SEC Chair Gensler Calls for More Risk Management of Money Market and Open-End Funds

You might not expect the sentence “There is a saying when you’re in the woods: ‘You don’t have to outrun the bear; you just have to outrun one of your fellow campers,’” to be the first words out of the chair of the SEC at a public speech.

But after thanking someone for an introduction and then providing that the views were his and not that of his agency or other commissioners or staff, it is how Gary Gensler opened a talk at the Investment Company Institute on May 25.

It was a metaphor, as the topic of the speech was not safer camping in crowds. Instead, it centered on the potential for risk from investment funds, “particularly in times of stress.”

The old saw was about investors and savers cashing out of investment positions and deposits before that proverbial bear catches them at the bank.” The bear being “dilution and illiquidity.”

“Money market funds and open-end bond funds, by their design, have a potential liquidity mismatch—between investors’ ability to redeem daily on the one hand, and on the other, funds’ securities holdings that may have lower liquidity,” Gensler said.

Even though the 1940’s Investment Company Act and Investment Advisers Act along with SEC regulation have used “fiduciary duty obligations, liquidity requirements, leverage limits, daily net-asset valuations, and pricing rules for sales and redemptions” to control problems, Gensler said that risk still remained, especially in times of financial stress.

“We know from history that financial fires can spread from regulatory gaps as well as herding and network interconnectedness,” he said. “Such gaps include when regulations don’t treat like activities alike. Market participants may then seek to arbitrage such differences.”

To that end, Gensler said that the SEC is in discussion with bank regulators on the topics and how to pursue greater regulatory risk management. Specifically, he called out short-term investment funds and collective investment funds that are overseen by bank regulators. He said that such funds managed by bank trust departments or some tax-qualified retirement funds are beyond SEC purview.

“Short-term investment funds, estimated to total more than $300 billion in assets, operate similarly to money market funds. Collective investment funds are estimated to be $7 trillion, $5 trillion at the federal level and $2 trillion at the state bank level,” he said. “The Office of the Comptroller of the Currency last substantively revised rules for short-term investment funds in 2012. Rules for these funds lack limits on illiquid investments and minimum levels of liquid assets. There is no limit on leverage, requirement for regular reporting on holdings to investors, or requirement for an independent board.”