Federal Reserve officials have discussed imposing exit fees on bond funds to avert a run by investors, underlining regulators’ concerns about the vulnerability of the $10tn market.
Officials fear 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.”
After the financial crisis, tougher rules and the abolition of in-house trading operations at major US banks have resulted in Wall Street’s 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 $235bn, according to Fed data.
At the same time, US retail investors have pumped more than $1tn into bond funds since early 2009. This has created a boom for fixed-income money managers, but raises the prospect of a massive disorganised flight of money should interest rates rise sharply.
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.
Fees could be highly unpopular with retail investors unable to access funds without paying. But some in the industry would welcome them. BlackRock, the world’s largest asset manager, has called for global rules setting 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 it calls “patient capital”, ready to be deployed when bond prices fall.
“If we see something like this happening and our best guess is it will stabilise 10 points down, we’ll wait,” said Andrew Feldstein, co-founder and chief executive of BlueMountain.
Additional reporting by Gina Chon in Washington