Thirty eight letters have now been posted in response to the Financial Stability Board's "Policy proposals to enhance money market fund resilience: Consultation Report", and we've quoted from several of them over the past week and a half. Today, we excerpt extensively from J.P. Morgan Asset Management's letter, written by CEO Americas John Donohue. He tells us, "JPMAM is pleased to provide comments on the Financial Stability Board's (FSB) Consultation Report on Policy Proposals to Enhance Money Market Fund Resilience. JPMAM is one of the largest managers of money market funds (MMFs) globally, with over $710B in assets under management. In the US, we manage over $460B in MMFs, across government and treasury MMFs (~$360B), institutional prime MMFs (~ $79B), retail prime MMFs (~$8B), and tax-exempt MMFs (~$12B). In Europe, we manage approximately $210B across the Low-Volatility Net Asset Value (LVNAV), Public Debt Constant NAV (PDCNAV) and Variable NAV (VNAV) MMF categories."

Donohue explains, "As was the case for many other MMF providers, JPMAM's non-public debt funds saw substantive redemptions in March 2020, as a result of global financial markets' reaction to COVID-19 and the actions taken by various governments to combat it. As such, we are supportive of policymakers' efforts to consider reform measures to improve the resilience of MMFs, as well as short-term funding markets (STFMs), while preserving the important functions they perform. We applaud the FSB for undertaking a thorough assessment of the potential impacts and consequences, to investors and markets more broadly, of the various policy options being considered."

He continues, "In order for reforms to be effective and to fulfil the objectives of policymakers, it is important they are appropriately calibrated and contextualized. At the peak of the pandemic-related market stress, there was an unprecedented demand for liquidity, which created significant strain across global financial markets, including STFMs. The significant tightening of market liquidity and the resulting dislocation permeated many areas of the market, including longer-dated government bonds, longer-term agency securities, corporate bonds, FX markets and global equities. In all of these markets, access to, and the preservation of, liquidity became paramount. As investors faced extraordinary uncertainty, the desire to hold cash prompted many companies -- even those on strong financial footing -- to draw down credit lines, issue debt, sell marketable securities, and redeem from MMFs. The market volatility only abated following public sector intervention, although the extent to which MMFs were able to avail themselves directly of such support differed across jurisdictions."

JPMAM comments, "Below we provide our views on the Consultation, including: The challenges faced by MMFs, on both the asset- and liability-side, and an assessment of potential MMF substitutes, where we have reservations on their effectiveness and availability; The various policy options presented, where we: outline our support for removing the tie between liquidity thresholds and the potential imposition of fees and gates, which we believe would be the most effective reform option; offer recommendations regarding potential modifications to the use of liquidity fees, incorporating certain elements of swing pricing; and discuss the drawbacks of the other options presented, some of which would undermine the viability of MMFs. We conclude by offering observations on risk monitoring and STFMs more broadly."

On "Potential substitutes," they state, "JPMAM welcomes the analysis of potential substitutes. While in theory the identified alternatives may perform a similar function to that of MMFs, in practice, they are not as readily available or interchangeable as suggested. Notwithstanding the key point that these substitutes also exhibit vulnerabilities, as noted by the FSB, there are material differences when compared to MMFs and/or significant practical challenges, which mean they are unlikely to be meaningfully utilized by investors or issuers. From an investor perspective, the two alternatives most frequently referenced are bank deposits and direct investments into the underlying instruments.... [T]he aversion of banks for such assets has been a key contributory element to the growth of the MMF sector.... With regards to direct investment, we broadly agree with the drawbacks referenced by the FSB. Only certain large investors will have the internal capacity, resources and necessary expertise to be able to invest directly."

The letter says, "The FSB also highlights the use of public debt MMFs as an alternative to non-public debt funds. While the comparatively lower yield offered by public debt MMFs may deter certain investors, a more material issue is capacity and supply-side constraints. For example, in Europe, the PDCNAV segment consists almost entirely of USD-denominated funds, with Sterling- and Euro-denominated funds collectively representing approximately 3 percent of total assets under management. Consideration should be given to the impact of further demand for Government MMFs on the US Treasury market, which, despite being the deepest and most liquid market in the world, also experienced market liquidity dislocations during March 2020 and are part of the ongoing review by policymakers."

It continues, "Another identified alternative is short-term fixed income funds. We note that in addition to having a different accounting treatment, which is a key consideration for MMF investors, these funds are likely to invest in longer-term assets, be subject to a greater degree of credit risk and maintain lower levels of liquidity relative to MMFs. In light of the current interest rate environment, one would expect those investors that could tolerate such risk in search of higher yield to have already done so. As such, we do not anticipate there being significant demand for such vehicles from current MMF investors."

Donohue also writes, "Following successive rounds of reforms, MMFs represent a highly regulated and highly transparent investment vehicle, which effectively matches investors with those in need of short-term funding. While new substitutes may arise, we note that none have yet done so which offer the same utility to MMF investors. Similarly, should these operate in a relatively less regulated environment, investors may need to accept higher risk and policymakers may have less visibility of market developments.... Issuers of short-term debt will need to find alternative means of funding. Given balance sheet constraints, the availability of bank loans will likely be limited."

