Monday, October 15, 2012

FSOC Taps a Novel Power to Tame Money Funds

Both the President's Working Group on Financial Markets and the Financial Stability Oversight Council have consistently called for the SEC to pursue additional reforms to address structural vulnerabilities in [money market funds], including unanimous recommendations in the [FSOC's] 2011 and 2012 annual reports. The Dodd-Frank Wall Street Reform and Consumer Protection Act gives the Council both the responsibility and the authority to take action to address risks to financial stability if an agency fails to do so.  (emphasis added) Accordingly, I would like the [FSOC] to consider taking a series of steps to address this challenge.

With Treasury Secretary Timothy Geithner and the Financial Stability Oversight Council taking the lead on further reforms to money market mutual funds, Geithner and the FSOC will be testing the limits of the super-regulatory powers granted by the Dodd-Frank Act.  Section 12(a)(1) of the Dodd-Frank Act set forth the essential duties and powers of the FSOC. Among these are:

  • identifing systemically important financial market utilities and payment, clearing, and settlement activities (as that term is defined in title VIII); and
  • making recommendations to primary financial regulatory agencies to apply new or heightened standards and safeguards for financial activities or practices that could create or increase risks of significant liquidity, credit, or other problems spreading among bank holding companies, nonbank financial companies, and United States financial markets.
As his September 27, 2012 letter to the FSOC makes clear, Geithner intends for the FSOC to use its Section 12(a)(1) power to bring money market funds into the ambit of the Dodd-Frank Act by declaring them systematically important nonbank financial companies.  Under the Act, nonbank financial companies are those that engage predominantly in financial activities, which includes selling interests in pools of assets and advising investment companies. By this operation, Geithner and the FSOC are able to designate money market mutual funds and their advisers as nonbank financial companies under Dodd-Frank, and therefore subject to FSOC oversight.  

Including Geithner, the voting members of the FSOC include: the Chairmen of the Federal Reserve, the SEC, the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation and the National Credit Union Administration Board, the directors of the Bureau of Consumer Financial Protection and the Federal Housing Finance Agency, the Comptroller of the Currency, and an independent insurance expert appointed by the president. While the FSOC is able to float its own money market fund reform proposal, it must do so in consultation with the SEC, whose chair, Mary Schapiro, is -- as stated above -- a voting member of the FSOC.  It is not clear whether or to what extent the FSOC must consult with the three dissenting SEC commissioners. 

How Geithner and the other members of the FSOC navigate the money market reform issue has precedent setting implications. Will the remaining voting members wish to arm the FSOC with a sweeping power to cajole an coerce a regulatory agency, a power that could theoretically be used on their own agency in the future?  This tricky balancing of powers and interests is perhaps the prime motivation for the stern yet somewhat conciliatory tone of Geithner's letter.  

The proposed recommendation should include the two reform alternatives put forward by Chairman Schapiro, request comment on a third option as outlined below, and seek input on other alternatives that might be effective in addressing MMF's structural vulnerabilities.

Secretary Geithner seems to be stepping lightly around the dissenting SEC commissioners, while at the same time making it clear which of the options he prefers.  Dodd-Frank is fairly clear that the SEC is not required to rubber stamp what the FSOC proposes and recommends they adopt; however, by passing the buck on this round of reforms in the first place, the SEC has put itself in the position of potentially having a measure of its regulatory autonomy ripped away.