Money Funds Need New Guardrails to Shore Up Markets, FSB Says

(Bloomberg) -- The inner workings of money-market funds need to be shored up with measures such as capital buffers and redemption costs to help ward off threats to the global financial system, according to the Financial Stability Board. 

Open-ended investment funds have been subject to debilitating runs, the kind that amplified the market shakeup at the onset of the Covid-19 pandemic in 2020. The FSB, comprised of global regulators, said in a report released Monday that it’s seeking to prevent another need for “massive central bank interventions.” It also listed a menu of recommendations including setting up minimum balances at risk for fund customers, removing ties between regulatory thresholds and the fees that come with them or limiting the funds’ investments to more liquid assets. 

“This creates a path forward for jurisdictions to make meaningful progress in addressing structural vulnerabilities in MMFs, including their susceptibility to sudden and disruptive redemptions, and the challenges they face in selling assets, particularly under stressed conditions,” FSB Chairman Randal Quarles wrote in a letter last week to the members of the Group of 20, set to meet this month.

The 65-page report -- written by a group within the FSB that’s co-chaired by the U.S. Securities and Exchange Commission -- gives a range of policy options for each jurisdiction to choose from. The final recommendations are similar to a preliminary set of proposals released in June. 

The regulator also suggested the possibility of stress-testing the funds, much like Wall Street banks are tested on an annual basis to ensure they’ll withstand shocks, and proposed more public disclosures of assets in the funds, which hold short-term government and corporate debt.

After the 2008 financial meltdown, U.S. regulators turned most of their attention to Wall Street banks. The rule changes imposed on money market funds didn’t fully address the hazards they posed, and Quarles -- who is also the vice chairman for supervision at the Federal Reserve -- made money funds a priority of his stint atop the FSB, which is set to end in December. 

While organizations outside the asset management industry sent the FSB comments that favored further reforms, those within were generally against changes in the money-market regulations other than the removal of ties between liquidity thresholds and the ability to impose liquidity fees and gates, according to the report. 

Still, many expressed agreement with using mechanisms to allocate liquidity costs to redeeming investors and, to a lesser extent, the removal of stable net asset value money funds. Most respondents also expressed support for work to enhance the functioning of short-term funding markets.

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