Last week, Fitch Ratings hosted a webinar on "Assessing Future MMF Regulatory Scenarios," which reviewed the recent President's Working Group Report on Financial Markets report and discussed potential regulatory reforms for money market funds. BlackRock's Tom Callahan explains, "Our experience, and I think this was another contributing factor to the amplified volatility, was that there was a fair degree of confusion amongst certain types of investors as to what these [previous MMF] reforms really meant. We were fielding an enormous amount of calls as there started to be some NAV volatility in FNAV funds. That's what the 'F' stands for ... it's floating, so these NAVs are supposed to go up and down. But when they went below par for the first time, there was a lot of confusion from some clients.... So we had to do a lot of education about what a money fund was in the post-2014 reform world, because I think a lot of people were sort of anchored to the old CNAV world and were alarmed when they saw NAVs starting to move around."
He continues, "I would say there was also confusion around the implementation of gates and fees, and what that rule really meant. Everyone was watching ... what the weekly liquid assets were doing across various funds. As they were pulled down towards the 30% threshold, that became a significant accelerant for outflows. Now, of course, the rules don't require gates and fees if a fund goes below 30%, and in fact, if you look across the industry, a ... provider did temporarily dip below that number. What the rule actually requires is a board meeting, but I don't think that that was widely understood either. I think the general sense was that if a fund goes below 30%, that it's some sort of 'trapdoor' effect, and that gates and fees are imminent. I think that anxiety led to the outsized reaction that we saw in terms of many prime funds in the course of a week or two seeing 30% outflows, 40% outflows."
Callahan comments, "The number one issue that needs to be addressed, in our view, is a market structure issue. The commercial paper markets, in times of market stress, freeze. And we saw that certainly in March. There was no bid for commercial paper, regardless of credit, regardless of tenure. The market just shut. As long as that is the dynamic, regulators can do whatever they like to prime funds in terms of changes, modifications, enhancement all the way to potentially banning the product. But if this issue of unstable market structure is not addressed, then in the next crisis, regulators will be forced to come right back in and bail out the CP markets because the same patterns will repeat."
He tells the webinar, "I think one of the issues that plagues credit markets broadly is lack of standardization and fragmentation. Are there ways that we could work as an industry to better standardize the issuance of CP to make [the market] inherently larger and more liquid? I think there's things that can be done there. But this issue of a bank's ability to hold CP is something that needs to be looked at because ... in times of market stress, the last thing banks want to be doing is congesting their balance sheet with a lot of low margin commercial paper. It's just not of great value to them. So, it is worth debating if making CP easier for banks to hold by classifying the highest quality CP as HQLA would make sense. Ideas like that would make it easier for banks to fill that role that they're supposed to be fulfilling, which is acting as an intermediary in times of market stress."
Asked about the Fed's emergency facilities in March, Callahan responds, "They were absolutely essential. You have to give global regulators, particularly the Fed and the SEC, you have to give them an A+, not only for the actions that they took, but the speed at which they reacted. Now, I suppose it was helpful that there were a number of these programs that were essentially on the shelf from the GFC. But I will tell you, we were having weekend conversations, late night conversations. Regulators were in touch literally minute by minute as things were progressing during that very difficult week of March 15th. They understood the severity. They understood the trajectory. I mean, you just can't have any product sustain 30, 40% outflows against a closed secondary market. That can't go on forever. They knew that, and they acted forcefully and they acted, most importantly, very, very quickly. I think we have to give our regulators immense, immense kudos and credit."
Callahan states, "An absolutely essential question, one that we get asked quite a bit by regulators, is, 'I thought we fixed this thing. Why are we having to come back again and bail out money funds?' I think you do have to admit that the reforms, as significant as they were both in Europe in '19 and the U.S. in '10 and '14, were clearly insufficient to make funds self-sustaining through times of acute market stress -- what they were intended to do. I think all of us in the industry need to step back and look at those regulations and try to figure out what worked and what didn't, and to propose common sense solutions to make them more resilient, so we don't rely on a market structure that once a decade or so requires sovereign support."
