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FSB Finalizes Proposals On Money Market Fund Reforms

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EDITOR'S NOTE: Central Banking reports that The Financial Stability Board (FSB) has “finalized its proposals for reforms to boost the resilience of money market funds (MMFs), despite complaints.” The organization does not set a global standard. Instead, it proposes a menu of options to choose from. The possible choices fall into one of four main groups. These are: imposing the cost of redemptions on those who are redeeming, absorbing credit losses, addressing threshold effects, and reducing liquidity transformation. The reason for this report and the ensuing suggestions is that troubles in MMFs were a major factor in the market stresses during the pandemic, and “many of the funds experienced large outflows, and regulators say this spilled over into wider market dysfunction.

financial stability board

Photo: Central Banking

The Financial Stability Board has finalised its proposals for reforms to boost the resilience of money market funds (MMFs), despite some complaints from the industry.

Members of the international body have signalled their commitment to implementing the measures, which aim to make the sector more resilient and less likely to amplify bouts of stress.

“FSB members are assessing, or will assess, MMF vulnerabilities in their jurisdiction and will address them using the framework and policy toolkit in this report, in line with their domestic legal frameworks,” the FSB said in a statement.

The final report, published today (October 11), proposes a menu of policy options rather than a set of fixed global standards. The FSB said this reflected the wide range of domestic legal frameworks and other “specific circumstances” that demand a tailored approach.

Measures in the report are grouped under four main headings: imposing the cost of redemptions on those who are redeeming; absorbing credit losses; addressing threshold effects; and reducing liquidity transformation. Possible measures include swing pricing, capital and liquidity requirements, and controls on eligible assets.

Beyond a few clarifications, the text of the final report is broadly unchanged from a version published for consultation in June. Though several asset managers criticised aspects of the proposals, the FSB ultimately was not swayed, concluding that the comments “did not introduce major new elements to the analysis”.

Troubles in MMFs were a major factor in the market stresses during the Covid-19 outbreak in 2020. Many of the funds experienced large outflows, and regulators say this spilled over into wider market dysfunction.

The FSB argues the structure of MMFs can trigger run-like dynamics by offering daily redemptions despite the illiquidity of underlying assets. Investors that are slower to pull their money out may lose some of it, creating an incentive to move first.

But many respondents to the consultation from the asset management industry said the troubles in the MMF sector were a symptom of the Covid-19 stress, not the cause of it.

“Industry respondents argued that MMF redemptions from certain types of funds did not contribute to increasing the cost of short-term funding for borrowers,” the FSB said. “They also argued that problems were exacerbated by the fact that dealers’ balance sheets were under pressure because of the large volume of various assets being sold relative to the dealer capacity.”

The FSB noted many of these same respondents laid the blame for the crisis on problems with the functioning of short-term funding markets, particularly those that deal in commercial paper and certificates of deposit (CP/CD).

The FSB has not ruled out that these may be partly to blame and is continuing work on improving their function. But it said it views the work on MMFs as complementary to work on funding markets. Furthermore, it noted there was only so much that can be done to improve the functioning of CP/CD markets, as there is limited demand for secondary market trading, making them inherently illiquid.

FSB members have until the end of 2023 to assess MMF vulnerabilities and start taking action. At that point, the FSB and the International Organization of Securities Commissions will conduct an initial “stocktake”. They will follow up with an assessment in 2026 of whether the measures are working. Further action could follow.

FSB chair Randal Quarles said in a letter to the G20 that the FSB is continuing work on other risks in the non-bank sector. Priorities for further study include open-ended funds, the impact of margin calls, and the structure of core funding markets.

Originally posted on Central Banking.

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