Last week, the SEC hosted a "Roundtable on Interconnectedness and Risk in U.S. Credit Markets," which followed the publication of its "U.S. Credit Markets: Interconnectedness and the Effects of the COVID-19 Economic Shock," a report that examined the chaos in financial markets that accompanies the mid-March sudden shutdown of the world economy. (See our Oct. 14 News, "SEC Covid Shock Study: Frozen CP Market, MMFs & Short-Term Funding.") Today, we excerpt from some of the sessions which mentioned money market funds and short-term funding markets. (Please join us for next week's Money Fund Symposium Online, which takes place Oct. 27, 2020, from 1-4pmET and features a keynote from ICI's Paul Stevens and a series of discussions about potential future regulatory changes.)
During the SEC's Roundtable, Barbara Novick, Vice Chairman of BlackRock, commented, "I think you summarized it well in the paper. This was the perfect storm for a market making. Virtually everyone made a dash for cash at exactly the same time, individuals and institutions. You have two primary suppliers of liquidity. One is banks and the other is the proprietary trading firms; each of these faced different issues. On the bank side, the regulatory requirements for liquidity and capital gave them a dilemma. They had to preserve capital to be able to meet contractual obligations like lines of credit and revolvers. And they deemed anything that was not contractual essentially an optional activity, totally sensible."
She continued, "The regulatory guidance they received, while it was good, encouraged them to use their buffers. [But] it also has liquidity and other implications down the road on stress testing and capital. So, without a balance sheet neutral program, the banks wouldn't take advantage of that guidance to use their buffers, which of course led them to step back. That's half the problem. Likewise, on the proprietary trading firm side, they experienced concerns with the quality of data and their algorithms. And they basically turned them off and stepped back from market making. So, I think as we look forward, we really need to look at both of those as well as the market structure."
Novick explained, "I think what's unusual in this crisis is the banks had a cash buffer or liquidity buffer, and money market funds did, too. But the way the regulations work, neither one was able to use those buffers. So, I would vote for a good look at the regulations around both banks and money market funds and how to be able to use those buffers on countercyclical basis.... Let me start by stating the obvious, everyone values liquidity in a period of uncertainty. And any solution we think about has to take that as a given, because, yes, people will run again for cash if there is a period of uncertainty of this magnitude."
She also told the webinar, "Turning to money market funds, after the Great Financial Crisis, they went through a series of reforms regarding both the portfolio and the structure themselves. Some of those turned out to be very good. For example, building up a fairly high buffer of liquidity, having maturity and credit criteria, things like that. However, the 30% test was also tied to a fund board meeting where the board would meet to consider whether or not to put down gates or impose a redemption fee. And this coupling actually turned out to create tremendous uncertainty. You could see any firm that got close to that 30%, a lot of pressure, almost like it was the new 'break the buck.'"
Novick added, "So, we would recommend two things. One is decouple that 30%. Yes, require a 30% weekly liquidity, but don't have it tied to any kind of board meeting or specific decision. And second, put out some more specific guidance on encouraging the use of the buffer in that countercyclical way. The bottom line is, 'What's the point of a 30 percent buffer if you can't actually use it?'"
Finally, she said about consolidation, "The last part is the other firms and decisions to exit the industry. And I think you have to look at the business model of each firm. For example, some firms focus on institutional investors, some focus on retail investors. Some use the money market funds as a sweep for their brokerage. And the elements of each business model are going to drive any individual firm's decision. I wouldn't read too much into it in a general sense, but [think it is] much more idiosyncratic to those firms."
In a later session, Natasha Cazenave, Deputy Head of the Policy of France's AMF (Autorite des Marches Financiers), stated, "If we look back at what we experienced in February and March, clearly the short term credit market is an area where we saw severe stress, and money market funds are an important component of that market. As we said also earlier, in the U.S. as investors were trying to react to this spike in uncertainty, investors were running for cash.... It translated into very strong redemptions from Prime money market funds [and] there was a very large amount of inflows into government money market funds, about $800 billion, in the month of March, as is very nicely described in your report.