He tells the FSB, "Based on these observations, we believe the most impactful policy options would be to 1) reduce threshold effects by removing the tie between the 30 percent WLA threshold and the imposition of fees and/or gates; and 2) modify redemption fees to facilitate their use, when appropriate, to impose on redeeming investors the cost of their redemptions (an alternative to swing pricing). Each of these is discussed in more detail below, after which we address the other policy options discussed in the Consultation, i.e., those designed to absorb losses and reduce liquidity transformation. We believe that the removal of the tie between consideration of fees and gates and the 30 percent WLA threshold is the single most impactful change regulators could make. As the Consultation observes, 'this option would reduce the likelihood of preemptive runs by investors in MMFs,' and make MMF 'managers more willing to use their WLA buffers to meet redemptions, thus reducing the need to sell less liquid assets.' While the impact of this change on the liability side of MMFs (investors being incentivized to redeem) is obvious, we believe the Consultation may underestimate the impact of such an action on the asset side. Both US prime and EU LVNAV funds hold nearly one third of their assets in highly liquid assets that could not be used to meet redemptions. If those assets had been usable, there would have been substantially fewer assets being liquidated, which would have reduced liquidity stress and decreased the downward pressure on prices."

JPMAM's comment states, "We believe the same beneficial result, namely that MMFs are able to use existing liquidity within a fund to meet redemptions during times of stress, will be more easily achieved if gates and fees are not linked to the 30 percent threshold, i.e., if MMFs do not risk accelerated redemptions as they approach 30 percent due to investor fear of gates or fees."

They quote, "[T]he swing pricing mechanism presents additional challenges, not identified in the Consultation, which would substantially limit the appeal and utility of MMFs. A more workable alternative would take certain elements of swing pricing and adapt them to the existing redemption fee mechanism.... MMFs ... routinely hold substantial amounts of short-term and maturing assets, and regularly see predictable, high levels of inflows and outflows (e.g., at month and quarter end); indeed, JPMAM maintains a 'cash flow calendar' that tracks expected subscriptions and redemptions, with input from client-facing representatives, to assist in cash flow management. Moreover, given the short duration of MMF assets generally, portfolio managers can plan for these redemptions by allowing assets to mature, rather than transacting in the secondary market. Thus, tying the execution of a NAV adjustment to net flows, as with swing pricing, does not make sense."

The letter opines, "We believe redemption fees, with some modifications, could be an effective mechanism to impose on redeeming investors the cost of their redemptions. Under current rules, fees are treated as essentially interchangeable from gates in the first instance, i.e., as an option for boards to consider when a MMF breaches regulatory thresholds.... We believe a more nuanced approach to fees could be beneficial, drawing on certain elements of swing pricing. As a preliminary matter, for investors, we observe that fees are a more tolerable intervention than gates.... While investors are comfortable with the concept that liquidity may come at a cost, in contrast, gates deny investors access to their cash entirely, which is highly problematic when a client has cash flow demands. Thus, it is worth considering an approach to fees as a remediation tool separate from, and to be used earlier than, gates. Importantly, we believe the existence of such a tool could be useful in educating clients away from viewing the 30 percent WLA as a bright line."

It continues, "Moreover, while current rules regarding fees are not prescriptive, we believe there is an opportunity to incorporate a framework similar to that used for swing pricing, to make fees more dynamic and reflective of the true cost of liquidity to those demanding it. Such an approach is likely to be more palatable to investors than a static 1-2 percent fee, imposed at the board's discretion. And, while swing pricing as currently used by mutual funds is operationally infeasible and conceptually problematic for MMFs, MMFs have already built an operational framework for the implementation of fees."

JPMAM adds, "Under our proposed approach, funds could be required to maintain detailed policies and procedures (i.e., a 'playbook'), reviewable by their supervising authorities to ensure they were sufficiently robust, that provide the board with clear direction on when to impose redemption fees and how to calculate them. We believe MMF sponsors are better positioned than boards to assess both when a fee should be imposed, and the right level of the fee; and further, that it is preferable to conduct this analysis ahead of time and have a decision tree prepared for the board, rather than expecting the board to make difficult determinations during periods of market stress."

Finally, they tells the FSB, "While we envision that the playbook would provide clear direction to the board on when to act, we expect the board would retain the discretion to decline imposing a fee if was not deemed in the best interest of shareholders. In developing the playbook, funds could consider a range of factors including net redemptions (single day, rolling average, cumulative, or other); WLA and other portfolio-specific characteristics (investor concentration, diversification of holdings, etc.); and market-based liquidity metrics (i.e., indications that non-WLA might not be readily sold).... Similar to the current practice for swing pricing, any fee recouped would be returned to the fund, which would protect remaining investors from the dilutive effects of the redemption activity."

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