At a glance
- The Financial Stability Board (FSB) recently published a menu of policy proposals designed to enhance the resilience of money market funds (MMFs).
- Some options would make MMFs more “cash-like” (i.e. aiming to preserve capital and liquidity for investors), while others would make them more “investment-like” (i.e. allowing greater price variability or changes in redemption terms in times of stress).
- Some options would create significant operational challenges for MMFs. For example, swing pricing requires firms to determine liquidity costs, which can be difficult in markets where transaction volumes are low and transparency is poor.
- The FSB leaves it up to each jurisdiction to assess which option or combination of options is appropriate given its jurisdiction-specific circumstances and policy priorities.
- The EU is already starting to review its MMF Regulation, and the UK authorities have mooted potentially significant reforms, such as structuring MMFs as variable net asset value (NAV) and limiting the proportion of non-public debt assets held by MMFs.
- The FSB will review the measures adopted by member jurisdictions in 2023, which suggests that it expects jurisdictions to formulate and implement policy changes in 2022. It will also carry out work to enhance the functioning and resilience of short-term funding markets.
- MMFs will want to consider how different reform proposals could affect their position in the market and how they can continue to remain attractive to investors. They may also want to consider the operational impacts of the proposals.
The March 2020 market turmoil triggered significant outflows from MMFs and made it challenging for them to meet the demand for liquidity. If these MMFs had been forced to suspend redemptions, this could have affected the ability of some large corporates to access cash, with a potentially severe impact on the real economy. During the crisis, central banks globally stepped in to maintain monetary and financial stability. Some, such as the US Federal Reserve, took steps to support MMFs and commercial paper markets.
Against this backdrop, the FSB has resolved to enhance the resilience of MMFs. In July it published a consultation paper, setting out a range of potential reforms, and recently it published its final report, which it prepared in conjunction the International Organization of Securities Commissions (IOSCO). This blog sets out the key impacts of the proposed reforms on MMFs. Our second blog sets out the implications for banks.
Why are MMFs important and how could they create systemic risk?
MMFs are key intermediaries in the financial system. They provide two key functions: short-term funding to issuers (especially banks and governments) and cash management for investors. Table 1 shows the major role MMFs play as buyers in the markets for commercial paper (CP) and certificates of deposit (CD) in the euro area and UK (where their market share is significantly higher than in the US). Banks are the biggest issuers in these CP markets, and account for all CD issuance. Banks are also major investors in MMFs, using them to earn a return on cash.
Table 1: Proportion of the market held by MMFs as at end 2020
Euro Area (only for domestic issuers and holders)
Euro Area (euro issuance only)
Commercial paper issued by financial institutions
Commercial paper issued by non-financial institutions
Certificates of deposit
Note: This data comes from Table 1 in the FSB’s report. The first column only includes paper issued by euro area issuers and held by euro area holders, while the second column includes all paper issued in euros irrespective of the domicile of the issuer. UK data refer to MMFs denominated in GBP rather than domiciled in the UK and so may be partially included in the first column’s figures.
As set out in the FSB’s report, MMFs can be vulnerable in stressed market conditions. They offer daily redemptions but the assets they hold can have a maturity of up to one year and, since they are typically held to maturity, they have limited secondary market liquidity. This means they may face difficulty selling assets, particularly in stressed conditions. MMFs are used for cash management by investors who value their cash-like features and expect these features to be maintained at all times. MMFs are also exposed to credit risk, and even relatively small changes in credit risk may cause investors to lose confidence in MMFs’ ability to maintain the value of their investments. These features can lead to a first-mover advantage for redeeming investors in a stress event. For some MMFs, regulatory thresholds may also cause investors to redeem pre-emptively to avoid the consequences of a fund crossing those thresholds (e.g. imposition of fees/gates). Overall, non-public debt MMFs are significantly more vulnerable than public debt MMFs.
What are the FSB’s policy proposals?
The FSB presents a menu of policy options which could enhance the resilience of MMFs (see Table 2), with the aim of preventing the need for central banks to step in during a crisis. The FSB leaves it up to each jurisdiction to assess which option or combination of options is appropriate given its jurisdiction-specific circumstances and policy priorities, as well as cross-border considerations including to prevent regulatory arbitrage and spillovers.
Table 2: Key policy options proposed by the FSB
Swing pricing or anti-dilution measures
Transaction costs arising from redemptions would be borne by investors selling shares with the aim of reducing first-mover advantage and mitigating the impact of large redemptions on the fund. A variation would be authorities imposing macroprudential swing pricing.
Minimum balance at risk (MBR)
A small fraction of each investor’s shares (“MBR shares”) could not be redeemed immediately. Each investor’s MBR shares would be subordinated in proportion to their recent redemptions, so early redeeming investors would be more likely to absorb losses than remaining investors.
A capital buffer could be held outside the fund in an escrow account financed by the fund manager or sponsor. If the fund experiences a sudden material loss, this could be absorbed by the capital buffer. Variations include sponsor support and a liquidity exchange bank.
Removal of ties between regulatory thresholds and gates and fees
For some MMFs (e.g. constant NAV and low volatility NAV in the EU), once regulatory thresholds for liquidity are breached, the fund’s board can consider imposing fees and gates. Under this option, MMFs would be able to activate fees and gates irrespective of their liquidity levels. Variations include countercyclical liquidity buffers, investor concentration limits and authorities imposing activation of fees and gates.
