The vulnerability of money market funds (MMFs) to runs and other systemic risks prompted the Financial Stability Board to ask the International Organization of Securities Commissions (IOSCO) to study potential changes to the market. IOSCO released its findings late last month, and is accepting comments on them until May 28, 2012. (The Financial Stability Board was established to coordinate the work of national financial authorities and international standard setting bodies. Representatives from the U.S. Federal Reserve, SEC and Department of the Treasury are among its members.)
The study, "Money Market Fund Systemic Risk Analysis and Reform Options," addresses several dozen questions posed by the Financial Stability Board. These include the role of MMFs in funding markets and in the recent financial crisis, the potential impact of regulatory initiatives being considered, and the extent to which globally agreed upon principles and/or more detailed regulatory approaches are required and/or feasible.
The paper doesn't advocate specific actions, but instead lays out the pros and cons of various policy options. Among its findings:
- On the question of moving from constant to variable net asset values, the report acknowledges that holders in a fund whose asset value is variable have less incentive to flee when the fund experiences a loss, since the price transparency reduces the advantage of being among the first to leave the fund. However, the paper notes that the available evidence suggests both types of funds behave similarly in normal and stressed markets, and that eliminating constant value funds could disrupt the market. So, the paper looks at the possibility of imposing an "NAV buffer" on MMFs. One way would be to establish a reserve fund, using investment income, as a potential backstop against losses. Another potential buffer: requiring MMFs to issue subordinated equity shares that take the first losses, but in return, receive a preferential fee. One more option would be to establish buffer, but one that's funded by shareholders.
- The report also considers the pros and cons of requiring MMFs to reorganize as special purpose banks, given the similarities between bank deposits and MMF shares. As banks, MMFs would have access to government insurance and be subject to a clear regulatory framework. However, the report points out that in the U.S., this type of move would require legislation. In addition, the interaction between these new banks and the existing banking system would have to be carefully analyzed.
- On the question of whether constant NAV funds should be reserved for either retail or institutional investors – the run on MMFs in September 2008 after the Reserve Fund broke the buck was due almost entirely to institutional investors, the report notes – in order to protect retail investors, the report points out it's often difficult to distinguish one from the other. Moreover, there's no guarantee that future runs would be confined to a specific type of investor.
- Should MMFs be required to hold a certain level of liquid assets, while also being limited in the level of illiquid assets they could carry? This would help firms cover redemptions. But, the paper points out that these requirements are not likely to be sufficient in the event of a run, and don't address redemptions resulting from credit losses.
The analysis reaches some of the same conclusions contained in a 2010 paper on money market reform options prepared by the (U.S.) President's Working Group on Financial Markets.
Comments on the IOSCO report should be sent to MoneyMarket@iosco.org. The subject line must say Money Market Fund Systemic Risk Analysis and Reform Options.