Some of the largest U.S. providers of money-market mutual funds have sought a compromise on new regulation, making adoption of tougher rules for the $2.6 trillion industry more likely if far from a sure bet.
A U.S. Securities and Exchange Commission proposal, scheduled to be voted on tomorrow, would require the riskiest funds to end the longstanding practice of pricing shares at a fixed value of $1 and instead force them to float. The vote will kick off a months-long burst of lobbying from investors, fund companies and other stakeholders before SEC commissioners consider a final version.
“This is going to be a long, drawn-out rulemaking initiative,” said Barry P. Barbash, a former director of investment management at the SEC. “The SEC staff and commission recognize you have to start somewhere.”
The proposal is the SEC’s second phase of response to vulnerabilities exposed by the 2008 financial crisis, when the $62.5 billion Reserve Primary Fund collapsed and money funds temporarily required a U.S. government guarantee.
U.S. regulators have long warned that money funds, which are commonly considered a safe, stable place to keep cash, aren’t insured deposits and could pose systemic risk to the financial system. The Financial Stability Oversight Council, an umbrella group of U.S. regulators including the Federal Reserve, said last year that money funds remain vulnerable to runs because shareholders are likely to flee if a fund’s share price drops below $1.
“Wholesale funding markets remain vulnerable to runs that could, in turn, trigger destabilizing fire sales,” Tobias Adrian , vice president of the Federal Reserve Bank of New York, warned the council members in a public meeting in April. “To address such concerns, the council recommends that the SEC consider regulatory action to improve the loss absorption capacity of money-market funds and mitigate run risk associated with those funds.”
Jeffrey N. Gordon, a professor at Columbia Law School and director of its Richman Center for Business, Law and Public Policy, expressed concern that the SEC proposal wouldn’t go far enough. He said the SEC should require funds to hold capital because the failure of single large issuer of debt could cause shares to fall below $1 and spark a run.
“I think it’s a missed opportunity,” Gordon said in a phone interview. “With the SEC, we are risking political actors trying to protect an industry.”
The SEC’s proposal, whose details have not been released, has divided the money-fund industry and faces additional resistance from investors concerned about potential tax liabilities. New money-fund regulation has also split the five- member commission, which deadlocked over the issue last year before the effort was revived. Several commission members have indicated support for the new proposal, which could be revised before a final vote.
The SEC’s proposal would impose the floating-share value only on “prime” funds that buy corporate debt and cater to institutional clients, according to two people familiar with the plan, who asked not to be identified because the proposal wasn’t public. Corporations that use the funds like cash accounts say the new regulations risk harming a convenient, highly liquid cash-management product.
‘Breaking the Buck’
A floating share value is intended to make funds more stable by signaling to investors that the value of the shares can fall below $1 -- known as “breaking the buck” -- without the fund collapsing.
“Breaking the buck should no longer be a significant event because money market funds would simply fluctuate in value in the same manner as other mutual funds,” FSOC wrote last year when it issued recommendations for further regulation of money funds.
The Investment Company Institute, the fund industry’s trade group, has argued a floating share value won’t stop a run on money funds. Even so, the ICI has adopted a wait-and-see approach, saying last week that it “expects this proposal will reflect the extensive research and discussion among commissioners and staff since last summer.”
The ICI has insisted funds should retain their fixed share value. Instead, the institute has proposed that fund boards be allowed to suspend withdrawals when weekly liquid assets fall to between 7.5 percent and 15 percent of total fund assets, or half the required level. After putting down such “liquidity gates,” funds would be able to charge a fee equal to 1 percent of redemption proceeds to investors who wanted to cash out shares, under the ICI proposal.
The SEC’s current floating-share proposal would affect fewer funds than a concept former Chairman Mary Schapiro championed in late 2011 and 2012, which envisioned changing the accounting standard for all money funds, including those that invest only in government securities or municipal bonds. The new proposal doesn’t include recommendations made by FSOC last year and opposed by money funds, including requiring them to hold capital against potential losses.
The U.S. Chamber of Commerce, which opposed the 2011 and 2012 proposals, expects “liquidity gates” to be part of the current proposal, said Alice Joe, the executive director of the Chamber’s Center for Capital Markets Competitiveness.
Next page: 'Careful Thought'
“This time around, there seems to be more careful thought into putting out a proposal and more of an openness of the staff and commissioners to listening to the views of the stakeholders,” Joe said in an interview.
SEC Chairman Mary Jo White said last month that the goal of new regulation is to mitigate the systemic risk posed by some money funds while preserving the product’s value to investors.
The Chamber, which has sued the SEC over other regulations, lauded a recent commission analysis for rigorously studying the issue. The report found that SEC reforms passed in 2010 wouldn’t have prevented the Reserve Primary Fund from breaking the buck and being liquidated. Those rule changes included new minimum liquidity levels, shorter average maturity limits, tougher credit quality standards and new disclosure requirements.
The SEC has held talks with the Internal Revenue Service over the tax implications of a floating-share value for money funds, since investors could owe taxes if they recorded a capital gain when selling shares. The proposal considered tomorrow isn’t expected to indicate the IRS’s decision on whether to waive the tax rules.
“I am not quite sure they can just wave their magic wand and at a the drop of a pin, give relief to it,” Joe said. “It may require congressional action to solve that problem.”
The $2.6 trillion money fund industry includes 580 funds, according to the Investment Company Institute. The top 10 fund families, including those run by Fidelity Investments, JPMorgan Chase & Co., and Federated Investors Inc., control 75 percent of assets, according to Crane Data LLC, a research firm in Westborough, Massachusetts.
The largest U.S. money-fund providers shifted their lobbying this year away from all-out opposition to limiting the scope of potential new rules.
A proposal limiting rule changes to prime institutional funds would be a victory for companies including Fidelity, Vanguard and Charles Schwab Corp. All three called for exempting funds that invest only in government debt or municipal bonds, as well as all funds that serve only retail investors. They pointed to data showing that withdrawals in the weeks following Reserve Primary’s demise were concentrated in prime institutional funds.
The proposal also appears to favor ideas championed by asset manager BlackRock Inc., which called for allowing funds to maintain their $1 share value while imposing a 1 percent fee on withdrawals when a fund’s weekly liquidity dropped below half the required level.
Federated Investors Inc., the third-largest manager of U.S. money-market funds, said last year it would sue to block changes contemplated by the SEC. Federated has said a floating net-asset value would destroy the value of money funds and lead to a substantially smaller industry.
Meghan McAndrew, a Federated spokeswoman, said the Pittsburgh-based fund company believes the SEC’s 2010 reforms were sufficient to improve the transparency and strength of money funds.
“You have a lack of consensus about whether there is an issue that needs to be resolved and how it needs to be resolved,” said Barbash, co-chairman of the asset management practice at Willkie Farr & Gallagher LLP. “That is what makes this an extraordinarily difficult environment in which to do a rule.”