Money market funds need reform to prevent runs, US regulators say

A group of powerful financial regulators have called for sweeping reforms to US money market funds after the $4.9tn industry showed signs of severe strain during the market turmoil in March.

A coalition that includes the heads of the Treasury department, Federal Reserve, Securities and Exchange Commission and the Commodity Futures Trading Commission issued a joint report on Tuesday outlining a set of policy options to improve not only the resilience of money market funds, but also short-term funding markets more broadly. 

In March, massive outflows in prime money market funds — which invest in corporate paper and other kinds of short-term debt and account for about 20 per cent of money market fund assets — rippled through financial markets. The disruption prompted the US central bank to step in to stave off a much more pronounced financial crisis. 

The episode revived memories of the 2008 crash, when the Fed was forced to act to halt a run on money market funds after the Reserve Primary Fund “broke the buck”, meaning the net asset value of the fund slipped below $1 a share.

Stringent rules were rolled out in 2016, but the regulators that make up the President’s Working Group on Financial Markets conceded on Tuesday that more needed to be done.

“During March, money markets experienced significant outflows, forcing Treasury and the Federal Reserve to step in to prevent a destabilising run,” said Justin Muzinich, deputy Treasury secretary, in a statement. “We must now consider reforms to ensure this vulnerability does not threaten financial stability in the future.”

The report included 10 ideas that regulatory bodies under a Joe Biden administration could prioritise, without endorsing any one option. Several of the proposals look to impose a cost on investors seeking redemptions that rises as liquidity stress worsens. Another set homes in on the minimum liquidity requirements that often spur redemptions.

“By diminishing the importance of thresholds, these options could also give MMFs greater flexibility, for example, to tap their own liquid assets to meet redemptions,” the group said. 

They also suggested raising required liquid-asset buffers for funds as one way to “motivate more conservative risk management”.

The regulators did note that some of the proposals may shrink the size of the market for prime and tax-exempt funds if implemented, with broader implications for funding markets.

“A shrinkage of MMFs could reduce the supply of short-term funding for financial institutions, businesses, and state and local governments,” they wrote.

The report comes roughly a month after the Financial Stability Board, a global rulemaking body composed of leading central bank and finance ministry officials, said more scrutiny needed to be directed at money market funds following March’s market volatility.

“Absent regulatory reform or other action that alters market expectations, these prior official sector interventions may have the consequence of solidifying the perception among investors, fund sponsors, and other market participants that similar support will be provided in future periods of stress,” the regulators added in their report on Tuesday.

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