executives, and it is masquerading as a small business bill. If Congress 

decides to act on BDCs, it should focus on the best interests of investors and on small businesses, not on BDC management. 

Thank you, Mr. Chairman. 

Chairman CRAPO. Thank you, Senator Warren. 

The vote has been called, or the beginning of the series of votes 

has been called. Senator Donnelly, you and I are the only two who 

have not gone. I will give you your shot now, and then I will try 

to wrap up real fast, and maybe we can—— 

Senator DONNELLY. Thanks. I will try to abbreviate it a little bit, 

too, then, Mr. Chairman. Thank you. 

Mr. Crane, what impact will a floating NAV rule have on the 

ability of municipal governments to obtain affordable financing? 

Mr. CRANE. Mr. Chairman and Senator Donnelly, I think it will 

have a negative impact. I think it already is having a negative impact. For example, I borrow about $500 million in tax anticipate 

notes annually as a bridge loan for the State of Idaho from November 15th to April 15th when the bulk of our revenues come in. And 

the cost that I paid last year was 29 basis points. This year, we 

just did a market study. We will go into the market in about 2 

weeks. That will be between 58 and 60 basis points, so it is doubling our cost to our taxpayers. That is happening not only in the 

25 

situation where Idaho borrows short-term notes, but also in other 

borrowing that occurs as well. 

Senator DONNELLY. The reforms that were put in place in response to the financial crisis of 2008, do you think the floating 

NAV reform improves financial stability and reduces systemic risk 

or not? 

Mr. CRANE. Mr. Chairman and Senator Donnelly, I think that 

probably this was a mistake that the SEC made. This particular 

legislation does not really repeal anything as far as Dodd-Frank is 

concerned. But I think there were unintended consequences by the 

rule that was proposed, and I think it is a reasonable fix and will 

assist. 

Senator DONNELLY. Mr. Arougheti, the bill changes leverage 

guidelines for BDCs, and increased leverage can be extraordinarily 

dangerous. Why would those changes not be risky? 

Mr. AROUGHETI. I articulated it again. I will try to say it in—— 

Senator DONNELLY. I appreciate it. I apologize that I have other 

obligations around here, too. 

Mr. AROUGHETI. No, I think you were here when I said it, so I 

apologize if I am repeating myself. But the way that the BDCs are 

structured, we actually access our leverage from banks themselves 

and from the unsecured debt markets. And if you look at the existing credit facilities that govern BDC leverage, they articulate in 

very great detail what assets are leverageable or not. And this is 

all publicly files, so if you were to look at Ares Capital Corporation’s financial statements, you would see that we could borrow 21⁄2

to 1 on a senior secured loan but 0 on an equity investment. 

So the Governors are already in place within the market to allow 

BDCs to borrow based on asset composition. So as I said earlier, 

if we were to leverage in excess of the current regulatory limit, it 

would by definition require that we were investing in senior secured loans and lower-risk assets; otherwise, you could not access 

the leverage. 

Senator DONNELLY. Thank you, Mr. Chairman. 

Chairman CRAPO. Thank you, Senator Donnelly. Actually, you 

asked a couple of my questions, so you will help me be even more 

brief. 

I have just a couple of things to wrap up, and then we might actually make it to the vote. 

I again want to thank you, Mr. Crane, for coming and bringing 

Idaho’s common sense here to Congress, and I appreciate you having done that. You just went through the numbers I wanted you 

to with Senator Donnelly, so I am going to move over to Mr. Fung. 

Again, referring to the floating NAV issue, my understanding is that there are about $100 billion of loans in commercial mortgagebacked securities that are set to mature in 2017. Is that correct? 

Mr. FUNG. Ye, that is the current estimate. 

Chairman CRAPO. What would be the expected increase in borrowing costs on those loans if we do not resolve this floating NAV 

issue? 

Mr. FUNG. It is probably in the neighborhood of 30 to 50 basis 

points, is our best guess. It could be as high as a 1-percent increase. It is still a bit of a question until the first securitization hits 

the market, subject to the current risk retention rules. Nobody 

26 

knows exactly what the increased cost will be to pass along to the 

borrowers. But what is clear today is that there are a number of 

issuers who are already leaving the market, so less capital flowing 

through to the secondary and tertiary markets I discussed in my 

testimony, as well as increased volatility causing decrease interest 

in, on the investor side, people buying the CMBS bonds, and that, 

you know, increased volatility makes it difficult to price the rate 

that we pass along to the borrower. And so you will see somewhere 

along a 30- to 50-basis-point increase, is our guess. 

Chairman CRAPO. All right. Thank you very much. I do have a 

whole bunch of questions here for the rest of the panel, but we also 

only have 5 minutes to get over to the Capitol. So at this point, I 

want to thank all of the witnesses for the time and effort that you 

have put into this to bring this information to us. You may get a 

few questions from some of the Senators. We would appreciate you 

responding to those timely. These are important issues, and I appreciate the input that you have provided to us today. 

The hearing is adjourned. 

[Whereupon, at 11:27 a.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 

27 

PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO 

Today’s hearing will provide insights into how business development companies, 

commercial real estate finance, and money market mutual funds provide access to 

capital and economic development for communities and businesses. 

There is a growing chorus that pending and existing Federal rules and statutory 

limitations are restricting access to capital and restraining economic growth. 

Because it is important for Congress to understand the factors that are impacting 

local communities and businesses, I welcome a discussion about specific proposals 

that would improve the current regulatory framework while maintaining proper 

safeguards. 

The House Financial Services Committee has already examined proposals to modernize the regulations for Business Development Companies and adjust the risk retention rules for commercial real estate loans. 

Senators Toomey and Menendez have introduced legislation to restore the stable 

share price for institutional, nongovernment money market funds. 

I look forward to hearing from our witnesses on these legislative proposals and 

learning what specific factors, including Federal regulations, are negatively impacting lending and borrowing in local communities. 

For example: How a pending regulatory effective date will impact commercial real estate financing since almost $100 billion of loans in commercial mortgage backed 

securities are set to mature in 2017—up from $52 billion this year. 

What will be the impact on State Treasurers to invest and use money market mutual funds when several types of these funds will be required to switch from a stable 

to a floating net asset value in October? 

What statutory changes can be made to allow business development companies to 

increase investments in small- and middle-market companies and enable investors 

to invest alongside with them and still provide adequate investor protections? 

Thank you. 

PREPARED STATEMENT OF RON G. CRANE 

IDAHO STATE TREASURER

MAY 19, 2016 

Chairman Crapo, Ranking Member Warner, and Members of the Subcommittee, 

I appreciate the opportunity to provide testimony on legislative proposals to improve 

access to capital and economic development for communities and businesses. 

As the statewide-elected Treasurer of Idaho since 1998, I am responsible for the 

State’s debt management, including the issuance of both short term debt, such as 

Tax Anticipation Notes, and bonds. My office oversees a number of debt management programs that support public infrastructure investment, including the Idaho 

Bond Bank Authority, the Idaho School Bond Guaranty Program, and Tax Anticipation Notes. Also established in statute are the Idaho Health Facilities Authority, 

which provides financing to nonprofit health care providers; the Idaho Housing and 

Finance Association, which issues revenue bonds to finance affordable housing; and 

the Idaho State Building Authority, which functions as the capital financing arm 

of the State. 

Also, on the cash management side, I am responsible for investing all general account and pooled agency cash, as well as managing Idaho’s $3.2 billion local government investment pool (LGIP). 

I direct receipt of all State monies, and the accounting and disbursement of public 

funds. 

In particular, I want to focus my comments today on S. 1802, the Consumer Financial Choice and Capital Markets Protection Act. 

This bipartisan legislation is important to protecting the financing and investment options of Governments, businesses and communities in Idaho and throughout 

the country. I want to express my gratitude to Senators Toomey and Menendez, as 

well as to you, Mr. Chairman, for your sponsorship of that legislation. 

Background 

The Securities and Exchange Commission (SEC) has taken important actions 

since the financial crisis of 2008 to strengthen the resiliency of money market funds, 

reduce systemic risk, and protect investors. In 2010, the SEC imposed new liquidity 

and transparency requirements on money market mutual funds that have proven 

successful through several market stresses, including the European debt crisis of 

2011, the U.S. debt ceiling impasse and concerns about the downgrading of U.S. 

debt that same year, and the debt-ceiling standoff in 2013. 

28 

1 In its Release adopting the 2014 amendments to Rule 2a-7, the SEC asserted that ‘‘institutional’’ investors likely held less than 15 percent of tax-exempt money market fund assets. 

Money Market fund Reform, Amendments to Form PF, www.sec.gov/rules/final/2014/33- 

9616.pdf at p.244; 79 FR 47736 (Aug. 14, 2014). However, the SEC was relying on data differentiating ‘‘institutional’’ and ‘‘retail’’ funds by criteria such as minimum account size; not the distinction in its rule of ‘‘natural’’ vs. ‘‘non-natural’’ persons. In addition, the SEC asserted that 

such data overstated ‘‘institutional’’ assets because omnibus accounts likely consisted of retail 

investors. Thus, the SEC assumed, without comparable data or performing its own study, that 

its action would not significantly impact the assets of tax-exempt money market funds. The 

present impact is an unintended consequence. 2https://www.sec.gov/divisions/investment/mmf-statistics/mmf-statistics-2016-3.pdf 

3Many supporters of S. 1802, in addition to myself, have acknowledged their support or made 

their letters available to the Coalition for Investor Choice. See www.protectinvestorchoice.com. For example: Letter of Massachusetts Treasurer Deborah B. Goldberg to Senator Warren (FebThen in July 2014, the SEC adopted additional obligations on money market 

funds, including enhanced disclosures, stress testing, and increased, portfolio diversification requirements, among other things. Like the 2010 reforms, these are welcome changes that have strengthened the ability of money market funds to safely 

meet the cash management and short-term investment needs of businesses, State 

and local governments, and other institutions. 

However, as part of the July 2014 amendments to Rule 2a-7, the SEC also adopted a requirement, effective on October 14 of this year, which in effect eliminates the 

utility of any money market fund to investors who are not ‘‘natural persons’’ (in the 

terminology of the Rule) unless the fund invests exclusively in U.S. Government securities. 

Under this new requirement, any tax-exempt or prime money market fund accepting any investor other than a ‘‘natural person’’ will no longer be able to offer and 

redeem shares based on amortized cost valuation of its portfolio to produce a stable, 

$1 net asset value (NAV). Instead, such funds will have to apply a fluctuating or 

‘‘floating’’ NAV using market-based estimated values. Simply, again, the floating 

NAV goes beyond regulation of the money market fund to just kill it as a cash management tool. I do not believe cash investors, such as myself, want, or will use, a 

floating NAV fund for cash investments. 

Thus, by October 14, all investors other than ‘‘natural persons’’ are forced to leave 

any stable value, dollar per share, prime or tax-exempt money market fund. Since 

these investors are managing cash, they will be looking to move to a different, stable-value cash management vehicle. As a practical matter, this means most will either put their cash in a money market fund investing exclusively in U.S. Government securities or deposit their cash in the bank. 

In either case, that money will no longer be available in the portfolio of a prime 

or true-exempt fund to loan to businesses or invest in tax-exempt notes and bonds 

of Idaho, other State and local governments, and other nongovemment issuers such 

as hospitals and universities. 

Treasury Strategies Survey 

Attached as an Appendix to this Statement is a survey and analysis of the extent 

to which the assets of tax-exempt money market funds are from ‘‘non-natural persons’’ performed by Treasury Strategies, an economic consulting firm, for The Coalition for Investor Choice. 

Treasury Strategies’ work to document the impact of the SEC’s new requirement 

forcing out ‘‘non-natural’’ person investors provides accurate data to underlie your 

support of S. 1802. To my knowledge, no one else has undertaken to discern this 

impact, including the SEC. 1

How S. 1802 Supports Economic Development 

Treasury Strategies has concluded that this one SEC requirement, by itself, will 

reduce the assets in tax-exempt money market funds by at least 40 percent. 

Further, as Treasury Strategies’ Report shows, in anticipation of this loss of assets, many funds lose viability and are simply liquidating, in total, now. Those who 

are not liquidating, but remain uncertain as to the extent of the loss of assets they 

will experience by October, are actively shortening their portfolio maturities. At the end of 2015, tax-exempt money market funds held about $263 billion in 

assets. 2 That is about 6.5 percent of the total tax-exempt debt market. But it’s 

about two-thirds of the short-term municipal debt market, and that has varied between two-thirds and 80 percent over the past 5 years. 

