Risks that the US and EU regulatory stance on money market funds (MMFs) might bifurcate in opposite directions are on the rise after Securities and Exchange Commission (SEC)’s Hester Peirce signalled a potential U-turn on liquidity rules, stating the market should be left to “work its way to a solution.”
Meanwhile, the head of risk analysis at the European Markets and Securities Authority (ESMA), Steffen Kern, doubled down on the need to bolster prudential requirements for the sector, reinstating that setting out additional policy measures was “absolutely warranted.”
Talking at an Official Monetary and Financial Institutions Forum panel on Tuesday, SEC commissioner Peirce and Kern conveyed opposing views on the need for tighter requirements on MMFs after the sector experienced widespread liquidity runs in March 2020, causing public intervention in the space for the first time since the 2008 financial crisis.
“I wonder if it would make sense for us to take an approach that allows the market to figure out what the right solution is […] and if we can provide as much flexibility and freedom for funds to figure out what tools would work, I think that would be the best way,” Peirce said.
The commissioner called into question the validity of rules that allow MMFs to impose curbs and fees on investor redemption when their portfolio’s liquid asset ratio falls below a 30 percent threshold.
“Seeing how having the possibility of fees and gates tied to the level of liquidity assets in the fund […] led to some bad consequences in practice, I think it does make sense for us to revisit that,” Pierce said.
While redemption gates and fees were laid out by US regulators in response to the role played by MMFs in transmitting and amplifying the 2008 financial crisis, the industry has been increasingly blaming the rules for exacerbating the widespread “dash for cash” that hit the market in the midst of the pandemic crisis, wiping out almost 30 percent of the US MMF market and 10 percent of the UK market in a short period of time.
“Having a chance to see how the reforms we had put in place before played out during March 2020, and seeing how a theory worked out in practice sometimes makes you question whether you were right on that theory,” Pierce said.
At the opposite side of the spectrum, ESMA’s Kern said last year’s events confirmed that the MMF segment does amplify systemic risks, even during instances where it may not be the direct cause of instability – shunning criticism that regulators would be “rounding up around MMFs as the usual suspects.”
“I want to contradict that explicitly, that is not the impulse that is going on: We have been very clear about the fact that MMFs have not caused the situation in 2020 – they became part of the problem that was caused somewhere else, and then trickled through the financial system.”
“But it is also a fact that they ended up in a situation where authorities felt compelled to intervene – And when you reach that point, this is where the public interest needs to be defined, whether this is something that we want or whether something in the regulatory environment can be fixed,” Kern said.
Despite representing a smaller market compared to the institutional investment sector, MMFs have “a much a larger propensity to convey irritations in the market, or ripple-on effects in the market than other industries,” Kern said.
“And this is why we believe that decisive and quick analysis, and then a good consideration of the policy options that we have is absolutely warranted.”
Peirce agreed that averting the use of public funds as a backstop needed to be a “primary consideration, whatever reform we put in place.”
Her suggestion of a more beneficial policy approach, however, involved “letting the market play out and work through a problem.”
“Capital markets especially are really good at trying to assess the value of different securities and finding willing buyers and sellers.”
“Some of the best work we can do is to make sure that the market where buyers and sellers meet can work as effectively and efficiently as possible,” she said.
Conversely, Kern said the analysis of what went wrong in March 2020 led to reaching a level of agreement among legislators – including ESMA, the European Systemic Risk Board and the Financial Stability Board – on policy areas where MMFs need improvement.
Regulators, he said, will be looking at three key areas: bolstering risk analysis, particularly for stress periods, through higher data transparency; tackling possible asset/liability mismatches and reviewing the current regulatory definition of different money market fund types and operations.
“These are certainly things we’ll jointly look at in terms of possible reforms,” he said.