UPDATE 1-BNY exec shows schism in US money fund sector on reform

Wed Nov 14, 2012 12:45pm EST

* Tighter capital requirements could favor banks over mutual funds

* Black Rock strikes conciliatory stance with regulators

* SEC still struggling to advance tougher rules

By Tim McLaughlin and Ross Kerber

Nov 14 (Reuters) - BNY Mellon Corp's investment management chief on Wednesday said he saw "some merit" to stiffer capital requirements and other rules for money funds proposed by U.S. regulators, in comments that exposed a schism in the $2.5 trillion industry.

BNY Mellon investment chief Curtis Arledge's positive remarks offer a sharp contrast to an industry that has widely panned the reforms proposed by U.S. regulators.

On Tuesday, leading members of the industry, including top money fund manager Fidelity Investments, criticized proposals by the Financial Stability Oversight Council, a board of top regulators chaired by Treasury Secretary Timothy Geithner.

But Arledge, who oversees BNY's $322 billion cash management business, expressed support for ideas like requiring riskier and less diversified funds to have a bigger capital buffer than safer funds.

"I'm not saying I would do it exactly the way it was in the (FSOC) proposal, although I think there is some merit to it," Arledge said at the Bank of America Merrill Lynch investor conference in New York.

"We do actually hold economic capital against our money funds," Arledge said. "So we are actually very well positioned for the world to shift to where sponsors need to recognize they have exposures. Not everybody does, so we think we're well positioned if that changed."

Regulators and fund companies have been at odds for years over whether the money fund industry needs more oversight coming out of the financial crisis. In 2008 one of the industry's best-known funds "broke the buck" and reported a net asset value below $1 per share, dragged down by its heavy holdings in the collapsed Lehman Brothers. Federal agencies eventually provided industry-wide backstops and in 2010 new rules required the funds to become more transparent and liquid.

But in August, Securities and Exchange Commission Chairman Mary Schapiro failed to win a majority of support from the SEC's five-member commission to move forward with additional changes she says are needed to make the funds more robust. That sent the matter to the FSOC. Many fund firms and their allies, however, have argued the 2010 reforms were sufficient and that some additional rules - like a proposed shift away from the funds' traditional $1-per-share value - would drive away investors.

David Scharfstein, a Harvard Business School professor who has backed some money fund reforms, said Arledge's comments seemed in line with the differing priorities among fund sponsors.

He said free-standing fund companies such as Fidelity, Vanguard Group and Federated Investors Inc - among the largest sponsors of money funds - might have a harder time with capital requirements than money funds sponsors who are banks, which already have capital.

Lance Pan, director of investment research for Capital Advisors Group, which works with institutional investors, said also that firms such as Fidelity and Federated have few other places to hold the cash of investors exiting money funds.

Banks like BNY Mellon and JPMorgan Chase & Co, meanwhile, can offer more products for customers who might leave money funds if they don't like new rules, Pan said.

Arledge put a finer point on the differences.

"If you personally had a choice, would you rather have your sponsor be the safest bank in the largest economy in the world, or an independent investment firm?" he said. "We're a winner in the scenario where risk is actually factored in to making money funds more resilient."

In addition, BlackRock Inc, which has been among the most vocal proponents of finding a compromise, is again engaged with regulators over the latest ideas, president Rob Kapito said on Wednesday. The New York-based firm will comment on the pros and cons of all three proposals issued by the FSOC, Kapito said while speaking at an investor conference.

Though Kapito did not give any specific views on the FSOC's preliminary plan, he said it was a "good starting place."

"I'm an optimist in this regard," he said, but added "this is going to be a tough process."

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