This is all money that is invested in funding State and local government. The 

Treasury Strategies’ Report shows you how those investments span the country, 

both in absolute and per capita terms. While States such as New York, Massachusetts, Illinois, Pennsylvania, New Jersey, Indiana, and Ohio 3 stand out as among 

29 

ruary 26, 2016); Letter of Carole Brown, Chief Financial Officer, City of Chicago to Senator Kirk 

(April 13, 2016); Letter of David J. Gray, Treasurer, Penn State University to Senator Toomey 

(December 14, 2015); Letter of Ann M. Cannon, President, New Jersey Association of Counties, 

to Senators Menendez and Booker; Letter of David Bottoroff of Association of Indiana Counties 

and Nancy Marsh, Indiana County Treasurers’ Association, to Senator Donnelly (June 5, 2015); 

and Letter of Matthew A. Szollossi, Executive Director, Affiliated Construction Trades of Ohio, 

to Senator Brown (October 24, 2015). 4https://www.sec.gov/divisions/investmentlmmf-statistics/mmf-statistics-2016-3.pdf 

the largest ten issuers in absolute dollar terms, the impact on Idaho is very significant on a per capita basis, along with every other State, including Virginia, Rhode 

Island, Montana, Tennessee, Louisiana, South Carolina, Nebraska, and Kansas. 

We in Idaho, including both State and local government directly, as well as other 

Idaho issuers, benefit from over $600 million of money market fund investments. 

If tax-exempt money market funds lose, at a minimum, half of their assets because 

‘‘non-natural persons’’ are no longer permitted to invest in them, that implies that 

Idaho could lose at least $300 million of its present financing from this source at 

the present rates. 

What, then, will my choices be for an alternative funding source? There will be 

two options. First, I will likely have to pay higher interest rates in order to place 

my debt. This is the most basic principle of supply and demand in the auction process of the market. When the assets available for investment go down, but the demand does not, the cost will go up. 

This impact is occurring right now. For example, each year I take approximately 

$500 million in Tax Anticipation Notes to market—and these notes have always 

been purchased by an array of different tax-exempt money market funds. There are 

substantially fewer bidders this year, and I’ve already been told my cost is going 

up. 

All issuers of municipal debt and nongovernment conduit borrowers are already 

beginning to feel the impact of the shrinkage in tax-exempt money market fund assets as a result of the floating NAV requirement. According to statistics released on 

April 20 by the SEC, gross yields on tax-exempt money market funds increased from 

eight basis points in February to 35 basis points in March. 4 This is not good news 

for State and local governments, school districts, port authorities, hospitals, universities, and others that have to pay more for working capital or to finance infrastructure and economic development projects that support local businesses, including 

contractors and engineering firms. 

My second option is to borrow the money in a different form, or from a different 

source, than a money market fund. For example, I can go seek a loan from a bank. 

Short-term borrowing in the capital markets has always been the lowest cost form 

of funding. This is the fundamental notion of the yield curve: short-term borrowing 

costs less than long-term borrowing. I would add that tax-exempt borrowing is normally less expensive than taxable loans. Thus, borrowing in the capital markets, 

such as from money market funds, costs less than borrowing from a bank. 

For a State or local government with a good credit rating, its financing authorities 

could expect to pay approximately 110 basis points more to borrow from a bank 

than to issue debt held by a money market fund. This would be at prevailing rates 

of LIBOR plus 40 to 50 basis points. For example, an entity that regularly borrows 

$10 million short-term through the issuance of Tax Anticipation Notes (TANs) 

would see its borrowing costs rise more than $100,000 per year if the debt could 

not be placed with money market funds and bank credit was needed as an alternative. Other, less credit worthy borrowers who need credit enhancement could see 

their cost of debt increase 200 to 300 basis points. 

These disruptions to financing by money market funds are occurring on top of 

other regulatory actions that are impacting liquidity and cost for municipal borrowing; including the Basel III bank capital rules and the SEC’s proposed liquidity 

standards for bond mutual funds. 

I would note that total tax-exempt assets held by money market funds were over 

$500 billion as recently as 2009 and, through October of last year, most of that decline was the result of the Fed’s zero interest rate policy. 

As an aside, to return to my point that cash investors do not want a floating NAV 

money market fund: 

At a time when money market funds are offering annual yields of only a handful 

of basis points to invest on a dollar in–dollar out basis, the stable value is a big 

reason why money market funds continue to hold, and attract, nearly $2.6 trillion 

in assets. Again, as the Treasury Strategies’ Report shows, regulators cannot force 

investors to invest in floating NAV funds and the Fund Sponsors themselves are not 

anticipating that investors will stay. Fund Sponsors are simply liquidating their 

30 

5See ‘‘The $400 Billion Money-Fund Exodus With Banks in Its Crosshairs’’, Bloomberg Business, Feb. 23, 2016. 6http://www.gasb.org/cs/ContentServer?c==PronouncementlC&pagename=GASBo/ 

o2FPronouncementlC%2FGASB SummaryPage&cid=1176167863852 

tax-exempt funds, and converting the prime funds, and expecting those assets to 

move to Government funds or elsewhere. 

Now, back to the $500 billion peak. It would be fair to assume that, absent the 

floating NAV requirement, once short-term rates begin to rise again, investors 

would flood back into tax exempt money market funds and assets could exceed $500 

billion again. That’s a lot of potential liquidity for building and maintaining hospitals, schools, roads, public transportation systems, airports, and other infrastructure projects. This implies that ample, low-cost funding would remain available to 

Idaho issuers, and your States’ issuers, from tax-exempt money market funds. 

There’s an indirect negative consequence of the floating NAV that will also be 

averted by enactment of S. 1802. As funding options become more limited, the credit 

ratings of States and municipalities will come under pressure and potentially lead 

to additional costs. Rating agencies use access to capital as an important variable. 

When tax-exempt money market funds close and municipalities have fewer buyers 

for their debt, it becomes a risk factor that could lead to ratings downgrades .and 

even higher borrowing costs. 

Although I am responsible for the investment and financing activities of the Idaho 

State Government, I think it is also important to mention the fact that money market funds do more than just support public infrastructure investment in our State. 

Prime money market funds currently invest in billions of dollars of short-term commercial paper issued by Idaho businesses to finance their payrolls and inventories, 

as well as the purchase of new equipment. JPMorgan Chase estimates that, as a 

result of the SEC’s 2014 actions, at least $400 billion in prime money market fund 

assets will be converted to funds the invest solely in U.S. Government securities. 5

The net result will be to reduce the Federal Government’s borrowing costs at the 

expense of main street businesses that are the backbone of our local economies. 

Local Government Investment Pools 

As Idaho State Treasurer, I am both a manager of, and investor in, money market 

funds, as well as being a borrower from them. 

First, here is how the SEC floating NAV requirement impacted me as the manager, in Idaho, of an investment pool that is equivalent to a prime money market 

fund. 

I am responsible for the management of our LGIP, which we offer to Idaho municipalities and other local government subdivisions for their cash management. It 

has a daily balance in excess of $3.2 billion. LGIPs use amortized cost valuation to 

operate similarly to money market funds and offer their participants a stable, $1 

unit price. 

Although LGIPs are exempt from registration under the Investment Company 

Act, and therefore not directly subject to Rule 2a-7, they are still subject to Government Accounting Standards Board (GASB) accounting principles. GASB sets accounting and financial reporting standards for external investment pools and pool 

participants. Until recently, GASB principles required LGIPs to follow 2a-7 like procedures. Thus, when the SEC said that ‘‘non-natural persons’’, such as Idaho local 

governments, can no longer benefit from amortized cost, our Idaho LGIP was faced 

with the prospect of not being able to comply with the GASB accounting principle. 

This past December, GASB acted to restore amortized cost to LGIPs by issuing 

accounting statement No. 79. 6 It requires LGIPs to meet many of the requirements 

of Rule 2a-7, such as portfolio duration and maturity, quality of portfolio assets, diversification of investments, and portfolio liquidity, but ‘‘de-links’’ from Rule 2a-7 to 

permit LGIPs to continue to use amortized cost valuation and penny rounding, and 

thereby transact with participants at a stable NAV per unit or share. 

Your enactment of S. 1802 restores the stable, $1 per share of the money market 

fund by enabling any money market fund to elect to continue to use the amortized 

cost method of valuing its portfolio. 

How S. 1802 Supports Liquidity Management 

Although, thanks to GASB, our LGIP is not subject to the pending floating NAV 

requirement of the SEC’s Rule 2a-7, we are still impacted by that requirement. Like 

in other States, apart from LGIPs, we also invest public cash in financial instruments that meet the investment policies of our State code, as well our investment 

objective priorities of safety, liquidity and yield. Eligible instruments include TreasVerDate Nov 24 2008 11:12 Dec 20, 2016 Jkt 046629 PO 00000 Frm 00034 Fmt 6621 Sfmt 6621 L:\HEARINGS 2016\05-19 IMPROVING COMMUNITIES AND BUSINESSES ACCESS TO C
31 

uries, U.S. Government agency securities, and stable value Government and prime 

money market funds. 

Safety of principal is the foremost objective of our investment program. That is 

why, in addition to Idaho’s LGIP, State agencies and local municipalities also use 

money market funds where appropriate for specialized cash management applications. For example, at any point in time, Idaho agencies and public entities will 

have between $300 and $500 million invested in prime money market funds. 

If stable value prime money market funds are no longer a permitted investment 

option, Treasurers will have limited choices for using pooled investment vehicles to 

invest in financial instruments that meet the needs of their investment programs. 

Further, with over $400 billion in prime money market fund assets converting to 

Government funds, rates on U.S. Treasuries are being driven even lower. 

Even in the absence of the SEC’s floating NAV requirement, liquidity management is an enormous challenge for State and local government entities. This makes 

enactment of S. 1802 doubly important. It will allow our liquidity management programs to continue to hold money markets funds in their portfolios that invest in assets other than U.S. Government securities. In addition to capital preservation, it 

will allow us to earn market rates of return throughout budgetary and economic cycles, which benefits our citizens. 

Conclusion 

S. 1802 will do much to preserve Idaho’s access to capital and economic development for our communities and businesses. It will preserve stable value money market funds as a safe, liquid, market-rate investment for our State’s cash management 

needs, and as a source of capital for public infrastructure investment and businesses 

growth. At the same time, this legislation protects the positive changes adopted by 

the SEC in 2010 and 2014 that have mitigated risk in, and strengthened the resilience of, money market funds without disturbing the authority of the SEC to regulate money market funds in its discretion. In S. 1802, Congress properly exercises 

its discretion to draw the policy line between regulating money market funds and 

killing them by imposing a floating NAV requirement. 

I appreciate your leadership on this issue, Mr. Chairman, and encourage the full 

Senate to support S. 1802 and protect the liquidity and investment options of State 

and local governments and all other investors. 

32 

33 

34 

35 

36 

37 

38 

39 

40 

41 

42 

43 

PREPARED STATEMENT OF MICHAEL J. AROUGHETI 

COCHAIRMAN OF THE BOARD OF DIRECTORS, ARES CAPITAL CORPORATION, ON BEHALF

OF THE SMALL BUSINESS INVESTOR ALLIANCE

MAY 19, 2016 

44 

45 

46 

47 

48 

49 

50 

51 

52 

53 

54 

55 

56 

57 

58 

59 

60 

61 

62 

63 

64 

65 

1 Better Markets, ‘‘The Cost of the Crisis: $20 Trillion and Counting’’, (July 2015), available 

at http://www.bettermarkets.com/sites/default/files/Better%20Markets%20-%20Cost%20of 

%20the%20Crisis.pdf. 

PREPARED STATEMENT OF STEPHEN W. HALL 

LEGAL DIRECTOR AND SECURITIES SPECIALIST, BETTER MARKETS, INC. 

MAY 19, 2016 

Introduction 

Chairman Crapo, Ranking Member Warner, and Members of the Subcommittee, 

thank you for the opportunity to testify today on behalf of Better Markets. Better 

Markets is a nonprofit, nonpartisan organization that promotes the public interest 

in the domestic and global capital and commodity markets. Its goal is to help establish a stronger, safer financial system that is less prone to crisis and the need for 

taxpayer bailouts. Better Markets seeks to achieve these goals through regulatory 

comment, public advocacy, independent research, and litigation. Through these 

channels, we serve as a counterweight to the financial industry to help ensure that 

policy makers and regulators prioritize the interests of hardworking Americans over 

special interests. 

Better Markets supports the goal of promoting and protecting capital formation 

for the benefit of the real economy but has serious concerns about all three of the 

bills that are the subject of this hearing. They would remove or weaken regulations 

aimed at protecting investors and maintaining financial market stability in the 

areas of money markets funds, real estate securitizations, and business development 

companies. 

In my testimony, I’ll describe the perspective that Better Markets brings to these 

issues; offer a general assessment of the deregulatory approach reflected in these 

measures; and highlight specific provisions in each of these bills that we believe 

would be harmful. 

The Better Markets Perspective 

Better Markets firmly believes that vibrant, fair, and stable capital markets are 

crucial to generating economic growth and prosperity for all Americans. We also believe that achieving these goals requires a strong regulatory framework. That framework must be capable of protecting investors to sustain their confidence in our markets and preserve their willingness to participate in capital formation. And above 

all, our regulations must limit systemic risk in our markets to avoid a recurrence 

of the type of devastating financial crisis that nearly destroyed our economy in 2008. 

