Federal Reserve officials have discussed whether regulators should impose exit fees on bond funds to avert a potential run by investors, underlining concern about the vulnerability of the $10 trillion corporate bond market.
Officials are concerned that bond funds are becoming "shadow banks", because investors can withdraw their money on demand, even though the assets held by the funds can be hard to sell in a crisis. The Fed discussions have taken place at a senior level but have not yet developed into formal policy, according to people familiar with the matter.
"So much activity in open-end corporate bond and loan funds is a little bit bank like, "Jeremy Stein, a Fed governor from 2012-14 told the Financial Times last month, just before he stepped down. "It may be the essence of shadow banking is ... giving people a liquid claim on illiquid assets."
In the wake of the financial crisis, tougher rules on capital and the abolition of in-house trading operations at major US banks have resulted in Wall Street pulling back from helping big funds buy and sell corporate bonds. Bank inventories of bonds have fallen almost three-quarters from their pre-crisis peak of $235 billion, according to Fed data.
At the same time, US retail investors have pumped more than $1 trillion into bond funds since early 2009. This has created a boom environment for fixed income money managers, but raises the prospect of a massive disorganized flight of money out of the industry should interest rates rise sharply in the coming years.
Exit fees would seek to discourage retail investors from withdrawing funds, thereby making their claims less liquid and making a fire sale of the assets more unlikely.
Introducing exit fees would require a rule change by the Securities and Exchange Commission, which some commissioners would be expected to resist, according to others familiar with the matter.
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Such fees could be highly unpopular with retail investors unable to access funds without paying a fee. But some in the industry would welcome them; BlackRock, the world's largest asset manager, has called for international rules setting exit fees on some funds.
Even as regulators worry about the potential of a sharp correction in the bond market, some investors are building a war chest to take advantage of it. BlueMountain Capital, the New York-based alternative asset manager, has stockpiled funds ready to be deployed when bond prices fall.
"If credit markets were to become stressed due to heavy mutual fund outflows, our funds with patient capital and flexible mandates would be in a position to capitalize on any dislocation," said Andrew Feldstein, co-founder and chief executive of BlueMountain.
Investors like Mr Feldstein and regulators like Mr Stein have a similar vision of how the dislocation could arrive. "A big theme post-crisis is a significant shift of credit risk from banks to mutual funds," said Mr Feldstein.
"Mutual funds aren't leveraged like banks are, so they probably don't create the same degree of systemic risk. But they do offer daily redemptions, and so they engage in a maturity transformation similar to banks, which could result in significant market stress in heavy outflow scenarios."