Regulators Set Mandate for Reform of Money-Market Mutual Funds

WASHINGTON – The Financial Stability Oversight Council voted unanimously Tuesday to release three proposed recommendations to reform the $2.9 trillion money market mutual fund industry.

The vote was an effort to break through a logjam at the Securities and Exchange Commission, where Chairman Mary Schapiro has been unable to win board approval to move forward with the agency's own reform plan.

At the meeting, Treasury Secretary Tim Geithner, who chairs the council, emphasized the important need for reform, saying that regulators' actions will allow the public to weigh in.

"As you know in August, SEC Chairman Schapiro announced the SEC did not have the basis to proceed with a vote to elicit public comment on a set of additional reforms," Geithner said. "In response to that and on the chairman's recommendation, the council is considering a set of recommendations we might embrace and propose in order to elicit comment from the public on the design of the next stage of reforms. Our hope, of course, is that a public debate on a series of concrete options will provide a basis for the SEC to move forward."

The money market mutual fund industry has so far successfully stymied reform.

Schapiro was unable to release the SEC's proposal this summer after commissioner Luis Aguilar, a Democrat and former mutual fund executive, told media outlets he would not support the plan just days before a planned vote. At the time, he said Schapiro's plan had too many unintended consequences and would wind up forcing investors into other unregulated markets.

Later, Republican commissioner Daniel Gallagher, who initially opposed the plan, said he might support a requirement that money market mutual funds have a floating net asset value if certain tax and accounting complications could get resolved.

Regulators have remained concerned that money market mutual funds are vulnerable to runs, as seen during the financial crisis four years ago. On Tuesday, they stressed the preferred approach would be for the SEC to manage this reform effort on its own.

"What we are doing today is not making a rule, all we are doing is putting out a proposal in order to gather public comment," said Federal Reserve Board Chairman Ben Bernanke at the meeting. "We look forward to seeing those comments. We are very hopeful these comments will be helpful to the SEC, which ultimately should be the agency that makes the appropriate rule."

Former Federal Deposit Insurance Corp. Chairman Sheila Bair lauded the effort by regulators to reform the industry, which could put the financial system at risk in the event of another run.

"Never again should policymakers be forced to choose between a financial meltdown or a taxpayer bailout of money market funds," she said in a statement.

The FSOC outlined three recommendations to address remaining structural vulnerabilities in the funds, built on earlier work done by the SEC. For one, funds could be required to float their net asset values, an idea opposed by many in the mutual fund industry. Alternatively, funds could be required to hold a capital buffer in order to absorb losses, along with placing restrictions on how much investors can redeem shares at one time. A third alternative would require a fund to keep a buffer of 3% to help absorb losses and potentially use other measures to increase its resiliency.

Schapiro made it clear she prefers a floating NAV, but recognized that option remains unpopular with the industry.

"I personally believe that floating the NAV is the pure option, the simplest option," said Schapiro. "It is the option that is most consistent with the SEC's regulatory approach of investment funds."

Regulators said they could ultimately adopt a mixed approach.

"The proposed recommendations are not necessarily mutually exclusive but could be implemented in combination to address structural vulnerabilities that result in MMFs susceptibility to runs," according to the FSOC's proposal.  

After the close of the comment period in 60 days, the FSOC will provide its recommendation to the SEC. The agency then has 90 days to respond to the council either by agreeing to the recommendation, suggesting its own suitable alternative, or explaining in writing why it won't be following guidance by outside regulators. If the SEC agrees to proceed with its own separate rule writing process, the council will suspend its own undertaking and not issue a final recommendation.

The issue has served as a focal point of several FSOC meetings. In September, Geithner warned the industry he would press ahead with reform on money market mutual funds if Schapiro was unable to make progress within the agency.

"The SEC, by virtue of its institutional expertise and statutory authority, is best positioned to implement reforms to address the risks that MMFs present to the economy," Geithner wrote in a letter to members of the council. "However, while we pursue this path, the council and its members should, in parallel, take active steps in the event the SEC is unwilling to act in a timely and effective manner."

In that letter, Geithner suggested that the council may consider designating individual mutual funds as systemically important – a power granted to it by the Dodd-Frank Act. Those firms would then be supervised by the Federal Reserve Board and face enhanced prudential regulation.

Another possibility, but far off option, would be for individual bank regulators to come up with their own measures to regulate the industry.