That crisis was the worst financial disaster since the Great Crash of 1929, and 

it produced the worst economy our Nation has seen since the Great Depression of 

the 1930s. It nearly destroyed our financial system, obliterating millions of jobs, 

triggering a tidal wave of home foreclosures, and wiping out the savings of countless 

American households. Small businesses were particularly hard hit. In 2008, for the 

first time in history, more businesses failed than were started. The costs have been 

staggering: tens of trillions of dollars in lost GDP and inestimable human suffering. 1

And the crisis is still being felt today. Underemployment remains at almost 10 

percent, 6.7 million homes are still underwater; median wages remain stagnant; and 

middle class Americans still struggle with $3.5 trillion in nonmortgage consumer 

debt. 

The lesson is clear: Without effective rules, our financial system is susceptible to 

financial crisis, and financial crisis poses the single greatest threat to capital formation and economic growth, especially among small businesses. Strong regulation is 

thus essential for protecting and promoting capital markets that support the real 

economy and ensure long term economic prosperity. 

General Concerns 

The deregulatory approach in these bills raises a number of concerns. First, we 

question whether these measures will really help businesses and municipalities access the capital they need to expand and contribute to economic growth. Throughout 

its history, members of the financial services industry have opposed regulation 

based on confident predictions that regulatory safeguards applied to their activities 

will limit access to capital and stifle economic growth. In fact, however, these claims 

tend to be speculative, anecdotal, and ultimately unfounded. In this case, we haven’t 

seen credible evidence that these bills will materially benefit our financial system 

or the larger economy. 

66 

2Proposed Recommendations Regarding Money Market Fund Reform, 77 FR 69,455 (Nov. 19, 

2012), at 69,481 (FSOC Release). 3 Id. at 69,482 (emphasis added). 

4See SEC Division of Risk, Strategy, and Financial Innovation, ‘‘Response to Questions Posed 

by Commissioners Aguilar, Paredes, and Gallagher’’, at 12 (Nov. 30, 2012), available at http:// 

www.sec.gov/news/studies/2012/money-market-funds-memo-2012.pdf. 

Second, if enacted, these bills will come with a heavy price. They will expose investors to an increased risk of loss. Inflicting harm on investors doesn’t fuel the real 

economy, and it ultimately undermines the investor confidence that is so essential 

to a well-functioning capital market. 

Of greatest concern, these bills would also lead us in the dangerous direction of 

increased systemic risk and a greater likelihood of financial crisis. For example, we 

know for a fact that money market funds and the securitization of real estate loans 

contributed heavily to the 2008 financial crisis. The floating net asset value (NAV) 

and the risk retention, or ‘‘skin in the game,’’ requirements that will soon take effect 

are key regulatory reforms designed to reduce the risk that our financial system— 

and these markets in particular—will once again be thrown into chaos. The bills at 

the center of this hearing would repeal or weaken those reforms before they have 

been given a chance to work. As result, these bills would increase the prospects for 

another devastating financial crisis that would destroy our economic growth. 

Perhaps the Financial Stability Oversight Counsel (FSOC) said it best when it 

issued its proposed recommendations on money market reform. At the top of their 

list was the floating NAV. The FSOC observed that by reducing the risk of runs 

on money market funds, their recommendations would decrease both the likelihood 

and severity of future financial crises. 2 It explained that because financial crises 

have such a profoundly damaging impact on economic activity and economic growth, 

‘‘reforms that even modestly reduce the probability or severity of a financial crisis 

would have considerable benefits in terms of greater expected economic activity and, 

therefore, higher expected economic growth.’’ 3

The bills we’re discussing today are at odds with this approach. They would weaken regulatory safeguards, thereby increasing the probability of another financial crisis, while putting investors needlessly at risk. We believe they would be counterproductive. 

S. 1802—Deregulation of Money Market Funds 

S. 1802 would allow all money market funds (MMFs) to maintain a fixed net asset 

value. This provision would effectively repeal the SEC’s 2014 rule requiring institutional prime and institutional municipal money market funds to adopt a floating 

NAV. But to ensure that money market funds remain stable, we actually need to 

apply more regulation in this area, not less. The bill is a step in the wrong direction. 

MMFs Are Vulnerable to Destabilizing Runs 

MMFs are susceptible to runs and when they do occur, the financial system can 

experience major disruptions that cripple the short-term credit markets. MMFs do 

not come with any form of reliable capital buffer or Government insurance that can 

mitigate the effect of a run. In addition, the MMF market is large, amounting to 

$2.7 trillion, and relatively concentrated. MMFs are highly interconnected with 

other financial institutions, and they are widely used by individuals, institutions, 

and businesses as cash management vehicles or as sources of credit. By virtue of 

these characteristics, MMFs present an ongoing risk of runs that can spread widely 

and rapidly throughout the financial system. 

The financial crisis of 2008 made this threat painfully clear. In the most compelling example of run risk, the Reserve Primary Fund broke the buck on September 

16, 2008, due to losses on debt instruments issued by Lehman Brothers Holdings, 

Inc. Although that debt was only 1.2 percent of the fund’s total assets, a run ensued 

when the fund sponsors declined to provide support. Within 2 days, investors sought 

to redeem $40 billion from the fund. This required the fund to dump tens of billions 

of dollars in assets immediately so that it could pay for the flood of shareholder redemptions. This fire sale in turn depressed asset values, further weakening the 

fund. 

The run quickly spread to the entire prime MMF industry, and during the week of September 15, 2008, investors withdrew approximately $310 billion (or 15 percent) of prime MMF assets. This industry-wide run caused immediate havoc in the 

short-term funding markets, triggering a vicious cycle of asset fire sales, falling 

asset prices, and mounting redemption requests. The run abated only after the 

Treasury, on September 19, 2008, established the Temporary Guarantee Program 

to guarantee money market funds, and the Federal Reserve established a variety 

of facilities to support the credit markets frozen by the MMF crisis. 4 The entire $3.7 

67 

5Moody’s Investors Service, Special Comment, ‘‘Sponsor Support Key to Money Market 

Funds’’ (Aug. 9, 2010), available at http://www.alston.com/files/docs/Moody’slReport.pdf; see 

also Release at 69,462 n. 28. 6See Steffanie A. Brady, et al., Federal Reserve Bank of Boston, Risk and Policy Analysis 

Unit, ‘‘The Stability of Prime Money Market Mutual Funds: Sponsor Support From 2007 to 

2011’’, Working Paper RPA 12-3, at 4 (Aug. 13, 2012), available at http://www.bos.frb.org/ 

bankinfo/qau/wp/2012/qau1203.pdf; see also SEC Press Release, supra note 10, at 4 (citing 

over 300 instances since the 1980s of sponsor support necessitated by the diminished value of 

holdings or extraordinary redemptions). 7Money Market Fund Reform; Amendments to Form PF; Proposed Rule, 78 FR 36,834 (June 

19, 2013), at 36,850. 8 Id. 

9 Id. at 36,851. 

trillion money market fund industry was backstopped, putting taxpayers on the 

hook for any losses. 

The collapse of the Reserve Primary Fund was not the first time—or the last— 

when MMFs faced significant stresses and potential collapse. During the crisis, 

other money market funds experienced significant stress levels requiring their sponsors to provide support. Going further back in time, one study found 144 cases from 

1989 to 2003 in which MMFs would have broken the buck had it not been for sponsor support. 5 Another survey revealed 78 instances between 2007 and 2011 in which 

sponsors provided support to their MMFs in the form of either cash contributions 

or purchases of securities from the fund at inflated prices. 6 Relying on sponsors to 

maintain a stable NAV is an unreliable approach, as we learned from the financial 

crisis. 

As the SEC and the FSOC have concluded, requiring MMFs to maintain a floating 

NAV is one the most important reforms we can adopt to reduce this run risk. Under 

this approach, instead of being fixed artificially at $1.00, the price of shares fluctuate and reflect the actual market value of the assets in the fund portfolio. 

The Floating NAV Mitigates Run Risk 

Floating the NAV offers several benefits. First and foremost, it reduces the incentive of any investor to expedite withdrawals from a stressed MMF in hopes of redeeming at the $1.00 price as opposed to something lower. 7 Investors who withdraw 

first no longer benefit from a ‘‘first mover advantage,’’ since they receive the actual 

market-based value of their shares. Eliminating this first mover advantage substantially reduces run risk. 

Second, the floating NAV also promotes greater fairness among investors. 8 As a 

result of the artificially stable NAV, an investor that succeeds in redeeming early 

in a downward spiral may receive more than they are due by liquidating at $1.00 

per share even though the underlying assets are actually worth less. Without a 

sponsor contribution or other rescue, that differential in share value is paid by the 

shareholders remaining in the fund. Early redeemers receive a windfall and later 

redeemers pay the cost. The floating NAV eliminates this disparity and unfairness. 

Finally, floating the NAV also enhances transparency. A fluctuating NAV helps 

correct the basic misconception among many investors that their MMF investment 

cannot lose value. Instead, investors see plainly that they bear the risk of loss as 

to MMFs, just as they do with other investment vehicles. Acclimating MMF investors to share price fluctuations would further mitigate their tendency to run in 

panic at the prospect that their MMF will ‘‘break the buck.’’ 9

Prospectus Disclosure Is Insufficient 

S. 1802 includes a provision apparently aimed at preserving the transparency 

benefits of the floating NAV. The bill would prohibit bailouts of money market funds 

and require prominent disclosure of that fact in all fund prospectuses and sales literature. It thus seeks to correct the widespread misimpression that MMFs cannot 

sustain losses or that they carry bank-like deposit insurance. However, we do not 

believe that disclosure alone would alter investors’ inflated confidence in the stability of MMFs. Demonstrating the truly variable nature of MMFs on a day to day 

basis through transparent price fluctuations would be far more persuasive than simply stating the fact in fine print disclosure forms. More importantly, this provision 

in the bill would do nothing to mitigate the powerful incentive to redeem shares 

that arises directly from the fixed NAV. Nor would it eliminate the unfair advantage that some investors can gain by redeeming shares early in times of stress 

under a fixed NAV. 

The concerns expressed by opponents of the floating NAV are understandable but 

not persuasive. The operational changes required by the SEC rule appear to be 

manageable, in part because the SEC established a 2-year compliance period. Most 

of the large fund complexes have made the necessary adjustments to implement the 

68 

10FSOC Release, at 69,480 n. 119. 11 As Better Markets detailed in this comment letter: Letter from Better Markets to the SEC, 

Money Market Reform (Release No. 33-9408) (Sept. 17, 2013). In our letter, we also explain why 

the SEC’s MMF reforms, while critically important, were still only half-measures. In addition 

to floating the NAV for all MMFs, the SEC must apply other safeguards, including capital buffers, especially where the fixed NAV is allowed to persist. 12 Id. at 2. 

rule. And Treasury and the IRS have addressed the tax and accounting concerns 

previously raised. 

Loss of Institutional Investment Will Not Be Significant 

Perhaps the single greatest lingering concern is that institutional investors will 

migrate away from floating NAV Funds, especially the municipal MMFs, raising the 

cost of credit for local governments. Under the SEC rule, however, the impact is not 

expected to be significant. As it is, institutional investors account for a small percentage of municipal debt in the money market space, and at least some institutional investors will continue to seek the tax benefits that municipal funds provide. 

In addition, municipal MMFs that serve retail investors will not be subject to the 

floating NAV requirement, so the feared reduction in investment will not occur in 

that sector. 

In any case, even if the cost of credit rises to some degree for businesses or municipalities, the gains in terms of systemic stability will be worth it. Policy makers 

responsible for mitigating systemic risks must at times face the need to ‘‘accept 

higher costs in normal times in order to significantly reduce the costs of financial 

crises.’’ 10

In short, repealing the SEC’s rule requiring institutional prime and municipal 

MMFs to float their NAV is a step backward. In reality, we should be floating the 

NAV for all money market funds, not just institutional funds. 11 In addition, regulators should be weighing the need for additional safeguards, including capital buffers. 12 Rolling back the progress that the SEC has made in protecting MMFs from 

the potentially disastrous runs is unwise. 

H.R. 4620—Risk Retention Exemption for Commercial Real Estate Loans 

H.R. 4620 would weaken the risk retention safeguards applicable to 

securitizations of commercial real estate loans. If properly regulated, the 

securitization markets can be an important source of affordable credit. However, 

when the securitization process is marked by recklessness or fraud in the origination and pooling of the underlying financial assets, coupled with a lack of transparency and disclosure, then securitized loans can inflict enormous harm on the entire financial system. 

Regulatory Gaps in Securitization Contributed to the Crisis 

It was precisely this type of broken securitization market that contributed so 

heavily to the financial crisis. In the years leading up to the crisis, the ‘‘originate 

to distribute’’ model became pervasive in the residential mortgage market. Loans 

were originated for the express purpose of being sold into securitization pools, allowing lenders to reap enormous fees without bearing the credit risk of borrower default. This widespread practice ultimately led to the accumulation of massive 

amounts of high-risk mortgage-backed securities in the hands of financial institutions and investors of all types. The situation epitomized the very concept of systemic risk, and when the housing bubble burst, it took a huge toll on markets, investors, and the economy. 

A similar pattern unfolded in the commercial real estate market, where underwriting standards sank to meet demand for loans that could be securitized. In fact, 

many banks that failed or were bailed out and rescued during the financial crisis 

did so in part because they held badly underwritten commercial real estate loans. 