He adds, "At BlackRock, we've certainly tried to make a number of those suggestions. We've put out some publications on the topic, and talked about some of the things I've already referenced here today. We also talked an awful lot about micro changes to prime funds, changes that we think can help make them more resilient."
Then, Callahan says, "Now pivoting to the second question about the President's Working Group, there were 10 suggestions there. We thought a lot of them were really constructive, helpful and practical. Some were a little bit confusing, and then there were others that we would put in the category of solutions that are not practical, that are not workable and would be de facto bans on the product, either because they're not operationally feasible, they're too expensive, or they're just features that clients would never accept. We think if the intention is to ban prime money funds, then ban prime money funds. Don't put a series of highly complex, unworkable, complicated solutions that kind of get you to that same place."
He explains, "The first suggestion in the President's Working Group letter, and the one we thought was the most constructive, is this idea of decoupling a board's ability to implement gates and fees in a prime fund. You need to detach that from any specific metric, as the rule exists right now ... that rule is 30%. So, at 30.01% the fund is fine, at 29.99%, all of a sudden, you're having emergency board meetings and it creates essentially a trapdoor affect that I think more than anything, incited the anxiety, borderline panic maybe even, of certain investors to get out of prime funds. There was this sense, if I don't get out before we get below 30%, then my money is going to be trapped or gated in some capacity."
Callahan says, "A board would have the ability to implement gates and fees in a fund at a time of their discretion. Remember, a board acts as a fiduciary in the best interest of their shareholders. They're not going to implement gates and fees for no good reason. They're going to do it only when they view it as being in the best interest of protecting shareholders of the fund. But let's not tie that to a specific metric because that essentially ... incentivizes the very behavior that everyone is trying to discourage, which is this instinct that clients need to rush from these funds at a time of market crisis. That is a recommendation we support, and we've written about."
He adds, "The second recommendation is a close cousin, which is: should you make these liquidity requirements countercyclical? We had an effective example of how this works in action from the OCC and how they modified liquidity requirements in STIFs during that same period in March 2020. Now, the binding constraint in STIFs is not a weekly liquid asset, it's the weighted average life. They actually allowed their regulated vehicles to extend their average life. I think the rule was 120 days and they extended to, I think 160 or 165. So, essentially countercyclical adjusting liquidity requirements to reflect the market that you're in.... If you're not allowed to use a liquidity buffer, it doesn't matter what it is. You could take from 30% to 50%, you can make it 90% -- if you're never really allowed to use it, it's not doing you any good. So, this whole idea of making that more flexible and reflective of liquidity and systemic issues that are happening, those are two suggestions that we support and think are spot on."
Callahan also tells the Fitch event, "All of these measures are going to make funds more liquid, more secure. But there's also likely to be a yield penalty. Obviously, we're in probably the most acute period, certainly in my career, of lack of supply, tight spreads, flat curves, and severely low yields. The spread between government funds and prime funds is already historically compressed.... So that's why, back to my point, I think we need to be mindful [that] certain of these measures will potentially just make these products uncompetitive. If you put a prime fund on top of a government fund, for example, in an extreme situation because of some of these measures, no one's going to buy them. That's a pretty good way to make sure prime funds pose no systemic risk, if there's no assets in them. We don't really want to head down that road. There is a balance of making sure that they're secure and stable."
Finally, he states, "I can't tell you exactly how many basis points of spread between prime and govie funds is the right balance, but I do think it is important to keep in mind as we look at all of these measures. What is sort of the cost versus the benefit? At BlackRock, we believe that if some of the measures we've written about in our Viewpoints are implemented, that prime funds do have a role and they can be strengthened and made resilient so that in times of market stress, they're not requiring sovereign support. We think those answers are out there, but it is not just something as simple as tweaking a liquidity level. It's got to be a comprehensive solution, looking at the ecosystem, looking at the structure of the CP market and looking at the structure of money funds. You take all of that together and that's where you'll find your answer. To the degree regulators play a role in bringing investors, issuers, all the different sort of representatives of this market ecosystem together, and bring great ideas to the fore, I think they will make tremendous progress."
