Money Funds Retreat as U.S. Managers Work to Limit Rules
Three of the five largest U.S. money-market fund managers, signaling they can’t stop a second attempt by regulators to overhaul rules for the $2.7 trillion industry, are fighting instead to limit the scope of any changes.
Fidelity Investments, Vanguard Group Inc. and Charles Schwab Corp. (SCHW) are urging regulators to exempt retail-oriented funds and focus on those that cater to institutional clients and buy corporate debt, a category that absorbed the bulk of an investor run in 2008. Known as prime institutional funds, they hold $987 billion, or 37 percent of U.S. money-market mutual- fund assets, according to research firm iMoneyNet.
“It’s a clear sign the funds believe regulation is coming, and there’s no doubt they’re hedging their bets,” Peter Crane, president of Westborough, Massachusetts-based research firm Crane Data LLC, said in an interview.
Five months after beating back a regulatory plan by then- Chairman Mary Schapiro of the U.S. Securities and Exchange Commission, fund companies acknowledge they face longer odds in blocking a similar proposal expected to reach SEC commissioners before the end of March. The agency is being pressed to reconsider changes by the Financial Stability Oversight Council, or FSOC, a risk-monitoring panel that includes the heads of the Federal Reserve and Treasury Department.
“It now appears that further regulation of all or some types of money-market funds sometime in 2013 is very likely,” Boston-based Fidelity said this month on its website in an update on the regulatory debate.
Fidelity last week drew regulators’ attention to data showing funds that cater to small investors, and those that invest solely in municipal or U.S. government-backed debt, were more stable than institutional prime funds. In the four weeks after the bankruptcy of Lehman Brothers Holdings Inc., retail funds had $41 billion in withdrawals compared with $453 billion from institutional funds, according to the letter.
“If, based on findings from its study, the SEC determines that further reform is necessary, then such reform should be narrowly tailored, so as to minimize disruption to short-term markets and lessen adverse impacts on long-term economic activity,” Fidelity, the largest U.S. money fund manager, wrote in a Jan. 24 letter to the SEC.
Vanguard, based in Valley Forge, Pennsylvania, made a similar appeal in a letter to the FSOC on Jan. 15. After detailing its objections to FSOC drafts, the firm, which ranks fourth in the market, recommended that any final proposal apply only to prime institutional funds.
No. 5 Schwab, based in San Francisco, went further in a Jan. 17 letter to the FSOC, saying the idea of forcing prime institutional funds to abandon their fixed $1 share price in favor of a floating value “merits consideration.”
Money managers have asserted that allowing a floating net asset value would destroy the appeal of money funds, which are often used as substitute for holding cash.
Fidelity has 36 percent of its money-fund assets in products categorized as institutional prime by iMoneyNet, which is based in Westborough, Massachusetts. Vanguard has 15 percent and Schwab 3.3 percent.
JPMorgan Chase & Co. (JPM), which holds 46 percent of its money fund assets in institutional prime funds and runs some of the largest such products, argued against applying rules only to some funds in a Jan. 14 letter to the FSOC.
“Importantly, reforms should apply to both institutional and retail funds since there is no difference in terms of exposure to credit risk between these two classes of investor,” wrote JPMorgan, the second biggest U.S. provider.
JPMorgan spokeswoman Kristen Chambers declined to comment.
“The industry is battle weary and some firms are presenting various options in order to make the issue go away,” Anthony Carfang, a partner at Chicago-based consulting firm Treasury Strategies Inc., said in a telephone interview. “There seems to be an element of self-interest and a willingness to throw competitors under the bus.”
Regulators have worked to impose tighter restrictions on money funds since the September 2008 collapse of the $62.5 billion Reserve Primary Fund. Its failure, caused by losses on debt issued by Lehman Brothers, triggered a wider run on prime funds that helped freeze global credit markets.
The Schapiro-led SEC made changes in 2010 that introduced minimum liquidity levels, lowered maturity limits and raised credit standards. Schapiro said funds remained vulnerable to destabilizing runs because their fixed share prices don’t necessarily reflect the market value of their holdings. Shareholders are then encouraged to flee at the first sign of trouble before the $1 share price collapses, as it did in the rare case of Reserve Primary.
Regulators have pointed to events during the global financial crisis in 2008 to show that big institutions had an information advantage over smaller investors in money funds, allowing them to react more quickly to market developments. Withdrawals by institutional investors were more consequential than those by individuals.
“Some of the fund companies have come around to see the SEC has identified at least one issue that may need some additional regulations,” Barry Barbash, head of the asset- management group at law firm Willkie Farr & Gallagher LLP and a former director of the SEC’s investment-management division, said in an interview from Washington.
Fund companies cast doubt on the notion of applying new rules only to institutional funds when the idea was examined in an October 2010 report from the President’s Working Group on Financial Markets. They said it would be impractical to draw a line between institutional and retail funds as there was no regulatory distinction between them and much client cross-over.
In their letters, Vanguard and Schwab offered proposals on how to differentiate between the two based on the size of client accounts, either as a dollar amount or as a proportion of a fund.
Schapiro drafted new rules last year that would have required that funds either adopt a floating share value or set aside capital to protect against losses and restrict redemptions to discourage runs. Industry leaders, including executives from Fidelity, Vanguard and Schwab, said the new rules would cripple sales and deny companies and municipalities a cheap source for short-term borrowing.
Led by their Washington-based trade group, the Investment Company Institute, the industry lobbied heavily against the plan. The 10 biggest money-fund managers and the ICI reported combined lobbying spending of $16 million in the first half of 2012 and $31.6 million in 2011 in disclosures that referenced money-market mutual funds, according to a review of documents by Bloomberg News. That compared with $16.7 million during all of 2010.
The efforts appeared to pay off when three SEC commissioners told Schapiro in August they wouldn’t approve her plan and wanted to see additional study of the issue. Schapiro shelved the proposal and turned to the FSOC, a panel charged under the 2010 Dodd-Frank Act with monitoring systemic risks to the financial system, to intervene.
The FSOC issued draft recommendations to the SEC in November that included the central elements of Schapiro’s plan. Once the recommendations are final, the SEC will have 90 days to adopt rules or explain in writing why it rejected the advice.
Schapiro resigned in mid-December. President Barack Obama last week nominated Mary Jo White, a formal federal prosecutor, to head the agency.
Republican Commissioner Daniel M. Gallagher said in a Jan. 16 speech that SEC staff were already preparing a rule-making proposal he expected to see before the end of March. Gallagher, one of the three commissioners who blocked the Schapiro plan, said in September he may support a floating share value.
Democratic Commissioner Luis A. Aguilar, another holdout, said in a December interview that a floating value “may make sense” after an SEC report allayed his concern that the agency’s 2010 reforms hadn’t been sufficiently studied.
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