The crisis devastated not only the residential mortgage backed securities market, 

but also the commercial mortgage backed securities market. 

Risk retention requirements are among the most important reforms in this area. 

They are designed to align the interests of securitizers more closely with investors, 

thereby increasing the quality of assets in securitization pools and reducing the risk 

of loss. These requirements help protect investors and restore confidence in mortgage-backed securities. This in turn helps allocate capital to real estate development 

in a way that will support economic growth without threatening a financial crash. 

Diluting the risk retention requirements is the wrong approach. 

69 

The Bill Would Create a Blanket Exemption for Single or Related Loans 

H.R. 4620 would make two particularly worrisome changes in the risk retention 

rule. First, it would create a blanket exemption for the securitization of a single 

commercial real estate loan or groups of related loans. The exemption is unwarranted for several reasons. Even single loans and groups of related loans can represent large and complex transactions that present underwriting challenges. Moreover, securitizations of these types of loans can actually present heightened risks 

of default since the loan pools lack diversity and therefore concentrate risk. In addition, the securitization of a group of cross-collateralized loans poses greater risk, 

since the default of one loan triggers default of the entire pool. Therefore, the risk 

retention requirements still have an important role to play in incentivizing careful 

underwriting for a single loan or a group of related loans as these investments are 

assembled for sale to investors. 

This exemption is also troubling because it is essentially unlimited. The bill would 

impose no boundary on the number, size, quality, or complexity of the loans that 

would fall within the exemption. Under the bill, groups could include any number 

of loans, provided that they have relatively tenuous connections through ‘‘related 

borrowers’’ and direct or indirect ownership of the underlying properties. Finally, 

the bill would leave no room for the agencies to impose any safeguards or objective 

risk-limiting requirements on such securitizations as a condition for the exemption. 

This restriction prevents the agencies from applying their expertise to the task of 

identifying commercial real estate loans that can be safely exempted from the risk 

retention requirement. 

The Bill Would Weaken the Exemption for Qualified CREs 

The bill would also dilute the protections in the risk retention rule applicable to 

qualified commercial real estate loans. These loans are exempt from the risk retention requirement provided they have certain attributes that make them relatively 

low risk. The risk retention rule currently specifies the features of qualified commercial real estate loans that make them eligible for the exemption. However, the 

bill would eliminate some of those features and actually prohibit the agencies from 

taking them into account when defining the universe of qualified loans. 

For example, the bill would permit interest-only loans to qualify, even though 

such loans can adversely affect repayment ability at maturity due to the absence 

of any principal reductions. In addition, the bill would prohibit minimum loan term 

requirements (now set at 10 years), and it would extend the maximum allowable 

amortization schedule to 30 years (now set at 25 years). It would also bar the application of separate loan-to-value caps to account for the risk associated with appraisals that use lower capitalization rates than other loans. Yet each of these loan characteristics is associated with weaker underwriting and heightened risk. 

In short, this bill would create a new exemption from the risk retention requirements for all single commercial real estate loans and groups of related loans. It 

would also water down the qualified loan exemption, broadening it to encompass 

loans of lower quality. These changes are likely to harm investors and increase the 

chances for the accumulation of systemic risk in the securitization market for commercial real estate loans. 

H.R. 3868—Deregulation of Business Development Companies 

H.R. 3868 would weaken multiple regulatory safeguards that govern the operation 

of BDCs. We have concerns, shared by the SEC, that the bill would expose investors 

to significantly greater risk, while diverting capital away from the companies they 

are intended to serve. 

Congress established Business Development Companies in 1980 as a special type 

of closed-end investment company. Their principal mandate is to invest in small, 

growing, or financially troubled businesses, many of which cannot obtain credit 

through more mainstream banking channels. To help ensure that BDCs fulfill their 

underlying purpose, the Investment Company Act (ICA) requires BDCs to provide 

managerial assistance to its portfolio companies. 

BDCs already present heightened levels of risk, due to the nature of their portfolio companies and the regulatory exemptions they enjoy under the ICA. For instance, BDCs are permitted to use more leverage than a traditional closed end fund, 

including a 1-to-1 debt-to equity ratio, as opposed to the more conservative 1-to-2 

ratio applicable to other funds. And they can issue multiple classes of debt securities. However, even as it relaxed the regulatory requirements applicable to BDCs, 

70 

13See H.R. Rep. No. 1341, 96th Cong., 2d Sess. 20-23 (1980). 14SEC Chair Mary Jo White, Letter to Representatives Hensarling and Waters, Nov. 2, 2015. 15Fitch: ‘‘BDC’s Are Getting Overleveraged’’, Barron’s (Apr. 25, 2016). 16S. Rept. No. 96-958, 96th Cong., 2d Sess. 23. 

Congress recognized that it was important ‘‘to avoid compromising needed protections for investors in the name of reducing regulatory burdens.’’ 13

The proposed bill changes the nature of BDCs by allowing them to increase their 

leverage; invest more money in financial companies rather than operating companies; and even purchase a registered investment adviser. 

The Bill Would Double Permitted Leverage 

The bill would allow BDCs to borrow more and double their already preferential 

leverage level. Because leverage magnifies potential losses as well as gains, this 

change would expose investors to a substantially increased risk of loss. Such losses 

would fall largely on retail investors, as they hold most BDC securities. 

The current trends in BDCs cast further doubt on the wisdom of this approach. 

The BDC universe has expanded rapidly over the last 15 years, both in terms of 

the number of BDCs in operation and their total assets. From 2003 to 2015, for example, BDC net assets rose ten-fold, from $5 billion to over $52 billion. 14 On the 

other hand, reports have recently emerged that BDCs are becoming overleveraged 

even under existing regulations. 15 Adding a new layer of leverage risk under these 

circumstances would seem to be especially unwise. 

BDCs Would Be Able To Divert Capital From Operating Companies to Financial 

Companies 

H.R. 3868 would also allow BDCs to invest greater amounts in financial companies, thus diverting capital from the types of operating businesses they were intended to assist. Today, BDCs are required to invest 70 percent of their funds in 

small- or medium-size operating companies, referred to as ‘‘qualifying assets’’ or ‘‘eligible portfolio companies,’’ which have often been rejected by ordinary funding institutions. Congress did allow BDCs to diversify their holdings by investing 30 percent 

of their funds in other securities, including financial firms. The 70 percent–30 percent asset holding structure of BDCs was selected after careful consideration and 

it was ‘‘chosen by the [Senate Banking Committee] as a matter of compromise between the [SEC] and the business development industry.’’ 16 The 70 percent requirement was clearly intended to direct BDC investments toward the small businesses 

that actually produce goods and services. 

This bill would expand the definition of ‘‘qualifying assets’’ to include other types 

of securities, including those issued by banks, brokers, insurance companies, and 

consumer finance companies, subject to a limit of 20 percent of total assets. With 

this new provision in place, BDCs could actually invest up to 50 percent of their 

assets in noneligible portfolio companies, including financial firms. Allowing such an 

increase in funding for financial firms would decrease the amount of funding directed to true operating companies by almost 30 percent. This approach conflicts 

with the basic rationale for the creation of BDCs: channeling capital to businesses 

in the real economy. 

BDCs Would Be Able To Own a Registered Investment Adviser 

Additionally, the bill would allow BDCs to own registered investment advisor 

firms. This too would divert capital away from the operating companies that BDCs 

were intended to serve. And it would enable a BDC, through control of its adviser, 

to circumvent various limits on BDC activities. For example, if the BDC’s adviser 

were to manage a number of private funds, and invest BDC money in those funds, 

then it could exceed the BDC leverage limits as well as limits on a BDC’s investment in financial companies. In addition, the adviser’s clients would be exposed to 

conflicts of interest arising from the adviser’s recommendation to invest in the parent BDC or its portfolio of companies. 

In sum, these provisions in H.R. 3868 violate Congress’s original admonition to 

avoid comprising necessary investor protections in the name of reducing regulatory 

burden. 

Conclusion 

Thank you again for the opportunity to appear at this hearing today. I look forward to your questions. 

71 

1The below article discusses some of the measures being considered by the European Union: 

http://www.wsj.com/articles/eu-proposes-new-capital-rules-to-boost-securitization-1443610493. 

PREPARED STATEMENT OF DREW FUNG 

MANAGING DIRECTOR AND HEAD OF DEBT INVESTMENT GROUP, CLARION PARTNERS, 

ON BEHALF OF THE COMMERCIAL REAL ESTATE FINANCE COUNCIL

MAY 19, 2016 

Thank you Chairman Crapo and Ranking Member Warner for the opportunity to 

testify today. My name is Drew Fung. I am a Managing Director and Head of the 

Debt Investment Group at Clarion Partners. I am testifying today on behalf of the 

Commercial Real Estate Finance Council, or (CREFC), where I am a Member of the 

Executive Committee. 

CREFC is the collective voice of the roughly $3 trillion commercial real estate finance market. CREFC’s 300 member firms include balance sheet, Agency and Commercial Mortgage-Backed Securities (CMBS) lenders as well as loan and bond investors and servicing firms. Our industry plays a critical role in financing properties 

of all types in all 50 States including apartments, nursing homes, grocery, and retail, just to name a few. 

My testimony will focus on the CMBS industry. In today’s economy, CMBS is an 

essential financing vehicle for the U.S. economy. However, a plethora of new rules 

and regulations could dramatically affect CMBS liquidity, and thereby undermine 

the viability of this critical source of funding. 

Introduction 

The legislators and regulators had a daunting mission in restoring the health of 

the financial services sector following the financial crisis and the Great Recession. 

Eight years later, we have the benefit of empirical data and anecdotal experience 

about the very real costs of a macroeconomic crisis and also, the costs of regulation. 

Underpinning this data, it is now also a generally held view that deceleration in 

growth is likely to be a longer term feature of the national and global economies. 

It is within the context of this growth picture that we must revisit our regulatory 

regime, and specifically its deleveraging objectives. It is critical to note that the 

Group of Twenty (G20) first added financial regulation to its agenda in 2009, broadening and enhancing the role that the international regulatory bodies played in determining home country requirements. At that time, goals for reducing leverage in 

the system were based on trends and observations ending with the deepest points 

of the mark-to-market losses. At the same time, there was little attention paid to 

the economic effects of regulation. It still remains a challenge to determine the collective effects and costs of the cumulative regulations aimed at the structured finance marketplace, partly because the rules are still being written, partly because 

some final rules have yet to take effect, and partly because they are so complex. 

Even so, many countries are seriously reconsidering the burden of the future regulatory agenda, given entrenched headwinds to growth. Some are not only contemplating, but also actively pursuing, relief for securitized products in order to support 

growth. 1

More recently, the CMBS market has seen excessive and sustained dislocation, 

also referred to as ‘‘illiquidity’’. To a certain degree, geopolitical events are to blame 

for some of the distress that many markets experienced in February and March, yet 

these events do not account for all the distress. While other fixed income asset classes started to trade more normally in recent months, CMBS continued to exhibit numerous signs of relative distress. What accounts for this lagging effect on CMBS? 

Market participants are unanimous in their belief that regulation is driving much 

of the present strategic decisions, and the effects of that regulation are causing the 

market to grow thinner and more fragile. Despite the fact most participants agree 

that credit trends in the commercial property market remain healthy, issuers and 

investors alike have shed staff, cut their budgets and reduced allocations. Some 

even closed their doors. 

Weeks after researchers and other market watchers released their 2016 issuance 

forecasts (as high as $125 billion), many if not most, reissued forecasts at roughly 

half of their original numbers. Commercial Mortgage Alert published an estimate 

of $50–60 billion in their most recent issue (05/13/16). In other words, with little 

to no stress, and despite the fact that many other fixed income asset classes reVerDate Nov 24 2008 11:12 Dec 20, 2016 Jkt 046629 PO 00000 Frm 00075 Fmt 6621 Sfmt 6621 L:\HEARINGS 2016\05-19 IMPROVING COMMUNITIES AND BUSINESSES ACCESS TO C
72 

2 As measured by the standard deviation of swap spreads, which are the benchmark off of 

which CMBS are priced. Higher standard deviations indicate lack of liquidity. Current readings 

in CMBS suggest that the market is undergoing significant stress. 3 According to a recent survey, U.S. institutional tax-exempt exposure to real estate debt and 

equity grew to $835 billion. One of the largest Asset Managers, TIAA-CREF, has $82 billion, 

or 9.4 percent, in exposure of a total of $866 billion in AUM as of 3/31/2015. http:// 

www.pionline.com/article/20141027/PRINT/310279999/real-estate-managers-back-over-1-trillion-again 4 Alan C. Garner, ‘‘Is Commercial Real Estate Reliving the 1980s and Early 1990s?’’ https:// 

www.kansascityfed.org/publicat/econrev/pdf/3q08garner.pdf (2008). 

gained their stride after the February pounding of oil prices and other macroeconomic challenges, the CMBS market continued to see record levels of volatility. 2

While the regulators periodically revisit the deleveraging question in speeches and 

analyses, the U.S. regulators, in particular, seem unwilling to meaningfully investigate the role that regulation is playing in the fracturing of markets, fund flows, 

and the global slowdown. This frustration was felt by CREFC members while submitting comments during the agency rulemaking processes. There are countless instances in which our trade association and others provided well researched and documented analyses of the CMBS and other structured products markets. Yet, the regulators answer with rule requirements that are less tailored than they need to be 

for each asset-class, let alone CMBS, in order to maintain the organic efficiencies 

of the market in favor of simplifying the regulatory regime globally. Now that the 

CMBS market is exhibiting severe distress, and there is evidence of a negative feedback loop between poor liquidity conditions, lending rates and capital raising, the 

effects of regulation must be addressed, and done so quickly. 

