Last week, the Federal Reserve "announced approval of a final rule that establishes the requirements for determining when a company is "predominantly engaged in financial activities." The Fed's release explains, "The requirements will be used by the Financial Stability Oversight Council (FSOC) when it considers the potential designation of a nonbank financial company for consolidated supervision by the Federal Reserve." Below, Stradley Ronan Counsel Joan Swirsky explained to Crane Data what this means for money market mutual funds.
Swirsky tells us, "The Federal Reserve ("Fed") has adopted a rule that establishes the requirements for determining when a company is "predominantly engaged in financial activities" ("PEFA"). Only companies that are PEFA (among other requirements) can be identified as nonbank financial institutions ("NBFC's") by the Financial Stability Oversight Council ("FSOC") for purposes of certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("DFA"). In the adopting release, the Fed explicitly states that mutual funds, including money market funds, and closed end fund, are engaged in "financial activities." Accordingly, these funds are eligible to be identified as NBFCs."
She explains, "With respect to money market funds, two provisions under the DFA have particular significance if money market funds are considered to be NBFCs. First, FSOC may designate NBFCs as systemically important financial institutions ("SIFIs") that are subject to supervision by the Fed. Second, FSOC may make recommendations to the SEC regarding activities of NBFCs. FSOC has already proposed recommendations to the SEC for fundamental reform of money market funds during November 2012. Some opponents of money market fund reform had argued that it was premature for FSOC to issue those proposed recommendations before the Fed finalized the rule regarding the meaning of the phrase PEFA. The issuance of the final rule thwarts that argument against those proposed recommendations, and also thwarts a potential argument that it would be premature for FSOC to designate a money market funds as a SIFI that is subject to supervision by the Fed."
Swirsky also comments, "Some opponents to money market fund reform also had made separate arguments to the Fed on the proposed rule defining the phrase PEFA. Those opponents stated that activities of a money market fund do not qualify money market funds as PEFA, based on the description of "financial activities" in the DFA. The Fed has rejected those arguments, and discusses its reasoning in the attached release."
Swirsky continues, "In sum, the Fed's action satisfies one regulatory prerequisite to FSOC's exercise of authority to pursue reform recommendations for money market funds or to designate money market funds as SIFIs. It was expected that the Fed would finalize the PEFA rule at some point, so the action is not surprising. The Fed's action also confirms that the Fed has rejected a separate argument against FSOC's authority to make reform recommendations to the SEC or to designate money market funds as SIFIs -- because the Fed opines that money market fund activities do constitute financial activities. Again, some may not be surprised by the Fed's rejection of this argument. The various stakeholders who oppose money market reform presumably will continue their arguments on other fronts. It also is possible that industry stakeholders, at some point, could mount legal challenges to the Fed's view that money market fund activities can qualify the funds as "PEFA" under the DFA."
Finally, she adds, "In the meantime, the money market fund industry faces continuing regulatory uncertainty, as it is unclear whether FSOC will finalize its proposed money market fund recommendations, and press reports indicate that the SEC is also fully engaged on this issue, but the SEC has not issued any formal proposal." We will continue to keep you informed as the landscape unfolds."
