Money market funds have been under stress on two occasions in the last 15 years – in 2008 at the peak of the financial crisis and in March 2020 during the COVID-19 crisis – but regulators should think carefully before introducing more reforms to ‘fix’ the industry.
Money market funds (MMFs) should not be penalised by policymakers as a response to the market shock in March 2020, and efforts to ‘fix’ the industry could end up doing more harm than good. That is the view presented in an Official Monetary and Financial Institutions Forum (OMFIF) report and in a webinar that was hosted last week.
In ‘The future of money market funds’ OMFIF states that proposals, such as capital buffers for MMFs, could be tackling problems that don’t exist and the danger is that investors could seek systemically-riskier alternatives.
On the question of whether MMFs should be regulated in a bank-like way with capital requirements, Hester Peirce, Commissioner, Securities and Exchange Commission (SEC) – who was speaking in a personal capacity – said in the webinar, “I don’t understand why we would need capital buffers in funds that are 100% capitalised… I’m looking at it as a securities regulator and these are funds, which means that shareholder equity is on the line – they’re not banks where you have depositors who are creditors.”
Peirce also noted how the events of March 2020, when pandemic panic gripped the financial markets, was an opportunity to test whether reforms that were introduced in the wake of the global financial crisis had the desired effect. “I was someone who was a proponent of fees and gates and thought that was a good mechanism to put in place after 2008,” she said.
These liquidity fees and redemption gates were introduced – under the SEC’s Rule 2a-7 – to protect funds and ensure they had sufficient liquidity in times of stress. However, Peirce said that after seeing how the fees and gates operate in practice, she is now of the view that the reforms led to some bad consequences and it makes sense for them to be revisited. This echoes the OMFIF report finding that the tie between the liquid asset threshold and the fee or gate actually backfired and exacerbated outflows from MMFs in March 2020.
David Marsh, Chairman of OMFIF, who moderated the webinar, commented on how it is still debated whether MMFs are to be blamed for causing, or adding to, upsets in the market or whether they have been the victim of them. He described the narrative surrounding MMFs as something of a mystery that could be found in an Agatha Christie novel. “We simply don’t know what is behind the actual narrative,” Marsh said.
On this question, the findings of the OMFIF survey were clear: “There is no evidence that [MMFs] were a cause except for a deeply flawed post hoc fallacy of what transpired in March 2020.”
MMFs seem to get blamed when they are not actually the culprit, Marsh noted. Deborah Cunningham, Executive Vice President, Federated Hermes, commented on how the views of regulators and industry participants are converging: “I do think progress has been made on the understanding of what happened in March 2020”. This is contrasted with the events of 2008, when MMFs were also under stress. The major difference, she noted, is that this time the crisis was beyond the control of the financial industry and was caused by a government shutdown that affected all sectors.
Eric Pan, President and CEO Investment Company Institute, said the empirical evidence shows that MMFs were not responsible for a liquidity crisis. And although this is the second time in 15 years (2008 and March 2020) there have been problems with MMFs, the circumstances are very different. “I cringe when I hear anybody talk about how these are two cases that should be viewed as somehow in the same bucket”.
From here, any reforms to the MMF industry need to be forward-looking, the OMFIF report noted. “All this will take some time. Policymakers should not rush to conclusions before properly assessing the facts and the potential unintended consequences of the suggested reforms.”