A strong contingent of CREFC’s members believe that regulatory burden is responsible for reducing liquidity in and weakening the resilience of our market, despite the impact of geopolitical forces. Many believe that liquidity is the CMBS 

linchpin and that the regulations are causing permanent damage to it. Yet, even 

buy-and-hold investors, such as the pension fund universe (that is reportedly 6.99 

percent invested in real estate) 3 need market liquidity in order to be able to meet 

their own regulatory and fiduciary requirements. 

CREFC and its members believe that thoughtful regulation can be a net positive 

and that some of the new regulatory requirements have improved the marketplace 

and the alignment of interest between issuers and investors. While the broad intent 

of the regulations is well founded, the overwhelming burden of rules that lack tailoring to the characteristics of different asset classes provides little marginal prudential improvement, if at all. At the same time, these rules generate significant 

costs to the end users (i.e., borrowers and consumers) and to savers whose investments are devalued as a result. Consequently, there is a growing chorus of urgent 

concerns from all ends of the industry that regulation is institutionalizing inefficiencies and may even severely disable liquidity for the CMBS market permanently. 

Moreover, lenders and investors agree that a dislocation in CMBS will travel 

quickly throughout the commercial real estate (CRE) debt and equity markets, impacting valuations and fundamentals. Certain aspects of the marketplace are so 

fragile today—even before half of the planned regulations come into place—that 

CMBS is experiencing severe pricing volatility, a marked contraction in issuance 

and reduction in capacity. We are working on borrowed time to investigate the solution and to initiate remediation, especially given the current schedule of new rules 

in the pipeline. 

CMBS the Asset Class and Historical Performance 

The securitization of commercial mortgages began out of the necessity to clean up 

the balance sheets of taxpayer-backed depository institutions in the late eighties 

and early nineties. A combination of excess development in the wake of strong commercial property demand, a subsequent economic downturn, tax reform, and loose 

credit from depository institutions led to a drastic overbuilding of office properties. 

By 1989, 534 depository institutions had become insolvent due to imprudent loans. 

Congress created the Resolution Trust Corporation (RTC) in 1989 to dispose of the 

failed institutions’ assets. In turn, the RTC pooled the mortgages and sold them off 

as diversified bonds, creating the first CMBS transactions. Since then, the market 

has become much more transparent and investor centric. 4

Credit retracted nationally across industries in the nineties. Not only had the universe of lenders shrunk dramatically, but the few banks that could lend on property 

were reluctant to do so, prompting innovative financiers to bypass the banking system for the capital markets. They pooled commercial loans and sold bonds tied to 

those loans to sophisticated institutional investors from pension funds and insurVerDate Nov 24 2008 11:12 Dec 20, 2016 Jkt 046629 PO 00000 Frm 00076 Fmt 6621 Sfmt 6621 L:\HEARINGS 2016\05-19 IMPROVING COMMUNITIES AND BUSINESSES ACCESS TO C
73 

5Sam Chandan, ‘‘The Past, Present, and Future of CMBS’’, http:// 

realestate.wharton.upenn.edu/research/papers/full/730.pdf (2012). 6For information on the IRP, please visit: http://www.crefc.org/irp or see Appendix A. This 

information anticipated by almost 20 years asset-level information now required by the SEC for 

other asset classes. 

ance companies. By 1998, issuance topped $50 billion per year, and by 2007, 

issuance topped $200 billion per year. 5

One of the attractive features of CMBS was that institutional investors (entities 

with monthly, quarterly or actuarially driven cash flow obligations) could achieve 

greater diversification across geography and asset class than by purchasing or originating whole loans themselves. Instead of owning a $50 million loan on a single 

property, the investor could purchase $50 million worth of bonds equally diversified 

on a pro rata basis across 40–100 loans in 10–30 individual markets. And importantly, the investor could decide how much risk they wanted to take based on a 

bond’s seniority in the capital structure and the duration of the security. The most 

secure bonds received cash flow payments first, while the riskiest bonds last. In the 

event of a distressed sale, bond holders are paid before the borrower who contributed the equity. Typically, these securities offer more yield, transparency, and diversification than similarly rated corporate bonds. 

At the asset level, an investor, generally a business entity (a partnership or corporation), seeks to purchase a commercial property and obtain debt financing for 

that transaction. Each commercial property can be thought of as a self-contained 

business with an income statement and balance sheet. The rents charged to use a 

property—including monthly apartment, office, or retail rents—serve as the ‘‘sales’’ 

or revenue for the business. 

Similarly, a property has expenses in the form of third-party property management fees (landscaping, maintenance, etc.), property taxes, insurance, leasing expenses (as in the case of an apartment leasing manager, or a retail leasing agent, 

who go and find renters for the property), and noncapitalized annual repairs to the 

property. These expenses subtracted from total revenues represent the property’s 

profit and loss, or ‘‘P&L’’. It is through this number that all applicable underwriting 

calculations, such as debt service coverage ratio (DSCR), whether from the investor 

or lender, are calculated. 

The property owner’s ability to pay off debt is not measured (since all CMBS loans 

are nonrecourse), but rather, the property’s, or business’s ability to service monthly 

payments is measured. A mid- to long-term holder of commercial property, regardless of property type, buys a building based on how much cash flow, or yield, the 

asset will generate each year, and considers hundreds of data points (ongoing surveillance of CMBS is reported on a monthly basis via the CREFC Investor Reporting 

Package (the ‘‘IRP’’), a monthly report with over 750 data fields and supplemental 

reports providing insight into asset, loan, and bond level performance, as well as 

the final disposition of specially serviced CMBS loans, 6 in addition to a business 

plan that includes market information ranging from demographics, supply and demand factors for the asset type, and relative positioning to comparable products. 

Post-financial-crisis (also known as ‘‘CMBS 2.0’’), there are two distinct CMBS 

markets: the conduit market and the single-asset single-borrower (SASB) market. 

The conduit market pools commercial mortgages ranging in size from $2 million to 

over $100 million (but generally not more than $100 to $300 million). These loans 

are collateralized by stabilized, cash-flowing properties with three years of operating 

history and professional ownership. As thousands of small banks either closed their 

doors or were purchased by larger firms in the wake of the 2008 credit crisis, conduits remain a substantial source of debt for secondary and tertiary market real estate operators. Conduit financing provides capital for grocery store shopping centers, 

strip malls, family owned hotels, shopping malls, and apartment buildings. 

The other type of CMBS lending is SASB loans. These loans typically are larger 

than $250 million and are made on a single, large property or portfolio of properties 

owned by one borrower such as large, well-capitalized, public and private real estate 

companies. Last year, SASB made up over one-third of the total CMBS market, up 

from roughly 10 percent historically. 

Institutional investors enthusiastically invest in SASB bonds. The demand for this 

market came about as banks and insurance companies were unable or unwilling to 

offer their balance sheets to finance trophy buildings or portfolios of properties. The 

credit characteristics of these loans are highly desirable—often many times oversubscribed by investors. Due to the durable nature of CRE’s cash flow, and subsequently the CMBS bonds, the asset class as a whole has performed extremely well. 

74 

7 As of 08/31/2013, per CREFC’s comment letter to regulators. 

8See CREFC’s Letter to various regulators on Risk Retention: http://docs.crefc.org/ 

uploadedFiles/CMSAlSitelHome/GovernmentlRelations/FinanciallReform/ 

RisklRetention/Risk%20Retention%20Proposed%20Rule%20Comment%20Letter.pdf. 

The all-time cumulative loss rate for SASB transactions is 0.25 percent, and 2.79 

percent for conduit transactions. 7

SASB transactions performed better in the depths of the crisis than most fixed 

income markets perform under efficient market conditions. Due to the structure and 

transparency of SASB deals, investors were (and still are) able to make informed 

decisions. With performance characteristics such as these, it is fairly improbable 

that regulation could benefit the market. Indeed, when members of the regulatory 

community have been asked this question, often the answer is that it is difficult for 

the agencies to grant exceptions. CREFC discussed these issues at length with the 

Agencies responsible for crafting the risk retention, and our list of submissions to 

the regulators can be found in Appendix B. 8

Why CMBS: Borrower Access to Credit 

CMBS provides the most democratic and cost effective method of financing for 

small real estate assets. While SASB financing makes it possible to spread the risk 

of a large dollar loan on a single property, conduit financing is an essential component of the main-street CRE market. If traditional credit providers—banks and life 

companies—service the borrowers who need mid-sized loans, then CMBS serves the 

ends of the barbell, with SASB transactions that are too big for a single institution 

to handle on one end, and loans on small, privately owned real estate companies 

and syndicates that make up 90 percent of CRE ownership on the other. 

In 2015, CMBS provided 21 percent of all of all CRE loans. This is the sector’s 

largest financing source, followed only by agency debt (18 percent) and regional 

banks (16 percent). Annual originations by banks and life companies ebb and flow, 

but have generally been steady and limited to specific niches. While CMBS’s 50 percent market share in 2007 was arguably too high, as witnessed prior to the crisis, 

securitization has proven to pick up a large portion of the slack that portfolio lenders and the Agencies typically eschew. 

One of the most popular sentiments expressed by all types of CREFC members 

(buy- and sell-side) is that the broader CRE market needs CMBS in order to function efficiently and to fill the gap in financing needs posed by underserved borVerDate Nov 24 2008 11:12 Dec 20, 2016 Jkt 046629 PO 00000 Frm 00078 Fmt 6621 Sfmt 6621 L:\HEARINGS 2016\05-19 IMPROVING COMMUNITIES AND BUSINESSES ACCESS TO C 51916034.eps
75 

9https://www.federalreserve.gov/bankinforeg/srletters/sr1517.htm 

10http://www.federalreserve.gov/boarddocs/snloansurvey/201605/ 

rowers in smaller cities and suburban areas. For instance, Idaho currently has over 

$1.1 billion worth outstanding loans distributed across cities including Boise, Twin 

Falls, and Meridian. Similarly, Virginia and Massachusetts currently have over $26 

billion and $17 billion, respectively, in outstanding CMBS financing (please see Appendix G for a breakdown of each State’s outstanding CMBS loans). 

The CMBS market represents a core source of capital that cannot easily be replaced. When new issuance is halved in a single year, especially one in which there 

are significant refinance needs, it is realistic to expect a broader market disruption. 

During liquidity interviews, CREFC members had significant concerns over the impact a declining new issuance market would have on bond values, and more importantly, property values. Members noted that all things being equal, removing 20 

percent of available debt capital from the marketplace would surely depress property values. Members also noted that they did not see a ready alternative to CMBS 

financing—that is, long-term, fixed rate mortgages. Instead, bank participation will 

be declining as the regulatory regime is ramped up across all banks, big and small, 

and as the regulators enforce limits on CRE exposures. 

Maintaining availability of CMBS financing is even more critical following regulatory warnings regarding CRE concentrations at banks. Many bank lenders in our 

membership report intentions to maintain, instead of grow, loan levels, which 

means that any reduction in the CMBS market should represent a reduction in capital availability across the sector. While some 1Q 2016 data series indicated that 

loan levels are still growing, the spurt in the first quarter represents loans that 

were negotiated before the end of the year and the prudential agencies published 

a warning to the CRE lenders. 9 Indeed, the April 2016 Senior Loan Officer’s Opinion Survey reflected a tightening of underwriting standards across the industry for 

the first time in this cycle, FRB: Senior Loan Officer Opinion Survey on Bank Lending Practices and this is considered to be a leading indicator of future trends. Industry watchers report that the CRE loan pipeline has contracted in 2Q 2016, which 

should be reflected in the second half of the year. 

Evolution of the CMBS Market Before and After the Crisis 

The CMBS market is generally viewed in two historical segments—CMBS 1.0, 

which existed before the crisis, and CMBS 2.0, which commenced after the crisis. 

The reason that the two phases are delineated is that the CMBS market has greatly 

evolved in several critical ways since the crisis: (1) pro forma (aspirational) underwriting is infrequently mentioned and in fact, underwriting criteria have been tightening; 10 (2) CMBS deals include much greater levels of subordination, or cushion, 

to absorb potential losses (see exhibit below); (3) collateralized debt obligations 

(CDOs) backed by CMBS are no longer issued; and, (4) even greater transparency 

and information is provided to investors. 

