New money fund rules could speed consolidation

BOSTON (Reuters) - Tough rules being considered for the U.S. money-market mutual fund industry, intended to reduce risk, could unintentionally do the opposite by stoking another round of consolidation in the $2.6 trillion industry.

The rules proposals, which could still be rejected or modified by commissioners at the Securities and Exchange Commission, are aimed at stopping problems at money funds from spreading throughout the financial system, as happened in the 2008 credit crisis.

The agency is considering requiring that funds set aside capital against losses, restrict a portion of withdrawals and eliminate fixed share prices. [ID:nL2E8D78IG] [ID:nL4E8D769N]

But by raising the costs of running funds, the new rules are also likely to prompt more smaller managers to get out of the business. That added consolidation could raise the risks that are already developing as money shifts to the largest funds.

"The direction we're going actually makes it more likely that any money market player that survives this is going to be too big to fail," said Roger Joseph, co-chair of financial services at the Bingham McCutchen LLP law firm.

Regulators must now judge whether it is worth accelerating the consolidation trend with the new rules. Many executives in the industry say the rule proposals would benefit larger players that could best afford capital buffers and other fixes.

"Everyone realizes this could create some consolidation if the SEC goes ahead with new rules," said Robert Deutsch, head of global liquidity for JPMorgan Asset Management, a unit of JPMorgan Chase & Co and the second-largest money fund manager. The bank ran $272.5 billion of money funds at the end of 2011, according to Lipper, a Thomson Reuters unit.

At a much smaller firm, Burnham Securities Inc in New York, which oversaw just $144 million at the end of 2011 according to Lipper, low interest rates are already causing pain.

"The earnings from the investments barely cover the expense ratio when interest rates are at zero percent and firms wind up subsidizing the funds," vice-president Debra Hyman said. Proposals like capital buffers "would be extremely burdensome for the small firms," she said.

Even without new rules, fears over a European debt crisis are also driving investors into the largest funds. Flows of investor cash used to be similar across fund companies of all sizes. But the pattern has broken lately as the largest players take in more cash while smaller ones trail.

Burnham had $180 million flow out of money funds in the last quarter of 2011, Lipper found. Hyman said outflows were due to an internal reorganization and to clients moving assets from its government money fund to equities and bonds, or to prime money funds with higher yields run by other companies.

THE BIG SIX

The industry's six largest fund sponsors, including Fidelity Investments, JPMorgan Chase and Federated Investors Inc, took in $50.4 billion in the fourth quarter, according to Lipper. The six companies accounted for about half the industry's assets; the rest of the industry took in just $6.6 billion in the quarter.

One reason could be that the big managers are seen as best able to back their funds in a time of crisis, said Adi Sunderam, assistant professor at Harvard Business School. The flow patterns "are consistent with investors preferring large funds because they have the ability to provide support in case of a run," Sunderam said.

Investors may share some of the SEC's concerns about fund safety because many money fund sponsors during the credit crisis had to use their own capital to prevent shareholders from experiencing losses. The Federal Reserve and Treasury Department also stepped in with backing after one of the industry's largest funds, the $65 billion Reserve Primary Fund, "broke the buck" and allowed its net asset value to drop below $1 in 2008.

Robert Plaze, deputy director of the SEC's division of investment management, in an interview last week acknowledged the broad trend of the big getting bigger. "There seems to be growing concentration among fund sponsors," he said.

Plaze said a separate question, one he could not yet answer, is whether institutional investors might favor money funds sponsored by larger banks that unlike pure asset managers have balance sheets they could tap to back up funds if necessary.

STAYING LIQUID

Top industry executives have argued that no new rules are needed. Reforms adopted in 2010 that tightened credit quality and imposed a new liquidity requirement were plenty, they say. In addition, they point to last summer when all funds met withdrawals by investors worried about a possible U.S. default due to congressional wrangling over the debt limit.

Plaze acknowledged the funds stayed liquid but said last summer's test was incomplete for two reasons. The U.S. avoided a default with a political budget deal that ended the pressure, and the withdrawals were orderly, in contrast to the crisis days of 2008 that amounted to an investor run on the funds.

"You didn't have a run," Plaze said.

The money market industry has become increasingly concentrated over the past decade. The number of money market funds declined to 632 at the end of 2011, as some 20 funds were shuttered just last year, according to asset-management trade group, the Investment Company Institute. The number of funds in the industry has shrunk by over 65 percent since peaking in 1999.

Fidelity was the largest U.S. money fund sponsor at December 31 with $434.7 billion in the funds, followed by JPMorgan Chase, with $272.5 billion, Lipper found.

(Reporting By Ross Kerber; Editing by Aaron Pressman and Tim Dobbyn)