Regulatory hardball on money market fund reform

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Potential reform of money market sector is pitting established regulatory bodies against newcomers, with messy results.

When outgoing SEC chairman Mary Schapiro announced her decision to abandon potential structural reform of the money markets at the end of August , the industry was warned not to breathe a sigh of relief too soon. The $2.6 trillion industry is too systemically important for the regulators to ignore. And the way in which the debate over how these funds should operate is being conducted shows few of them in a very flattering light.

Shortly after Schapiro’s announcement, on September 27, Treasury secretary Tim Geithner wrote a letter to the Financial Stability Oversight Council (FSOC), which was created by Dodd-Frank and came into being in July 2010, declaring that "further reforms of the money market industry are essential for financial stability" and urging the FSOC to "use its authority under section 120 of the Dodd-Frank Act to recommend that the SEC proceed with MMF reform". He said that the FSOC should "take active steps in the event that the SEC is unwilling to act in a timely and effective manner". In other words, Geithner wants to force the FSOC to push through reform if the SEC will not. He states that Dodd-Frank gives the FSOC both the responsibility and the authority to take action to address risks to financial stability if an agency fails to do so.

The fact that Geithner was prepared to play hardball and use new regulation to overrule the outcome of SEC due process took some in the industry by surprise. Writing to Geithner on November 5, David Hirschmann of the US Chamber of Commerce described his actions as inherently premature, irresponsible and potentially damaging. He pointed out that the SEC withdrew its proposal in August because of a fundamental disagreement within the SEC itself rather than an outright refusal to act. He called on the Treasury secretary to withdraw his request to the FSOC.

Geithner did not, and on November 13 the FSOC released its own proposed recommendations for MMF reform. They – not surprisingly – bear a strong resemblance to the SEC proposals: floating net asset values or stable net asset values with a 1% NAV buffer and a 3% minimum balance at risk or alternatively a stable NAV with a 3% NAV buffer and other measures. Its case was bolstered with the Financial Stability Board’s release on November 18 of its proposals for regulating shadow banking, which essentially endorse what the FSOC is proposing.

The three SEC commissioners that vetoed Schapiro’s proposals in August (Luis Aguilar, Daniel Gallagher and Troy Paredes) argued that more time was needed to evaluate the full impact on the industry that the proposed reforms would have. The FSOC’s proposals – which are open for comment for 60 days – are a kick in the teeth for the commissioners. Hirschmann at the US Chamber of Commerce described the FSOC’s move as a "mad dash to a predetermined outcome". They are a stark illustration of just how much the world of financial regulation has changed in the five years since it was found so wanting in 2007.