- The Washington Times - Tuesday, March 17, 2009

BOSTON (AP) - An industry group is proposing stricter rules for money-market mutual funds after one fund exposed investors to losses last fall, triggering fears about the nearly $4 trillion held in what are supposed to be safe-haven, low-yield investments.

Recommendations that the Investment Company Institute plans to announce Wednesday include a requirement that taxable money funds maintain an adequate cushion of cash and liquid investments that can quickly be converted to cash.

The ICI also wants the Securities and Exchange Commission to further restrict the types of securities money funds can hold to limit risk. That proposal would shorten the average maturity for debt that all funds can hold to 75 days from the current 90 days, to reduce the risk funds face from fluctuating interest rates.

Such a restriction could further erode money funds’ current historically low yields _ now averaging around 0.3 percent _ since longer-term debt offers greater returns because of its higher repayment risk.

The ICI’s board approved the recommendations Tuesday, and The Associated Press obtained a summary, written by an ICI panel of fund company leaders.

The panel also wants a requirement that funds pass a “stress test” to gauge whether they could weather a potential run on fund assets if market conditions sour, as happened when a more than $60 billion fund called the Reserve Primary Fund collapsed last fall.

The industry is rejecting private insurance for money funds to replace temporary government guarantees that are similar to FDIC bank deposit insurance, and set to expire April 30.

The U.S. Department of Treasury is widely expected to extend those guarantees to mid-September, or a year after the Reserve Primary Fund “broke the buck” when the value of assets the fund held fell below $1 for each investor dollar put in. That was just the second instance that money fund investors have been exposed to losses in the nearly four decades money funds have been available as safe places to park cash while earning a modest return.

The chairman of the ICI panel that developed the proposals, Vanguard Group Chairman John Brennan, said the recommendations “respond directly to weaknesses in current money-market fund regulation, identify additional reforms that will improve the safety and oversight of money market funds, and will position responsible government agencies to oversee the orderly functioning of the money market more effectively.”

One of the panel’s members, Marty Flanagan, president and chief executive of Invesco Ltd., said in an interview that ICI is asking its member fund companies to voluntarily adopt the recommendations before the SEC rules on whether to implement the proposals.

“I would be surprised if you don’t see the whole industry adopt these immediately,” Flanagan said.

Flanagan said the recommendations acknowledge that money fund investors primarily seek a return of at least a dollar-for-dollar on their investments, and the ability to access cash quickly.

Investors, he said, want “safety, liquidity and yield, in that order.”

Robert Plaze, associate director of the SEC’s Division of Investment Management, told the AP in an interview last week that his agency was awaiting the ICI recommendations. He also said the SEC was reviewing ways to prevent individual investors from being hurt by institutional clients who can destabilize a fund by suddenly pulling out a huge sum.

And Federal Reserve Chairman Ben Bernanke said in a speech last week that policymakers “should consider how to increase the resiliency of those funds that are susceptible to runs.”

Money funds are generally safe places to park cash because they invest in the safest types of debt. Many buy government bonds such as Treasury bills, while so-called prime funds seek slightly higher yields but accept marginal risk by venturing into short-term corporate bonds.

The downside of such risk hit home when the Reserve Primary Fund wrote the value of a $785 million investment in Lehman Brothers debt down to zero after the investment bank’s Chapter 11 filing last September. Although the Lehman Brothers debt represented a small fraction of the fund’s more than $60 billion in assets, it spooked institutional investors who suddenly pulled cash out. The redemption orders forced fund managers to quickly unload assets at fire-sale prices amid sharply declining markets. Many Reserve Primary Fund investors could ultimately end up losing roughly 8 cents on each dollar invested in the fund, which is now gradually being liquidated.

The Reserve Primary Fund’s troubles led institutional investors to pull out cash from money funds en masse in late September, prompting the government to intervene with the temporary guarantees to prevent another fund from breaking the buck. Since then, market declines have sharply eroded the values of riskier investments in stocks and bonds, and the government guarantees have helped fuel a recent return of investor cash into money funds. They now hold about 40 percent of the total $9.4 trillion in all U.S. mutual fund assets.

Money funds buy about 40 percent of commercial paper _ a low-cost source of cash for companies to meet short-term financial needs _ as well as one-fifth of marketable Treasury bills and nearly one-fifth of municipal securities.

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