As we mentioned in Monday's "Link of the Day," late last week, IOSCO, the International Organization of Securities Commissions, released the European version of the President's Working Group report, entitled, "Money Market Fund Systemic Risk Analysis and Reform Options: Consultation Report." The 69-page report's "Foreward" states, "Certain events during the recent financial crisis highlighted the vulnerability of the financial system, including Money Market Funds, to systemic risk. These events have prompted a review of the regulation of the role of MMFs in the non-bank financial intermediation system. In this regard, the Financial Stability Board (FSB) asked IOSCO to undertake a review of potential regulatory reforms of MMFs that would mitigate their susceptibility to runs and other systemic risks, and to develop policy recommendations by July 2012. IOSCO has mandated its Standing Committee on Investment Management (SC5) to elaborate such policy recommendations."

It explains, "To ensure a sound base for evaluation of these options, the FSB asked IOSCO to review: The role of MMFs in funding markets; Different categories, characteristics and systemic risks posed by MMFs in various jurisdictions, and the particular regulatory arrangements which have influenced their role and risks; The role of MMFs in the crisis and lessons learned; Regulatory initiatives in hand and their possible consequences for funding flows; and The extent to which globally agreed principles and/or more detailed regulatory approaches are required/feasible. The objective of this consultation paper is to share with market participants IOSCO's preliminary analysis regarding the possible risks MMFs may pose to systemic stability, as well as possible policy options to address these risks." Comments must be submitted by May 28, 2012, and e-mailed to moneymarket@iosco.org. (The subject line should say "Money Market Fund Systemic Risk Analysis and Reform Options."

The Executive Summary says, "Although there is no globally accepted definition, MMFs can be defined as an investment fund that has the objective to provide investors with preservation of capital and daily liquidity, and that seeks to achieve that objective by investing in a diversified portfolio of high-quality, low duration fixed-income instruments. Specifically, MMFs are broadly used by both retail and institutional investors as an efficient way to achieve diversified cash management. MMFs act as intermediaries between shareholders seeking liquid investments and diversification of credit risk exposure and borrowers seeking short term funding. In some jurisdictions, including the United States and Europe, MMFs serve as an important source of financing for governments, business and financial institutions. The health of MMFs is important not only to their investors, but also to a large number of businesses and national and local governments that finance current operations through the issuance of short-term debt."

The IOSCO report continues, "With a worldwide financial footprint of over US$ 4.7 trillion in assets under management as of 3rd quarter 2011, MMFs comprise over 20 percent of the assets of CIS [funds] worldwide, and are a significant source of credit and liquidity. MMFs typically invest in high-quality, short-term debt instruments such as commercial paper, bank certificates of deposit and repurchase agreements and generally pay dividends that reflect prevailing short-term interest rates. MMFs' history of providing daily liquidity and principal preservation have played a significant role in differentiating MMFs from other CIS and have facilitated the use of MMFs as important cash management vehicles."

It explains, "Assets under management total approximately US$ 2.7 trillion in the United States and US$ 1.5 trillion in Europe, which together represents around 90 percent of the global MMF industry. Within Europe, three countries (France, Luxembourg and Ireland) represent a combined market share close to 90 percent. Two business models co-exist: constant net asset value (CNAV) funds, which are offered in the United States and in other jurisdictions such as Canada, China, Luxembourg, Ireland and Japan, and variable net asset value (VNAV) funds. CNAV funds dominate the MMF market with an estimated market share of close to 80 percent globally (around 40 percent in Europe). Over the last three years, money market funds have experienced a decline in their total assets under management, reflecting the low interest rate environment."

IOSCO adds, "It has been said that a "break in the link [between borrowers and MMFs] can lead to reduced business activity and pose risks to economic growth." The regulation of MMFs, therefore, is important not only to fund investors, but to a wide variety of operating companies, as well as national and local governments that rely on these funds to purchase their short-term securities. However, certain events during the recent financial crisis highlighted the vulnerability of the financial system, including MMFs, to systemic risk. These events have prompted a review of the regulation of the role of MMFs in the non-bank financial intermediation system."

It says, "In this regard, the Financial Stability Board (FSB) asked IOSCO to undertake a review of potential regulatory reforms of MMFs that would mitigate their susceptibility to runs and other systemic risks, taking into account national regulatory initiatives, and develop policy recommendations by July 2012. IOSCO has mandated its Standing Committee on Investment Management (SC5) to elaborate such policy recommendations. The FSB's mandate indicates that a crucial issue to be considered by such a review is whether the regulatory approach to MMFs needs to choose between (i) encouraging/requiring shifts to variable Net Asset Value (NAV) arrangements, (ii) imposing capital and liquidity requirements on MMFs which continue to promise investors constant NAV, and/or (iii) whether there are other possible approaches."

The report adds, "To ensure a sound base for evaluation of these options, the FSB asks IOSCO to review: - The role of MMFs in funding markets; - Different categories, characteristics and systemic risks posed by MMFs in various jurisdictions, and the particular regulatory arrangements which have influenced their role and risks; - The role of MMFs in the crisis and lessons learned; - Regulatory initiatives in hand and their possible consequences for funding flows; and - The extent to which globally agreed principles and/or more detailed regulatory approaches are equired/feasible."

Finally, the intro says, "The products covered by this report are investment funds marketed as "money market funds" as well as collective investment schemes (CIS) which use close terminologies for their marketing e.g., "cash" or "liquid" funds) or which are presented to investors and potential investors as having similar investment objectives even though they are labeled differently. This definition is not intended to cover non-MMFs (e.g. short-term bond funds) but is intended to be broad enough to cover products that seek to arbitrage around money market fund regulation in certain jurisdictions. MMFs are not homogeneous and as such demonstrate a range of characteristics dependent on their structure, which is reflected in the regulatory approach adopted by different jurisdictions. Nonetheless, MMFs are a type of CIS and are subject to CIS regulation in SC5 jurisdictions."

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