APRIL MONEY-FUND ASSETS UP
THE BoE WEIGHS-IN ON MMF REFORMS
Bank of England Governor Andrew Bailey has added his voice and the BoE’s authority to the chorus of regulators, academic researchers, think tanks, and even some fund sponsors – such as Charles Schwab – in arguing for a reconsideration of the role played by MMFs last spring and advocating for additional reforms.
In remarks delivered at a U.K. financial conference last week, Bailey explicitly refuted arguments made by MMF defenders that structural vulnerabilities in money funds played no significant or consequential role in last spring’s pandemic-induced “dash-for-cash,” and he committed the Bank – through the Financial Stability Board – to follow through on reforms so as “to avoid history repeating itself yet again.”
A Coherent Approach to Reform
Contrasting less liquid and less rigorously regulated non-bank funding schemes with more robustly regulated bank lending, Bailey conceded that, while “the dash-for-cash was, of course, a broader financial-system phenomenon driven by the pandemic and its economic implications, money-market funds are an important part of the volatility story because they seek to bridge the gap between the desire of investors for immediate redemptions and the desire of banks for term funding such as CP and CDs.”
The objective of regulators in the post-pandemic period, Bailey said, is “to improve the resilience and functioning of MMFs in order to protect financial-system stability [and] to recognize that the reforms after the financial crisis did not tackle this issue conclusively.”
A set of principles to achieve the objective would include more specifically aligning a fund’s redemption terms with the liquidity of its assets; prohibiting funds from holding “less liquid assets on a scale that would make them more suitable for investment funds;” removing current “thresholds or ‘cliff-edges’ that create first-mover incentives;” and making “cash-like” funds more resilient.
Broad Changes, Specific Reform Proposals
From those principles, Bailey asserted, three broad changes need to be made in money-fund structures: “First, remove the adverse incentives related to the use of suspensions, gates, and redemption fees. Second, simplify the critical distinction between cash-like funds and investment funds. Third, define more clearly in an accounting and substantive sense what constitutes ‘cash-like.’”
About specific reforms that would be consistent with the overall objective, Bailey suggested, first, at one extreme, limiting asset holdings to government instruments: “Given the low risk and liquid nature of these instruments, run risk would be materially reduced,” he observed.
Second, at the other extreme, “removing the liquidity mismatch [in money-market funds] by making funds non-daily dealing” – that is, prohibiting same-day redemptions, which he said would have the effect of making funds resemble term deposits, a reform he acknowledged would likely change “fundamentally the uses for which MMFs could be held.”
Third, identifying and implementing a range of risk mitigation reforms, such as requiring all funds to convert to a VNAV structure – a strategy advanced by Charles Schwab; limiting non-government assets in funds’ portfolios; rescinding post-financial crisis reforms, such as the mandatory or discretionary imposition of gates and fees when daily and weekly liquidity descend to certain thresholds; and thinking-through other reforms in order that the ultimate structure of money funds “doesn’t fall foul of the familiar issues missed by the post-financial crisis reforms.”
Likely a Changed MMF Landscape
“Properly differentiated,” Bailey said, “there may be a role for funds of each of these types to suit the needs of the diverse set of existing MMF investors. We may end up with some MMFs becoming more cash-like and some less cash-like, but we need to avoid the muddy middle.”
To these operational challenges, Bailey added the admonition that, “given the cross-border nature of MMFs, regulators in Europe and the U.S. must work together to ensure that we are aligned in our objectives and adhering to common principles.”
“The dash-for-cash,” Bailey said in concluding his remarks, “provided an unwelcome reminder that post-financial crisis reforms did not finish the job and left a dangerous gap in our exposure to financial instability. We must finish the task this time.” s
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