By Sarah N. Lynch
WASHINGTON (Reuters) - A portion of the $2.6 trillion money market fund industry would be required to fundamentally change how it prices its shares in an effort to reduce the risk of abrupt withdrawals, under a proposal released by U.S. regulators on Wednesday.
Funds could also charge withdrawal fees and delay return of funds to customers in times of financial distress, under the Securities and Exchange Commission's proposal.
The SEC plan comes after a long debate over whether changes made in 2010 were enough to avoid a repeat of a run on money market funds seen at the height of the financial crisis.
In 2008, the Reserve Primary Fund, one of the largest money funds, suffered losses on Lehman Brothers debt and could not maintain its $1 per share price, known as "breaking the buck."
That ignited a run by investors across the money fund industry, cutting off a major source of overnight funding for many corporations.
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In 2010, the SEC adopted rules that bolstered fund transparency, tightened credit quality standards, shortened the maturities of fund investments and imposed a new liquidity requirement.
For years, proponents of further reform have raised concerns that money market funds, mutual funds that invest in short-term debt securities, can be considered as safe as bank deposits even though they do not have a government guarantee.
The fund industry has warned that further major reforms could kill investor interest in money market funds.
In a compromise move, the SEC's plan mostly focuses on prime funds for institutional investors, which are seen as more prone to runs because those investors are more sophisticated and more likely to pull large blocks of money first if there is a panic.
The SEC estimated that institutional funds represent 37 percent of the market with $1 trillion in assets.
The SEC's plan calls for two alternative proposals that it said could be adopted alone or in combination.
The first piece would require prime funds used by institutional investors to transition from a stable, $1 per share, to a floating net asset value (NAV) - a move designed to reduce the risk of runs like those during the financial crisis.
The SEC said that retail and government funds, which are not considered to be at the same risk for runs, would not have to move to a floating NAV. Retail funds are defined as those that limit shareholder redemptions to $1 million per day.
The industry has long fought against moving away from a stable share price, which it says is appealing to investors looking for a safe product.
The second proposal, meanwhile, would give fund boards for institutional and retail funds the authority to impose so-called "liquidity fees and redemption gates" during times of stress.
That would give funds the power to stop an outflow of investor money, an idea that the SEC's two Republican commissioners last year said they might be able to support.
The five commissioners voted unanimously on Wednesday to put the plan out for 90 days of public comment.
AGENCY INFIGHTING
The SEC's roughly 700-page plan comes after more than a year of infighting at the agency over how to craft new rules for the industry.
Major fund sponsors like Fidelity and trade groups such as the U.S. Chamber of Commerce have actively lobbied against major structural changes to funds. But pressure for at least some new rules did not let up, and several major fund sponsors including Charles Schwab began offering compromise measures.
Paul Schott Stevens, the head of the Investment Company Institute, the main money market fund trade group, said he was "particularly pleased that the commission recognized the effectiveness of liquidity fees and gates in addressing risks that might arise in a widespread crisis."
In a statement, the Chamber said it was reserving judgment on the proposal, but that it remains "concerned" about aspects of the rules, such as the floating NAV and the potential accounting and tax burdens it could impose on investors.
The industry has feared a move to a floating NAV could create a major tax burden that would require investors to report daily gains and losses.
In response to that concern, SEC officials told reporters that they expect the Internal Revenue Service will agree to allow investors in funds with a floating NAV to only be required to report once a year.
The initial industry reaction on Wednesday indicated the SEC's plan may not generate the same degree of opposition that the SEC faced last summer when then-SEC Chair Mary Schapiro called for what some consider stricter reforms.
Schapiro, who stepped down as SEC head last December, had advocated for a series of possible reforms, including capital buffers and redemption holdbacks, or a broader switch to a floating NAV - two ideas vehemently opposed by the industry.
She was unable to muster the votes needed to issue a proposal for comment after three of her fellow commissioners said they could not support her plan without additional study.
Schapiro's proposal was starkly different from what the SEC unveiled on Wednesday. This time, the SEC's plan contains some proposals that a few fund sponsors have previously said they could live with.
"It has been a journey to get to this point," said SEC Chair Mary Jo White, who took over the agency earlier this spring.
Former SEC chairman Arthur Levitt, who has been pushing for reform for all money market funds for years, said the plan put forth was significant, but still disappointing. "It was very unfortunate that the commission wasn't able to put through a rule that Mary Schapiro had aggressively supported," Levitt told the Reuters Global Wealth Management Summit.
THE PATH FORWARD
While the commissioners all supported gathering feedback on the plan, it is unclear whether they will agree on a final rule.
Several commissioners signaled they have differences of opinion on how to proceed. Democratic Commissioner Elisse Walter and Republican Commissioner Daniel Gallagher both expressed an openness to considering both proposals in tandem.
Republican Commissioner Troy Paredes, meanwhile, said he remains "unconvinced that floating the net asset value is justified."
But it is likely that Walter and Paredes will not be at the SEC for the final rule vote, as President Barack Obama recently nominated two new commissioners to replace them.
The plan is also significantly different than ideas floated by the Financial Stability Oversight Council, a group of financial regulators headed by the Treasury Department, which intervened after money fund reforms stalled last year and included capital buffers in its suggestions.
In a statement, the Treasury commended the SEC for continuing to work on the issue. "We look forward to reviewing the details of the proposed rule," the Treasury said.
(Addditional reporting by Tim McLaughlin in Boston and Suzanne Barlyn in New York; Editing by Karey Van Hall, Nick Zieminski and Tim Dobbyn)