The Financial Stability Board (FSB) published, "Policy Proposals to Enhance Money Market Fund Resilience: Consultation Report," a 67-page report that summarizes global regulators' views on potential money market fund regulatory reforms. The press release, subtitled, "Enhancing MMF resilience will help address systemic risks and minimise the need for future extraordinary central bank interventions to support the sector," says, "The FSB's holistic review of the March 2020 market turmoil highlighted structural vulnerabilities in MMFs and related stress in short-term funding markets. MMFs are susceptible to sudden and disruptive redemptions, and they may face challenges in selling assets, particularly under stressed conditions. These features can make individual MMFs, or even the entire MMF sector, susceptible to runs, and may also give rise to system-wide vulnerabilities. The policy options in the report aim to address these vulnerabilities and are intended to inform jurisdiction-specific reforms and any necessary adjustments to the policy recommendations for MMFs issued by the International Organization of Securities Commissions (IOSCO). Enhancing MMF resilience will help address systemic risks and minimise the need for future extraordinary central bank interventions to support the sector."
It explains, "The policy options are grouped according to the main mechanism through which they aim to enhance MMF resilience -- namely, to: impose on redeeming investors the cost of their redemptions; absorb losses; reduce threshold effects; and reduce liquidity transformation. The report assesses the likely effects of each option on the behaviour of MMF investors, fund managers and sponsors, as well as their implications for the underlying markets. `The consultation report also sets out considerations on how different policy options could be selected and combined to address all the vulnerabilities arising from different types of MMFs. The optimal combination should take account of jurisdiction-specific circumstances and policy priorities, as well as cross-border considerations including to prevent regulatory arbitrage that could arise from adopting divergent approaches across jurisdictions."
The release adds, "Policies aimed at enhancing the resilience of MMFs could be accompanied by additional reforms in two areas: (i) policies to support robust risk management by fund managers and risk monitoring by authorities; and (ii) measures to improve the functioning of the underlying short-term funding markets. Responses to the public consultation should be sent to fsb@fsb.org by 16 August with 'MMF policy proposals' in the subject line. All responses will be published on the FSB website unless respondents request otherwise. The final report will be published in October 2021."
The full report's "Executive Summary" explains, "This consultation report sets out policy proposals to enhance money market fund (MMF) resilience, including with respect to the appropriate structure of the sector and of underlying short-term funding markets (STFMs). The proposals form part of the FSB's work programme on non-bank financial intermediation and are intended to inform jurisdiction-specific reforms and any necessary adjustments to the policy recommendations for MMFs issued by IOSCO. Enhancing MMF resilience will help address systemic risks and minimise the need for future extraordinary central bank interventions to support the sector."
It tells us, "MMFs are open-ended investment funds that are managed with the aim of providing principal stability, daily liquidity, risk diversification and returns consistent with prevailing money market rates. MMFs are not homogeneous and their structure and risk characteristics differ across jurisdictions. MMFs are important providers of short-term financing for financial institutions (especially dollar funding for banks headquartered outside the US), corporations, and governments. They are also used by retail and institutional investors to invest excess cash and manage their short-term liquidity needs. While MMFs invest mostly in short-term debt instruments, their shares are redeemable on demand and many investors tend to treat MMFs as cash-like. Non-public debt MMFs are particularly active in the commercial paper (CP), negotiable certificates of deposit (CDs) and repo markets. Secondary markets for CP and CDs are generally not liquid as investors, including MMFs, tend to buy and hold these instruments to maturity."
The FSB report continues, "MMFs are subject to two broad types of vulnerabilities that can be mutually reinforcing: they are susceptible to sudden and disruptive redemptions, and they may face challenges in selling assets, particularly under stressed conditions. The first type of vulnerability arises from the fact that MMFs engage in liquidity transformation, are used for cash management by investors, and are exposed to credit risk. In addition, regulatory thresholds for some MMFs may cause investors to pre-emptively redeem to avoid the consequences of a fund crossing those thresholds (cliff effects), while certain types of investors (notably institutional investors) may amplify redemption risks. Taken together, these features can contribute to a first-mover advantage for redeeming investors in a stress event and thus make individual MMFs, or even the entire MMF sector, susceptible to runs. The second type of vulnerability arises because some MMFs hold financial instruments that have limited liquidity, even under normal market conditions. In practice, these two types of vulnerabilities have been significantly more prominent in non-public debt MMFs."
