Pressure mounts on SEC to scrap liquidity-based gates and fees on money market funds

Pandemic-driven runs on prime MMFs strengthen the case for ‘delinking’ redemption curbs from asset liquidity

by | June 16, 2021 | bobsguide

Recent pandemic-led investor runs on prime money market funds (MMFs) have piled pressure on US regulators to scrap liquidity fees and redemption gate thresholds.

The Securities and Exchange Commission (SEC) needs to fully remove the “regulatory tie” linking prime money market funds’ liquid asset ratios to investor redemptions curbs, market sources warned, or risks jeopardising efforts to create more resilient money markets.

“What we saw during the [coronavirus] crisis was that the tying of possible fees or gates to the weekly liquid assets actually put more redemption pressure on money market funds, rather than making them more resilient,” says Jane Heinrichs, associate general counsel at Investment Company Institute (ICI).

At present, SEC rules dictate that if a money market fund (MMF) portfolio falls below a weekly liquid asset (WLA) threshold of 30 percent, it may only acquire liquid assets such as cash or government securities until the minimum threshold is restored. In this scenario, the MMF can impose liquidity fees on investors or temporarily suspend redemptions.

Though intended to safeguard MMFs, some market participants argued that these regulations were largely to blame for the $155bn in investor redemptions from prime funds at the beginning of the pandemic.

The activation of fees and gates “isn’t an automatic trigger”, says Heinrichs, “but investors were viewing it as if it could be, and just the mere possibility of not having access to their cash made them pre-emptively redeem as the fund started approaching that 30 percent”.

UK MMFs experienced a similar slump at the onset of the pandemic, with £25bn (equivalent to 10 percent of the market) being withdrawn by investors during a nine-day period in March last year.

Bank of England governor Andrew Bailey has since attributed this to the persistence of significant weaknesses in the system, stating that MMFs proved “not sufficiently resilient”, and that the situation highlighted a “dangerous gap” in regulation.

The need for swift regulation in the sector was initially acknowledged by the Financial Stability Board ahead of the G20 summit in November last year. A report addressed to leaders noted that investigation into the structure and regulation of various markets was warranted, and that policy proposals to shore up MMFs would arrive in summer 2021.

However, Heinrichs insists that reforms should aim to remove the tie between fees and gates and WLAs as a source of increased vulnerability. ICI research data published in April showed that daily redemptions were around twice as common among funds with liquid assets below 35 percent than those above.

In response to the ‘dash for cash’, the Federal Reserve was forced to intercept for the second time in 12 years, announcing an emergency stimulus package to stifle the March 2020 run on MMFs. The package largely comprised the inception of the Money Market Mutual Fund Liquidity Facility (MMLF), which was designed to enhance the liquidity and functioning of money markets via $10bn of backing.

Heinrichs partly attributes this to the “regulatory tie”, arguing that in theory, the stimulus should not have been required.

“The MMLF allowed funds to bring their weekly liquid asset ratios back up. But the problem is, the regulatory tie made prime money market funds less resilient to redemptions and much more dependent on financial intermediaries.”

Chanakya Dissanayake, global head of investment research at Acuity Knowledge Partners echoes the calls for “delinking”, arguing that it “could ease investor concerns that redemptions may not be permitted”.

Dissanayake also argues for the implementation of floating net asset values (NAVs) in prime funds, whereby daily share prices fluctuate based on market value accounting. This, he argues, could “result in better liquidity conditions”, and would be a “natural extension” of floating NAV usage in other funds.

However, Heinrichs goes on to reject this idea, noting that such measures are already in place among some prime institutional funds, and that these funds saw redemptions in March 2020.

“The floating itself does not stop investors from redeeming when they want to redeem,” she says.

Striking the right balance

Both “delinking” and floating NAVs were cited in a December 2020 report issued by the US President’s Working Group on Financial Markets (PWG), a taskforce established in the ’80s to enable Treasury, central bank and market supervision regulators to intervene in case of problematic market conditions.

The report outlined 10 potential reform options for MMFs, and highlighted the need for improvements to the reforms enacted following the 2008 financial market crisis, including a more nuanced approach to redemption gate thresholds and liquidity gates, recognising their potential adverse effects.

Overall, MMFs have come under much stricter scrutiny after the 2008 crisis, which revealed 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 investment that was almost as safe as cash, the domino effects ignited by the Lehman Brothers’ collapse highlighted their vulnerability to sudden financial runs.

Following a SEC request for feedback on the PWG recommendations in February, ICI argued against several key points as not fit for purpose.

“[We think] most of the ideas that were put forward by the PWG are not viable options for the MMF industry,” says Shelly Antoniewicz, senior director of industry and financial analysis at the ICI.

“If you throw too many bells and whistles on prime MMFs, investors will simply move to other products such as government MMFs. A lot of our comments are cautioning policymakers to think about some of the indirect consequences – they might take out certain risks, but at the same time they would possibly be killing the products.

“If you start to take away the differential between prime and government yields, there’s no point offering a prime product.”

Among the recommendations rejected by the ICI are swing pricing and capital buffer requirements.

Dissanayake offers similar criticism of the recommendations, pointing out that they “may not be entirely positive for investors”, and that they “do not answer the key question of the rush to safe-haven assets amid volatility”.

Antoniewicz also urges regulators and policymakers to observe the broader market before homing in on prime MMFs, arguing that a broader scope is needed in order to prevent future crises.

“We’re advocating that they go and look at the other 70 percent of the market. If you just focus on prime MMF reform, you won’t have solved the problem when the next crisis comes along – so it’s like the easy scapegoat in some respects.”

In a June meeting of the Financial Stability Oversight Council (FSOC), SEC chairman Gary Gensler stated that he has directed staff to prepare recommendations that can be voted on by the organisation.

Treasury Secretary Janet Yellen, who heads the FSOC, said that last year’s crisis has prompted “extreme policy interventions” for money markets, and that she fully supports the SEC’s efforts to reform the system.

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