(Bloomberg News) The mutual-fund industry fleshed out a plan for a private backstop to money-market funds, rejecting alternatives considered by U.S. regulators that include abolishing the funds' stable $1 net asset value.
The industry's plan, proposed in a letter yesterday by the Washington-based Investment Company Institute, calls for fund companies to finance a private bank with $350 million in assets that would grow to $24 billion after 10 years. Other options are impractical, unworkable or fail to address the most important risk to money funds, the ICI said in its letter.
The rejection puts the fund industry on a collision course with officials from the Treasury Department and the Securities and Exchange Commission, who said several ideas laid out in October by a White House advisory body remain on the table. Regulators last year enacted one round of rule changes for the funds to prevent a repeat of the run on money funds that followed the collapse of the Reserve Primary Fund in the financial crisis.
"Some in the industry believe the SEC rules changes have been made and that should be enough," Robert Plaze, an associate director in the SEC's investment-management division, said in a Jan. 6 interview in Washington.
The ICI's submission included a new outline for a private liquidity facility, first pitched in March. The plan would create an emergency pool of cash, chartered as a bank or trust, that would buy commercial paper at full value from prime funds in the event of another crisis. All prime funds would be required to participate.
Fund companies would collectively kick in $350 million--as much as $17.2 million for the largest firms--to get the facility started, and individual funds would contribute 0.03% of assets annually, the ICI said. The bank would add leverage by issuing time deposits starting in year three, and be a member of the Federal Reserve system, giving it access to the Fed's discount borrowing window.
"The primary issue is to create sufficient liquidity so that money funds can meet redemptions" in a crisis, ICI President Paul Schott Stevens said in an interview.
After 10 years, the facility would hold about $24 billion in equity and debt capital, and be eligible to borrow an additional $30 billion from the Fed.
Money funds, with $2.8 trillion in assets, are the largest collective buyers in the $1.1 trillion U.S. market for commercial paper, a form of short-term debt issued by banks and other companies. That role broke down in September 2008 after the $62.5 billion Reserve Primary Fund closed and delayed repayment to clients because of losses suffered when Lehman Brothers Holdings Inc. declared bankruptcy.
Investors, concerned about whether their funds held debt issued by Lehman or other struggling U.S. banks, withdrew about $230 billion across the industry within three days, helping to freeze global credit markets and threatening to push more funds to sell holdings at a loss and suffer collapse.
To alleviate the crisis, the Treasury provided insurance to money funds, guaranteeing them against losses in the event of further defaults. The Federal Reserve rolled out two programs to buy commercial paper, one directly from issuers and another from money funds at face value to provide liquidity.
The Dodd-Frank financial overhaul signed into law in July has made it more difficult for the Fed to make similar emergency bailouts, and the Troubled Asset Relief Program, under which the Treasury insured money funds, has expired.
In addition to creating an industry-funded liquidity facility, options include forcing some or all money funds that buy corporate debt, known as prime funds, to abandon their traditional fixed $1 share price for a floating value; making in-kind redemptions during a crisis mandatory for some shareholders, so that securities could be transferred instead of sold at a loss; creating insurance for shareholders; and regulating money funds as special-purpose banks.
The idea of a two-tiered system in which stable-priced funds face tighter regulations and floating-value funds have more leeway is vague and requires more details, the ICI said.
"What's at stake is the future of an industry that provides a very important intermediation function," said Roberto Perli, a managing director at International Strategy & Investment Group in Washington and a former Fed economist who helped write the October report. Regulators "want to make it less risky, but they could also make it less useful or kill it," said Perli, whose firm is an investment adviser and broker-dealer.
Following the public comment period that ended yesterday, the issue goes to the Financial Stability Oversight Council, a panel of regulators formed under Dodd-Frank that is headed by Treasury Secretary Timothy F. Geithner and includes Fed Chairman Ben S. Bernanke, SEC Chairman Mary Schapiro and seven others. The body is charged with addressing companies and activities seen as posing a systemic risk to the U.S. economy.
If the oversight council designates money funds as systemically important, they will become subject to Fed oversight.
Perli and the SEC's Plaze and Perli said the ICI's concept was already being taken seriously by the securities regulators and the Federal Reserve.
"It would alleviate the government's concern that it will have to be the backstop to the industry, and would make the industry pay for the risk it imposes," Perli said.
The size of the facility is likely to be a point of conflict, he said.
"The government will want it to be as big as possible and the industry will want it to be as small as possible," Perli said.
Stevens and industry executives said that would probably be enough to withstand a crisis similar to 2008, considering that funds were forced by new SEC rules to meet certain liquidity requirements for the first time in 2010. Funds now must be able to convert 10% of holdings into cash within one day and 30% within one week.
"That's a huge step that would have helped handle the Reserve Primary" crisis, Stevens said.
The ICI's plan is supported by JPMorgan Chase & Co. in New York, Pittsburgh's Federated Investors Inc. and Vanguard Group Inc., in Valley Forge, Pennsylvania, three of the six largest money-fund providers.
Fidelity Investments, the largest company, didn't back the proposal for a private liquidity facility in its comment letter filed yesterday.
"We have concerns that the costs, infrastructure and complications associated with private liquidity facilities are not worth the minimal liquidity that would be provided," wrote Scott C. Goebel, general counsel for Boston-based Fidelity.
BlackRock Inc., the fifth-biggest competitor, said it supported the plan "only to the extent that its capital levels are modest." Simon Mendelson, managing director at the New York-based firm, said in a letter filed yesterday the sharing of capital might encourage risk-taking by funds.
Mendelson proposed that each individual fund company provide capital to its own vehicle that would have access to the Fed's discount window.
Patrice Kozlowski, a spokeswoman for fund provider Dreyfus Corp., didn't return a call seeking comment.