Late last week, the Investment Company Institute, the trade group for the mutual fund industry, wrote a letter to the Financial Stability Oversight Council entitled, "Authority to Require Supervision and Regulation of Certain Nonbank Financial Companies (FSOC-2011-0001-0001)." It says, "The Investment Company Institute appreciates the opportunity to provide further comment as the Financial Stability Oversight Council ('FSOC' or 'Council') seeks to develop the process by which it will designate certain nonbank financial companies for heightened supervision pursuant to Section 113 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. As both issuers of securities and large investors in U.S. and international financial markets, ICI's registered investment company members are keenly interested in policies that promote a well functioning financial system able to withstand the periodic shocks that are an inevitable part of our complex, global marketplace."
The letter explains, "It is disappointing that the proposed rule does not specify how the FSOC intends to apply the criteria set forth in Section 113 when analyzing whether a particular company should be designated as a systemically important financial institution ('SIFI'). For example, while the Release outlines a proposed analytical framework for assessing the ten specific statutory criteria, the rule text contains no evidence of that framework. In addition, the Release gives little indication as to the Council's views on the specific criteria, and simply summarizes the views of commenters on its advance notice of proposed rulemaking ('ANPR'). We realize that the Council may wish to preserve sufficient flexibility to respond, as circumstances dictate, to new or emerging risks to the financial system. The need for flexibility must be balanced, however, against the needs of financial market participants for clarity regarding the 'rules of the road.'"
ICI says, "In our view, the broad scope of these ... authorities should allow the FSOC to reserve SIFI designation for those circumstances in which the risks to the financial system as a whole are both large and quite plain, and nothing less than designation will suffice to address them. Finally, we turn to the suggestion by some commenters that certain (presumably larger) money market funds should be designated for heightened supervision pursuant to Section 113. We explain why such designation would not be an appropriate regulatory tool for further strengthening the resilience of money market funds to severe market distress."
The letter continues, "As the Release indicates, the six categories identified by the FSOC -- size, lack of substitutes, interconnectedness, leverage, liquidity risk and maturity mismatch, and existing regulatory scrutiny -- reflect different dimensions of a company's potential to pose risk to the financial system."
It explains, "A financial company that already is highly regulated is more likely to have robust internal controls and compliance procedures. Moreover, its primary regulator is the 'subject matter expert' regarding the applicable regulatory scheme, and will be knowledgeable about the industry of which the company is a part, industry best practices, areas of regulatory concern, and the markets in which the company operates. These circumstances may mititate against the need for imposing additional regulation by the Federal Reserve Board, as is required for any company designated by the FSOC under Section 113. Further, the FSOC should look specifically at the degree to which the regulatory requirements already applicable to that company serve to limit or control risk. As a general matter, a financial company that must adhere to risk-limiting requirements is less likely to warrant a SIFI designation. Funds are subject to a comprehensive regulatory regime under the Investment Company Act of 1940, the most significant protections of which relate to leverage, custody of assets, transparency, mark-to-market valuation of fund assets, and transactions with affiliates. Fund investment advisers also are highly regulated."
"ICI believes one important reason for restraint with respect to SIFI designations is that it should help ensure that the FSOC and other financial regulators use the 'right tool for the job.' In the context of designations under Section 113, we think this means, among other things, that the FSOC should have a reasonable expectation that the 'remedies' that would flow from SIFI designation are necessary and will be effective to address the specific risk(s) that the FSOC seeks to minimize. This is particularly important because, in practice, designation decisions -- once made -- will have significant consequences that are unlikely to be reversed," the comment adds.
It continues, "Judicious use of the FSOC's Section 113 designation authority also is consistent with legislative intent, as described by former Senate Banking Committee Chairman Christopher S. Dodd. In a Senate colloquy, Chairman Dodd stated: 'The Banking Committee intends that only a limited number of high-risk, nonbank financial companies would join large bank holding companies in being regulated and supervised by the Federal Reserve.' Federal Reserve Board Chairman Ben Bernanke likewise has expressed his view that Section 113 designations should be limited in number."
Under "SIFI Designation Not Appropriate for Money Market Funds," ICI writes, "Some commenters have suggested that the FSOC should use its authority under Section 113 to designate certain (presumably larger) money market funds for enhanced supervision and regulation by the Federal Reserve Board. We strongly disagree, for the reasons discussed below.... Analysis of the application of the Section 113 criteria using the six broad categories proposed by the FSOC (size, lack of substitutes, interconnectedness, leverage, liquidity risk and maturity mismatch, and existing regulatory scrutiny) to money market funds would be similar to the analysis for mutual funds generally, as discussed in ICI's ANPR Response and above. In fact, money market funds must comply with an additional set of regulatory requirements beyond the comprehensive requirements of the Investment Company Act to which all registered investment companies are subject. These legal requirements include stringent credit quality, liquidity, maturity, and diversification standards. The basic objective of money market fund regulation is to limit a fund's exposure to credit risk, interest rate risk, liquidity risk, and the risk that certain shareholders may act precipitously to seek large redemptions."
ICI states, "Building upon the lessons of the financial crisis, the Securities and Exchange Commission in early 2010 put in place significant enhancements to these requirements that were designed to better enable money market funds to withstand certain short-term market risks. The SEC's amendments raised credit standards and shortened the maturity of money market funds' portfolios -- further reducing credit and interest rate risk. The rule changes also require more frequent disclosure of money market funds' holdings and mark-to-market prices, so both regulators and investors will better understand funds' portfolios. In the recent financial crisis, some money market funds had to liquidate assets quickly to meet unusually high redemption requests. The SEC's amendments directly addressed this liquidity challenge by imposing for the first time explicit daily and weekly liquidity requirements."
They add, "To the extent there is a desire to bolster yet further the resilience of money market funds to severe market stress, designating each of the 652 money market funds or even each of the 277 prime money market funds offered in the U.S. market as a SIFI and subjecting each to ongoing prudential supervision by the Federal Reserve Board is not the way to accomplish this. Nor does it make sense to pick and choose among money market funds or complexes for this purpose, or to designate a fund adviser solely on the basis of its money market fund activities. Rather, a process to assist the FSOC in determining the appropriate course of action is already well underway. And that process, quite appropriately, is focused on industry-wide solutions."
Finally, the ICI comment letter says, "More specifically, last October, the President's Working Group on Financial Markets issued a report discussing several options for further reform of money market funds and recommending that the FSOC examine those options. These options range from measures that could be implemented by the SEC under current statutory authorities to broader changes that would require new legislation, coordination by multiple government agencies, and the creation of new private entities. Nowhere in its detailed and thoughtful analysis of money market funds, however, does the PWG even suggest that the FSOC consider taking a fund-by-fund, complex-by-complex, or adviser-by-adviser approach under Section 113. To the extent the FSOC has any remaining concerns with respect to money market funds, we urge it to evaluate money market funds under this separate path as outlined in the PWG Report. In our comment letter on the PWG Report, we explained that after examining the reform options outlined in the PWG Report, we believe that creating a private emergency facility to serve as a back-up source of liquidity for all prime money market funds in the event of unusual market stress is the best way to strengthen money market funds and mitigate any remaining risks these funds pose to the U.S. financial system with the least negative consequences. We would welcome any further opportunities to discuss this proposal with the FSOC."
