Divisions within the U.S. Securities and Exchange Commission could prompt a panel of regulators from other agencies to intervene in a debate over strengthening rules governing the $2.6 trillion money-market fund industry, three people familiar with the situation said.
If the SEC is unable to reach agreement, the Financial Stability Oversight Council, established by the 2010 Dodd-Frank Act to monitor large risks to the economy, may decide to officially designate money funds as “systemically important.” That would increase pressure on the SEC to overcome industry opposition and internal disagreements to propose new rules.
“I expect FSOC to declare money market funds” systemically significant “if it becomes clear the SEC cannot act,” said Karen Shaw Petrou, co-founder and managing partner at Washington-based Federal Financial Analytics Inc., a regulatory consulting firm. “And I expect them to do so by the summer.”
SEC Chairman Mary Schapiro has warned since November that a run on money-market firms could damage the economy, a view shared by the Obama administration and other regulators. She hasn't been able to convince a majority of her colleagues on the five-member commission to join her on tighter rules that could include capital requirements or a change to the industry's traditional $1 share price.
SEC spokeswoman Judith Burns declined to comment on the prospect of an FSOC intervention. Treasury spokesman Anthony Coley wouldn't comment on behalf of the FSOC.
Other regulators, particularly those at the Federal Reserve, are stepping up the pressure on the SEC to act soon. In an April 9 speech at a Federal Reserve Bank of Atlanta conference, Fed Chairman Ben Bernanke said that though the SEC strengthened rules on money-market funds in 2010, more needs to be done.
“The risk of runs remains a concern,” he said at the speech in Stone Mountain, Georgia. “Additional steps to increase the resiliency of money-market funds are important for the overall stability of our financial system and warrant serious consideration.”
Concern over money funds, once seen as among the safest of investments, grew after the September 2008 collapse of the $62.5 billion Reserve Primary Fund Ticker:(REPXX), which triggered a broader run that contributed to a freeze in global financial markets. The run calmed only after the Treasury Department temporarily guaranteed money-fund shareholders against losses and the Fed began buying fund assets at face value to help them meet redemptions.
Trillions in Assets
All U.S. money funds now hold a combined $2.56 trillion in assets, including $919 billion in institutional prime funds, according to research firm iMoneyNet in Westborough, Massachusetts. The largest funds include JPMorgan Prime Money Market Fund Ticker:(CJPXX), Fidelity Cash Reserves Ticker:(FDRXX) and Vanguard Prime Money Market Fund. Ticker:(VMMXX)
The rules the SEC adopted in 2010 introduced liquidity minimums, average maturity limits and new disclosure requirements. Additional options include ending the funds' traditional $1 share price. Although the stable price is a central selling point for the funds, critics say it also makes them more vulnerable to runs because investors are likely to flee after even small losses that don't immediately reduce the $1 share value.
At the Fed conference this week, Eric Rosengren, the president of the Federal Reserve Bank of Boston, dedicated an entire speech to the links between money-market funds and financial stability.
“There may be opportunities for SEC policy making and monitoring to inhibit funds from taking on excessive credit risk,” he said. “The SEC limitations placed on credit risk are currently too broad to avoid significant credit risk exposure.”
Treasury Secretary Timothy F. Geithner, who is the FSOC's chairman, has also called on the SEC to address the risk that he says money-market funds pose.
Still, Republican SEC Commissioners Daniel Gallagher and Troy Paredes, remain opposed to new rules. In several recent speeches, Gallagher has outlined a philosophy of keeping the SEC out of debates over whether a particular company or industry poses a systemic risk to the economy.
“Contrary to the perceptions of some, we are not systemic risk regulators,” Gallagher said March 8 at an investor adviser conference in Arlington, Virginia. “Dodd-Frank created the Financial Stability Oversight Council to take on that systemic risk role and although the SEC chairman is a member of the FSOC, the Commission is not. Given the SEC's mission and the nature of investing in securities, the commission cannot -- and should not -- endeavor to eliminate risk-taking.”
Commissioner Luis Aguilar, a Democrat, is uncommitted and is seen as the swing vote that could deny Schapiro the majority she would need to issue a proposal for public comment. Aguilar was the general counsel at money-management firm Invesco Ltd. (IVZ) during the 1990s.
The SEC has also been hobbled because of intense opposition to additional regulation from money-market funds. Christopher Donohue, the chief executive officer of Pittsburgh-based Federated Investors Inc. Ticker:(FII), the third-biggest U.S. money fund provider, said Jan. 27 that his firm would sue the SEC if it went forward with a proposed rule.
In an April 6 comment letter to the SEC, Marie Chandoha, the president of Charles Schwab Investment Management, said the types of changes Schapiro has discussed could “devastate” money-market funds.
“Proposals such as requiring money-market funds to float their net asset values or imposing a mandatory holdback that would prevent investors from having immediate access to all of their assets are unworkable for funds and for individual investors,” Chandoha wrote.
The FSOC could intervene into the money-market debate by either declaring the industry's activities or individual funds as a systemic risk. If the FSOC designated the sector as risky, the SEC would have to either propose rules or explain why it is unable to do so.
That would increase pressure on either Aguilar or the Republican commissioners to support a rule, said Cornelius Hurley, the director of the Morin Center for Banking and Financial Law at Boston University.
“If you have a 15-member council, 10 of whom can vote, telling you to do something and you don't, you have some serious explaining to do,” Hurley said.
$50 Billion Threshold
Individual funds must have assets exceeding $50 billion to be declared systemically significant. There are seven such funds, according to data compiled by Bloomberg, and they would be subject to heightened supervision by the Fed if they were declared significant.
It is not clear whether Schapiro would be willing to cede work on one of her signature issues to regulators at other agencies, Hurley said. That underscores why Congress created the FSOC as part of the 2010 financial-regulatory overhaul.
“We've witnessed instances in which agencies are captured by the industries they regulate,” he said. “Schapiro is trying to push back against that and having difficulty mustering a majority to do it. This is the proper role of FSOC to take a more eclectic view.”