She explained, "In Europe, we actually saw similar moves. Investors were faced with the same kind of uncertainty and they also were all running for cash. So in the European framework, we also saw very significant redemptions out of the equivalent of prime money market funds. So in the E.U., they are low volatility NAV or floating NAV funds. And those funds really experience extremely severe stress. So it's best to give you an example. We [French MMFs] had assets under management of Euro 360 billion at the onset of the crisis. And these funds experienced redemptions that reduce AUM by 46 billion in just two weeks. And that is about the same magnitude as what we had experienced in 2008, 2009, although in a much shorter period of time."
Cazenave told the panel, "But now, since then, gradually the essence of the mongered have increased and we've now reached pre-crisis levels again. But still, the stress was very significant. And if we look at other European ... jurisdictions or money market domiciles, Ireland and Luxembourg, they also saw very significant outflows from the usually dollar denominated but also sterling denominated funds [in their] low volatility NAV funds, a special category here in the EU. But they also saw material inflows into public debt [MMFs].... You have to understand in the EU we have three categories of funds. We have a floating NAV funds, low volatility funds and public funds, and they can be in any currency."
She continued, "It's largely also an institutional investor market, which is slightly different from the US market. And at the same time, like in the U.S., secondary money market liquidity actually froze for a few days. The dealers were no longer either able or willing to back the short term debt securities and provide liquidity into the market. So that's also a big area of concern that we have to be looking at. This strain only eased up aggressively after the ECB meets the short term debt eligible to its purchase program. So actually, for us, the way we see this market is we consider March as a real life stress test."
Cazenave also said, "As was mentioned earlier, there have been very significant reforms in this segment of the market, post the global financial crisis, with the objective of strengthening the resilience of money market funds. Still for the second time in only in the decade there had to be intervention. So here's an area where certainly we consider that there will have to be some thinking going forward. I just wanted to point out that there's work underway internationally within IOSCO and the objective is we need to provide an in-depth analysis of what happened based on the available data and give a clear picture. We're looking at flows. We're looking at holdings. We're looking at different fund structures and building on that. The regulatory community will have to identify any outstanding fragilities, and this report will be published in the coming weeks."
She explained, "From a European perspective ... for us, it will be really important to factor in those differences in fund structures and currencies and regulation because we've seen different kinds of triggers or effects depending on fund structures. [W]e believe that the sequence of events raises a number of questions we'll have to address, particularly the one around precisely credit markets, so the ecosystem, how these markets function and how the interaction between money market funds and the functioning of the market should work. And also ... we have to reinforce the system with international standards and international forums. And we've seen issues. So this is maybe an area also that will have to be looked at more closely going forward."
Cazenave added, "So to sum up, money market funds are very important, critical vehicles, highly interconnected. And with other parts of the financial system inherently systemic by nature.... And so, again, it will be really important that we collectively draw the lessons of what happened [and] make sure we give diagnosis to provide the proper responses going forward."
Finally, the U.S. Treasury's Brett McIntosh commented, "Natasha identified ... a number of favorable actions that have been taken since the 2008 financial crisis. I think we can't underestimate the extent to which the 2010 and 2014 reforms made real progress here, and yet it's very clear that those reforms, in light of the turmoil of March, may not be enough. The question is whether we've exchanged one psychological barrier for another. Obviously, when you set a bright line rule, it hasn't tendency to encourage wrong behavior."
He finished, "So the question here is obviously in this case, policymakers were able to avert a run. But are there ways to enhance liquidity in this space without a bright line or in a way that draws a line without creating some sort of first mover advantage? I thought there have been a number of interesting suggestions on that today. It's something we need to discuss. I don't want to prejudge where we end up on that question, but there are complicated issues here that I think got a lot of smart thinking needs to go into it." (Again, see also the FT's "EU sets sights on money market fund reform".)
