Money Market Funds and Regulatory Reform
by Travis Barker, Outgoing Chairman, Institutional Money Market Funds Association
Financial markets continue to be convulsed by the deepest and most pervasive crisis since the Great Depression. The crisis has many underlying causes: lax lending standards; off-balance sheet finance; poorly understood derivatives and structured products; easy credit and exuberant markets; over-indebted private and government sectors; mispricing of risk; weaknesses in the institutional design of the euro; and so on. Given the complexity of those causes, the crisis has moved through inter-connected phases: a sub-prime debt crisis in 2007; a full-blown banking crisis in 2008; and an on-going sovereign debt crisis since 2009.
Money market funds (MMFs) have not been immune to these events. In particular, following the collapse of Lehman Brothers in 2008, US MMFs experienced unprecedented redemptions: USD369bn were redeemed in a single week, representing 17.9% of those funds’ assets under management. The scale of those redemptions and the nature of the response by the US Federal Reserve were such that US regulators are engaged in an on-going regulatory reform debate. Although non-US MMFs did not experience comparable redemptions, non-US regulators have joined that debate, notably the European Commission and the Financial Stability Board (FSB).
The regulatory debate has exposed two profoundly different narratives about the purpose and regulatory requirements of MMFs. One narrative maintains that MMFs are harmful products, engaged in regulatory arbitrage, and ought to be subject to bank regulation. The opposing narrative maintains that MMFs are a legitimate product used by corporate treasurers to manage credit risk through diversification, and ought to be subject to proportionate securities regulation.
Three further articles in this supplement attempt to summarise those issues.
The first article, ‘Shadow Banking’, presents the case that MMFs are engaged in regulatory arbitrage, and ought to be subject to bank regulation. The second article, ‘CNAV versus VNAV’, describes different ways that MMFs are priced and the supposed regulatory significance of those differences. The third article, ‘A Way Forward?’ presents the case that MMFs are used for legitimate purposes, and ought to be proportionately regulated.
Before proceeding, I should declare an interest: for the past three years, I have been the Chair of the Institutional Money Market Funds Association (IMMFA) and therefore am essentially sympathetic to the cause of MMFs. Irrespective of my particular sympathies, the debate about MMF reform should be of acute interest to corporate treasurers. When companies make deposits with banks, they expose themselves to credit risk. That risk is real; indeed, the direction of bank reforms means that credit risk is more real today and in the future, than it was in the past. Insofar as corporate treasurers use MMFs to manage that risk, they have a vital interest in the outcome of the MMF reform debate.