BOSTON (Reuters) - In a rare split, the clubby mutual funds industry is divided over how to backstop the $2.6 trillion kept in money market funds.
It is a hot issue after one of the largest funds struggled during the financial crisis and ultimately “broke the buck,” failing to maintain the $1 per-share net asset value considered sacrosanct by many investors.
Regulators have already put tighter rules in place and are considering more, perhaps even doing away with the $1 per share standard and allowing net asset values to “float.” Fund companies fear that change would be so drastic it would drive hundreds of billions of dollars away from their products and into traditional bank accounts.
“The floating NAV is seen as the biggest threat to money funds as we know them,” said Peter Crane, whose Cranedata.com site follows the industry.
Within the industry, however, the dispute is over how much reform is needed to stave off the floating NAV. The fault lines gelled in May when three of the largest managers proposed each money market mutual fund should set aside some extra money for times of trouble, called an “NAV buffer.”
Proponents included Fidelity Investments, the largest money fund operator, plus powerhouses Charles Schwab Corp and Wells Fargo. With each fund maintaining its own buffer, the plan would avoid subsidizing smaller competitors or eroding the appeal of the largest managers as the safest.
Most of the industry favors a broader approach that would spread out the risks, however, a plan rolled out in January by trade group the Investment Company Institute and backed by big players like Federated Investors and Vanguard Group Inc, as well as by smaller firms. The plan would feature a “liquidity bank” to buy securities from troubled funds during a crisis, into which all fund families would pay.
The central disagreement, said several fund specialists, is that Fidelity, Schwab and Wells would not want to help build up a facility that could be of more benefit to competitors with fewer assets to support troubled funds. “The bigger companies may just be positioning themselves because they may not want to subsidize the smaller companies,” Crane said.
Jonathan Macey, who teaches corporate law at Yale Law School, said any industry backstop would amount to a subsidy, by diminishing the sales appeal of a large company's ability to prop up troubled funds. Still, the NAV buffer "subsidizes less" than the ICI's idea, Macey said. (For a graphic on U.S. money market mutual funds, click: r.reuters.com/sez89r )
Proponents of the so-called floating NAV include some academics, regulators, and the editorial page of The Wall Street Journal. Backers say investors could get used to fluctuations and reduce the panic during a crisis.
That might have helped during the fall of 2008 when dozens of money funds had trouble maintaining $1 per share. One of the best-known, Reserve Primary fund, reported a net asset value of 97 cents per share, dragged down by a large stake in collapsed investment bank Lehman Brothers. (It ultimately paid back 99 cents on the dollar, an argument for the fund’s resilience.)
Other fund companies poured millions of dollars into their own funds and the Federal Reserve began a temporary support program. The Securities and Exchange Commission has since set new rules on fund holdings and is hearing ideas for more changes, sparking the companies’ rare public quarrel.
More is at stake than just fund company profits, since money funds also buy much of the commercial paper that finances payrolls and inventory. In a comment letter companies like CVS Caremark, Boeing Co and Kraft Foods wrote a floating NAV would force away many money fund customers — reducing commercial paper demand and, they said, “ensuring a severe setback for an economy emerging from recession.”
Closely held Fidelity of Boston set off the last internal policy spat in the funds industry seven years ago, when the company helped beat back a proposed rule that would have had a personal effect on its leader, Edward Johnson, by requiring an independent chairman for fund boards.
This time, it is just business. Fidelity says one advantage of its approach on money funds would be to reduce the chances of new regulations that the trade group’s proposal would invite — because the liquidity bank would also be able to borrow from the Fed in a pinch.
Fidelity declined to forecast the cost of its program, though others estimate it would raise an extra $6 billion or so across all the money funds — much less than the $55 billion that the liquidity bank would build up over time.
Fidelity says its approach would still suffice because rather than buying securities its NAV buffers would help funds reconcile the differences between their market values and the amortized cost accounting standard they use to calculate their net asset values daily — in short, making it easier for funds to report NAVs of $1 per share.
“We’re looking to prevent a crisis as opposed to responding to one,” said Fidelity money fund executive Robert Brown.
A spokeswoman for the ICI said its leaders would not discuss Fidelity’s plan. But Federated, of Pittsburgh, fired back in an SEC comment letter. Like the analysts, Federated Vice Chairman John McGonigle cited competition: large funds could more easily establish an NAV buffer, he wrote.
Also, he wrote, the buffer idea “further enhances the public misperception that Money Market Funds are guaranteed and blurs the line between bank products and Money Market Funds.”
The fate of all the proposals now lies with the Financial Stability Oversight Council, made up of top financial regulators and charged by Congress with reviewing risks to the financial system. A spokesman for the SEC, leading money fund reviews, said its next steps have not yet been determined.
Reporting by Ross Kerber, editing by Aaron Pressman and Matthew Lewis