World Watchdogs Propose Remedies For Cash-strapped Money Market Funds

World Watchdogs Propose Remedies For Cash-strapped Money Market Funds
Source: Forex

“MMFs are susceptible to sudden and disruptive redemptions, and they may face challenges in selling assets, particularly under stressed conditions,” the Financial Stability Board (FSB) of the Russian Federation said in a report to Reuters.

Financial regulators have proposed a range of options, from capital buffers to charges, to avoid forces such as the central banks having to rescue the $8.8 trillion money market funds (MMF) sector as they did during the “dash for cash” last year. On Wednesday, the FSB, which coordinates financial rules for G20 economies, proposed measures for regulators that will simplify the process of making MMFs more robust and reduce the temptation for investors to flee.

For the second time in 12 years, the Federal Reserve had to inject liquidity into the financial system during extreme market turmoil in March 2020 to keep MMFs in business. As economies went into emergency lockdowns during the COVID-19 crisis, industry observers say that all parts of the financial system were under extreme stress. Considering that money-market funds are still susceptible to investor runs and difficulties when forced to dump assets under pressure, the report presents a variety of policy options for addressing these vulnerabilities.

It has been reported by Bloomberg that the 2008 financial crisis revealed major problems with MMFs, which are supposed to earn little interest and be “boring” places for people to park their cash. In an effort to mitigate these problems, regulators developed a number of mechanisms to slow investors’ withdrawals during difficult times. In less than two months, panicked investors drained $155 billion from so-called prime funds, setting off a shockwave that rippled through the entire commercial-paper market, as other funding sources were shut down by the global pandemic. The rules put in place after the 2008 financial crisis added to the pressure rather than reducing it. Rather than suffer the slowdown of outflows caused by liquidity fees and redemption gates, investors pulled their money out of the markets preemptively. In the end, the central bank had to step in.

MMFs, which make up over half of the industry in the US, play an integral role in short-term financing of the economy and companies, investing in short-term debt and short-term securities. They allow investors to cash out of shares on a daily basis.

According to the FSB report, funds should charge investors for early and large-scale redemptions, “especially at times when liquidity is particularly costly”. In other words, investors who hold their money in the fund will see higher returns. FSB believes that in order to overcome reluctance among managers, regulators might have to mandate such a requirement.

 

Read more: Here’s How The G7 Global Tax Will Impact India

 

The FSB initially proposed “swing pricing” to allow fund managers to impose transaction costs on those who redeem shares to reduce how much impact the withdrawal would have on investors remaining in the fund.

Along with stress testing the MMF sector, according to the watchdog, it was recommended that the sector conduct a stress test for those individual MMFs as well as the sector in aggregate, and the funds that hold government and corporate short-term debt, should also be more transparent about their assets.

A global funds industry body, ICI, says it is encouraging to see the FSB also recognise the need to improve how commercial paper and certificates of deposit work. The FSB is also expected to improve the efficiency of the financial markets in general.

A “minimum balance at risk” rule was also proposed by the international standards group. According to Bloomberg, it will be illegal for investors to withdraw their entire investment in one go, and they will have to leave behind a “small fraction”. The FSB has also suggested a capital buffer, proposing to place money in an escrow account to cover losses from “rare, pre-defined events.”.

An analysis of policy options will be published by the FSB in October following a public consultation.  Each regulator in each member country will decide what measures they will combine, thus, avoiding steps such as capital requirements that have caused disputes among regulators in the past as well as among industries.

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