U.S. Treasury weighs money fund reforms, faces hurdles
BOSTON/WASHINGTON (Reuters) - The U.S. Treasury Department is consulting with other regulators about next steps to add protections to the $2.4 trillion money market fund industry, but faces an uphill battle after industry pressure and internal dissension defeated a reform proposal at the industry's primary regulator.
Mary Schapiro, the head of the U.S. Securities and Exchange Commission, late on Wednesday said she had failed to win enough support at her agency to advance reforms, which had faced fierce opposition from fund companies and their allies.
The issue has been kicked to the newly formed Financial Stability Oversight Council, a group of leading regulators chaired by the Treasury Secretary.
"Treasury is in the process of consulting with the Federal Reserve Board, the Securities and Exchange Commission and other regulatory agencies to consider the appropriate next steps to reduce risks to financial stability from money market funds," Treasury spokeswoman Suzanne Elio said in a statement.
But legal analysts say FSOC will have to overcome the same industry forces that turned back the SEC plan, and it has less clear authority over fund matters.
Also, because the group is chaired by Treasury Secretary Timothy Geithner, the upcoming presidential election could change FSOC's focus before it has time to act.
Boston University law professor Cornelius Hurley said he believes Geithner lacks the time and the focused motivation it would take to drive through controversial reforms before his tenure is up.
"If it's Romney making the appointment, the issue is dead," added Hurley, who served as assistant general counsel at the Federal Reserve under Paul Volcker.
A Treasury spokeswoman had no comment on Hurley's remark, but Geithner has advocated for reforms.
Republican Presidential candidate Mitt Romney's campaign has not responded to questions about money funds this week.
Money funds were long a sleepy corner of the fund industry, collecting money from investors and serving as leading buyers of short-term debt from corporations, municipalities and the U.S. government.
But in September of 2008, the Reserve Primary Fund, one of the largest money funds, suffered losses on Lehman Brothers debt and could not maintain its $1 per share price, known as "breaking the buck."
That ignited a run of withdrawals from investors across the industry, cutting off a major source of overnight funding for many corporations. The run did not abate until the government stepped in to back the funds.
In the aftermath, Congress took away the authority for such backing in the future and the SEC, in 2010, approved rules tightening credit and maturity limits for money fund investments.
SEC's Schapiro and other regulators said further regulation was needed to prevent future runs on the funds from disrupting the financial system. But on Wednesday, she conceded she did not have the votes among fellow commissioners to get her preliminary proposal issued for public comment.
Luis Aguilar, the commissioner seen as the swing vote, said there remained too many unknowns to feel confident new rules would not spook investors away from money funds, which play a central role in financial markets.
The Schapiro-backed plan offered two alternatives. One would have required funds to set aside capital against future losses and restricted customer withdrawals at times of stress. The other would have stopped funds from keeping their net asset value share price pegged at $1 and instead required floating share prices.
Ending the SEC effort "provides the needed clarity for other policymakers as they consider ways to address the systemic risks posed by money market funds," Schapiro said in a statement on Wednesday. "I urge them to act with the same determination that the staff of the SEC has displayed over the past two years."
Members of the Fed's Board of Governors, from Chairman Ben Bernanke on down, have warned that money funds continue to pose a risk to the financial system and called for further regulation. A spokeswoman for the Fed, a member of FSOC, declined to comment on Thursday.
FSOC has mainly focused on improving regulation of the largest banks in its short two-year life thus far. The group did offer possible criteria for regulating some money managers when it issued guidelines in April for naming non-banks as "systemically important financial institutions."
The FSOC could formally dub certain individual large funds or possibly fund managers as systemically important, which would subject them to greater regulatory oversight and even capital requirements. A two-thirds majority is required to make such a designation.
It is unclear whether or not the FSOC has the votes to take such an action, but many of its banking regulator members as well as Schapiro have all been vocal supporters of imposing more rules on the money market funds.
The FSOC could also take an alternative approach by applying pressure on the SEC to act. Under one measure in Dodd-Frank, sometimes referred to as the "name and shame" provision, the council can issue recommendations to the SEC calling for more stringent oversight of money market funds.
If the FSOC decided to invoke that provision, it would be the first time in its brief history. The law would then require the SEC to either comply with FSOC's request, adopt similar standards or formally reject the request in writing within 90 days. FSOC would then need to report back to Congress.
The council's lack of a long track record or extensive rulemaking proceedings would be a hurdle if it moves forward to regulate money market funds, according to Robert M. Kurucza, partner at the law firm Goodwin Procter LLP.
The group's members have "a heartfelt and legitimate concern" about potential risks to the financial system, Kurucza said. But the regulatory procedures for new rules from the FSOC are "not crystal clear exactly" and would be certain to face a stiff legal challenge from the industry, which previously threatened to sue if the SEC moved forward, he said.
An FSOC effort would be moving into "uncharted territory," warned industry attorney Stephen Keen, former general counsel at Federated Investors, one of the leading money market firms.
The fund industry was quick to declare victory after the SEC's failure to move forward.
"Fund shareholders and the economy benefit from the fact that there is no current plan for further regulation of money market mutual funds," Fidelity Investments, the largest manager of U.S. money market funds, said in its own statement.
BlackRock, the world's largest asset manager, had previously discussed a possible compromise on new rules. The New York-based firm declined to comment on Thursday.
Apart from the FSOC itself, some banking regulators like the Federal Reserve could try to take matters into their own hands.
While Schapiro's SEC plan was the "preferable" route, bank regulators could also contemplate "second best alternatives" such as setting new limits on banks' reliance on funding provided by money market funds, Federal Reserve Board Governor Daniel Tarullo said in a June 12 speech.