UPDATE 1-NY Fed report aims to end money fund reform stalemate

Mon Oct 15, 2012 6:09pm EDT

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By Ross Kerber

Oct 15 (Reuters) - Money market mutual funds could delay full redemptions from customers at all times, researchers at the Federal Reserve Bank of New York suggested on Monday, fleshing out one of the latest ideas that could break a stalemate over regulating the $2.5 trillion industry.

Under the proposal, funds would make a small fraction of every investor's balance in a money fund subject to delayed withdrawal at all times in what the authors called a "minimum balance at risk," or MBR.

The idea drew opposition from the fund industry's main trade group, however.

U.S. regulators have been trying in vain to tighten rules affecting money fund investors in the wake of the 2008 financial crisis, when dozens of funds ran into trouble and needed backing from their sponsors and the government. The industry maintains that more stringent fund investing rules added in 2010 are sufficient.

The new plan published in a blog post by two Fed economists and two other Fed officials would motivate investors to look closely at a fund's riskiness before putting in money, the four wrote. That would be an advantage over proposals to restrict redemptions only when funds come under stress, the report added.

The minimum balance could be five percent of an investor's highest balance over the previous thirty days, for example, they said. The MBR "would strengthen incentives for early market discipline," according to the proposal outlined on the New York Fed's Liberty Street Economics blog.

The authors include Marco Cipriani, senior financial economist at the New York Fed, plus two other officials at the bank and a senior economist for the Fed's Board of Governors.

A similar idea was raised in an opinion piece by New York Fed President William Dudley in the middle of August, based on a prior research paper by the four.

At the time, Securities and Exchange Commission Chairman Mary Schapiro was weighing whether to issue for comment several other possible regulatory solutions.

But a week later three of the SEC's five commissioners sided with the industry and stopped Schapiro from moving forward with the proposal. The proposal would have required money funds to either abandon the $1-per-share net asset value many investors prefer, or put in place capital buffers and redemption restrictions to cope with rapid withdrawals.

That left the issue to the Financial Stability Oversight Council chaired by U.S. Treasury Secretary Timothy Geithner. In a letter on Sept. 27 he urged the council to consider reforms, including the "minimum balance at risk" idea.

In the blog post on Monday, the New York Fed group said a main advantage of their idea is that during times of stress, it gives investors an incentive to stay with a fund.

Also, "retail investors, who traditionally have been less quick to run from distressed funds, would enjoy greater protection if they don't run" from a troubled fund, the Fed group wrote.

The minimum balance at risk idea would work well in tandem with a capital buffer for the funds, they added.

Asked about the New York Fed proposal, a spokeswoman for the Investment Company Institute in Washington, the fund industry's main trade group, said in an e-mailed statement that it could make money funds less appealing.

The minimum balance at risk concept "is essentially a redemption freeze that bars investors from accessing all of their cash when they want it. Surveys of money market fund investors have shown that the product would become unattractive to them if a daily redemption freeze were implemented," said spokeswoman Rachel McTague.

That could dry up a major source of funding for businesses and public-sector debt issuers, she said.

She added that the Fed did not address the operational complexities of the change.

Also, she said: "A daily redemption concept is one that a majority of Commissioners at the SEC have opposed, so recycling an idea from July that's already met strong resistance doesn't seem to help the debate."

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