WASHINGTON The financial risk council rolled out a framework of new rules for the $2.5 trillion money market fund industry on Tuesday, saying current regulations are not enough to prevent runs in a time of crisis.
The Financial Stability Oversight Council's proposal largely mirrors a plan championed this summer by Securities and Exchange Commission Chairman Mary Schapiro, but it failed to garner enough support from three of her colleagues.
The proposal by the FSOC, a council of federal financial regulators created by the 2010 Dodd-Frank reform law and chaired by Treasury Secretary Timothy Geithner, could pressure the SEC to agree on a course of action.
The recommendations are not binding and Geithner indicated the council would suspend its work should the SEC reach an agreement on its own.
Regulators said money fund reforms remain a key piece of unfinished business after the 2007-2009 financial crisis.
During the crisis, heavy exposure to collapsed investment bank Lehman Brothers caused the Reserve Primary Fund's net asset value to fall below $1 per share, or "break the buck" in industry parlance.
"Some basic vulnerabilities in the design of money market funds helped accelerate the financial crisis of 2008 and 2009," Geithner said during the public portion of the FSOC's meeting on Tuesday.
"We are not yet at the point where we have achieved and put in place a set of reforms that provide us a sufficient degree of comfort against those basic vulnerabilities."
The council's recommendations are largely centered on concepts widely rejected by the industry and some regulators, such as capital buffers and a floating net asset value. Funds and corporate treasurers have said such changes could drive investors out of the products and harm companies that use them for short-term borrowing.
The proposal does touch on an alternative concept supported by funds such as Blackrock Inc that would impose liquidity gates in times of stress, but the idea is not given a starring role in the council's 73-page document.
Government officials largely downplayed that alternative, saying they fear it could actually accelerate a run on funds.
The FSOC proposal generated a negative response almost immediately from critics such as the Investment Company Institute (ICI), the U.S. Chamber of Commerce and Republican Senator Pat Toomey, who called it "a mistake."
"The proposed regulations would significantly shrink the industry and would result in less borrowing, less economic growth, less investment options for households, and ultimately fewer jobs," Toomey said in a statement.
ICI president and CEO Paul Schott Stevens said the plan "fails to advance the debate" and is "deeply flawed."
DEVIL IN THE DETAILS
The council's recommendation consists of three main options, which are not mutually exclusive and could potentially be implemented in combination.
One would call for funds to hold a capital buffer of up to 1 percent of a fund's value and require a 30-day redemption hold-back of 3 percent of a shareholders' account value.
Another would call for a move from a stable to a floating net asset value so investors would not get spooked by the prospect of funds breaking the buck.
Both of those proposals were also considered by the SEC. The FSOC also announced a third option that securities regulators did not propose.
This alternative would impose a higher buffer of 3 percent of a fund's value, but funds could potentially hold less capital if they met other liquidity and diversification requirements.
For instance, if a fund were to reduce its exposure to any one company, that could allow it to meet a lower capital buffer requirement.
Sheila Bair, the former head of the Federal Deposit Insurance Corp, who also has championed reforms, praised the recommendations in a statement on Tuesday.
"I hope the Securities and Exchange Commission will recognize the risks posed by these products and implement the needed reforms," she said.
The FSOC's plan will now be issued for a 60-day public comment period after which the council may vote on a final recommendation. The SEC would have 90 days to embrace the recommendation or reject it in writing.
However, Geithner said he hopes the SEC will continue efforts on its own to come up with rules everyone can agree on.
"Our hope, of course, is that a public debate on a series of concrete options would provide a basis for the SEC to move forward," Geithner said.
Just how the FSOC proposal will play at the SEC remains to be seen.
Three of the SEC's commissioners, Republicans Dan Gallagher and Troy Paredes and Democrat Luis Aguilar, have remained skeptical about implementing new reforms, noting that a series of rules imposed by the SEC in 2010 may be enough to address the risk of runs.
Those reforms tightened credit quality standards, shortened weighted average maturities, imposed a liquidity requirement on money market funds and increased disclosure of fund holdings.
Earlier this year, the three commissioners asked the agency's economists to study the impact of the 2010 rules before forging ahead on new regulations.
In a prepared statement, Aguilar said on Tuesday he is "anxiously awaiting" the results of that study and expects it to be available soon.
He said he had not yet reviewed the FSOC's plan, but he is "optimistic that the resulting public discussion and dialogue will shed light into what is best for the public interest."
In addition, he added that he hopes that FSOC's plan will lead to a "serious inquiry about the possible adverse impact of migration from the transparent, regulated markets of money market funds to the opaque, unregulated parts of the cash management industry."