The Investment Company Institute kicked off its virtual 2021 Mutual Funds and Investment Management Conference yesterday with a Keynote Address from new President and CEO Eric Pan. Pan discussed money market funds and potential future regulations throughout his remarks, telling us, "I would like to speak with you today about the discussions that US and international policymakers are having about the March 2020 market turmoil and their work to make the financial markets more resilient in the face of a similar liquidity shock. Such work is taking place in international bodies such as the Financial Stability Board (FSB) and International Organization of Securities Commissions, with the active participation of US financial regulators."
He continues, "For those familiar with the regulatory debates following the 2007–2009 global financial crisis, these discussions should give you a sense of déjà vu. Regulated funds, including money market funds and long-term open-end funds, such as bond funds, are being closely scrutinized for systemic vulnerabilities. Indeed, some commentators have gone as far as to argue that the market events of March 2020 indicate that the business models of these funds should fundamentally change because they contend that these funds are unsafe for the global financial system in the absence of a central bank liquidity backstop."
Pan comments, "Although US Treasury securities are usually a safe haven for market participants during times of market stress, data indicate that investors were selling Treasury bonds in early March 2020, signaling that the Treasury market was becoming dislocated. This dislocation began in advance of redemption pressure on money market funds. Numerous factors appear to have contributed to this aberrant behavior, ranging from market participants rebalancing positions to account for changing market conditions to capital requirements for banks."
He explains, "Money market funds and bond mutual funds are, of course, inextricable components of the financial system. However, they did not trigger the stresses in the financial markets. This observation is important because, as regulators consider what reforms may be needed, they should prioritize examining the factors that created the stresses and, only after identifying and addressing those factors, consider necessary policy reforms for regulated funds."
Discussing "Considerations for Policymakers and Regulators," Pan comments, "First, policymakers and regulators should acknowledge the importance of nonbank financial intermediation to the global financial system. This includes the vital role of money market funds, long-term open-end funds, and other regulated funds -- particularly in jurisdictions with robust capital markets. Capital markets are powerful engines of economic growth and innovation, especially today as the world looks to the capital markets to finance a more sustainable future."
He continues, "Money market funds especially are a liquid and diversified cash management tool for investors and a key source of funding for governments and the private sector. At the end of last year, US-regulated money market funds held $3.9 trillion in short-term Treasury and agency securities and repurchase agreements, along with $414 billion in short-term municipal debt, bank certificates of deposit, and commercial paper. Money market funds accounted for 17 percent of the commercial paper market, which is an important source of short-term funding for banks and other financial institutions that provide funding for US households and businesses."
In a section on "Money Market Funds," Pan says, "Last fall, the FSB began the important process of reviewing and assessing the market events of March 2020, with specific focus on money market funds as significant participants in the short-term funding markets. In December, the President's Working Group on Financial Markets issued a report discussing 10 reform measures that policymakers could consider to improve the resilience of money market funds and the broader short-term funding markets. In recognition of the importance of money market funds to investors and the economy, ICI and its members have devoted significant time and effort over the years to considering how to make these funds more robust under even the most adverse market conditions -- goals we share with the Securities and Exchange Commission (SEC) and other policymakers."
He states, "Three principles have always guided our analysis of money market fund reform proposals: First, given the tremendous benefits that money market funds provide to investors and the economy, it is imperative to preserve this product's essential characteristics. Second, in devising a solution, we need to stay focused on the objective that policymakers are seeking to achieve. This objective is to strengthen money market funds even further against adverse market conditions and to enable them to meet extraordinarily high levels of redemption requests. Finally, any solution must be designed to promote this important policy goal while minimizing the potential for unintended negative consequences."
Pan also says, "With these principles in mind, we have found that a number of the reform options that have been proposed suffer from significant drawbacks -- ranging from potential detrimental impacts on money market funds, their investors, and the markets, to complicated regulatory, structural, and operational hurdles. For example, one proposal would be to introduce swing pricing to money market funds. To make swing pricing work, however, funds would have to eliminate popular features such as same-day settlement and multiple NAV strikes, reducing the utility of the product to investors without necessarily reducing the incentives for investors to redeem during times of stress."
He tells the MFIMC, "Another example is the use of capital buffers. Capital buffers would negatively affect money market fund yields, making such funds not commercially viable, while they are unlikely to offer any substantial protection during a liquidity crisis, such as the one we had last March. For those who remember the debate about money market funds between 2012 and 2014, the potential policy options should evoke some strong memories. Many were considered back then and, in several cases, rejected by the SEC itself. Therefore, it should not surprise regulators that some of these options remain problematic even today."
He continues, "On the other hand, at least one option could prove useful. Removing the tie between money market fund liquidity and fee and gate thresholds could address policymakers' concerns with the least negative impact. The run risk that regulators appropriately worry about is exacerbated by these bright lines in regulation where market participants find themselves trying to stay on one side of the line."
Finally, Pan adds, "ICI's analysis indicates that, as the weekly liquid assets of particular prime money market funds fell toward 30 percent, investors were increasingly likely to redeem. Investors apparently reacted to the mere possibility that funds had the legal authority to impose fees and gates rather than the probability that they would do so. Thus, the 30 percent weekly liquid asset requirement, combined with the possibility of fees and gates, created a bright line that investors sought to avoid despite the fact that these funds still had plentiful weekly liquidity."
