BOSTON Oslo may seem far removed from Chicago, but the downgrade of a Norwegian lender's debt rating last fall led U.S.-based Northern Trust Corp to step in with $69.7 million of support for two of its money market funds.
The unusual backstop - shown in filings and which the Chicago trust bank acknowledged to has become a flashpoint in the debate over the future of the $2.5 trillion U.S. money fund industry.
At a time when regulators are urging tighter rules for the funds, some specialists say the support shows how even developments in distant lands can affect fund companies.
"This seems to be a really small event, and it's still extracting its pound of flesh," said Rene Stulz, an Ohio State University professor who has led calls for new rules such as requiring money funds to build up their reserves.
Northern Trust executives would not comment on the policy debate, but sent a statement to Reuters describing the support as a routine decision after Moody's Investors Service downgraded the Norwegian lender, Eksportfinans, in November when it lost its role as sole operator of an export loan system.
Eksportfinans notes were held by two money funds that Moody's would have downgraded as well, Northern Trust said, had it not bought the paper.
Northern Trust said the notes paid off at par, meaning it did not suffer losses. Others say even though the notes paid off, the support shows how the fund sponsor took on some extra cost and risk.
"If Northern at the time of the transaction thought they were not subsidizing the funds, (then) I have a lot of bonds I would like to sell (to) them," said Kenneth French, director of investment strategy at Dimensional Fund Advisors and a Dartmouth College finance professor who has worked with Stulz on matters aside from money fund policy.
A fund industry trade group said Eksportfinans is a special case that should not figure in the money fund regulatory debate. Officials at the U.S. Securities and Exchange Commission declined to discuss specific funds.
Northern Trust is one of the largest custody banks. Its money funds are among many that have looked to hold securities from institutions in Northern Europe amid debt concerns further south.
The shift away from countries like Greece and Italy is the latest challenge for money funds, which play a central economic role as major buyers of commercial paper and other instruments.
During the financial crisis one well-known fund failed to maintain the $1 per share net asset value that investors typically expect, dragged down by its holdings in the collapsed investment bank Lehman Brothers. Many other funds struggled to avoid "breaking the buck," an industry term used to describe falling below $1 a share.
New rules in 2010 made the funds more liquid and transparent. Some like U.S. Securities and Exchange Commission Chairman Mary Schapiro still want more controls.
Draft SEC rule changes would give funds two options: allow their net asset values to vary from $1, or adopt capital buffers and restrictions on some withdrawals. Fund executives worry the changes could drive away investors, and note the funds managed through the 2011 debt limit debate under the current rules.
A point of contention is how much support the funds have needed in the past. Schapiro told Congress on June 21 her staff found more than 300 cases of funds getting support from their sponsors since the 1970s.
Fund executives have lashed back. In a blog post Sean Collins, analyst for the fund industry trade group the Investment Company Institute, called the figure of 300 "highly misleading" and contrasted it with a study by Moody's Investors Service. It found at least 36 cases of support for U.S. funds from 2007 to 2009.
FACING A DOWNGRADE
Support can come in other forms than cash, Collins wrote, and it does not necessarily mean a fund is in danger of breaking the buck. For instance, a sponsor may just wish to maintain a credit rating. Since the 2010 reforms his group knows of just one case when support was required, the one involving Eksportfinans.
Some U.S. funds held Eksportfinans notes around the time like First American Prime Obligations Fund, run by U.S. Bancorp. A spokesman said the notes either matured or were sold, and that no support was needed.
A February 3 SEC filing states Eksportfinans notes also were held by two Northern Trust funds, Diversified Assets Portfolio and Prime Obligations Portfolio. On November 25 they sold the notes to their parent for $50.3 million and $19.4 million, respectively. Northern Trust's statement said the sales stemmed from Moody's plans to downgrade funds that held the notes.
"While Northern Trust acknowledged the Moody's downgrade, our credit research team believed that Eksportfinans had strong credit and would repay its maturing debt," the statement said.
Other funds not rated by Moody's continued to hold the notes, it said, and both sets of notes paid off at par in 2012.
The ICI's Collins did not name Northern Trust. But he called the Eksportfinans situation "a red herring" as far as the policy debate over money funds, since the challenges funds faced around its notes were different than the broader euro zone debt concerns that fund critics have raised. Also funds faced no danger of breaking the dollar, he wrote.
Henry Shilling, the Moody's analyst who authored the report cited by Collins, said the support to the Northern Trust funds showed how money funds remain exposed to what he called "idiosyncratic events" that crop up.
A problem in money funds, he said, is that they can have little room to absorb a credit event while maintaining their $1 per share net asset value. "That's a vulnerability in their construction," he said.
(Reporting By Ross Kerber; Editing by Richard Chang)