76 

11 A full list of these self-regulatory measures is available in CREFC’s letter to the Federal 

Reserve System, the FDIC, Treasury, the SEC, and the OCC: http://docs.crefc.org/ 

uploadedFiles/CMSAlSitelHome/GovernmentlRelations/FinanciallReform/ 

RisklRetention/Risk%20Retention%20Proposed%20Rule%20Comment%20Letter.pdf. 

Recent economic conditions were primed to result in a return of aggressive lending and funding. Environments marked by low rates and improving credit trends, 

as we saw in recent years, are prime ecosystems for higher leverage, because the 

economics work. However, risky leverage did not return to the CMBS market. In 

fact, the opposite happened. The levels of loan and deal level leverage remained 

much lower than in CMBS issued prior to the crisis (CMBS 1.0). Importantly, the 

double leverage that came with CDO funding seems to be wrung out of the system. 

Early regulatory and industry intervention at the beginning of the crisis were indeed the integral in weeding out the most ambitious lending and financing forms 

from the CMBS industry. The combination of accounting changes and additional requirements of the rating agencies, as well as other rules helped to stabilize the 

CMBS market starting in 2010. While the Term Asset Backed Loan Facility (TALF) 

did support several CMBS transactions, the TALF’s activities in the commercial 

market were limited. In other words, the market participants agreed on a new architecture which instilled the requisite confidence from both buy and sell sides. This 

caused the market to rebound with little assistance from the TALF facility established to liquefy the market during the crisis. 

Indeed, CREFC members played a vital role in this stabilization, as our community contributed a critical new feature of the CMBS 2.0 (postcrisis CMBS) marketplace—additional transparency measures in the form of the IRP, described in detail 

above, and in Annex A, which is the deal package. (See Appendix A for more details 

on CREFC IRP). These two transparency measures are proof that through the leadership of CREFC, the CMBS industry has self-regulated over the years as investors 

demanded standardized deal documents and up-to-date performance data. 11 However, regulators gave the industry little credit for these self-imposed reforms. 

In 2009, CMBS issuance had collapsed to almost $0 from a height of $231 billion 

in 2007. Issuance rebounded to roughly $100 billion in the private label market last 

year. Until recently, many bonds had excess bidders and the CMBS market enjoyed 

inflows of capital correspondent with performance. It seemed that despite low interVerDate Nov 24 2008 11:12 Dec 20, 2016 Jkt 046629 PO 00000 Frm 00080 Fmt 6621 Sfmt 6621 L:\HEARINGS 2016\05-19 IMPROVING COMMUNITIES AND BUSINESSES ACCESS TO C 51916035.eps
77 

12http://www.crefc.org/CREFC/Publications/RegulatorylImpactlStudy/CREFC/Resources/RegulatorylImpactlStudy.aspx?hkey=47af34d5-3cea-43e1-942f-309fd7508928 

est rates, market participants generally agreed that CMBS was functioning well in 

the main. 

As a result, CMBS 2.0 has continued to evolve. First, more stringent accounting 

and rating agency rules resulted in greatly reduced economic incentives for CDO 

structuring. Now that CMBS are not releveraged through CDOs, the dollar value 

of investable capital is lower today than it was when interest rates were higher. Second, the rating agencies have all significantly revised their models and required 

much greater amounts of subordination. As a result, the bonds at the bottom of the 

stack that absorb losses have roughly doubled. Third, better transparency in the 

form of Annex A and the IRP, now in its 8th version, has reinforced better underwriting standards and more extensive due diligence. While the market is constantly 

evolving, CREFC believes that these positive conditions are not temporary, but rather more permanent features of the CMBS 2.0 market and the upcoming CMBS 3.0 

market. 

Regulatory Regime and the Question of Effectiveness 

The CREFC community is generally supportive of prudent regulation that appropriately weighs the cost of the requirements with the corresponding benefit it is expected to achieve. In our comments to the various regulators, including the Securities and Exchange Commission (SEC), we made this fact known and expressed a 

desire to work with them in identifying solutions that would enhance positive market practices, including those put in place by the CMBS market itself. Currently, 

the CMBS market is subject to an extraordinary amount of direct regulation, and 

many of these measures have the impact of treating CMBS more harshly than other 

asset classes (e.g., Fundamental Review of the Trading Book and Liquidity Coverage 

Ratio). Further, there are innumerable rules that indirectly impact the market by 

greatly changing the conditions under which the entire financial system operates. 

These rules then drive the conditions in which CMBS functions. Of the subset of 

these new rules that affect CMBS most directly, there are: 

• the accounting changes FAS 166 / FAS 167; 

• rating agency rules; 

• Regulation AB II (a set of disclosure requirements); 

• reporting requirements to the TRACE facility; 

• Volcker Rule (which sanctions CMBS market making but presents a set of very 

high hurdles for compliance); 

• Basel III leverage ratio (which affects how market making desks fund themselves with repurchase agreements); 

• Liquidity Coverage Ratio (LCR); 

• Net Stable Funding Ratio; 

• Risk based capital rules; and 

• Risk Retention rule (which requires that issuers hold 5 percent of a 

securitization). 

Last year, CREFC produced a study 12 of the regulatory impacts on the CRE sector overall and found through interviews and quantitative analysis that taken together, regulation has done some good things for our sector, but it has also reconfigured the structure of the markets in such a way that makes it ultimately less resilient in times of stress. These outcomes generally run counter to broader policy goals 

of maintaining sound functioning markets and supporting sustainable growth. 

Broadly speaking, the rules under the Dodd-Frank Act and also the various components of Basel III discriminate against longer-term assets and those that are not 

highly standardized, such as residential mortgages. At the same time, there is little 

acknowledgment of the unique transparency in the CMBS market or how the market functions differently than other asset classes that tend to be traded on more of 

a quantitative, and less on a fundamental, basis. 

78 

13With an historical realized loss of 0.25 percent, SASB deals have performed remarkably 

well, which explains the spike in investors’ demand for these bonds in recent quarters. 

CMBS Liquidity and Market Resiliency 

The universal concern of all industry participants is that the constant march of 

new regulatory requirements will create such a drag on margins that a critical mass 

of participants will exit. Many CREFC members have commented on this likely end 

game for CMBS now that they can envision a more complete regulatory timeline. 

Starting with the risk retention rule, which goes into effect on December 24, 2016, 

borrowers, issuers, and investors are keenly analyzing implementation at this time. 

CREFC gathered estimates last year and found that the regulation would likely add 

roughly 10 percent to the interest rate the borrower pays. This number was calculated assuming stable conditions and before CMBS participants started to consider the implementation challenges in earnest. Based on a sampling of issuers and 

investors more recently, CREFC found that on average, our members believe that 

much of the current spread widening is driven by regulatory burden, suggesting 

that the 10 percent of marginal costs originally estimated will prove to be lower 

than the actual costs incurred in a volatile trading environment such as the one prevailing for some time now. Given that risk retention is the next piece of regulation 

to move into effect for our sector, it can reasonably be credited as the greatest driver 

of costs to the borrower at this time and one of our industry’s top priorities. The 

regulatory factor is often cited as the driving force beyond continued spread volatility at this time, while other fixed income asset classes revert back to more stable 

trading environments. 

CREFC and the majority of its members have often supported differentiated treatment for SASB bonds, because the asset class has performed better than most other 

fixed income sectors, and in some ways, is simply the best performing sector 

through the crisis. Yet, the six regulators that were obligated to promulgate the risk 

retention rule, chose to include SASB deals in the coverage universe, even though 

there was very little, if anything, more that rules and restrictions could accomplish 

with the sector. 13 The risk retention rule was written with conduit structures in 

mind, yet will also be applied to the SASB universe, despite the fact that the requirements cannot be adopted without wholesale restructuring the SASB model and 

the market with it. 

79 

14 Even after the Basel Committee on Banking Supervision reduced the risk weighted requirements for structured products in their final version of the standards published on January 14, 

2016, industry participants anticipate that new U.S. rules may require that market makers 

maintain more capital than the market value of certain CMBS bonds. 

Additionally, it is important to note that risk based capital rules and the LCR are 

steep for our sector, and, more importantly, they treat CMBS relatively poorly compared to other financial instruments. Additional rounds of Basel capital requirements will make CMBS even less viable. Based on a series of interviews conducted 

with market leaders since the beginning of 2016, the FRTB, which changes capital 

requirements for all inventories kept for market making purposes, has been cited 

as one of the most concerning pieces of regulation, if not the most. 14

Even though the Basel Committee on Banking Supervision (BCBS), reduced the 

magnitude of the charges applied to CMBS in the final version of the FRTB published on January 14, of this year, these requirements place CRE-backed deals on 

par with subprime residential mortgages. In turn, it will be even more challenging 

to allocate capital to CMBS businesses, and ensures increased fragilities. The LCR, 

which is the first of two new liquidity requirements under Basel III, is also an example of a punitive approach toward all nonsovereign asset classes, but particularly, 

securitizations and CMBS. The LCR requires that CMBS issuers apply an additional cost to the production of their assets, even after they have been sold. The recently proposed Net Stable Funding Ratio follows the LCR’s construction and is expected to additionally disadvantage CMBS relative to other asset classes. 

Other Countries Easing Regulatory Treatment of Securitizations 

In contrast to the tightening of the regulatory regime in the U.S. anticipated in 

the near future, the European Union is using the securitization markets to help restart growth. Policy makers across many jurisdictions and throughout legislative 

and banking authorities have recognized in many ways that the securitization markets can provide safe and alternative funding to the banking system. As such, the 

European Central Bank (ECB) is utilizing the financial technology as part of its 

small- and medium-sized business program. 

Additionally, the ECB and other European regulators have begun to consider how 

to ease the burden on safer securitizations through reduction of risk based capital 

requirements and other mitigating measures. Importantly, they have noted that 

compliance and accounting measures have increased the discipline in the markets 

and believe that an offset in the capital and liquidity requirements would be warranted. 

The European authorities are not the only jurisdictions contemplating a reduction 

in the regulatory burden on structured products. In light of slowing growth globally, 

other regulatory agencies have considered certain changes too, including China, 

Japan, and Australia. 

Regulation and Market Liquidity 

In short, these regulations are and will continue to have a significant impact on 

CMBS. The precipitous decline in CMBS liquidity (e.g., inventories, turnover, trade 

size), especially the prolonged spikes in swap spreads, are particularly troubling. 

These trends suggest that the market is trading inefficiently; in the absence of credit concerns, anticipation of the next round of regulation must be driving much of 

the volatility. Moreover, certain trends suggest that the pattern may be sustained 

for some time, if not deepened becoming a negative feedback loop as many have 

warned: 

a. The number of market making platforms is declining rapidly, especially those 

that provide ‘‘balance sheet’’ and that can hold inventories. Based on a partial 

survey of the market in April, it appears that at least one in five people have 

been downsized this year, and at least one institution, the number is reversed; 

of five original market-making staff, one remains. One member investor speculated that there were 10 true dealers with capacity to hold inventories and to 

make markets across a range of new issues last year; that number was halved 

by year-end 2015 and as of this writing, the number is now down to two or 

three true market makers. 

b. As expected, the investors who relied on liquidity—those who care more about 

total returns than relative value—have exited en masse in lock step with the 

liquidity providers, leaving a distinct and troublesome gap at the lower end of 

the bond stack. 

c. Yet, buy-and-hold investors have reacted decisively to the distress in the market too by reducing allocations to the sector and many are actively retreating 

80 

15 Commercial Mortgage Alert, 05/13/16. 16 Issuers/sponsors must retain 5 percent of the credit value of the bonds for 5 years, during 

which time the bonds cannot be hedged (except for interest rate and foreign exchange). 

from the conduit market. All are concerned about the ability to price their investments accurately in a volatile market. 

d. The proportion that CMBS represents in the Barclays Aggregate Index, which 

is the one of most often used fixed income benchmark indices, has declined significantly to 1.2 percent from a high of 5.7 percent, meaning that the demand 

for CMBS will continue to decline. 

e. While there were roughly 40 conduit lenders and sellers last year, they too are 

closing their doors and now number roughly 28. 

f. The pipeline of new issues has been moving at a slow pace since April. The 

SASB deal calendar, especially, seems to be drying up in the summer with a 

couple of small deals scheduled in June and none in July. 15 Both sides of the 

business are seeing smaller deal sizes, which also indicates general lack of liquidity and is a concern for both buyers and sellers. 

g. The primary hedging instrument for the industry, the CMBX, has begun to 

trade very differently than the underlying cash bonds, which also indicates inefficiencies in the market and portends a deepening of the dislocation if pricing 

of the two products, the bond and the hedging instrument, do not become reasonably more correlated in their movements again. 

Demand for liquidity relative to market supply is stark. A survey of issuers, traders, investors and other market participants conducted by CREFC in early February 

suggests that, market-making capacity was already undercapitalized by one quarter 

to one half. Since then, additional traders have lost their seats, draining further capacity from the system. 

Recommendations and Conclusions 

Considering all of the perverse impacts of regulations—both individually and in 

the aggregate—our list of recommendations would be long, and mostly within the 

regulatory purview. As such, we began this process first by petitioning the regulatory community for correction and clarification. Regulators accepted some of our 

recommendations but also declined a good number. It is for this reason that we now 

seek Congressional intervention. 

