10. Money Market Funds Reform

See for an historical overview: T. Cook, et al., (1979), Money Market Mutual Funds: A Reaction to Government Regulation or a Lasting Financial Innovation? Federal Reserve Bank of Richmond. Economic Review, July/August 1979, pp. 15–31.

Another argument of its rapid emergence was that money market funds could gain nationwide scale as they did not fall under the legal restrictions on interstate banking; D. Luttrell, et al., (2012), Understanding the Risks Inherent in Shadow Banking: A Primer and Practical Lessons Learned Federal Reserve Bank of Dallas Staff Papers Nr. 18, November.

H. Mai, (2015), Money market Funds- an Economic Perspective, Deutsche Bank Research, February 26, pp. 2–3.

H. Mai, (2015), Ibid. pp. 10–16.

The US had MMF incoming regulation both in 2010 and 2014. The European Commission issued its proposal in 2013, which were also based on their experiences with the 2012 eurozone sovereign crisis.

Mai indicates (regarding the European model): ‘[b]ut in case the industry nevertheless experiences a loss of investor confidence, mitigating the risk of an investor run would probably still be difficult. VNAV funds (with a variable NAV (ed.)) in tight financial conditions might still face accelerated redemption requests, and financial distress might still spread via counterparty or market channels. CNAV funds would be able to draw on a significant 3% capital buffer as a line of defense. However, pairing a CNAV with a capital requirement further blurs the difference between a mutual fund investment and a bank deposit’ (p. 17).

H. Mai, (2015), Ibid. pp. 18–19.

Rule 2a-7 of the Investment Company Act of 1940, which governs the operation of US money market funds (‘MMFs’).

That transparency includes that money market funds report additional information to the SEC and to investors. It also requires investment advisers to certain large unregistered liquidity funds, which can have many of the same economic features as money market funds, to provide additional information about those funds to the SEC.

See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, pp. 1–2.

See in detail: Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33–9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, pp. 6–32.

And also a flight to liquidity. Gallagher and Collins comment: ‘the majority of redemptions reflect a generalized flight-to-liquidity and are, therefore, primarily a function of the liquidity needs of a fund’s investor base. Funds holding Treasury securities at greatest risk of default or with market values below their $1 share price experience flows that are insignificantly different from other funds, all else equal. We also find evidence that a significant portion of the outflows stem, not from liquidity concerns, but from an opportunistic yield play on the repo market created by the crises’; E. Gallagher and S. Collins, (2015), Money Market Funds and the Prospect of a U.S. Treasury Default, Working Paper, August 21, mimeo.

See, for example, R. Wermers, et al., (2013) Runs on Money Market Funds, Working Paper; L. Schmit et al., (2016), Runs on Money Market Mutual Funds, Working Paper, mimeo. That implies that the riskier the MMF, the higher the expected outflows will be under distress; see for a confirmation: P. E. McCabe, (2010), The Cross Section of Money Market Fund Risks and Financial Crises, Federal Reserve Board Finance and Economic Discussion Series Paper, Nr. 2010-51.

‘Fire sales’ refer to situations when securities deviate from their information-efficient values typically as a result of sale price pressure. See in detail on the theoretical and empirical research on asset ‘fire sales’, A. Shleifer & R. Vishny, (2011), Fire Sales in Finance and Macroeconomics, Journal of Economic Perspectives, Vol. 25, pp. 29–48.

It could also lend the cash need from the bank. However, those loans would create liabilities that must be reflected in the fund’s shadow price, and thus will contribute to the stresses that may force the fund to ‘break the buck.’

See in detail: J. Witmer, (2012), Does the Buck Stop Here? A Comparison of Withdrawals from Money Market Mutual Funds with Floating and Constant Share Prices, Bank of Canada Working Paper, Nr. 2012-25.

See in detail: N. Gennaioli, et al., (2012), Neglected Risks, Financial Innovation, and Financial Fragility, Journal for Financial Economics, Vol. 104, pp. 452–468, in particular p. 453.

See in detail: D. W. Diamond & R. G. Rajan, (2011), Fear of Fire Sales, Illiquidity Seeking, and Credit Freezes, Quarterly Journal of Economics, Vol. 126, Issue 2, pp. 557–591.

The abovementioned DERA study reports ‘[i]nvestor redemptions during the financial crisis, particularly after Lehman’s failure, were heaviest in institutional share classes of prime money market funds, which typically hold securities that are illiquid relative to government funds. It is possible that sophisticated investors took advantage of the opportunity to redeem shares to avoid losses, leaving less sophisticated investors (if co-mingled) to bear the losses.’ (p. 10).

See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov. See also Sec, (2014), SEC Adopts Money Market Fund Reform Rules, Rules Provide Structural and Operational Reform to Address Run Risks in Money Market Funds, 2014–143 via sec.​gov.

See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, pp. 713–720 for a break-down of the individual compliance items.

See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, p. 33.

See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, p. 34.

S.G. Hanson et al., (2014), An Evaluation of Money Market Fund Proposals, HBS Working Paper, p. 14.

See infra this subsection for an evaluation of the alternatives in a post-2014 regulatory environment.

SEC, (2012), DERA study, via sec.​gov, pp. 34–35.

S. Chernenko & A. Sunderam, (2012), Frictions in Shadow Banking: Evidence from the Lending Behavior of Money Market Funds, Review of Financial Studies, Vol. 27, Nr. 6, pp. 1717–1750.

