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The Financial Stability Board (FSB) has released a final report and set of policy proposals designed to improve resilience in money market funds (MMFs).
FSB members will assess the vulnerability of MMFs within their jurisdictions and apply the framework and policy toolkit outlined in the report to address these weaknesses in line with their domestic legal frameworks.
Subsequently, the FSB will work with IOSCO to evaluate the effectiveness of these member-level responses, as well as taking further steps to promote the resilience and efficient functioning of short-term funding markets.
These efforts represent part of a multi-year work plan to enhance the resilience of non-bank financial intermediation (NBFI) following the market turmoil of March 2020.
The FSB has delivered the report, entitled Policy Proposals to enhance MMF Resilience, to the G20. An accompanying letter, sent on 11 October, highlights important progress made since the start of the project through steps to address risks in open-ended MMFs, to assess the impact of margin calls and the structure of core funding markets.
A draft version of the report was released for public consultation in June 2021 and this final report integrates feedback provided during this consultation process.
The FSB expects to submit a full progress report on its work on NBFI resilience to the G20 in late October 2021.
Central to its analysis, the FSB indicates that MMFs are subject to two broad areas of vulnerability: sudden and disruptive redemptions from investors wanting access to liquidity; and challenges they may face in selling assets, particularly in stressed market conditions.
The first type of vulnerability arises because MMFs engage in liquidity transformation, they are used for cash management by investors, and they are exposed to credit risk. Alongside this, regulatory thresholds may prompt investors to redeem from a fund to avoid the consequences of the fund crossing that threshold — what the FSB calls “cliff effects”.
Considered collectively, the FSB says that these features can contribute to a first-mover advantage for investors that redeem from the fund in a stress event and this can leave the individual MMFs, or in some circumstances the full MMF sector, vulnerable to runs.
The report advances a range of policy options to address MMF vulnerabilities, examining how these options would affect the behaviour of MMF investors, fund managers and sponsors, along with their broad impact on short-term funding markets.
The policy options include the use of swing pricing to impose the cost of redemptions on fund investors that redeem from a fund. These include provisions to guard against potential losses, including capital buffers and application of minimum balance at risk metrics (p 2).
These also include steps to review regulatory thresholds that may potentially result in cliff effects — including removing ties between regulatory thresholds and the application of fees or gates.
The FSB recognises that individual jurisdictions require flexibility to tailor measures to their specific circumstances.
It makes clear that a single policy option may not be sufficient to address all MMF vulnerabilities. For some jurisdictions the goal of enhancing MMF resilience may be to make funds more cash-like, targeting preservation of capital and liquidity for investors. For others, this may be in extending greater flexibility to investors, for example by allowing changes in redemption terms during periods of market stress. For many, this will involve a combination of the options detailed in the policy toolkit.
In reviewing progress, the FSB will conduct a “stocktake” of the measures adopted by individual member jurisdictions before the end of 2023.
It will conduct a further evaluation in 2026 of the wider impact that these collective initiatives have had in addressing risks to financial stability.
IOSCO will review its policy recommendations for MMFs, published in 2012, to accommodate the framework and policy toolkit detailed in this FSB report.
