The President's Working Group on Financial Markets, which includes the Secretary of the Treasury, the Chair of the Board of Governors of the Federal Reserve, the Chairman of the SEC, and the Chairman of the CFTC, published a "Report of the President's Working Group on Financial Markets, Overview of Recent Events and Potential Reform Options for Money Market Funds." The paper reviews the coronavirus crisis in March and lists a number of possible regulatory changes for money market funds. It explains, "In March 2020, short-term funding markets came under sharp stress amid growing economic concerns related to the COVID-19 pandemic and an overall flight to liquidity and quality among investors. Instruments underlying these markets include short-term U.S. Treasury securities, short-term agency securities, short-term municipal securities, commercial paper ('CP'), and negotiable certificates of deposit issued by domestic and foreign banks ('NCDs'). Money market funds ('MMFs') are significant participants in these markets, facilitating investment by a broad range of individuals and institutions in the relevant short-term instruments. Because these short-term instruments tend to have relatively stable values and MMFs offer daily redemptions, investors in MMFs often expect to receive immediate liquidity with limited price volatility. However, in times of stress, these expectations may not match market conditions, causing investors to seek to liquidate their positions in MMFs. These investor actions, which are motivated by both the expectation-market condition mismatch and the structural vulnerabilities of MMFs, can amplify market stress more generally."
The PWG continues, "The economic and public policy considerations raised by this dynamic among investors, MMFs, and short-term funding markets are multi-faceted and significant. The orderly functioning of short-term funding markets is essential to the performance of broader financial markets and our economy more generally. It is the role of financial regulators to identify and address market activities that have the potential to impair that orderly functioning. Crafters of public policy and financial regulation also must recognize that the broad availability of short-term funding is critical to short-term funding markets and, for many decades, prime and tax-exempt MMFs have been an important source of demand in these markets although their market share has decreased and assets shifted toward government MMFs in the past decade. In addition, the participation of retail investors in MMFs raises considerations of fairness and consumer confidence, particularly in times of unanticipated stress, that can affect regulatory and public policy responses."
They explain, "These dynamics and policy considerations were brought into stark relief in March 2020. While government MMFs saw significant inflows during this time, the prime and tax-exempt MMF sectors faced significant outflows and increasingly illiquid markets for the funds' assets. As a result, prime and tax-exempt MMFs experienced, and began to contribute to, general stress in short-term funding markets in March 2020. For example, as pressures on prime and tax-exempt MMFs worsened, two MMF sponsors intervened to provide support to their funds. It did not appear that these funds had idiosyncratic holdings or were otherwise distinct from similar funds and, accordingly, it was reasonable to conclude that other MMFs could need similar support in the near term. These events occurred despite multiple reform efforts over the past decade to make MMFs more resilient to credit and liquidity stresses and, as a result, less susceptible to redemption-driven runs. When the Federal Reserve quickly took action in mid-March by establishing, with Treasury approval, the Money Market Mutual Fund Liquidity Facility ('MMLF') and other facilities to support short-term funding markets generally and MMFs specifically, prime and tax-exempt MMF outflows subsided and short-term funding market conditions improved."
The report tells us, "Prime and tax-exempt MMFs have been supported by official sector intervention twice over the past twelve years. In September 2008, there was a run on certain types of MMFs after the failure of Lehman Brothers caused a large prime MMF that held Lehman Brothers short-term instruments to sustain losses and 'break the buck.' During that time, prime MMFs experienced significant redemptions that contributed to dislocations in short-term funding markets, while government MMFs experienced net inflows. Ultimately, the run on prime MMFs abated after announcements of a Treasury guarantee program for MMFs and a Federal Reserve facility designed to provide liquidity to MMFs. Subsequently, the Securities and Exchange Commission ('SEC') adopted reforms (in 2010 and 2014) that were designed to address the structural vulnerabilities that became apparent in 2008."
The PWG comments, "Because prime and tax-exempt MMFs again have shown structural vulnerabilities that can create or transmit stress in short-term funding markets, it is incumbent upon financial regulators to examine the events of March 2020 closely, and in particular the role, operation, and regulatory framework for these MMFs, with a view toward potential improvements. In addition, absent regulatory reform or other action that alters market expectations, these prior official sector interventions may have the consequence of solidifying the perception among investors, fund sponsors, and other market participants that similar support will be provided in future periods of stress."
They add, "With that history and context, this report by the President's Working Group on Financial Markets ('PWG') begins the important process of review and assessment. After providing background on MMFs and prior reforms, the report discusses events in certain short-term funding markets in March 2020, focusing on MMFs. The report then discusses various measures that policy makers could consider to improve the resilience of MMFs and broader short-term funding markets. This report is meant to facilitate discussion. The PWG is not endorsing any given measure at this time."
