Fidelity, Federated Lead Charge Against Money Fund Reform

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NEW YORK (TheStreet) -- Fidelity Investments and Federated Investors have been leading the charge as the investment industry lobbies fiercely against reforms to money market funds.

Runs on money market funds were among "several key events during the financial crisis that underscored the vulnerability of the financial system to systemic risk," according to an Oct. 2010 report by the President's Working Group on Financial Markets, comprised of the U.S. Secretary of the Treasury, and the Chairmen of the Federal Reserve, the Securities and Exchange Commission and the Commodity Futures Trading Commission.
The threat of money market reforms has prompted four letters and nine visits to the SEC from Fidelity over the past 15 months.
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While the SEC made some reforms in early 2010, the PWG report concluded "more should be done to address systemic risk and the structural vulnerabilities of money market funds to runs."

The SEC is expected to come out with a new rule proposal in the next few weeks.

The stakes for the $3 trillion money market fund industry could hardly be higher, since its success rests largely on investors' assumption that the funds are as safe as bank accounts. Reforms that would undermine that assumption "would be detrimental to Federated's money market fund business and could materially and adversely affect Federated's operations," Federated Investors argued in its 2011 10-K. Federated gets more than 40% of its revenues from its money market business.

William Birdthistle, professor at Chicago-Kent College of Law, believes money market sponsors such as Federated are right to worry that regulatory changes designed to demonstrate to investors that money market funds are not risk free could spell the end of the business.

"I don't think the industry will collapse overnight, but it wouldn't be difficult for banks to say, 'if you want a safe investment there is one and only one safe investment, and that's a bank account,'" he says.

It is not surprising, then, that the mutual fund industry continues to argue no new changes are needed. No companies appear to be working harder at making that point than Fidelity and Federated. Fidelity is the largest money market fund manager in the U.S., according to Thomson Reuters.

Since November 2010, representatives from Fidelity have met with SEC officials nine times and sent four comment letters related to a 2010 President's Working Group report on money market reforms, according to information on the SEC's website. Federated representatives have sent 12 letters and held one meeting over that time.

"Fidelity is an industry leader and we believe that it is important to take a leadership position and engage with policymakers on important matters, such as the prospect of further money market mutual fund changes, which may significantly affect investors, the economy, our company and our industry," wrote a spokesman via e-mail. A Federated spokesman declined to comment on the company's lobbying activities.

While the issue is clearly of great importance to the entire mutual fund industry, other companies do not appear to have been nearly as active as Federated and Fidelity in their lobbying efforts. Next most active after those two companies are BlackRock Inc. and the Investment Company Institute (ICI), the chief lobbying organization for the mutual fund industry. BlackRock officials have sent three letters and held one meeting with the SEC, while the ICI has sent two letters and held two meetings.

At issue is special accounting treatment granted to the money market fund industry in 1982, contributing to an illusion that money market funds "were as safe as bank accounts," as former Treasury Secretary Hank Paulson put it in his 2010 book "On the Brink: Inside the Race to Stop the Collapse of the Global Financial System"

The accounting rule allows money market funds to report to investors that their investment in the fund hasn't declined in value as long as it hasn't changed by more than .5%. When the funds decline by more than that amount, they may have to seek outside support or report the decline, known as "breaking the buck."

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"Funds that broke the buck were as good as dead: investors would withdraw all their money," Paulson wrote.

That is precisely what happened following the collapse of Lehman Brothers in 2008. The Reserve Primary Fund, the nation's oldest money market fund, had $785 million in Lehman Brothers debt on the day of the investment bank's historic bankruptcy filing. Over the next two days, the $62 billion fund faced $40 billion in redemption requests, according to the President's Working Group report.

The Reserve Primary Fund was the only institution that broke the buck during the crisis, the PWG report states, because banks and other financial institutions that sponsored money market funds stepped in to bail them out. Still, during the week of September 15, 2008, investors withdrew some $310 billion or 15% of assets from prime money market funds, according to the report.

Reflecting on that dire period, Paulson wrote, "in retrospect, I see the industry's setup was too good to be true. The idea that you could earn more than what the Federal government paid for overnight liquidity and still have overnight liquidity made no sense."

Among the possible changes are removing that special treatment and requiring money market funds to report the change in their value each day as other mutual funds do, or requiring money market funds to hold more capital.

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It is unclear whether the fund industry will succeed in putting off reforms. One former SEC official, now representing fund companies in their efforts to block reforms, believes they can at least be stalled until the Presidential election. At that point, a Republican victory might succeed in pushing the issue off the agenda.

Even if President Obama holds on to the White House, SEC Chairman Mary Schapiro is widely expected to resign, and a new Chairman might have a new set of priorities, the ex-SEC official reasons. He further notes that three of the five SEC commissioners have expressed reservations about new rules for money market funds.

That doesn't surprise Chicago-Kent Professor Birdthistle.

"It's not hard to conclude that the SEC would rather oversee a $3 trillion industry than to oversee a $0 industry. No regulator wants to succeed so much that they put themselves out of business."

The SEC may be powerless to stand in the way of changes, however, since the big push for reforms comes from the Federal Reserve, according to Ed Mills, government policy analyst at FBR Capital Markets. Nonetheless, Mills isn't sure new rules will be as destructive to the industry as some fear.

"There are many ways of threading the needle here. There is a way of making sure these reforms are implemented that protect money market funds but do not throw out the baby with the bathwater," he says.

Among changes suggested by Mills include increasing capital requirements only against some of the riskier holdings of money market funds.

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Despite several meetings between SEC officials and industry executives and the continued submission of comment letters, the industry has hardened its position this year, according to SEC Commissioner Elisse Walter.

"The two-way conversation broke down, and the industry generally stopped talking and started 'just saying no," Walter wrote via email.

-- Written by Dan Freed in New York.

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