The European-based International Organization of Securities Commissions (IOSCO) published its "Policy Recommendations for Money Market Funds today. The paper, the release of which was not backed by the majority of the IOSCO-member SEC, says on "Background," "The September 2008 run on some money market funds (MMFs) alerted regulators to the systemic relevance of MMFs. Although MMFs did not cause the crisis, their performance during the financial turmoil highlighted their potential to spread or even amplify a crisis. Despite the significant reforms already adopted by regulators to address some of the issues identified during the 2007-2008 crisis, concerns remain regarding the stability of the money market fund industry and the risks it may pose for the broader financial system. In this regard, the Financial Stability Board (FSB) asked the International Organization of Securities Commissions (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. This work is part of the efforts undertaken by the FSB to strengthen the oversight and regulation of the shadow banking system. It follows the endorsement by the G20 Leaders of the FSB's initial recommendations and work plan regarding Shadow Banking submitted at the November 2011 Cannes Summit."
The IOSCO report continues, "The FSB's mandate indicated that a key issue to be considered was the Constant Net Asset Value (CNAV) feature of some money market funds. In developing its policy recommendations, IOSCO has considered this crucial question but also other aspects of MMF regulation where greater harmonization between jurisdictions and improvements to existing regulations were seen necessary."
It explains, "On 27 April 2012, IOSCO published a consultation report, Money Market Fund Systemic Risk Analysis and Reform Options, which provided a preliminary analysis of the possible risks that money market funds could pose to financial stability and proposed a broad range of possible policy options to address those risks as well as to address other potential issues identified with regard to money market funds. This report used the results of a mapping exercise conducted in June 2011 to assess and compare existing regulatory frameworks for MMFs among IOSCO members. IOSCO's Committee 5 on Investment Management also held two high-level hearings with industry representatives at the beginning of 2012. In addition to presenting possible policy options, IOSCO's consultation paper included a background report that reviewed the historical development of MMFs, their market significance and investor base, their role in funding markets, the experience during the 2007-2008 financial crisis, the changes to MMF regulatory frameworks adopted since then, as well as a review of some of the recent literature on MMFs. This background report is provided in Appendix III." (See Crane Data's May 5, 2012, News, "IOSCO Money Market Fund Risk, Reform Report Is Europe's Answer to PWG".)
The Final Report continues, "The consultation period ended on 27 June 2012, after a one-month extension of the initial deadline. A total of forty-one contributions were received, from twelve countries (Canada, China, France, Ireland, India, Japan, Oman, South Africa, Spain, Switzerland, the United Kingdom and the United States), as well as from several international and regional associations. The majority of answers came from the asset management industry, although IOSCO also received contributions from representatives of customers, one credit rating agency, and regulators. A feedback statement is provided in Appendix II highlighting the main opinions and elements for consideration provided in those answers, together with the list of respondents. Non-confidential answers are available on IOSCO's website."
IOSCO explains, "The MMF industry is significant in size, since it represents approximately US$ 4.7 trillion in assets under management at first quarter 20122 and around one fifth of the assets of Collective Investment Schemes (CIS) worldwide. The United States and Europe represent around 90 percent of the global MMF industry. Money market funds provide a significant source of credit and liquidity. Recent figures for US MMFs show that "These funds owned over 40 percent of U.S. dollar-denominated financial commercial paper outstanding at the end of 2011 and about one-third of dollar-denominated negotiable certificates of deposit." Data for Europe show that money market funds play a significant role in money markets, with "short-term debt securities with an original maturity of less than one year representing around one half of total MMF assets", and are key providers of short-term funding for banks, which represent roughly three-quarters of the MMF total assets in the euro area. MMFs are broadly used by retail and institutional investors (including non-financial corporations) as an efficient way to achieve diversified cash management."
The report's recommendations include: Recommendation 1: Money market funds should be explicitly defined in CIS regulation. MMFs present several features which make them unique among the CIS universe. Accordingly, money market funds should be explicitly defined in the regulation. As a basis, and although definitions may slightly vary from jurisdiction to jurisdiction, money market funds may generally be defined as investment funds that seek to preserve capital and provide daily liquidity, while offering returns in line with money market rates. The definition should ensure that all CIS which present the characteristics of a MMF or which are presented to investors or potential investors as having similar investment objectives are captured by the appropriate regulation even when they are not marketed as a "MMF" (e.g. "liquid" funds, "cash" funds)."
They continue, "Recommendation 2: Specific limitations should apply to the types of assets in which MMFs may invest and the risks they may take. Requirements on MMFs should include restrictions on the type of assets that are permitted to be held, i.e. money market funds should invest mainly in high quality money market instruments and other low-duration fixed income instruments.... MMF regulation should define limits on the average weighted term to maturity (WAM) and the weighted average life (WAL) of the portfolio.... Recommendation 3: Regulators should closely monitor the development and use of other vehicles similar to money market funds (collective investment schemes or other types of securities)."
IOSCO writes, "Recommendation 4: Money market funds should comply with the general principle of fair value when valuing the securities held in their portfolios. Amortized cost method should only be used in limited circumstances.... Recommendation 5: MMF valuation practices should be reviewed by a third party as part of their periodic reviews of the funds accounts.... Recommendation 6: Money market funds should establish sound policies and procedures to know their investors.... Recommendation 7: Money market funds should hold a minimum amount of liquid assets to strengthen their ability to face redemptions and prevent fire sales. Recommendation 8: Money market funds should periodically conduct appropriate stress testing. Recommendation 9: Money market funds should have tools in place to deal with exceptional market conditions and substantial redemptions pressures."
The recommendations continue: "Recommendation 10: MMFs that offer a stable NAV should be subject to measures designed to reduce the specific risks associated with their stable NAV feature and to internalize the costs arising from these risks. Regulators should require, where workable, a conversion to floating/ variable NAV. Alternatively, safeguards should be introduced to reinforce stable NAV MMFs' resilience and ability to face significant redemptions. Recommendation 11: MMF regulation should strengthen the obligations of the responsible entities regarding internal credit risk assessment practices and avoid any mechanistic reliance on external ratings. Recommendation 12: CRA supervisors should seek to ensure credit rating agencies make more explicit their current rating methodologies for money market funds. Recommendation 13: MMF documentation should include a specific disclosure drawing investors' attention to the absence of a capital guarantee and the possibility of principal loss."
Finally, they include: Recommendation 14: MMFs' disclosure to investors should include all necessary information regarding the funds' practices in relation to valuation and the applicable procedures in times of stress. Recommendation 15: When necessary, regulators should develop guidelines strengthening the framework applicable to the use of repos by money market funds, taking into account the outcome of current work on repo markets."
