INTERNATIONAL: IOSCO Consults on Money Market Funds Systemic Risk Analysis and Reform Options

Friday April 27 2012

Funds-Axis wishes to report that as of today the Technical Committee of IOSCO has published a consultation report on Money Market Fund Systemic Risk Analysis and Reform Options. This report is designed by IOSCO in order to provide a preliminary analysis of the possible risks that money market funds (“MMF’s”) could pose to systemic stability and invites consultations on an extensive range of policy options it proposes in order to address those risks.

IOSCO Consultation on MMF`s Systemic Risk and Reform Options

 To put into context the systemic importance of MMF’s and therefore the risk that they pose to market stability if not managed correctly please note the following;

• MMF’s have over US$ 4.7 trillion in assets under management Q3, 2011; and

• MMFs account for over 20% of the assets of Collective Investment Schemes (“CIS”) worldwide and are a significant source of credit and liquidity to the markets.

MMFs’ history of providing daily liquidity and principal preservation have played a significant role in differentiating MMFs from other CIS and have facilitated the use of MMFs as important cash management vehicles.

Their importance and interconnectedness with the rest of the financial system make their safety crucial for financial stability at large.

The reason this consultation paper has been developed by IOSCO is that the September 2008 run on MMF’s alerted regulators to the potential that MMF’s have to increase systemic risk. Although MMF’s were not the cause of the crisis, their performance during the crisis highlighted to Regulators their potential to spread and / or a crisis. With this experience in mind, the Financial Stability Board (“FSB”) asked IOSCO to undertake a review of potential regulatory reforms of MMF’s that would minimise their susceptibility to runs and other systemic risks and to issue their policy recommendations by July 2012.

The FSB’s mandate wished that key issues to be considered by such a review is whether the regulatory approach to MMFs needs to choose between;

         i.            Encouraging / requiring shifts to Variable Net Asset Value (VNAV) arrangements;

       ii.            Imposing capital and liquidity requirements on MMF’s which continue to promise investors Constant NAV (CNAV); and / or

      iii.            Whether there are other possible approaches that could be considered.

 Also, to ensure a sound base for evaluation of these options, the FSB asked IOSCO to review:

• The role of MMF’s in funding markets;

• Different categories, characteristics and systemic risks posed by MMF’s in various jurisdictions, and the particular regulatory arrangements which have influenced their role and risks;

• The role of MMF’s in the crisis and lessons learned;

• Regulatory initiatives in hand and their possible consequences for funding flows; and

• The extent to which globally agreed principles and/or more detailed regulatory approaches are required/feasible.

In its report, IOSCO analyses the features of MMF’s that make them vulnerable to risk, and explains some of the implications for policy options that they have proposed:

• Susceptibility to runs: In general, MMF’s are vulnerable to runs because shareholders have an incentive to redeem their shares before others do when there is a perception that the fund might suffer a loss.

• Importance in short-term funding and contagion effects: MMF’s are important providers of short-term funding to financial institutions, businesses and governments. Due to this intrinsic link of MMF’s to the short-term markets, confidence shocks in MMF’s can quickly have a broader macroeconomic impact. Confronted with redemption pressures, managers may have to unwind their positions against a declining market, potentially fuelling a liquidity crisis.

• Importance for investors: MMF’s are often viewed as a diversified and safe alternative to bank deposits and are used as an important cash management tool by institutions and investors.

In the consultation report, IOSCO asks its members and others to comment on options that fall within the following categories and are aimed at reinforcing the robustness and safety of MMF’s:

• Options regarding a mandatory move to variable net asset value funds, or other structural alternatives, in an effort to lower investor expectations that MMF’s cannot suffer losses and reduce the potential for heightened run risk when a fund fails to live up to those expectations

• Options regarding MMF valuation and pricing frameworks that are aimed at increasing price transparency.

• Options regarding liquidity management that seek to ensure that MMF managers are able to face redemption pressure at any time.

• Options to address reliance on ratings, with a view to reduce the herding and “cliff-effect” that currently arise from rating thresholds being hardwired into laws, regulations and standards, and to encourage the establishment of stronger internal credit risk assessment practices

IOSCO has asked that all comments on the consultation report be submitted by Monday 28 May 2012

Funds-Axis would encourage Asset Managers, particularly those who manage MMF’s to consider these IOSCO proposed options very carefully and submit a response to IOSCO should they feel a particular policy option is not feasible or practical. It is very likely that the outcome of the final IOSOC report following the consultation period will lead to a regulatory impact for MMF’s in the near future and as such if Asset Managers do have any concerns on relation to the proposed policy options then now is the opportunity to address same. If you require any assistance in addressing your response to IOSOC or would like to explore the possible impact of the above proposed options, please don’t hesitate to contact Funds-Axis on info@funds-axis.com