The presidents of all 12 Federal Reserve regional banks backed tougher oversight of some money-market mutual funds to strengthen the financial system, saying one alternative is to replace the fixed $1 share price with a market-based value.
The Fed’s regional bank chiefs said in a joint letter to the Financial Stability Oversight Council that their recommendations focus mainly on prime funds, which are those that can buy corporate debt, because they are subject to the greatest credit risk.
“We agree with the council’s proposed determination that the conduct, nature, size, scale, concentration and interconnectedness of MMFs’ activities and practices could create or increase the risk of significant liquidity and credit problems spreading among bank holding companies, nonbank financial companies and the financial markets” of the U.S., the Fed regional bank presidents said in a letter dated today.
“For this reason, we support the council’s efforts to address the structural vulnerabilities” of the funds, the central bank officials said in a letter released by the Boston Fed.
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 FSOC, a risk-monitoring panel that includes the heads of the Fed and the Treasury Department.
The Fed presidents’ letter “runs up the numbers for the voices in favor of reform,” said Peter Crane, president of Crane Data LLC, a research firm in Westborough, Massachusetts. “The handful of regulators that do seriously believe reforms would do more good than harm are looking for more voices to join them.”
Still, without a new SEC chairman or U.S. Treasury Secretary in place, it’s “mystifying” how regulators can achieve significantly stronger oversight, Crane said.
Timothy F. Geithner in January ended his term as Treasury Secretary, a post that includes leadership of FSOC. While the Treasury has said the SEC is best suited to oversee money funds, the FSOC could subject funds to Fed oversight by individually designating them as important to financial stability.
“It’s far from a done deal” and “both sides are having an easy time criticizing one another,” Crane said. “It’s a decent bet that nothing’s going to happen until you get new chairpeople in both of those roles.”
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 Holdings Inc., triggered a wider run on prime funds that helped freeze global credit markets.
“As currently structured, MMFs provide a stable price at which an investor may purchase or sell an interest in the MMF, but MMFs have no explicit loss-absorption capacity,” the Fed bank presidents said in the letter. “By allowing redemptions at a constant share price rather than at a share price reflecting the current market value of the underlying portfolio assets, MMFs give investors a financial incentive to redeem before others during times of stress. As such, reforms are necessary.”
Money managers have said allowing a floating net asset value would destroy the appeal of money funds, which are often used as a substitute for holding cash.
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. 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.
The Fed regional bank presidents offered the first reaction from regulators to an industry plan proposed in October that would seek to bolster money funds by imposing withdrawal restrictions on funds under stress.
“These mechanisms, as proposed by some industry participants, do not meet reform requirements,” they said in the letter.
Fund companies, including BlackRock Inc. and Fidelity Investments, presented their plan to SEC commissioners as a substitute for FSOC’s proposals. Industry leaders believe the council’s recommendations would destroy the attraction of money funds to investors and deny borrowers a cheap source of short-term funding.