Money Fund Dealmaking Resumes After Geithner Breaks Logjam
One month ago, a U.S. Securities and Exchange Commission proposal to tighten rules for the $2.6 trillion money-market mutual fund industry was declared dead. Now, it’s coming back to life.
The revival was sparked by Treasury Secretary Timothy F. Geithner, who added fuel to a new round of dealmaking among regulators, funds and banks when he used the 2010 Dodd-Frank Act to force the issue back onto the SEC’s agenda.
The money-market mutual-fund industry, which provides critical short-term financing for companies and financial firms, pushed against the rules in the first round and could still be successful in derailing them, analysts said.
Regulators “are still in the game. They found a way to keep this one alive,” said Stephen Myrow, managing director at ACG Analytics Inc., an investment research firm in Washington. “That doesn’t necessarily mean that proponents of strong reform will get what they want in the end.”
SEC Chairman Mary Schapiro last month gave up on a plan to strengthen regulation of the funds after three of the agency’s five commissioners told her they opposed it. One of those commissioners, Daniel Gallagher, said this week that he probably would vote for a new version.
Geithner’s move -- his first under Financial Stability Oversight Council powers created by Dodd-Frank -- puts the ball back in the SEC’s court. If the SEC doesn’t pass new rules, Geithner said in a letter yesterday, FSOC should designate activities of money market funds a systemic threat, effectively ordering the agency to take action.
FSOC, a panel of regulators led by Geithner, voted today to move closer to designating some non-bank financial companies as systemically important, the Treasury Department said in a statement. “The council also discussed ongoing efforts to support reform of money-market mutual funds and has asked staff to work on a recommendation for the council to consider at its November meeting,” the agency said.
The council also has the authority to designate individual firms or their payment, clearing and settlement activities as systemically important, which would put them under heightened government supervision.
Geithner recommended that the SEC consider three steps to reduce the risk funds might pose to the financial system: floating net asset values, requiring funds to hold capital buffers of “adequate size,” and imposing capital and enhanced liquidity standards, possibly with redemption fees. The changes are similar to those proposed by Schapiro.
The SEC is already laying the ground for compromise and passage of a new plan. In response to a request on Sept. 17 from the three commissioners, SEC staff members have begun studying whether the rules could disrupt money market funds and short- term credit markets, according to two people familiar with the matter. The study could be completed within six weeks.
“People have to come back to the table and talk about the issue and be willing to put something out for public comment and debate,” Schapiro said today in an interview with Trish Regan on Bloomberg Television’s “Street Smart.” The SEC is “willing to engage with the industry and see if we can find a way forward.”
The SEC, along with the Fed and Treasury Department, has pressed to make money funds safer since the September 2008 collapse of the $62.5 billion Reserve Primary Fund, which triggered an industrywide run and helped freeze credit markets. The crisis calmed only after the Treasury guaranteed shareholders against losses and the Fed began buying fund assets at face value to help meet redemptions.
Schapiro has argued that the funds’ $1 share price encourages investors to flee at the first sign of trouble because those who act quickly can sell shares at $1 each even if the net asset value has dropped below that level. Her proposal offered two options: a capital buffer combined with some limits on redemptions, or a floating share price.
“The chairman has long believed that addressing the susceptibility of money market funds to destabilizing runs is a critical piece of unfinished business from the financial crisis,” John Nester, an SEC spokesman, said in a statement.
While the fund industry has been united in its general opposition to Schapiro’s plan, individual companies have staked out different positions on the options and made varying overtures to the SEC on what new rules might be acceptable.
New York-based BlackRock Inc. (BLK), the world’s biggest asset manager, released a new proposal today, a signal that some firms are still actively looking for a resolution. The plan, detailed in a note sent to clients and regulators, backed the concept of redemption “gates” included in Geithner’s letter.
BlackRock suggested that funds be authorized to impose “standby liquidity fees” when their net asset value dipped below $.9975 -- half-way to breaking the buck -- or if its seven-day liquidity fell below 7.5 percent. Liquidity represents the portion of a fund that can be paid out to clients in cash without selling securities in that period.
The company also recommended that some of the SEC’s 2010 changes, which tightened rules on asset quality, maturity and liquidity, be applied globally.
In the paper, BlackRock repeated its earlier position that the fund industry could survive with a floating share price provided that market pricing was applied only to some securities and the Internal Revenue Service agreed not to treat price fluctuations as taxable events. Still, the firm said it wouldn’t protect investors if there were mass withdrawals.
Talks between the SEC and the Investment Company Institute, the mutual fund trade group, broke down in December 2011. Executives from BlackRock, Vanguard Group Inc. and JPMorgan Chase & Co. (JPM) briefly revived discussions in May.
“I think the likelihood is that some compromise will emerge,” Joan Swirsky, an attorney at Philadelphia law firm Stradley, Ronon, Stevens & Young LLP who specializes in money fund oversight, said in an interview.
Regulators including Geithner have coordinated in pressuring SEC commissioners to tighten regulations of the funds. With Schapiro struggling to find support for her nearly 400-page proposal, at least two commissioners who opposed the plan received calls from Gary Gensler, chairman of the Commodity Futures Trading Commission, according to two people familiar with the matter.
Still, a week before the scheduled Aug. 29 vote, Schapiro was forced to give up on her plan when the three commissioners - - Republicans Gallagher and Troy Paredes and Democrat Luis Aguilar -- told her they wouldn’t vote for it. In a statement that day, she urged “other policy makers” to take up the issue instead -- a comment widely understood as referring to FSOC, established by Dodd-Frank as a cross-regulator to protect the economy from systemic crises.
The potential danger posed by money funds, Schapiro said, was too important to “put our head in the sand and wish it away.”
That statement sparked a flurry of public barbs among SEC commissioners. Gallagher, Paredes and Aguilar said the agency lacked needed data and analysis as a basis for new rules and put in a formal request for further study on Sept. 17.
Three days later, Schapiro wrote an opinion piece in the Wall Street Journal calling on the FSOC, -- which includes the SEC, CFTC and is headed by the Treasury -- to take action.
If FSOC formally recommends action on money market funds, the SEC would then have 90 days to impose standards or explain to Congress in writing why it failed to move.
“Secretary Geithner seems determined that something’s going to get done, one way or another,” Swirsky said.
An FSOC move toward designating funds and fund companies as systemically important effectively encourages regulators to supersede the SEC’s oversight of money funds and subject them to direct regulation by the Fed in the event the SEC rejects the recommendations.
That option could attract legal challenges.
“FSOC’s path is fraught with peril,” Peter Crane, president of fund research firm Crane Data LLC, said in an interview. “It’s unclear they have the authority to do this.”
Lawmakers and industry officials have said they prefer the SEC resolve the issue without relying on FSOC.
“While we want to work with all policy makers, we believe the SEC is best situated to deal with money-market funds,” Vincent Loporchio, a spokesman for Boston-based Fidelity Investments, the largest U.S. money-fund provider, said in an interview.
Paul Schott Stevens, president of the Investment Company Institute, said funds would continue to oppose any regulation.
“The money-market fund proposals Secretary Geithner presents to the FSOC already have been the subject of extensive analysis and commentary,” Stevens said in a statement. “These proposals have elicited strong opposition for their adverse impacts on investors, issuers and the economy.”
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