From the legislative perspective, we urge the Members of this Committee to work 

together in a bipartisan fashion to introduce the companion to the bill sponsored by 

Representative French Hill of Arkansas. H.R. 4620, the ‘‘Preserving Access to CRE 

Capital Act’’ addresses the challenges posed by the risk retention rule in a targeted, 

fair, and responsible fashion. Though the recommendations in the bill do not affect 

the core requirements codified in the Dodd-Frank Act, Section 941, 16 they are 

meaningful and would have a positive impact on the marketplace. The majority of 

CREFC issuers, investors and servicers support the bill, however, there is a minority contingent of investors who support the final regulation without modification. 

Introduce and Report Out of Committee a Companion to H.R. 4620 

CREFC strongly supports the recommendations below, which restore the proper 

balance between protective measures and a healthy, functioning CMBS market for 

the borrowers and employers in every Congressional district. Specifically, the recommendations would: (1) exempt from the risk retention requirements the highly 

sought and extraordinarily transparent SASB transactions; (2) set reasonable parameters for regulating and designating as ‘‘qualified’’ certain high-quality commercial loans (QCRE Loans) under the risk retention rules; and (3) provide flexibility 

in structuring the retained interest to suit investors without modifying the amount 

nor relaxing the general restrictions surrounding the retained interests. 

First, the recommendations would address the issues related to the transparent 

and high-performing SASB transactions by making them exempt from the risk retention requirements. As mentioned above, SASB transactions are marked by superior performance—the SASB segment booked a mere 0.25 basis points in cumulative 

losses between 1997 and 2013. This financing option is ideal for borrowers seeking 

to finance apartment complexes, hotels, office buildings, and, of course, gateway 

market ‘‘trophy’’ properties. Despite this superior performance, current regulations 

do not include an exemption for SASB transactions, which threaten to raise borrowing costs, decrease borrower choice in this market, and induce them to seek 

other modes of financing that may be less transparent and low risk (e.g., corporate 

bond markets). 

81 

17See Appendix B for Industry Support Letter to House Financial Services Committee 

Second, the recommendations would put in place commonsense parameters for 

considering which CRE loans would be deemed ‘‘qualified’’ under the risk retention 

requirements. Currently, only a small percentage of CMBS loans would be considered as QCRE loans, and exempt from the risk retention requirements. Although 

modeled after the Qualified Residential Mortgage (QRM) exception, the application 

of QCRE has vastly different consequences. Surprisingly, private label residential 

mortgage-backed securities were given a generous set of qualifying requirements 

under the QRM standard; in fact, it is estimated that nearly all of today’s RMBS 

loans would qualify for an exemption. Yet, conversely, in the CMBS space, the qualifying conditions are so onerous that only 3 percent–8 percent of all CMBS conduit 

loans written since 1997 would qualify for an exemption from the core 5 percent risk 

retention requirement. This has little sense of proportion or compelling rationale. 

H.R. 4620 would moderately widen the underwriting requirements for QCRE, 

thus helping maintain credit quality in this space, along with stable pricing and 

availability of financing for a broad swath of business owners. Specifically, the bill 

would allow pools of unrelated/unaffiliated, or conduit loans will be allowed to amortize over not more than 30 years (from the current 25-year standard); permit lowLTV interest-only loans to be treated as ‘‘qualified’’ where no authority was granted 

previously; and permit loans less than 10 years in term as qualifying for exemption 

under the QCRE rule. We expect that this would raise the QCRE percentage to 

about 15 percent of all loans, still well below all the RMBS loans that will qualify 

under the QRM exception. In other words, the parameters are targeted and responsible. In no way would it allow a blanket carve out for the CMBS community, rather 

it would only truly apply to transparent and highly performing loans. 

Third, under the risk retention rules, there are special rules for CMBS that allow 

a third-party investor to purchase the B-piece (known under the rule as the eligible 

horizontal residual interest, or ‘‘EHRI’’). The risk retention rule allows up to two 

third-party investors to share the 5 percent retention burden, but requires them to 

hold their positions pari passu (i.e., horizontally). The proposed legislation supported by CREFC would allow third-party purchasers to share the retention obligation pari passu or in a senior-subordinate (i.e., vertical) structure. H.R. 4620 does 

nothing at all to change the core retention requirement or any of the other requirements surrounding the B-piece investors. The core 5 percent retention requirement 

and all other general requirements (e.g., substantive due diligence, holding the interest for 5 years, etc.) would remain intact. 

The legislation allows for a reasonable amount of flexibility in how the B-piece 

is held internally by two purchasers. This flexibility will allow the B-piece buyer to 

match investor capital with the additional capital investment (the retained risk 

amount) that the rules require. For CMBS, the required amount of risk retained 

will be about two times that of what is currently invested by B-piece buyers in a 

typical CMBS deal. That is a massive amount of incremental capital B-piece buyers 

have to raise in order to be risk retention compliant. And that investment is essentially nontransferable—meaning that the funds raised will be ‘‘parked’’ in a single 

deal for at least 5 year. Obviously, this comes with an illiquidity premium that investors will seek—further increasing costs to borrowers. The senior-sub structure 

will be used to help align investors with this new retained risk requirement. It will 

not affect at all the amount of risk that must be retained, the underwriting due diligence required by the rules or the holding period requirements of the rules. It simply gives the industry flexibility to achieve the risk retention goals of the regulations and is supported by 14 real estate trade associations. 17

Conclusion 

CREFC would like to thank the Members of this Subcommittee for providing us 

the opportunity to submit this statement. CREFC asks that the Subcommittee give 

serious consideration to the negative consequences of the latest round of rulemaking—consequences far beyond the CMBS markets. More to the point: without 

a robust and competitive CMBS marketplace our members anticipate a liquiditydriven stress event that could potentially take years to rebalance as market participants leave the arena for other lines of business. This imbalance will have far-reaching and profound effects on communities in a very visible way, by constricting the 

funding for commercial properties that we all come to rely on daily for our groceries, 

housing, workplaces, health care, education, and goods and services. In short, the 

roughly $200 billion of maturing CMBS debt in the next 2 years will need to be financed regardless of the actions Congress takes. In the absence of intervention and 

continuity of a competitive CMBS marketplace, we fear that buildings currently 

82 

funded could fall into foreclosure, resulting in blighted, perhaps empty structures 

and loss of principal for America’s pension and other investors and retirees. 

We remain optimistic that there is time to correct this looming liquidity crunch, 

and we are eager to work with Members of the Committee, and with Congress, to 

ensure that the discretely tailored recommendations become law. 

83 

84 

85 

86 

87 

88 

89 

90 

91 

92 

93 

94 

95 

96 

97 

98 

99 

100 

101 

102 

103 

RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN CRAPO 

FROM MICHAEL J. AROUGHETI 

Q.1. Can you explain the impact of the ROE for BDC investors and 

how operating efficiently as a BDC structure can help investors 

earn better returns, especially compared to other financial services 

companies or products? 

A.1. A higher return on equity for a BDC translates into higher 

dividends for investors (due to the pass through nature of the earnings) and potentially growth in net asset value for the BDC. Research has shown that higher ROEs typically translate into improved stock price valuations for BDCs (see chart below). By operating more efficiently, a BDC can improve its ROE. There are several ways a BDC can improve its ROE through efficient operations: 

(1) given the positive spread between asset yields and borrowings, 

higher leverage results in improved ROEs, (2) increasing asset 

yields or reducing funding costs can improve ROE, (3) increased 

scale in assets can improve ROE as greater interest income is 

spread over some fixed operating costs. 

Over the last 2 years, large BDCs have generated higher returns 

on equity than comparable mid-size banks. As the chart below indicates, large BDCs have averaged returns on equity of over 9 percent compared to return on equity for the KBW mid-cap index 

ranging from 7.6 percent to 8.5 percent. 

104 

BDCs have historically generated higher ROEs using less leverage. As the table below indicates, BDCs operate with average assets to equity of 1.89x compared to 8.88x for BBB Banks. In addition, the BDCs have favorable efficiency ratios compared to the 

banking sector. 

105 

Q.2. During the hearing there was some discussion over whether 

institutional investors are more or less active in the BDC space. 

What is the data over the last 5 years? 

A.2. Institutional investors are still a very meaningful owner in the 

BDC sector and there has not been a mass exit of actively managed 

institutional accounts. In March 2014 the passive investment funds 

that tracked the Russell 2000 had to exit the space due to the removal of BDCs from the Russell indices. The removal was related 

to pressure exerted on the Russell by large passive funds and the 

additional fee calculations that were required with BDC ownership. 

While the removal was unfortunate (and ill-advised) it did not impact the majority of institutional investors for Ares, but it did have 

an impact on the majority of the BDC industry, triggering a 25 percent reduction across the industry. 

Figure 1 provides data on institutional ownership in the BDC 

sector ($ ownership and average # of accounts). We would note that 

the number of institutional owners has increased but the $ amount 

in the sector has declined. We attribute the decline to two factors: 

(1) 10–12 percent of the sector holdings were in passive funds that 

exited BDCs in 2014 due to the Russell index exclusion and, (2) 

three of the BDCs in the data set (AINV, FSC, PSEC) have experienced significant issues post the recession and have price declines 

of -62 percent, -52 percent, -40 percent, respectively. Excluding 

these outsized price declines the institutional ownership in the 

data set increased on a dollar basis by +16 percent over the past 

5 years (even with the Russell exclusion). Institutions are not 

avoiding fundamentally strong BDCs. 

106 

Q.3. How does a registered investment advisor (RIA) help a BDC 

fulfill its core mission of providing capital for growing small- and 

middle-market companies and what guard rails might help ensure 

that it is not used for purposes well beyond the BDC’s core mission? 

A.3. The proposed bill would allow BDCs to own registered investment advisers, which as a technical matter is currently prohibited 

under the 1940 Act. Investments in RIAs owned by BDCs serve as 

an extension of the BDCs’ mission to raise capital from third party 

investors and then, in turn, deploy that capital to small- and medium-sized companies. For example, a large institutional investor 

may desire to make investments in small- and medium-sized U.S. 

private companies, but is unable to (or prefers not to) make such 

investments through the equity of a publicly traded entity such as 

a BDC. Finally, it is important to note that BDCs are currently 

able to, without restriction, own unregistered investment advisers. 

The SEC has recently issued exemptive orders on this topic, 

which include very specific conditions to be satisfied in order for a 

BDC to own, make investments in and grow an RIA. We believe 

that these conditions create sufficient existing ‘‘guardrails’’ to ensure that a BDC-owned RIA remains, as a general matter, focused 

on the BDC’s core mission, stated investment objective, and 

Congress’s 1980 mandate to create BDCs. 

Q.4. BDCs are investment vehicles open to retail or ‘‘mom and pop’’ 

investors. What has been the overall return to a retail investor in 

the BDC sector over the last 1, 3, 5, and 10 years, and can you 

compare it to other benchmarks? 

107 

A.4. BDCs only have one class of stock (per regulation) and are attractive investment vehicles for both retail and institutional investors. The return to the retail investor and the institutional investor 

is exactly the same; there is no preferential treatment for either investment group. Figure 2 below provides the total return in ARCC 

stock since IPO relative to the Wells Fargo BDC Index and the 

S&P 500. 

The chart below highlights ARCC and BDC sector total returns 

to investors over the last 1, 3, 5, and 10 year periods. 

108 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN 

FROM STEPHEN W. HALL 

Q.1. During the hearing, there was discussion of the upcoming SEC 

rules requiring a floating net asset value (NAV) for institutional 

prime and municipal money market funds (MMFs). In particular, 

it was suggested that a floating NAV would reduce investor demand for municipal MMFs and then reduce demand for short-term 

obligations of municipalities. It was argued that these changes 

could raise municipalities’ borrowing costs. 

Based on any publically available information, please describe 

your understanding of the assets under management (AUM) of (i) 

all municipal MMFs, (ii) institutional municipal MMFs (which will 

have a floating NAV under the new rules) and (iii) retail municipal 

MMFs (which will not be subject to a floating NAV). Please also 

discuss the market that retail and institutional municipal MMFs 

serve, in particular the identities of the purchasers of the funds 

and investments of the funds. 

A.1. Recent data confirm that the floating NAV will have little if 

any impact on municipal financing—Table 1 below sets forth information about the level of investment by institutional municipal 

MMFs in municipal debt. It confirms one of the key points that the 

SEC highlighted when it issued its rule implementing the floating 

NAV. In its 2014 release explaining the final rule, the SEC observed that the upcoming transition of institutional municipal 

MMFs to a floating NAV would likely have a minimal impact on 

municipal finance, because ‘‘institutional tax-exempt funds hold apVerDate Nov 24 2008 11:12 Dec 20, 2016 Jkt 046629 PO 00000 Frm 00112 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\05-19 IMPROVING COMMUNITIES AND BUSINESSES ACCESS TO C 51916091.eps
109 

1SEC: Money Market Fund Reform; Amendments to Form PF (p.255) (emphasis added). 2Data pulled from multiple publicly available sources are linked in this response. 

proximately 2 percent of the total municipal debt outstanding and 

thus at most 2 percent is at risk of leaving the municipal debt market.’’ 1

Recent data confirm this point and it is critical to a proper assessment of the impact of institutional municipal MMFs on municipalities’ borrowing costs. As reflected in Table 1, institutional municipal MMFs currently hold even less of the total $3.7 trillion municipal debt market today than in 2014, now amounting to only 

1.22 percent or $45.7 billion dollars. This means that the floating 

NAV will have an even more minimal potential impact on the borrowing cost of municipalities . 

