August 23, 2012 8:19 am

Schapiro admits defeat over money funds

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A senior US regulator has been thwarted in her efforts to reform the $2.6tn money market fund industry, a sector some identify as a source of systemic risk to the financial system.

Mary Schapiro, Securities and Exchange Commission chairman, said she was cancelling a vote by the regulator to propose fixes to the industry after Luis Aguilar, SEC commissioner, said he opposed the proposals.

“Other policy makers now have clarity that the SEC will not act to issue a money-market fund reform proposal and can take this into account in deciding what steps should be taken to address this issue,” Ms Schapiro said.

“I urge them to act with the same determination that the staff of the SEC has displayed over the past two years,” she added.

Regulators have been determined to address perceived weaknesses in money market funds, used by US households and companies as an alternative to bank accounts, since they played a role in freezing financial markets in the credit crisis.

Money market funds have a fixed $1 share price and offer higher yields than bank deposits but are not guaranteed by the US government.

The funds played a prominent role in the financial crisis when one popular fund, the Reserve Primary Fund, “broke the buck” by falling to a value of 97 cents a share after being hit by the Lehman Brothers collapse in 2008.

Ms Schapiro has championed proposals that would force the industry to either switch to a floating price for its funds, instead of being fixed at $1 per share, or to accrue capital for a rainy day and penalise investor withdrawals during times of stress. The funds’ fixed $1 share price is a “fiction”, Ms Schapiro has said.

The SEC chairman’s reform proposals, which had been backed by the US Treasury and Federal Reserve among other regulators, were vigorously opposed by big fund management groups, including Federated Investors.

Mr Aguilar, a former executive at a company that offers money market funds, had been viewed as the swing vote on the five-person securities commission.

The fight over how to regulate the funds is now likely to shift to the Financial Stability Oversight Council, the body of US regulators charged with responding to potential sources of systemic risk. It has been debating whether to designate the entire industry as systemically significant, according to people familiar with the matter.

Doing so would subject the industry to Federal Reserve oversight, weakening the ability of money market fund companies to lobby regulators such as Mr Aguilar who can stand in the way of enacting government-recommended reforms.

When the Reserve Primary fund suffered big losses on investments in short-term debt of Lehman Brothers in 2008 it sparked a run on other money market funds that unsettled the broader financial system and forced the US government to backstop the industry.

The perception that the funds will never drop below their $1 a share has allowed fund managers to take greater risks in search of higher returns without having to worry about losing investors’ money, officials have said.

A Treasury representative said that FSOC “has recommended in its last two annual reports that additional reforms are needed to mitigate the risks that money market funds pose to financial stability”.

“This was a key source of stress during the financial crisis, and it must be addressed.”

In advance of what Ms Schapiro had hoped would be an August 29 vote on the matter, a chorus of voices had emerged to support her in her bid to reform the industry.

Bill Dudley, New York Fed president, called Ms Schapiro’s proposals “essential” to reform an industry with a “glaring vulnerability”.

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