The section on "Potential Policy Measures to Increase the Resilience of Prime and Tax-Exempt Money Market Funds," states, "While many of the post-2008 MMF reforms added stability to MMFs, the events of March 2020 show that more work is needed to reduce the risk that structural vulnerabilities in prime and tax-exempt MMFs will lead to or exacerbate stresses in short-term funding markets. The following discussion sets forth potential policy measures that could address the risks prime and tax-exempt MMFs pose to short-term funding markets."
It explains, "These potential policy measures differ in terms of the scope and breadth of regulatory changes they would require. For example, many of the potential reforms would apply only to prime and tax-exempt MMFs, while reforms such as swing pricing could apply to mutual funds more generally. Moreover, some potential reforms would involve targeted amendments to SEC rules, which relevant MMFs could likely implement fairly quickly, while others would involve longer-term structural changes or may require coordinated action by multiple agencies. The different measures are not necessarily mutually exclusive, nor are they equally effective at mitigating the vulnerabilities of prime and tax-exempt MMFs. Policy makers could combine certain measures within a single set of reforms. Some policy measures listed below have been raised for consideration previously, including in the PWG's October 2010 report on MMF reform options and the FSOC's 2012 proposed recommendations on MMF reform, and warrant renewed consideration in light of recent MMF stresses."
The PWG report tells us, "This report focuses on reform measures for MMFs only. It is important to recognize MMFs' role in the market events in March 2020 and to examine measures that would address concerns and structural vulnerabilities specific to MMFs. Although they are beyond the scope of this report, and as discussed generally above, there were other stresses in short-term funding markets in March 2020 that may have contributed to the pressure on MMFs."
It says, "As discussed in more detail below, the potential policy measures for prime and tax-exempt MMFs explored in this report are: Removal of Tie between MMF Liquidity and Fee and Gate Thresholds; Reform of Conditions for Imposing Redemption Gates; Minimum Balance at Risk ('MBR'); Money Market Fund Liquidity Management Changes; Countercyclical Weekly Liquid Asset Requirements; Floating NAVs for All Prime and Tax-Exempt Money Market Funds; Swing Pricing Requirement; Capital Buffer Requirements; Require Liquidity Exchange Bank ('LEB') Membership; and New Requirements Governing Sponsor Support."
Finally, the report asks, "As a threshold matter, it should be recognized that the various policy reforms, individually and in combination, should be evaluated in terms of their ability to effectively advance the overarching goals of reform. That is: First, would they effectively address the MMF structural vulnerabilities that contributed to stress in short-term funding markets? Second, would they improve the resilience and functioning of short-term funding markets? Third, would they reduce the likelihood that official sector interventions and taxpayer support will be needed to halt future MMF runs or address stresses in short-term funding markets more generally?"
The SEC comments on the report and requests feedback in a post entitled, "Staff Statement on the President's Working Group Report on Money Market Funds." Dalia Blass, Director of the Division of Investment Management (who is retiring soon), writes, "The President's Working Group on Financial Markets ('PWG') has studied the effects of the COVID-19 pandemic on the short-term funding markets and, in particular, on money market funds.... The Report discusses various reform measures that policy makers could consider to improve the resilience of prime and tax-exempt money market funds and broader short-term funding markets. As noted in the Report, many of the measures discussed could be implemented by the Commission under its existing statutory authority, while others may require longer-term structural changes and coordinated action by multiple agencies. The Report does not endorse specific recommendations for future reforms. Instead, it is meant to provide context and facilitate discussion by outlining potential reform options."
The statement adds, "Feedback backed by data where feasible would be helpful to the Division in evaluating what, if any, recommendations the Division might make to the Commission in this area. Specifically, the Division believes that feedback on the expected effectiveness of the measures identified in the Report (both individually and in combination) in: (1) addressing money market funds' structural vulnerabilities that can both cause them to come under stress and contribute to stress in short-term funding markets; (2) improving the resilience and functioning of short-term funding markets; and (3) reducing the likelihood that official sector interventions will be needed to prevent or halt future money market fund runs, and/or to address stresses in short-term funding markets more generally would be particularly helpful. The Division is also interested in feedback on other topics stakeholders believe are relevant to further money market fund reform, including other approaches for improving the resilience of money market funds and short-term funding markets generally. If you would like to let the Division know your views, we are providing an email box as a convenient method for you to communicate with the Division. We encourage you to communicate through the following address: IM_MMFPWG@sec.gov and insert 'PWG MMF' in the subject line. The Division anticipates making submissions public."