They write, "Some features of MMFs and their uses may also give rise to system-wide vulnerabilities. For example, similarities in portfolios may present contagion risks among MMFs, as strains on one fund may affect others that hold similar assets. Common features in fund structure and regulation, such as thresholds, may cause investors to react to news about one fund by redeeming shares from other funds. The usage of MMFs for cash management and specialised financial functions, such as to meet margin calls, may add a common component to MMF flows that exacerbates stress. The susceptibility of non-public debt MMFs to sudden and disruptive redemptions in episodes of stress has been evident in a number of jurisdictions and triggered by different shocks, most notably in the US and Europe in September 2008 and March 2020."
The FSB states, "The report considers the likely effects of a broad range of policy options to address MMF vulnerabilities, by examining how these options would affect the behaviour of MMF investors, fund managers and sponsors, as well as the options' broader effects on short-term funding markets, including through impacts on the use of potential substitutes for MMFs. Policy options are grouped according to the main -- though not necessarily the only -- mechanism through which they aim to enhance MMF resilience. Representative options under each mechanism include: swing pricing (to impose on redeeming investors the cost of their redemptions); minimum balance at risk and a capital buffer (to absorb losses); removal of ties between regulatory thresholds and imposition of fees/gates and removal of the stable net asset value (to reduce threshold effects); and limits on eligible assets and additional liquidity requirements and escalation procedures (to reduce liquidity transformation). Other options that can be considered as variants or extensions of the representative options are also presented in the report."
They comment, "Two sets of considerations are relevant for jurisdictions when selecting MMF policy options. The first is about how to prioritise specific options in the context of identified vulnerabilities. Important factors to consider will be existing regulations, the size and structure of the MMF sector in the jurisdiction, and the use of MMFs by different types of investors and borrowers in STFMs. These factors will affect the need for certain options across jurisdictions and their effectiveness. Currency denomination is another important consideration in jurisdictions with MMFs offered in foreign currencies. The wider impact on the financial system will depend on how the reforms will affect the linkages between MMFs and other market participants, as well as on the types of MMF alternatives available to investors and borrowers in STFMs, including on a cross-border basis."
The FSB confesses, "A single policy option on its own may not address all vulnerabilities. Accordingly, the second set of considerations is how authorities can combine options to address all MMF vulnerabilities prevalent in the jurisdiction. A natural starting point is to consider tools that authorities and MMFs have at their disposal, but have not used in practice. In terms of new policies, certain measures may be straightforward to implement and broadly compatible with all options, while others may be incompatible with each other. Another possible consideration may be the intended functions of MMFs -- for example, whether the goal of enhancing resilience is to be achieved by making them more cash-like (i.e. aiming at preservation of capital and liquidity for investors) or more investment-like (i.e. allowing greater price variability or changes in redemption terms in stress)."
Finally, they add, "Policies aimed at enhancing the resilience of MMFs could be accompanied by additional reforms in two areas. The first involves policies such as stress testing and transparency requirements on STFMs and their participants. While not directly addressing MMF vulnerabilities, such policies can support robust risk management by fund managers and risk monitoring by authorities. The second area involves measures that aim at improving the functioning of the underlying STFMs. The structure of the CP and CD markets makes them susceptible to illiquidity in times of stress. This highlights the need for policy reforms to enhance MMFs' own resilience, as those funds cannot rely on liquidity in these markets to raise cash to meet redemptions in stress. At the same time, even in jurisdictions where MMFs are large investors in CP and CDs, MMF reforms by themselves will not likely solve the structural fragilities in STFMs. Authorities might therefore consider adopting measures to improve the functioning of CP and CD markets. While useful in their own right, it is not clear that such measures would change the limited incentives of market participants to trade or of dealers to intermediate, particularly during stress periods."
