Treasury Secretary Timothy Geithner issued a letter late Thursday afternoon, to the members of the Financial Stability Oversight Council. He urged them to pressure the Securities and Exchange Commission to overhaul the regulations for money market mutual funds. Advocating the reforms, Geithner said that the US financial system will remain threatened until the reforms take place.

Timothy Geithner

SEC head Mary Schapiro had favored changes, but she had to abandon the reforms last month, as three of the five SEC commissioners opposed the new regulations. The reforms were first proposed during the 2008 economic crisis, with the primary purpose of allowing funds to have capital cushions, just like banks. The mutual fund industry holds approximately $2.7 trillion in assets. Investors and professional money managers rely on mutual funds to reduce the losses when stocks plunge.

The money market funds have openly opposed the reforms, sending a clear warning that any further reforms would make mutual funds an unattractive bet, and investors will exit them altogether. Geithner urged the SEC to act immediately and effectively, otherwise FSOC will go on to label some of the money funds as SIFIs (Systemically Important Nonbank Financial Institutions). So, the Federal Reserve will keep a close watch on those firms. The financial firms likely to fall in SIFI are American International Group, Inc. (NYSE:AIG) and  BlackRock, Inc. (NYSE:BLK). We also see the likelihood of T. Rowe Price Group, Inc. (NASDAQ:TROW), Invesco Ltd. (NYSE:IVZ), and Franklin Resources, Inc. (NYSE:BEN) to be added in the list.

After the collapse of Reserve Primary Fund in 2008, the financial market was so scared, the government had to temporarily guarantee the money fund assets to maintain the faith of investors.

Research by Citigroup says that the regulators seem to be looking for a consensus oriented solution, at the same time protecting the efficacy of money market funds. FSOC is likely to bring forth the reform options for public opinion before placing the final recommendation to the SEC.

RBC Capital states:

Last night’s news leads us to believe that Federated’s shares could lag other asset managers that are not as dependent on money

market funds as Franklin Resources, Inc. (NYSE:BEN) is. With 75% of its AUM in money market funds, Franklin Resources, Inc. (NYSE:BEN)’s shares could come under pressure if reforms are adopted. Given the regulatory overhang, we continue to favour other names in the sector.

The Citigroup research report reveals that Geithner’s letter raises serious issues to bear thesis. Three reasons:

1- Introduction of 4th option that directly calls for consensus with key stakeholders: It focuses on maintaining the product efficiency, while adding the main stakeholders in the process, most of whom do not want any incremental reform measures.

2- Geithner prefers SEC to be the primary regulator in reforms: That implies more measured changes, given the interest of SEC commissioners to conduct further study.

3- Geithner wants the reforms to preserve the efficacy of money market funds without giving any competitive advantage to unregulated cash management products.

All these reasons reduce the risk of radical reforms.

Citigroup Inc. (NYSE:C) lists the winners from any potential changes. Citi belives that FII is the biggest beneficiary among A/Ms & B/Ds; NTRS among Trust Banks — , followed by Charles Schwab Corp (NYSE:SCHW), Legg Mason, Inc. (NYSE:LM), IVZ, and BlackRock, Inc. (NYSE:BLK) among A/Ms & B/Ds. For FII, they believe the bear thesis is increasingly less valid as severe reform is diluted, and the stock could potentially be setting up for a short squeeze. Additionally, they see: 1) money market overhang declining; 2) franchise risks dissapating; and, 3) disintermediation concerns evaporating. Within the Trust Bank universe, Northern Trust Corporation (NASDAQ:NTRS) is most positively impacted followed by The Bank of New York Mellon Corporation (NYSE:BK) and State Street Corporation (NYSE:STT)