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A Way Forward?

by Travis Barker, Outgoing Chairman, Institutional Money Market Funds Association

The MMF industry has overwhelmingly rejected regulatory reforms based on the premise that MMFs are shadow banks, or that would require CNAV funds to adopt a VNAV. Instead, the industry has endorsed regulatory reforms that focus on managing liquidity risk. What regulatory reforms are supported by the industry? What regulatory reforms remain contentious? And how is this debate likely to resolve itself?

What regulatory reforms are supported by the industry?

There is broad support within the MMF industry for the following narrative about the events of 2008.

MMFs provide a simple but valuable intermediation service between lenders and borrowers in the short-term debt markets. They are used, in particular, by corporate treasurers whose cash assets are generally in excess of the amount guaranteed by deposit insurance schemes. To that extent, investors are exposed to credit risk when they make deposits, and manage that risk by diversifying deposits between creditworthy banks. But there are constraints on the level of diversification that investors can achieve on their own, in particular because they don’t have the expertise to assess creditworthiness across a large number of issuers. Therefore they use MMFs which – like other collective investment schemes – can provide higher levels of diversification than investors could achieve individually, and can employ specialist credit analysts through economies of scale.

Prime MMFs invest substantially all of their assets in high-quality, low duration fixed income instruments issued by banks, businesses and governments. In September 2008, a series of headline events undermined investor confidence in the solvency of the global banking system. That caused some US investors to switch their investment from prime MMFs to treasury and government MMFs (which invest in US Treasury Bills and other government agency securities): a classic ‘flight to quality’.