MMFs to come under shadow banking, CRD 4 reporting rules as EU rushes to tighten scrutiny on the sector

EBA announces temporary MMFs rule shift until ESMA’s sector review turns into law

by | July 26, 2021 | bobsguide

Money market funds (MMFs) will be considered as shadow banking entities and fall under the relevant banking regulations at least until European lawmakers complete their reforms of the sector, the European Banking Authority (EBA) announced today.

The EU’s banking watchdog launched a public consultation on Monday setting out criteria for the identification of shadow banking entities that banks hold exposure to and are thereby called to report on as under the Capital Requirement Regulation (CRR/CRD 4).

Among these entities, the EBA highlighted the increasing significance of MMFs, which have made a comeback into the global regulatory agenda after posting worrying signs of a liquidity crunch at the beginning of the coronavirus crisis last year.

“In view of the severe liquidity issues that affected MMFs during the Covid-19 crisis and the ongoing discussions at EU and international level to strengthen their regulation, MMFs are identified as shadow banking entities,” the EBA said.

MMFs faced “large redemptions from investors on the liability side, and a severe deterioration of liquidity of money market instruments on the asset side,” the supervisor said, but the rule revision currently carried out at the EU level means that “the risks associated with MMFs have not been fully addressed by prudential requirements in the Union” yet.

In a matter of just a few days in March 2020, the global pandemic filtered through to financial markets spurring a ‘dash for cash’ that wiped out almost 30 percent of the MMF market liquidity in the US and 10 percent of the UK market.

As a result, the EBA wants to consider MMFs as shadow banking entities until the European Securities and Markets Authority (ESMA) completes its review of the MMF regulation (MMFR) – which covers firms operating under the Ucits and the alternative investment funds frameworks – before then re-assessing its policy stance.

At present, ESMA is in the process of consulting on tighter MMFs requirements, with a review of the MMFR due to be published in the second half of 2021 – but a date for full policy implementation is not expected until July 2022.

“In view of the ongoing review of the MMFR to tackle the vulnerabilities identified with MMFs, it is considered appropriate to follow the EBA guidelines and consider MMFs as shadow banking entities until such reforms are in place before re-assessing the current policy stance,” it said.

Incorporating MMFs under shadow banking requirements means that financial firms that have exposure to these funds will be called to comply with more stringent CRR requirements around capital exposure limits and risk reporting – including on liquidity, credit and operational risk as well as contagion risk.

Since the 2008 global financial crisis, MMFs have come under much closer scrutiny due to the expanded role they had taken on in the highly leveraged financial system of the pre-crisis era. While prior to the crisis, MMFs were considered a low-risk, almost cash-like investment, the domino effects ignited by the Lehman Brothers’ collapse highlighted their vulnerability to sudden financial runs.

In November last year, worries of other pandemic-related liquidity crunches prompted global standard-setters at the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) to call for sounder MMFs policies worldwide – with the FSB publishing sector-specific proposals in June.

Bank of England’s governor Andrew Bailey had also warned in May 2021 that MMFs failed to prove “sufficiently resilient” during the Covid-19 crisis, foreboding a similar tightening of regulatory scrutiny in the UK.

Additional reporting by Anna Brunetti

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