Removal of stable (or constant) NAV
A variable NAV can remove incentives to redeem in situations where a stable NAV is at risk of not being tenable.
Limits on eligible assets
MMFs would be required to invest a higher portion of their assets in shorter dated and/or more liquid instruments, or in government debt. Variations include limiting MMFs to public debt, redemption-in-kind, non-daily dealing and liquidity-based redemption deferrals
Additional liquidity requirements and escalation procedures
Funds would have to hold minimum amounts of assets that can be readily converted to cash over a two-week horizon or less. In stressed conditions, MMFs would be required to use price-based tools (e.g. swing pricing) first, then quantity-based tools (e.g. notice periods), before finally being able to use gates.
The FSB suggests that policies aiming to enhance the resilience of MMFs could be accompanied by additional reforms in two areas:
- policies to help fund managers to manage their risks and authorities to monitor them (e.g. stress testing, transparency requirements); and
- measures to improve the functioning of the underlying markets (e.g. changes in the microstructure to reduce the need for dealer intermediation, increased market transparency and regulatory reporting).
The FSB stops short of opining on which options jurisdictions should pursue. However, the IMF suggests a phased approach, which allows for an assessment of the impact of initial reforms before proceeding to more extensive changes. This includes:
- “quick wins”, such as removal of ties between regulatory thresholds and gates and fees, enhanced reporting and improved stress testing;
- “incremental steps” to be implemented in the short-term, including a waterfall of liquidity management tools that should be used sequentially (e.g. improving asset-side liquidity first, then using swing pricing or MBR, then redemption-in-kind and finally industry-wide redemption gating) and limits on eligible assets for non-public debt MMFs; and
- “major reforms” to be implemented in the medium term, including allowing only public debt MMFs to have a constant NAV and constraints on daily dealing for non-public debt MMFs.
How are the FSB’s policy options likely to translate into EU and UK regulation?
The European Commission is due to review the EU’s MMF Regulation by July 2022. ESMA has already consulted on its advice to the Commission, and the European Systemic Risk Board (ESRB) has also set out its preliminary views on this subject. Similar to the FSB’s paper, the list of policy options considered by ESMA and the ESRB is broad and they have not yet decided which to incorporate into future policy proposals.
In the UK, the Financial Policy Committee (FPC) has proposed to:
- structure MMFs as variable NAV;
- limit the proportion of non-public debt assets held by MMFs;
- remove “cliff edge effects” created by regulatory thresholds; and
- ensure that liquid asset buffers are usable in stress.
The first of these would be a major change for MMFs currently using constant NAV or low volatility NAV and may reduce the attractiveness of those funds to investors who are using MMFs for cash management purposes. The second of these could significantly reduce MMF demand for bank short-term debt (depending on how it is calibrated) and may reduce the returns that MMFs provide to investors. Overall, this package of proposals could significantly change the nature of many MMFs and could reduce investor demand in the MMF sector.
In addition to the above proposals, the FPC has proposed frameworks for swing pricing and liquidity classification for all open-ended funds, including MMFs (see our blog), meaning these measures are likely to be central to the UK’s package of reforms. Swing pricing would represent a significant change for investors in constant NAV funds, as they could no longer rely on getting a fixed redemption value. It is also likely to be challenging for MMFs to implement since it is difficult to determine transaction costs precisely in markets which have low transaction volumes and poor transparency. Under the FPC’s swing pricing framework, firms would have to include implicit transaction costs when calculating their liquidity pricing adjustments. Calculating implicit transaction costs is not a straightforward exercise, as we have seen under the Packaged Retail and Insurance-based Investments (PRIIPs) framework, where some firms have ended up reporting negative transaction costs and there has been some debate about the calculation methodology .
How will these reforms affect MMFs?
Some of the proposed reforms would make MMFs more “cash-like” by reducing credit and liquidity risk on the assets side (e.g. capital buffers or limits on eligible assets). This would facilitate the use of MMFs for cash management purposes by investors and make their provision of financing potentially more stable but would lower the returns that MMFs provide to investors.
Other proposed reforms would make MMFs more “investment-like” by ensuring that the risks and costs are borne equitably by investors, such as swing pricing and/or removing the stable NAV. These options could make those funds less appealing as cash management vehicles for investors with a lower risk appetite.
Some reforms might also create operational challenges for MMFs. We have noted above the operational challenges associated with swing pricing. The MBR proposal is complex and would require significant operational adjustments to implement. Policy makers will want to strike a careful balance between addressing the macroprudential issues they have identified in the current structure of MMFs and ensuring they do not in turn create dislocation in short-term funding markets with consequences for the banks that rely on them. They will also want to consider what risks are associated with alternative cash management vehicles that investors might switch to due to any MMF reforms.
It is now up to FSB members to assess which policy options to pursue in their jurisdictions. The EU’s MMF review and the UK’s FPC policy proposals point to their likely direction of travel.
MMFs will want to consider how these reform proposals could affect their business models, and how they can continue to remain attractive to investors, as well as what operational challenges they may face.
The FSB and IOSCO will review the measures adopted by member jurisdictions in 2023 and will assess the effectiveness of those measures in 2026. This suggests that the FSB expects jurisdictions to formulate and implement policy changes in 2022, in order to review them the subsequent year.
IOSCO will also update its Policy Recommendations for Money Market Funds in light of the FSB’s report. The FSB and IOSCO will also carry out further work to enhance the functioning and resilience of short-term funding markets.