A portion of the $2.6 trillion money market fund industry would be required to fundamentally change how it prices its shares under proposals issued by U.S. regulators on Wednesday to reduce the risk of abrupt withdrawals.
But the Securities and Exchange Commission plan was not as strict as some market players feared and included an industry-favored provision for funds to charge withdrawal fees and delay return of funds to customers during times of financial distress.
For more than a year the SEC has been debating 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.
The additional reforms proposed on Wednesday did not go as far as a draft proposal floated last year by then-SEC Chair Mary Schapiro, who left in December.
The fund industry had warned that further major reforms could kill investor interest in money market funds.
In a compromise move, the SEC's new 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 in 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).
That reform is a direct response to what happened in 2008 when 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.
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.
Government funds would be limited to Treasuries, but the SEC said that most funds featuring tax-exempt debt sold by state and local governments would qualify as retail funds.
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 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.
Schapiro in a statement applauded the movement on a proposal, but said, "I hope the Commission will remain open to meaningful reform of the entire sector and not just institutional prime funds."
The five commissioners voted unanimously on Wednesday to put the plan out for 90 days of public comment.
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.
In 2010, after the financial crisis, the SEC adopted rules that bolstered fund transparency, tightened credit quality standards, shortened the maturities of fund investments and imposed a new liquidity requirement.
The SEC's roughly 700-page plan released on Wednesday comes after more than a year of infighting at the agency over whether and how to craft further 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."
But fund manager Federated Investors Inc issued a statement in response to the proposal saying the idea of a floating NAV is especially troubling.
"What this proposed change will do is dramatically decrease or totally eliminate the utility of money market funds for ... millions of Americans who depend on them," Federated said.
In a statement, the Chamber of Commerce 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.
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.
"It has been a journey to get to this point," said SEC Chair Mary Jo White, who took over the agency earlier this spring.
While acknowledging the achievement, some reform advocates said Wednesday's proposal was significantly watered down from the one put forth by Schapiro. She was considering measures such as capital buffers and redemption holdbacks, or a broader switch to a floating NAV.
Former SEC Chair Arthur Levitt, who has been pushing for reform for all money market funds for years, said Wednesday's plan 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.
Sheila Bair, the former head of the Federal Deposit Insurance Corp, said, "I am concerned that it falls short of what is necessary to protect taxpayers, mutual fund investors, and the stability of the financial system."
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 is "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.