September 19, 2011 / 8:01 PM / 8 years ago

Rules clash could limit money fund rates: Fidelity

BOSTON (Reuters) - Conflicting regulations could limit the rates that money market mutual funds pay investors, a senior Fidelity Investments executive said, reflecting some of the many forces weighing on the sector.

Rules passed by the U.S. Securities and Exchange Commission in 2010 require funds operated by Fidelity and its rivals to own more short-term securities, said Robert Brown, president of Fidelity money fund operations, in a recent interview.

At the same time, international bank capital rules known as Basel III, still under development, would have banks rely more on long-term debt, which would reduce the supply of short-term instruments in which money funds invest.

The result could be lower returns for money fund investors, Brown said, even once interest rates rise from their historic lows of late.

“In a normalized rate environment, it will reduce the market rate we will pay out,” he said of the clashing policies.

Lower rates will only add to the pressures on the $2.6 trillion money funds industry, which has grappled with yields close to zero for several years. Industry tracking site cranedata.com shows the highest-yielding money funds paying only around 15 basis points, for instance.

Fidelity and other firms have waived millions of dollars of fees in response. Charles Schwab Corp waived $240 million in fees in the first six months of 2011 alone. Other industry specialists have also begun to voice concerns about the appeal of money funds.

INDUSTRY IN CRISIS

Until broader economic forces boost rates again, many investors could put their money either in FDIC-insured bank accounts or into government money funds rather than prime funds that buy bank debt and corporate commercial paper, said Lance Pan, research director at money manager Capital Advisors.

“The industry is going through a crisis,” Pan said. “If the thesis doesn’t improve in one to three months, it will be awfully difficult to have investors remain in prime funds.”

Others wonder if prime funds might invest in nontraditional assets to boost yields. Either way, a loss of assets from the funds could limit a key source of corporate funding.

Closely-held Fidelity is the largest player, with $431 billion, or 17 percent of the industry’s total assets as of August 31, according to the Lipper unit of Thomson Reuters. Competitors including JPMorgan Chase & Co, Vanguard Group Inc and Federated Investors Inc.

DUAL ROLE

Two recent crises have shown the tensions facing money funds in their dual role as asset manager and bank investor.

The funds have faced scrutiny over their holdings in French banks exposed to Europe’s financial woes. The funds also saw major outflows in July as investors feared the potential impact on Treasuries were the federal government to default, a threat averted when a debt deal was reached in early August.

Investors have since returned, which fund leaders say is a win, or as Brown put it, “a tremendous success story.”

However, one way the funds avoided trouble was by shortening the length of time they would hold securities. That made less money available for banks such as France’s Societe Generale and BNP Paribas SA, both of which have faced questions about their own stability.

For instance, the largest money fund at August 31 was Fidelity Cash Reserves, with $120 billion in assets. According to Lipper, the weighted average maturities of the fund’s holdings in CDs of the top French banks fell to 32 days at the end of August from 62 days at the end of June.

“The availability of cash to purchase longer-term securities isn’t there in the marketplace,” Brown said.

A Fidelity spokesman said the firm is now “very comfortable with our money market funds’ French banks holdings.”

REGULATORS CLASH

Brown said the situation in part reflects differing priorities by regulators.

On the fund side, the SEC as of 2010 required money funds to hold some of their assets in “highly liquid” instruments such as cash or securities that convert to cash within a week. It also shortened maturity limits.

The idea was to reassure investors and to give funds more of a cushion to handle volatile periods. During the financial crisis in 2008, dozens of money funds ran into trouble and required support from their parent firms.

At the same time the bank-capital rule set known as Basel III, now being hashed out by central bankers, would encourage large banks to seek long-term financing. That could make even fewer short-term instruments available for money funds. Brown called the situation “opposing regulatory forces in the marketplace.”

Brown’s comments are similar to the views of several academics who follow the money fund industry. In Washington some have called for additional reforms such as abandoning the funds’ traditional $1 per share net asset values that many investors prefer.

But regulators do not want to make moves so dramatic they would upset prime funds’ role in funding corporate activities.

Between the SEC and reforms such as Basel III, “there’s a certain inconsistency,” said Harvard Business School professor David Scharfstein.

Scharfstein said sorting out the conflicts is among the jobs facing Financial Stability Oversight Council, an umbrella group set up under the Dodd-Frank financial reform act and led by U.S. Treasury Secretary Timothy Geithner. The challenge for the body will be to reconcile the interests of various industries and their regulators.

“Certainly investors need a place to park liquid assets. We want to make sure it’s in a place that is consistent with financial stability,” he said.

Reporting by Ross Kerber; editing by Ros Krasny and Andre Grenon

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