Recent trends in the level of investment in various types of 

MMFs support this conclusion. As reflected in Table 2 below, investment in all municipal MMFs has decreased somewhat over the 

last 6 months. However, the data suggest that this is not due to 

the floating NAV rule but is instead part of a broader trend. In 

fact, retail municipal MMFs have experienced a greater reduction 

in dollars invested than institutional municipal MMFs have experienced. Compare third and fourth columns in Table 2 (showing that 

nearly $3 billion more has been withdrawn from retail municipal 

MMFs than from institutional MMFs). Yet retail municipal MMFs 

will not be subject to the floating NAV, so the floating NAV cannot 

account for the decrease. 

Furthermore, retail prime MMFs have also experienced a nearly 

16 percent decline in investment dollars over the last 6 months. 

See sixth column of Table 2. They too will be exempt from the 

110 

3 ICI Research and Statistics: ‘‘Release: Money Market Fund Assets June 9, 2016’’, and ‘‘Summary: Money Market Fund Assets Data (xls)’’. 4SEC: Money Market Fund Reform; Amendments to Form PF (p.247). 

floating NAV, further indicating that any decrease in municipal 

MMF investment is actually part of a larger trend affecting nongovernmental MMFs, unrelated to the floating NAV. Any number 

of factors may be contributing to this trend, including a shift in demand due to ultra-low risk in government MMFs or recent volatility in the yields offered by MMFs.

Even if the floating NAV were to have some dampening effect on 

the 1.22 percent invested in institutional municipal MMFs, it will 

not significantly reduce municipalities’ access to financing. For example, even with the floating NAV in place, institutional investors 

will still have an incentive to seek out the beneficial tax exemptions associated with municipal MMFs. In addition, some investors 

may withdraw from institutional municipal MMFs but then migrate to retail municipal MMFs, causing no net change in funds invested in municipal MMFs. For example, as the SEC explained in 

the final rule, some retail investors currently invest in municipal 

MMFs through omnibus institutional accounts. Some estimates 

submitted to the SEC indicate that as much as 50 percent of the 

assets held in ostensibly institutional municipal MMFs are actually 

beneficially owned by institutions on behalf of investors. 4 To the 

extent the rule prompts them to withdraw from institutional funds, 

they are likely to reinvest in retail municipal MMFs, with no negative impact on municipal financing via MMFs. 

Finally, any impact of the floating NAV must be viewed in a 

larger context. The reforms adopted by the SEC in its rule are necVerDate Nov 24 2008 11:12 Dec 20, 2016 Jkt 046629 PO 00000 Frm 00114 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\05-19 IMPROVING COMMUNITIES AND BUSINESSES ACCESS TO C 51916093.eps
111 

5 ‘‘Better Markets, The Cost of the Crisis: $20 Trillion and Counting’’ (2015), available at 

www.bettermarkets.com/costofthecrisis (incorporated herein by reference as if fully set forth). 6Testimony of Stephen W. Hall, Better Markets, Inc., Before the Subcommittee on Securities, 

Insurance, and Investment of the U.S. Senate Committee on Banking, Housing, and Urban Affairs, ‘‘Improving Communities’ and Businesses’ Access to Capital and Economic Development’’, 

May 19, 2016, at p.6 and n.11; Comment Letter From Better Markets to the SEC, Money Market Reform (Release No. 33-9408) (Sept. 17, 2013). 

essary to help mitigate the risk of another devastating financial 

crisis. 5 In reality, as we explained in our testimony and in our 

comment letter to the SEC, 6 the SEC reforms are only a partial 

solution, and more needs to be done. But at least they begin to address the proven threat to financial stability posed by MMFs, as exemplified by the dramatic run on the Reserve Primary Fund during 

the 2008 financial crisis (see response to Question #2 below). The 

floating NAV is a critical element of those reforms. If it is rolled 

back, the risk of another devastating financial crisis, and its intensity, will increase. As we saw in 2008, such a crisis would throw 

all MMF markets into disarray, cause a massive and prolonged increase in unemployment, and ultimately devastate economic 

growth—to the detriment of local governments along with everyone 

else. The far wiser course is to allow all of the SEC reforms to go 

into effect, notwithstanding any minimal or speculative impact 

they may have on municipal financing obtained through MMFs. 

Q.2. As discussed at the hearing, S. 1802 would allow MMFs of all 

types to use a stable NAV instead of a floating NAV. One witness, 

the Idaho State Treasurer, expressed concern that if prime institutional MMFs, which typically hold short-term corporate debt, are 

required to have a floating NAV, those funds could become less desirable and no longer satisfy his investment criteria. The impact on 

prime institutional MMFs may be difficult to quantify or predict, 

but those were among the investments that suffered significant distress during the financial crisis. 

Based on reports or studies, including by the Department of the 

Treasury or the Securities and Exchange Commission, how did the 

financial crisis impact prime institutional MMFs? Specifically, 

please discuss any data that describes the ‘‘run’’ on prime institutional MMF assets. Also, what kinds of companies are the typical 

investments of prime MMFs? 

A.2. Part 1: The 2008 financial crisis crippled prime institutional 

MMFs, and a future crisis would have the same devastating impact—The financial crisis made it painfully clear that MMFs 

present a serious risk of systemically significant runs and that 

those runs can cripple the short-term credit markets, potentially 

tipping the entire financial system into chaos. In the most compelling example of MMF run risk, the Reserve Primary Fund broke 

the buck on September 19, 2008, due to losses on debt instruments 

issued by Lehman Brothers Holdings, Inc. This nearly unprecedented event happened even though Lehman-related assets comprised only 1.2 percent of the fund’s total assets. 

When the fund sponsors declined to provide support and priced 

its securities at $0.97 per share, a run immediately ensued. Within 

2 days, investors sought to redeem $40 billion from the fund. This 

required the fund to sell tens of billions of dollars in assets immediately so that it could pay for the flood of shareholder redempVerDate Nov 24 2008 11:12 Dec 20, 2016 Jkt 046629 PO 00000 Frm 00115 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\05-19 IMPROVING COMMUNITIES AND BUSINESSES ACCESS TO C
112 

7SEC: President’s Working Group Report on Money Market Fund Reform, at 11-12 (Release 

No. IC-29497) (11/3/2010). 8See ‘‘SEC Division of Risk, Strategy, and Financial Innovation, Response to Questions Posed 

by Commissioners Aguilar, Paredes, and Gallagher’’, at 12 (Nov. 30, 2012), available at http:// 

www.sec.gov/news/studies/2012/money-market-funds-memo-2012.pdf. 9See generally ‘‘FSOC, Proposed Recommendations Regarding Money Market Mutual Fund 

Reform’’, 77 FR at 66,464 (Nov. 19, 2012) (FSOC Proposal). 10 ‘‘FSOC Proposal’’, at 69,455, 69,458, 69,464; ‘‘Perspectives on Money Market Mutual Fund 

Reforms’’, Hearing Before the S. Comm. on Banking, Housing, and Urban Affairs, 112th Cong. 

6 (June 21, 2012) (Testimony of Mary Schapiro, Chairman, SEC) available at http:// 

www.banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStorelid=66f4ddb5- 

4823-4341-bad9-8f99cdf5fe9a (Schapiro Testimony). 11Schapiro Testimony, supra n.8, at 6-7. 12 Better Markets: ‘‘The Cost of the Crisis’’, at 95. 13 ‘‘President’s Working Group Report on Money Market Fund Reform’’, at 18 (Release No. IC29497) (11/3/2010). 

tions. This fire sale in turn depressed asset values, further weakening the fund. The run quickly spread to the entire prime MMF 

industry, and during the week of September 15, 2008, investors 

withdrew approximately $310 billion (or 15 percent) of prime MMF 

assets. 

That September, over 90 percent of the redemptions from prime 

MMFS were from institutional not retail funds. This caused immediate havoc in the short-term funding markets, triggering a vicious 

cycle of asset fire sales, depressed prices, redemption requests, 

more asset fire sales, and rapidly evaporating liquidity. That 

month alone MMFs reduced their holdings of commercial paper by 

about $170 billion or 25 percent. 7 The run abated only after the 

Treasury, on September 19, 2008, established the Temporary Guarantee Program for Money Market Funds, and the Federal Reserve 

established a variety of facilities to support the credit markets frozen by the MMF crisis. 8

Notwithstanding this unprecedented and massive intervention in what was then a $3.7 trillion market, the September 2008 run resulted in large and rapid divestment by MMFs in short-term instruments, ‘‘which severely exacerbated stress in already strained 

financial markets.’’ 9 The decline in outstanding commercial paper 

contributed to a sharp rise in borrowing costs for commercial paper 

issuers. 10 In addition, while the losses ultimately sustained by investors in the Reserve Primary Fund were modest, those investors 

suffered substantial liquidity damage, losing access to their money 

for an extended period pending the outcome of judicial proceedings. 11

The buckling of MMFs contributed heavily to the financial crisis, 

and all sectors of the economy paid a heavy price: ‘‘Regardless of 

which metric you look at—long-term unemployment, number of 

foreclosures, small business growth, Federal R&D spending—there 

is irrefutable evidence that the financial crisis of 2008 and the subsequent Great Recession have set the U.S. and tens of millions of 

Americans back like no other economic calamity since the Great 

Depression.’’ 12 MMF reform is essential to prevent a recurrence. As 

stated by the SEC, ‘‘[w]ithout additional reforms to more fully mitigate the risk of a run spreading among MMFs, the actions to support the MMF industry that the U.S. Government took beginning 

in 2008 may create an expectation for similar Government support 

during future financial crises, and the resulting moral hazard may 

make crises in the MMF industry more frequent than the historical 

record would suggest.’’ 13

113 

14SEC Division of Investment Management: ‘‘Money Market Fund Statistics’’, at 13 (06/14/ 

2016). 

Part 2: The types of companies that are the typical investments 

of prime MMFs—The aggregated data from the SEC, reflected in 

Table 3 below, reveals that prime MMFs invest largely in private 

debt instruments but historically hold about 20 percent of assets in 

Government issuances. The 80 percent is invested in two types of 

nongovernmental obligations: certificates of deposits from banks 

and thrift institutions, and short term issuances including commercial paper and securities issued by financial institutions, 

securitizers, and nonfinancial institutions.

114 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

STATEMENT FROM LYNN FITCH, TREASURER, STATE OF MISSISSIPPI, 

SUBMITTED BY CHAIRMAN CRAPO 

115 

116 

LETTER FROM RICHARD JOHNS, EXECUTIVE DIRECTOR, STRUCTURED FINANCE INDUSTRY GROUP, SUBMITTED BY CHAIRMAN 

CRAPO 

117 

LETTER FROM THOMAS C. DEAS, JR., CHAIRMAN, NATIONAL ASSOCIATION OF CORPORATE TREASURERS, SUBMITTED BY CHAIRMAN 

CRAPO 

118 

119 

LETTER FROM MICHAEL FRERICHS, ILLINOIS STATE TREASURER, 

SUBMITTED BY CHAIRMAN CRAPO 

120 

LETTER FROM TOM SALOMONE, 2016 PRESIDENT, NATIONAL 

ASSOCIATION OF REALTORS®, SUBMITTED BY CHAIRMAN CRAPO 

121 

LETTER FROM JIM BAKER, DEPUTY DIRECTOR OF RESEARCH, UNITE 

HERE, SUBMITTED BY CHAIRMAN CRAPO 

122 

123 

124 

STATEMENT FROM THE MORTGAGE BANKERS ASSOCIATION, 

SUBMITTED BY CHAIRMAN CRAPO 

125 

126 

127 

128 

STATEMENT FROM THE STATE FINANCIAL OFFICERS FOUNDATION, 

SUBMITTED BY CHAIRMAN CRAPO 

129 

130 

131 

132 

133 

134 

135 

136 

LETTER FROM J. CHRISTIAN BOLLWAGE, MAYOR, CITY OF 

ELIZABETH, NEW JERSEY, SUBMITTED BY SENATOR MENENDEZ 

137 

LETTER FROM JOSEPH N. DIVINCENZO, JR., ESSEX COUNTY 

EXECUTIVE, SUBMITTED BY SENATOR MENENDEZ 

138 

LETTER FROM JOHN G. DONNADIO, EXECUTIVE DIRECTOR, NEW JERSEY ASSOCIATION OF COUNTIES, SUBMITTED BY SENATOR MENENDEZ 

139 

140 

LETTER FROM ABRAHAM ANTUN, COUNTY ADMINISTRATOR, HUDSON 

COUNTY, NEW JERSEY, SUBMITTED BY SENATOR MENENDEZ 

141