FSOC's Risky Push for Money-Market Fund Reform

The Financial Stability Oversight Council exercised its authority to recommend heightened standards for risky financial activities for the first time last November, when it issued recommendations to the Securities and Exchange Commission regarding the regulation of money-market mutual funds. 

The FSOC is engaging in a risky business. Depending on how the SEC reacts to these recommendations, detractors are likely to conclude the FSOC's authority is either toothless or too harsh.

MMF regulation has remained a point of contention since the financial crisis. Former SEC Chairman Mary Schapiro scheduled an August 2012 commission vote on a staff proposal on reform, apparently anticipating a majority voting in favor. Once three commissioners announced that they were against the proposal, the vote was deferred. 

Former Treasury Secretary Timothy Geithner, acting as chairperson, next pushed for the FSOC to recommend heightened MMF regulation to the SEC. In November 2012, the FSOC, including Schapiro, unanimously voted to propose recommendations that largely mirrored Schapiro's earlier SEC proposal. These recommendations were subject to a 60-day public comment period, which was extended by 30 days in January. It remains unclear how the SEC will react, should the FSOC ultimately issue final recommendations in the same form once this comment period is over.  

The process governing the issuance of recommendations is simple. Once the FSOC issues final recommendations to an agency, that agency either must adopt those standards substantially as proposed or articulate its reasons for not doing so within 90 days. The FSOC has no authority to impose its will on any agency, so any decision addressing MMF reform is within the sole discretion of the SEC.

Undoubtedly the SEC's failure to vote last August resulted in heightened pressure on individual commissioners to reconsider their stance in the issue. Presumably, that pressure was ineffective. Otherwise, the FSOC would not have acted. But why would public pressure by the FSOC prevail where earlier pressures had not?  Isn't there an equal risk that the FSOC intervention will merely entrench opposition? Even if the FSOC succeeded in increasing attention on the subject, there has not been a public groundswell demanding quick action. 

The SEC's current composition makes approval of recommendations seem remote. Schapiro resigned in November, and, given the current focus on fiscal issues, one wonders how soon the Senate can confirm her potential replacement, nominee Mary Jo White.

Even with a swift confirmation, it will be difficult to assemble a majority to accept the recommendations. Commissioner Luis Aguilar, who was against the proposal in August, appears to have softened his stance, stating "the outflow of money fund assets to an unregulated market is a significant systemic risk concern" and that the recommendations would "inform the nature of any needed reforms."  But he has yet to publicly change his position on the staff proposal or the FSOC recommendations. 

Similarly, there is no indication that Commissioners Daniel Gallagher and Troy Paredes have changed their views. Of the remaining commissioners, only acting Chairman Elisse Walter publicly supports the original SEC staff proposal. 

Since the SEC has only 90 days to adopt the FSOC's final recommendations or explain in writing why it has rejected them, one wonders whether the SEC can do anything other than document its objections. 

A larger question is why the FSOC intervened in this particular matter. Congress has long entrusted the regulation of the financial sector to regulators with specialized expertise.  Presumably Congress did not create the recommendation mechanism as a means for regulators without that expertise to second guess the decisions of their colleagues. Should the FSOC serve as a political lever, exerting public pressure on regulators whose views may be inconsistent with those of a current administration?  When would such pressure become inappropriate? 

If the FSOC fails, it could look weak.  If it succeeds, this mechanism will be used more often. The FSOC is engaged in a risky business, as intervention will inevitably carry a price: potential resentment by regulators who are jealous of their independence and possible divisions among regulators who need to cooperate with their peers.  At some point, the FSOC should articulate its policy for using this extraordinary tool.

Donald N. Lamson is a partner and head of the Financial Institutions Advisory & Financial Regulatory Group in the Washington office of the global law firm Shearman & Sterling. Sylvia Favretto is a Shearman & Sterling associate.