A basic tenet of the $18 trillion mutual fund industry, and why the SEC is loathe to see a firm lock up investor cash, is that managers get to raise money from a broad swath of customers in return for offering them daily liquidity. Stein is among officials concerned that allowing such frequent withdrawals might not work for funds investing in assets such as corporate loans and high-yield debt.
Most of the rules under consideration at the SEC are months or even years in the making. For instance, the agency still hasn’t proposed a regulation required under the 2010 Dodd-Frank Act that requires mutual funds to stress test their portfolios.
Coming Rules
The SEC intends to move forward on that measure now that it has proposed, but not finished, rules on fund liquidity and a separate plan that caps how much leverage firms can create using derivatives, said a person with knowledge of the matter who asked not to be named because the deliberations aren’t public.
Most measures of corporate bond liquidity point to a “healthy market,” including a record level of new issuance and a rising number of trades, the Financial Industry Regulatory Authority, Wall Street’s self regulator, said in a Dec. 10 report. Still, the failure of the Third Avenue fund has prompted SEC staff to reach out to asset managers that follow similar strategies to inquire about any looming problems, according to two other people with knowledge of the discussions.
Some former SEC officials think that’s a wise move, considering predictions that default rates will soon rise for highly indebted companies that could be on the edge of financial distress.
“It makes me think of Bear Stearns” in 2007, said Norm Champ, a former director of investment management at the SEC and lecturer at Harvard Law School. “Bear Stearns started falling apart, but that was early and everyone kind of thought we’d get by that. Now we have a fund in trouble when bond default rates are still historically low. What happens when they go up?”