As we mentioned in our "Link of the Day" Friday, the Financial Stability Board, an international regulator organization based in Basel, Switzerland, published "Policy Recommendations to Strengthen Oversight and Regulation of Shadow Banking. The FSB's statement from late last week says, "The Financial Stability Board (FSB) is publishing today policy recommendations to strengthen the oversight and regulation of the shadow banking system. These recommendations take into account public responses received on the consultative documents issued on 18 November 2012. The FSB has focused on five specific areas in which policies are needed to mitigate the potential systemic risks associated with shadow banking: (i) to mitigate the spill-over effect between the regular banking system and the shadow banking system; (ii) to reduce the susceptibility of money market funds (MMFs) to "runs"; (iii) to assess and align the incentives associated with securitisation; (iv) to dampen risks and pro-cyclical incentives associated with securities financing transactions such as repos and securities lending that may exacerbate funding strains in times of market stress; and (v) to assess and mitigate systemic risks posed by other shadow banking entities and activities."
The press release explains, "The documents published today comprise: A report entitled An Overview of Policy Recommendations that sets out the FSB's overall approach to addressing financial stability concerns associated with shadow banking, actions taken to date, and next steps. A report entitled Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos that sets out recommendations for addressing financial stability risks in this area, including enhanced transparency, regulation of securities financing, and improvements to market structure (ref. (iv) above). It also includes consultative proposals on minimum standards for methodologies to calculate haircuts on non-centrally cleared securities financing transactions and a framework of numerical haircut floors. [And] a report entitled Policy Framework for Strengthening Oversight and Regulation of Shadow Banking Entities that sets out the high-level policy framework to assess and address risks posed by shadow banking entities other than MMFs (ref. (v) above). As far as other shadow banking policy areas are concerned, the Basel Committee on Banking Supervision will complete its work in area (i) above in 2014, and the International Organization of Securities Commissions has already set out final policy recommendations for areas (ii) and (iii) above in its reports Policy Recommendations for Money Market Funds and Global Developments in Securitisation Markets."
The document entitled, "Strengthening Oversight and Regulation of Shadow Banking: An Overview of Policy Recommendations," discusses, "2.2. Reducing the susceptibility of money market funds (MMFs) to "runs"." It tells us, "MMFs provide a deposit-like instrument to investors, especially when they are redeemable on short notice and at par. Through their placement of investor funds, MMFs extend credit, and are also an important provider of short-term funding for the regular banking system as well as for other non-bank chains of credit intermediation that involve maturity transformation and leverage. MMFs demonstrated their vulnerability during the crisis when a large segment of MMFs experienced contagious investor runs, necessitating large scale support from sponsors or the official sector to maintain stability in the MMF sector. Absent such support, credit intermediation dependent on MMFs' funding would have been cut back dramatically. In order to address the demonstrated systemic risks of contagious investor runs on a large segment of MMFs, the International Organization of Securities Commissions (IOSCO) has developed policy recommendations that provide the basis for common standards for the regulation and management of MMFs across jurisdictions." (See IOSCO's report here.)
The report continues, "The FSB has endorsed the IOSCO recommendations, including the requirement that MMFs that offer stable or constant net asset value (NAV) to their investors should be converted into floating NAV where workable. Where such conversion is not workable, the FSB believes that the safeguards required to be introduced to reinforce stable NAV MMFs' resilience to runs should be functionally equivalent to the capital, liquidity, and other prudential requirements on banks that protect against runs on their deposits." (See FSB's previous Consultative Document on Shadow Banking here.)
It adds, "National and regional authorities are currently reviewing their existing approaches to regulating MMFs in light of the IOSCO recommendations. In the US, home to the world's largest MMF market, the Financial Stability Oversight Council (FSOC) issued for consultation in November 2012 proposed recommendations to support the implementation of structural reforms to mitigate the vulnerability of MMFs to runs. The Securities and Exchange Commission (SEC) also recently proposed rules that would reform the way that MMFs operate in order to make them less susceptible to runs. It is considering the following two alternatives that could be adopted alone or in combination: (i) Floating NAV – Prime institutional MMFs would be required to transact at a floating NAV. Government and retail MMFs would be allowed to continue using stable NAV. (ii) Liquidity fees and redemption gates – Non-government MMFs would be permitted to use liquidity fees and redemption gates to reduce run risks in times of stress."
The FSB writes, "In the EU, the second largest MMF market, the European Commission organised in 2012 a public consultation on the asset management regulatory framework including possible ways to strengthen MMFs' resilience to systemic risks (e.g. investor runs). [See document here.] An impact assessment has been prepared with a view to make a proposal for a MMF regulation in the second half of 2013. Meanwhile, the European Systemic Risk Board (ESRB) also published recommendations on stable NAV MMFs in December 2012 that include: mandatory conversion of stable NAV MMFs to floating NAV MMFs in order to reduce the shareholders' incentive to run when the MMF has experienced a loss; additional liquidity requirements; additional public disclosure on important features; and more detailed reporting by MMFs. IOSCO will launch a peer review process in 2014 to examine the implementation by national/regional authorities of its recommendations in this area. The results will be reported to the FSB so that they can be included in the overall monitoring and reporting of national/regional implementation progress in the shadow banking area."
