Universities will bid for short-term pots of cash tied to government policy objectives under proposals announced last week.
The Higher Education Funding Council for England wants to bring about changes in the academy "that are in the public interest" by using its funding more effectively.
A "strategic margin" of the total money available for teaching should be used to reward universities for certain activities, a consultation document says.
The marginal cash would be "short term and highly fluid", and would replace the current system of targeted allocations.
Institutions would "create their own funding package by selecting streams from the strategic margin to add to the core", Hefce says.
The document does not say what proportion of total teaching funds would fall into the strategic margin.
The council does not expect all institutions to bid for all of the money available.
It says: "Some will choose to focus on delivering one or two policy objectives ... Others may prefer not to divert attention from their core missions."
The consultation lists several methods by which Hefce could use the strategic margin to encourage universities to modify their activity.
The proposals include channelling student numbers to institutions that support a particular "policy priority"; providing extra funds for students studying particular subjects; and reducing funding levels for low-priority activities.
The funding council also hints that any extra income universities may receive from higher tuition fees in the future could be offset by cuts to teaching grants.
Responses to the consultation should be made by 12 July.