Given a choice between a regulator whose mission is to promote growth through investment, or an unfamiliar committee dominated by the Federal Reserve, the mutual-fund industry opted for the devil it knew.
The threat of regulation by the Financial Stability Oversight Council, an umbrella group charged with monitoring regulators’ blind spots, encouraged fund companies to negotiate with the Securities and Exchange Commission on new rules for money-market mutual funds that were approved yesterday. The strongest provisions affect funds that hold about one-third of the industry’s assets, while those catering to retail investors and holding U.S. government securities were exempted.
The Investment Company Institute, a lobbying group of fund sponsors that two years ago said it was “pleased” when the SEC failed to advance similar changes, saluted the SEC for striking “the proper balance” and “preserving the utility and value of these funds for investors.” Money-fund sponsors such as BlackRock Inc. and Charles Schwab Corp.’s asset-management arm also embraced the rules, which exempted a large swath of the industry from the biggest changes.
“Probably some in the industry wanted nothing to happen, and those folks saw the FSOC’s letter and realized, ‘Gee, if it didn’t happen at the SEC, it would happen elsewhere,’” said Commissioner Daniel M. Gallagher, a Republican who supported the new rules. “So, better to engage the SEC.”
The council should get credit for prompting the SEC to take action, said Treasury Secretary Jacob J. Lew, who leads the oversight group.
“The FSOC came together, identified an unaddressed risk to financial stability, and encouraged the relevant regulator to take action,” Lew said in a statement yesterday. “While the SEC’s reforms will require careful consideration and continued monitoring of their effectiveness in addressing risks to financial stability, the SEC’s final rule is a significant step forward.”
Money funds are products that many investors and corporations treat like bank accounts that aren’t subject to market fluctuations. They play a key role in funding markets because they purchase short-term debt issued by corporations, governments and other borrowers that need cash to fund payrolls and other expenses.
The oversight council, established in the wake of the 2008 financial crisis, issued recommendations for reforms in 2012 that included imposing market-based pricing on money funds or requiring them to hold capital against losses. Gallagher helped to revive the debate over new rules by saying in September 2012 he would support a measure forcing the industry to abandon its marquee $1 share price.
The council has kept up pressure on the SEC to finish its rules by examining whether money-fund sponsors such as BlackRock and Fidelity Investments pose a systemic risk to the financial system. Such a designation can lead to stiffer regulation by the Fed. The SEC’s action should reduce the likelihood that the council takes that step, Gallagher said in an interview this week.
“They would be hard pressed seeing us take one of the options from the letter that was sent to the SEC, going final with it, and not saying we have taken that issue off the table,” Gallagher said.
The SEC’s work on new regulations for money funds dates to the September 2008 collapse of the $62.5 billion Reserve Primary Fund, which triggered a run on other money funds and helped freeze credit markets. In response, the Treasury Department temporarily guaranteed shareholders against losses and the Fed began buying fund assets at face value to help them meet redemptions.
The SEC’s new rules try to reduce that risk by giving funds the ability to slow runs by levying fees on withdrawals and locking up investors’ money for as long as 10 days.
The rules also require funds to allow their share prices to float, one option recommended by the FSOC. The measure was limited to the riskiest funds, those that primarily invest in corporate debt. The rules exempt funds that didn’t experience runs in 2008, such as those used by retail investors and ones that primarily invest in government debt.
The SEC says a floating share price will make investors less likely to pull out cash when a fund declines in value because they wouldn’t want to sell at a loss.
“Today the FSOC has proven its importance by pushing the SEC to regulate money-market funds when it was unwilling in the past,” Representative Maxine Waters, a California Democrat, said in a statement.
Critics of the SEC’s rules say a floating share price will do little to discourage runs because shareholders will be tempted to pull cash when they think a fund will lock up their money. The SEC should have advanced earlier proposals to require money funds to hold capital that would help them absorb losses on their holdings, these critics say.
Other regulators on the 10-member oversight council should pick up their earlier recommendations and potentially designate the largest money funds as systemically important, Columbia Law School professor Jeffrey N. Gordon said.
“The SEC’s rule adoption today regarding money-market funds is the single most discouraging regulatory action taken post-crisis,” Gordon said in an e-mail. “Strong industry pressure, an administrative agency that is focused on turf protection for the benefit of its industry clients, and short- sighted leadership will open the door for the next financial crisis.”
Pittsburgh-based Federated Investors Inc., which earns 40 percent of its revenue from money funds according to Moody’s Investors Service, told the SEC that a move to market-based pricing will kill demand for the products. Republican Commissioner Michael S. Piwowar voted against the rules yesterday, saying that 95 percent of the comment letters received by the SEC “generally opposed the floating-NAV proposal.”
The rules include an agreement with the Treasury and Internal Revenue Service to relieve the tax burden from investing in a fund whose share price can change. Investors will only have to account for gains and losses once a year, instead of tracking all the prices at which they buy or sell. “This is tough medicine in general,” Gallagher said. “But we have done a really terrific job of addressing many of the concerns we heard in the comment letters to try to make this still a viable product for investors.”