Those hoping for a return to the good old days of self-regulated, self-correcting markets need to face reality: Those days are over.
Investment industry leaders are already bracing themselves for the approaching tsunami of new regulations, and many fear these changes could easily go too far. Regulators are sensitive to these concerns and understand that the changes they make will shape the investment landscape for decades.
"We have entered what will be one of the most active rulemaking periods in the Commission's history," Mary Schapiro, chairman of the Securities and Exchange Commission, recently told a group of industry executives at the Investment Company Institute's General Membership Meeting in Washington.
"Any system of regulation should be designed to facilitate fair and efficient financial markets, not to supplant them," she said. "Events of the last year provide a brutal reminder that markets are neither self-regulating nor self-correcting. A strong and steady regulatory hand is needed to assure their continued survival, but that hand must not be so intrusive as to point to winners and losers, lest we lose the benefits of competition."
Even though mutual funds are already highly regulated, they will not be spared from new regulation. Specifically, Schapiro said the SEC is looking at changing regulations governing money market funds, target-date funds and 12b-1 fees.
Money market funds suffered a shocking blow last September when the Reserve's Primary Fund broke the buck and rattled the confidence of millions of other money fund investors. Since then, the ICI's newly created Money Fund Working Group came up with a comprehensive proposal to shore up the funds and prevent future failures through self regulation. The mutual fund industry hoped this would be enough, but the SEC plans to consider additional recommendations to strengthen the funds next month.
"The ICI proposals go a long way to reducing risk, but I don't think the Commission is completely satisfied with it," said Domenick Pugliese, a partner in the investment management practice at the international law firm Paul Hastings.
A major threat to the fund industry is the SEC's proposal to replace the fixed-rate, $1 net asset value with a floating-rate NAV. Eliminating the $1 NAV would deal a huge blow to the fund industry, and experts fear funds could lose hundreds of billions of dollars in assets to banks.
The SEC is also concerned that target-date funds may have too much freedom in determining asset allocations, particularly after many 2010 funds suffered significant losses last year (see related story, page 1).
"Target-date funds are a long-term product," Pugliese said. "I'm concerned that any regulations of target-date funds would be imposed because of the short-term implications of the recession, rather than broader needs."
Shapiro also said the Commission may revisit 12b-1 fees for shareholder distribution and servicing expenses, but she did not give a specific timeline for any such changes.
Like most regulators and industry leaders, Schapiro supports the idea of a systemic risk regulator to monitor certain financial institutions that have broad impacts across the global economy, and that can step in to put out small fires before they turn into firestorms.
"Despite the economic devastation of the 1930s, the New Deal reformers possessed the wisdom and foresight to recognize that competitive capital markets are essential to allocate risk efficiently and promote economic prosperity," she said. "They did not attempt to banish risk from the capital markets; instead, they fashioned a regulatory structure that would channel competitive forces to manage risk efficiently. Stable markets that manage risk and allocate capital effectively are essential for economic prosperity.
"If there was ever a time when investors need and deserve a strong voice and a forceful advocate in the federal government, that time is now," she said. "It is precisely because investors don't always have the most clout that they deserve and need a strong, independent regulator dedicated to providing for fair financial dealings, timely and meaningful disclosure of information, and protection from unscrupulous actors."
Schapiro said she supports Federal Insurance Deposit Corp. Chairman Sheila Bair's proposal to create a council of existing regulators to oversee financial market risk, rather than give the job to one person or regulatory entity.
"Given the various components of effective financial regulation, I have long been concerned about effective concentration of power, which really means effective concentration of point of view in a single regulator," Schapiro said.
She suggested a new regulatory system would include a council responsible for regulating capital markets, an entity responsible for banking institutions, and for monitoring and averting risks to the financial system. It would also be responsible for the resolution of troubled institutions.
Roger Ferguson, president and CEO of TIAA-CREF, said he thinks the Federal Reserve is the best candidate for a systemic risk regulator because they have "eyes and ears around the country," and because "they are the most credible regulator in Washington these days."
Ferguson served as vice chairman of the Board of Governors of the Federal Reserve for several years, and said that if he were still at the Fed, he would probably be quite conflicted about this.
"Monetary policy is an intensely political issue," he said. "What does it mean to be a systemic risk regulator? What happens when something goes wrong?"
"Almost all of us agree that there should be [a systemic risk regulator], but the devil's in the details," said James "Jes" Staley, CEO of J.P. Morgan Asset Management. "We need a regulator who can minimize the damage of the next systemic failure. We're not going to prevent the next one."
ICI President and CEO Paul Schott Stevens said a systemic risk regulator will need to be transparent, but he is concerned whether the Fed could be effective in both roles.
"The Federal Reserve operates under a degree of insulation. It would be a hat trick to manage both," Stevens said.
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