Are more regulations needed for MMFs? - Editor's Blog -

The money market fund industry was hit by reforms in the aftermath of the global financial crisis, as regulators tried to reduce investor risk. After dramatic outflows in March last year, MMFs are in the spotlight again — but are more regulations the answer?

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In mid-March 2020, as the Covid-19 pandemic began to send shock waves through the global markets, virtually no corner was left unscathed including money market funds (MMFs), which is a $7tn market globally. MMFs are funds that only invest in low risk, low return assets, such as Treasury bills and short-term commercial paper, and are seen as ultra-safe, liquid places to park excess cash.

However, the volatility seen in the market early in the year induced dramatic outflows from prime MMFs, with some of the large US institutional funds experiencing outflows to a level of 30-40% of their assets, according to Fitch Ratings. The Federal Reserve had to quickly intervene with the Money Market Mutual Fund Liquidity Facility and the Commercial Paper Funding Facility to calm the market.

Many have drawn parallels to the global financial crisis (GFC), when the Reserve Primary Fund’s net asset value (NAV) fell below $1 per share, known as “breaking the buck”, in September 2008.

Following the GFC, the regulators stepped in with rounds of reforms aimed at increasing market stability and prevent future runs on a fund, including liquidity fees and redemption gates. Until earlier this year, none of these reforms had yet been tested a stressed market environment. Now it seems, the regulators are back for more as MMFs did not hold up as hoped for in March.

In late December, the President’s Working Group on Financial Markets, a coalition of the Commodity Futures Trading Commission, Federal Reserve, Securities and Exchange Commission and the Treasury, issued a joint report, suggesting 10 reforms to enhance the resiliency of MMFs.

Proposals include removing the tie between MMF liquidity and fee and gate thresholds, countercyclical weekly liquid asset requirements, capital buffer requirements and minimum balance at risk. 

In a statement, then deputy Treasury secretary Justin Muzinich said: “During March [2020], money markets experienced significant outflows, forcing Treasury and the Federal Reserve to step in to prevent a destabilising run. We must now consider reforms to ensure this vulnerability does not threaten financial stability in the future.”

The proposals include, among others, removing the tie between MMF liquidity and fee and gate thresholds, countercyclical weekly liquid asset requirements, capital buffer requirements and minimum balance at risk. But will these new regulations work for MMFs?

In a recent Fitch Ratings webinar, entitled Assessing Future Money Market Fund Regulatory Scenarios, industry experts pointed out the difficulties in trying to regulate a solution for MMFs, especially when the underlying market structure issue — that it is entirely dependent on bank intermediation — is not being addressed. There were calls for alternative venues, or all-to-all platforms, which have been effective in introducing transparency and liquidity into other parts of the fixed income market.

Out of the 10 proposals, however, the most popular seemed to be the removal of the link between MMF liquidity and fee and gate thresholds, as well as countercyclical weekly liquid asset requirements.

While the main aim of the working group’s proposals is to prevent central banks from having to step in a future crisis, the panellists warned that the any solutions put forward must be practical, workable and commercially viable. They also emphasised the valuable role that MMFs play in financing the economy and, more specifically, the short-term funding needs of companies. 

It raises the question of whether it is possible to regulate out risk in a market which, while flawed, serves the constitutes well except in times of extreme stress. The panellists pointed out that the 2008 crisis was one of credit, while in 2020 it was a crisis of liquidity. Can regulators completely safeguard the market for the next unforeseen event?

Joy Macknight is managing editor of The Banker. Follow her on Twitter @joymacknight

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