Moody's Investors Service published a "Sector Comment on European Money Market Funds" entitled, "Cancellation of European Parliamentary Vote Gives Temporary Reprieve to CNAV Fund Managers." It tells us, "On 10 March 2014, the European Parliament's Economic and Monetary Affairs Committee (ECON) decided to cancel a much anticipated vote on proposed changes to money market fund (MMF) regulation because of persisting disagreements between members of the European parliament (MEPs). The vote cancellation is at least a temporary positive reprieve for constant net asset value (CNAV) MMF managers. It gives them more time to prepare their clients and adjust their product strategy to the likely outcome of the regulatory reform. Most of the measures contemplated by the proposed regulations would reduce CNAV funds' attractiveness and likely cause investors to move some of their monies to other products."
Moody's adds, "Driven by concerns about the MMF market's systemic importance and key vulnerabilities, especially structural susceptibility to runs, regulators in both Europe and the US have proposed reforms, including the possible elimination of CNAV funds or the creation of a capital buffer for CNAV MMFs. The discussions within the European Parliament (EP) are now on hold for several months pending the EP elections in late May."
They comment on the "Implications of the Proposals," "Much of the regulatory debate focuses on the elimination or the severe alteration of the CNAV funds framework in a way which might significantly reduce the product's attractiveness to investors. Variable net asset value (VNAV) structures would be less attractive to institutional investors under current tax and accounting rules. Shares in CNAV funds are typically bought and sold at the same price. Shareholders do not realize capital gain or loss upon a redemption and all of the fund's returns are ordinary income to its shareholders. The stable value of a CNAV fund also eliminates the need to consider the timing of sales and purchases of fund shares. From an accounting perspective, CNAV funds meet the characteristics of a "cash equivalent"."
Finally, Moody's adds, "If a 3% capital buffer was imposed, CNAV MMFs would become a non-economically viable product, at least in the current interest-rate environment. The application of such a buffer would potentially result in the elimination of CNAV funds, as managers would be forced to convert their funds to VNAV structure to avoid the buffer. Capital buffers and/or redemption limits will also cause investors' interest in MMFs to diminish, as at least some of the capital costs will likely be passed over to them, and redemption limits will alter the very nature of MMFs as a same-day liquidity instrument. MEPs decided on 10 March to give more time to the consideration of these matters and to postpone the discussions to the next European Parliament, which will be elected in May."
The Federal Reserve Bank of New York's Liberty Street Economics website posted "Liquidity Risk, Liquidity Management, and Liquidity Policies," "[T]he first in a series of six Liberty Street Economics posts on liquidity issues." Written by Tobias Adrian and Joao Santos, it says, "During the 2007-09 financial crisis, banks experienced widespread funding shortages, with shortfalls even hindering adequately capitalized banks. The Federal Reserve responded to the funding shortages by creating liquidity backstops to insulate the real economy from the banking sector's liquidity crisis. The regulatory reforms initiated by the Dodd-Frank Act and Basel III introduced systematic liquidity risk management into bank regulations. In the past year, research economists from the Federal Reserve Bank of New York have undertaken a number of research projects to further the conceptual and empirical understanding of banks' role in liquidity creation and to guide the design of arrangements to minimize the impact of liquidity shortages on financial stability and the real economy. On the Liberty Street Economics blog this week, we will publish a series of posts summarizing this work. This post provides an overview of the research projects."
The blog explains, "In "Depositor Discipline of Risk-Taking by U.S. Banks," Stavros Peristiani and Joao Santos examine how depositors responded to the amplified risks of bank failure over the last three decades, motivated by the large rise in the number of bank failures since the 2007-09 financial crisis. The authors show that uninsured depositors discipline troubled banks by withdrawing their funds well in advance of bank failures. Focusing on the recent financial crisis, the authors find that banks experienced an outflow of uninsured time deposits after the near-failure of Bear Stearns and bankruptcy of Lehman Brothers. Depositors became less risk sensitive after the Federal Deposit Insurance Corporation (FDIC) introduced the Transaction Guarantee Account Program in October 2008, which raised the maximum deposit insurance limit from $100,000 to $250,000."
It continues, "In "The Liquidity Stress Ratio: Measuring Liquidity Mismatch on Banks' Balance Sheets," Dong Beom Choi and Lily Zhou present a liquidity stress indicator that measures the potential for illiquidity in the banking sector. They note that while maturity transformation -- funding long-term assets with short-term liabilities -- is a key function of banks, this liquidity mismatch exposes banks to liquidity risk. This risk was clearly demonstrated in the 2007-09 financial crisis when banks' funding liquidity dried up and their market liquidity evaporated. Since the crisis, liquidity risk management has become one of the top priorities for regulators. Choi and Zhou introduce the Liquidity Stress Ratio as a new measure of liquidity mismatch, analyze how it has evolved for large banks, and study the correlation between the Liquidity Stress Ratio and key bank characteristics over time."
