Over 30 comment letters have been posted in response to the European Securities and Markets Authority's (ESMA's) "Consultation on EU Money Market Fund Regulation - Legislative Review." While we'll be reviewing and quoting a number of these in coming days, we'll pick one from one of the largest managers of European MMFs to start. The first comment says, "BlackRock appreciates the opportunity to respond to the questions raised by ESMA in its consultation on the review of the EU Money Market Fund Regulation (MMFR). The short-term markets experienced sharp stresses in March of 2020 because of COVID 19 and an overall flight to liquidity. This highlighted potential weaknesses in money market funds (MMFs) and vulnerabilities in the surrounding short-term market ecosystem. Such an unprecedented market-wide event affords regulators and market participants the opportunity to draw conclusions from a live 'stress test' that can help improve the resilience of MMFs and the short-term markets."
BlackRock's post tells ESMA, "In forming a clear view of the stresses on MMFs in March 2020, it is important to note first and foremost, that the experience of US and European MMFs was different; and again, within Europe, the dynamics varied across different fund types and currencies. While the extent of, and underlying reasons for, client redemptions differed, one universal observation shared by MMFs in the US and across Europe is that the short-term credit markets were highly distressed, with bank dealer-driven liquidity severely constrained."
It explains, "The liquidity of the entire short-term market ecosystem in the US improved quickly and dramatically upon the introduction of the U.S. Federal Reserve's Money Market Mutual Fund Liquidity Facility (MMLF) and other facilities which both provided bank dealers with a dedicated liquidity backstop and ensured any liquidity they provided to the market was capital neutral. In Europe, however, market interventions by the European Central Bank (ECB) and Bank of England (BoE) had a far more indirect effect; as a result, the European short-term market ecosystem did not return to more normal liquidity conditions for months."
They comment, "As noted in our recent ViewPoint 'Lessons from COVID 19: The Experience of European MMFs in Short-Term Markets,' we recommend that policy makers look holistically at short-term markets to identify areas for improvement rather than look at MMFs in isolation. We outline three areas for improvement: short-term market structure; bank capital and liquidity rules; and MMF product regulation. It is our view that improvement in all three areas is essential to enable short term markets (and in turn MMFs which provide the most transparent access to these markets) to respond effectively to potential future shocks of the magnitude of that experienced in March of last year."
BlackRock writes, "We appreciate that the subject of this consultation focuses on the final element of that holistic view: MMF product regulation and in particular on identifying potential vulnerabilities exposed by the COVID-related market turmoil. We would summarise our input to this consultation around four key observations: 1. March 2020 was fundamentally a liquidity shock, and the primary policy question this should raise is whether or not MMFs' portfolios were positioned with sufficient levels of useable liquidity to navigate the situation.... 2. In situations where short-term liquidity is insufficient to meet redemptions, MMFs need tools to manage any dilutive effect of selling longer-dated securities to meet redemptions.... 3. With the possible exception of the rotation from prime MMFs into government MMFs observed in the US market and the (less-severe) spillover we saw in USD LVNAV funds, outflows were driven by investors' underlying cash and liquidity needs, not by investor confidence in the structural features of different types of MMFs.... [and] 4. Beyond any specific reforms to money market funds, we believe that transparency can and should improve in short term markets where data about issuers, investors, and even some MMFs can be difficult to source for both market participants and public authorities."
They add, "We commend the structure of ESMA's request for feedback not just on the specifics of the policy options presented in the paper, but on the potential impact on investors and any broader macro implications of pursuing specific reforms. We believe these are incredibly important considerations and should be central to shaping future policy."
Finally, BlackRock states, "MMFs, because they are the most transparent point within the short-term market ecosystem, are often seen as analogous to the entire investor base in short-term markets, but this is not the case. There are a variety of other investor types who invest in these markets directly, and if the use case of MMFs is removed through regulatory reforms, it is likely that direct investment through investors' own in-house treasuries would increase. This would result in more disaggregated, opaque markets, and less direct regulatory oversight over the investor base in the short-term markets. And as direct investors would likely not be holding the same quantity and quality of overnight and short-dated liquidity as a MMF would, in a future disruption in short-term markets, a wide range of companies and market participants may have far greater difficulty raising cash than was actually experienced in March of last year. This could increase, rather than reduce, the potential need for public sector interventions to support market functioning."
In other news, Moody's Investors Service published the brief, "Financial Stability Board's proposals are credit negative for money market fund sponsors." They tell us, "On 30 June, the Financial Stability Board (FSB) opened a consultation on policy proposals designed to make money market funds (MMFs) less vulnerable to sudden withdrawals of client money and to make it easier for them to sell assets under stressed conditions. The FSB's proposals would make prime MMFs safer, but also raise questions about whether prime MMFs can remain a commercially viable fund product if the proposals are implemented. If prime MMFs were less commercially viable, it would be credit negative for their asset manager sponsors. The consultation will also explore the possibility of additional stress tests and measures to improve the functioning of commercial paper (CP) and certificate of deposit (CD) markets."
The report explains, "The FSB consultation is designed to encourage national authorities to consider ways of reinforcing MMFs that they have not yet used in practice.... It sets out a range of options that would either make MMFs more cash-like, with an emphasis on preservation of capital and liquidity, or more investment-like, with greater leeway for price variation and changes in redemption terms during times of stress. Some of the FSB's reform options aim to reinforce the sector by imposing redemption costs on investors or by improving MMFs' loss absorption capacity. Others would reduce MMFs' liquidity transformation or limit adverse 'threshold' effects, such as preemptive withdrawals as fund liquidity declines toward levels where redemption restrictions kick in. `The FSB recommends that national authorities combine a mix of these policy options into a reform package that addresses all MMF vulnerabilities, selecting the combination most appropriate for their jurisdiction."
It states, "Many of these options would enhance MMFs' resilience during periods of stress, but would also make them less attractive to investors and sponsors. For example, measures such as swing pricing and minimum balances at risk would make MMF shares less liquid, potentially deterring some investors. They would also entail costly operational challenges that could in some cases make MMFs uneconomical for their sponsors. This would weigh particularly heavily on prime MMF funds because they invest in less liquid securities than government MMFs. A contraction of the prime MMF fund sector, a significant buyer of short-term debt instruments, would have an adverse impact on short-term funding markets. Nonpublic debt MMFs are particularly active buyers of CP and negotiable CDs. Euro-denominated MMFs hold around 54% of euro-denominated financial sector CP."
Moody's comments, "In this scenario, some prime fund investors would instead put money into government MMFs or in bank deposits, reducing the supply of short-term debt funding for financial institutions and some corporates. Investors may also opt for less regulated and transparent short-duration bond funds, which are also susceptible to runs that can cause stress in short-term markets. One of the FSB's proposals is to reduce MMF exposure to less liquid assets such as CP and CDs. This would better align the average liquidity of MMF assets with their redemption terms. However, these securities account for a large share of prime MMFs' portfolios, and replacing them would reduce the funds' investment yield."
They add, "The FSB separately suggests that MMF sponsors and regulatory authorities use stress tests to identify vulnerabilities in individual funds and in the sector as a whole. It also proposes measures, such as greater standardisation and increased transparency over volumes and pricing, designed to improve the functioning of CP and CD markets. The consultation closes on 16 August and the FSB will publish a final report in October." (For more, see our July 1 Crane Data News, "FSB Policy Proposals for Money Fund Resilience; Broad Range of Options and the FSB's "Policy Proposals to Enhance Money Market Fund Resilience".)
