Third Avenue Bust Won't Keep Funds From Fighting SEC Safeguards

  • Vanguard opposed to disclosing time needed to sell assets
  • ICI says agency's cash cushion requirement is misguided

The failure of a high-yield bond fund at Third Avenue Management LLC isn’t stopping financial firms like Vanguard Group Inc. from arguing that the mutual fund industry doesn’t need a slew of new regulations to protect investors during market routs.

The industry’s regulator, the U.S. Securities and Exchange Commission, proposed requirements in September to ensure funds have more easy to sell assets to meet withdrawals amid turmoil. The worst fears of regulators were realized last month when Third Avenue blocked clients from pulling their money from a $788.5 million fund because it couldn’t meet redemptions without selling holdings at steep discounts.

In a letter to the SEC on Wednesday, Vanguard urged the agency to reconsider its measures. The asset manager, which handles about $3.3 trillion, called for the SEC to withdraw its proposal for funds to disclose how many days it would take them to sell every asset they own at a fair price.

The Investment Company Institute, the fund industry’s lobbying group, is also opposed to the SEC’s approach, David Blass, the ICI’s general counsel, said in an interview. He said they’re too cumbersome and could create hurdles for high-yield bond funds to carry out bona fide investment strategies. While the SEC should update its approach to overseeing how funds manage liquidity risk, key elements of the regulator’s plan, including a call for funds to hold a minimum cushion of cash or cash-like investments that can be sold within three days, are misguided, Blass said.

The SEC’s plan was issued after the Federal Reserve and International Monetary Fund warned that some funds with riskier holdings could struggle to return cash to investors during a surge in redemption demands. A hallmark of the $18.2 trillion mutual-fund industry is that investors can expect to easily sell their shares back to the fund and receive their cash within seven days.

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The proposal also would give mutual funds the choice of using swing pricing, which would permit them to pass on trading costs to investors who cash out during periods of market stress. John Nester, a spokesman for the SEC, declined to comment on the industry letters, citing a quiet period that the agency observes while a regulatory plan is out for public review.

It’s unclear how willing the SEC will be to water down its proposal, which could be adopted as a final rule later this year. Some agency officials have taken a critical view of what they describe as excessive risks building up in mutual funds. SEC Commissioner Kara Stein, a Democrat, last year questioned whether some funds, including those that principally invest in bank loans, are buying too many assets that should be deemed illiquid.

Executives at Fidelity Investments including Joseph DeSantis, chief investment officer for equities, met with Stein as well as Republican Commissioner Mike Piwowar last month to discuss the SEC’s proposal, according to the agency’s meeting records. Adam Banker, a Fidelity spokesman, declined to comment on what the executives told Stein and Piwowar.

Vanguard said in its comment letter that the requirement to classify how many days it would take to sell all a fund’s holdings is too subjective and could mislead investors “by implying a degree of precision” that doesn’t exist.

Funds probably wouldn’t use the three-day buffer to meet withdrawals and instead, many would probably treat those assets as a minimum capital buffer that couldn’t be touched, according to ICI’s Blass.

“It wouldn’t be helpful in stress situations and ultimately could result in funds not being buyers in situations where it’s very attractive for the funds to do so,” he said.

More industry criticism of the plan, including letters from the ICI, whose members include Fidelity and BlackRock Inc., is expected next week before the comment period ends.

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