October 26, 2010

By ELEANOR LAISE

A game of regulatory roulette is renewing scrutiny of money-market mutual funds and could drive further consolidation in the $2.8 trillion industry.

A report on money-fund overhaul options by the President's Working Group on Financial Markets, released last week, left on the table several overhaul measures that the industry has spent about two years opposing. Without fully endorsing or dismissing any particular changes, the report analyzed such steps as subjecting funds to banking regulations or requiring them to have floating share prices.

More should be done to address money funds' susceptibility to runs, the report said. In the days after one big money fund "broke the buck" in September 2008, falling below the $1 share price that the funds typically seek to maintain, skittish investors yanked billions from the funds.

"The drumbeat continues" for money-fund overhaul, said Henry Shilling, senior vice president at Moody's Investors Service. "It's not a subject that the industry will be able to sweep under the rug."

With some fund firms already backing away from the money-fund business, the prolonged regulatory uncertainty could favor the largest players and hasten industry consolidation, analysts say. Smaller firms may not be able to absorb the cost of further change, Mr. Shilling says.

Overhaul options being debated could "change the structure and economics of money market funds in such a way that they're just not an attractive product for the fund sponsors," said Roger Merritt, managing director at Fitch Ratings.

The 20 largest money-fund managers already account for roughly 92% of money-fund assets, up from 82% at the end of 2006, according to Moody's.

Money-fund assets being concentrated in the hands of fewer, larger players can increase the cost to fund firms of financially supporting the funds if needed in case of fund losses, Moody's said in an August report. Such financial support is ongoing. For instance, T. Rowe Price Group Inc. said on Friday that it would make a capital contribution to some of its money funds to offset losses realized in recent years, resulting in a pretax charge of about $17 million.

The Investment Company Institute, the fund-industry trade group, has proposed that a liquidity bank be formed and capitalized by the prime money-fund industry. The ICI will further discuss the proposal when the Securities and Exchange Commission solicits public comments on the overhaul options, said Karrie McMillan, ICI general counsel.

The report comes on the heels of another sharply worded call for money-fund overhaul. An International Monetary Fund report released late last month suggested that money funds over time be required to move to a floating net asset value, which would allow the funds' share prices to move up and down. The step "would enhance awareness that the market risks are borne by the investor," the report said.

The industry argues that floating NAVs would destroy the money-fund business and wouldn't reduce risks to the financial system.

The funds are moving into uncharted regulatory territory. The SEC, the funds' primary regulator, issued rules earlier this year further restricting money funds' investments in lower-quality securities and requiring them to keep at least 30% of their assets in securities maturing within seven days, a step designed to ensure funds can quickly meet investors' redemption requests. Reserve Primary, the fund that broke the buck in September 2008, saw a rush of redemption requests as its holdings in Lehman Brothers debt plunged in value.

Now that the President's Working Group has weighed in, it is asking the Financial Stability Oversight Council, newly established by the Dodd-Frank financial-regulatory overhaul law, to consider the options and pursue next steps. Money-fund regulation "is this hot potato that hasn't landed anywhere yet," said Joan Ohlbaum Swirsky, of counsel at law firm Stradley Ronon Stevens & Young LLP.