Should federal regulators impose exit fees on bond funds?  Officials at the Board of Governors of the Federal Reserve may think so.

The Financial Times reported on June 16, 2014 that Fed officials have discussed whether regulators should impose exit fees on bond funds to avert a potential run by investors.  The regulators apparently are concerned that bond funds are becoming “shadow banks” because investors can redeem their shares on any day, even though funds may face difficulties in selling off assets to meet redemptions in a liquidity crunch.

The FT reported that Jeremy Stein, who recently stepped down as a Fed governor, implied that bond mutual funds resemble banks and “may be the essence of shadow banking. . . .”  The discussions at the Fed were at a senior level and have not yet developed into a formal policy.

The implications of such a policy could have dramatic effects, and it is far from certain that the SEC would propose, much less adopt, rules imposing exit fees on bond mutual funds.  But the mention of mutual fund regulation by a Fed governor seems consistent with what some see as attempts by federal banking regulators to regulate funds and investment managers as if they are banks.

These high-level discussions are being held in the context of heightened concerns that future liquidity events in the bond markets could destabilize the financial system.  For example:

  • The Division of Investment Management recently expressed concern about the liquidity of the bond markets;
  • The SEC is considering new rules that would tighten regulation of money market funds to prevent future “runs”;
  • The Financial Stability Oversight Council is considering designating several non-bank investment companies as SIFIs; and
  • The Office of Financial Research of the Department of the Treasury recently published a study suggesting that asset managers could present systemic risks to the financial