See most recently: P. Schnabl, (2012), The International Transmission of Bank Liquidity Shocks: Evidence from an Emerging Market, Journal of Finance, Vol. 67, pp. 897–932.

Chernenko & A. Sunderam, (2012), Ibid. pp. 1718–1719.

‘Our empirical specifications effectively compare the change in lending to the same issuer of two MMMFs, one with high exposure to Eurozone banks and one with low exposure to Eurozone banks. These specifications show that for the same issuer, MMMFs with larger exposures to Eurozone banks are more likely to withdraw financing. Thus, our results cannot be explained by unobservable issuer characteristics, including riskiness or direct or indirect exposure to Europe’ (pp. 1721–1722).

P. Bolton, et al., (2013), Relationship and Transaction Lending in a Crisis, BIS Working Paper Nr. 417 and V. Ivashina, and D. Scharfstein, (2010), Bank Lending During the Financial Crisis of 2008, Journal of Financial Economics, Vol. 97, pp. 319–338.

See for an analysis covering the 2008 crisis: H. Almeida, et al., (2012), Corporate Debt Maturity and the Real Effects of the 2007 Credit Crisis, Critical Finance Review, Vol. 1, pp. 3–58; for an analysis covering the Russian sovereign default (1998): P. Schnabl, (2012), The International Transmission of Bank Liquidity Shocks: Evidence from an Emerging Market, Journal of Finance, Vol. 67, pp. 897–932.

Which governs money market funds, requiring funds to invest in higher quality assets of shorter maturities and maintain larger buffers of liquid assets.

Squam Lake Group, (2011), Reforming Money Market Funds, Proposal. Other proposals suggest submitting MMFs (and any other money-like claim issuer) to commercial bank regulation (M. Ricks, (2011), Regulating Money Creation after the Crisis, Harvard Business Law Review, Issue 1, pp. 75–144 and M. Ricks, (2011), Shadow Banking and Financial Regulation, Columbia Law and Economics Working Paper Nr. 370), insurance to guarantee payment to investors (G. Gorton and A. Metrick, (2010), Regulating the Shadow Banking System, Brookings Papers on Economic Activity 2010, pp. 261–312) or reserve build-up to cover losses in case of a forced liquidation of an MMF (P.E. McCabe et al., (2012), The Minimum Balance at Risk: A Proposal to Mitigate the Systemic Risks posed by Money Market Funds, Federal Reserve Bank of New York Staff Report Nr. 2012-47).

See in detail: See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, pp. 135–202.

See in detail: See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, pp. 277–288.

See in detail: See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, pp. 39–134.

See in detail: See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, pp. 39–134.

See in detail: See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, pp. 552–592.

See in detail: See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, pp. 288–373, 488–551.

‘Of this approximately $2.1 trillion, we estimate retail prime funds managed approximately 33% of prime fund assets (not including tax-exempt funds) or $593 billion, whereas retail tax-exempt funds managed 71% of tax-exempt fund assets or $197 billion of assets, or $790 billion in total retail fund assets’; See in detail: See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, p. 596. The remaining funds are prime institutional funds subject to a floating NAV requirement.

More equitable in the sense that investors are not exposed to dilution and fire sales and therefore discount prices just because other investors reacted faster or anticipated on potentially lower prices or contagion effect.

Comment Letter of Thrivent Financial for Lutherans (Sept. 17, 2013). They btw argue against the statement that fees and gates improve transparency of risk for investors: ‘[t]he imposition of a liquidity fee or gate will always be a surprise to the investors that do not redeem quickly enough to avoid it. The need to impose such a fee or gate will not be transparent to the investor unless redemption activity is disclosed in a timely manner providing sufficient time for investors to react.’

See in detail: See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, p. 598.

This will be limited to investors with large cash management requirements and active treasury function given the expertise requirements to self-manage cash and the costs associated with it.

See for a full review of all principal features (valuation, investment risk, redemption restrictions, yield, etc.) of various cash alternatives to MMFs, Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, pp. 604–607, Table 1.

See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, pp. 614–615.

See Securities and Exchange Commission, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13, via sec.​gov, pp. 617–618.

Regarding the contribution of MMFs to systemic risk see S.G. Hanson et al., (2014), An Evaluation of Money Market Fund Reform Proposals, HBR Working Paper, pp. 8–11. Later on also published in IMF Economic Review 2015, Vol. 63, Issue 4, pp. 984–1023

See S.G. Hanson et al., (2014), An Evaluation of Money Market Fund Reform Proposals, HBR Working Paper (also published as “An Evaluation of Money Market Fund Reform Proposals,” IMF Economic Review, Palgrave Macmillan; International Monetary Fund, 2015, Vol. 63, Issue 4, pp. 984–1023, November).

See for the appreciation of the market ‘failures’ that led to the MMFs regulatory proposals: S.G. Hanson et al., (2014), An Evaluation of Money Market Fund Reform Proposals, HBR Working Paper, pp. 11–16.

Which essentially makes investors in MMFs understand that MMFs also entail a certain level of risk and analysis is required.

That seems a hard sell, as most MMF investors are risk averse and compromises to a certain degree the risk-sharing of the MMF model.

‘Condensed’ as it is a backward looking exercise.

See S.G. Hanson et al., (2014), An Evaluation of Money Market Fund Reform Proposals, HBR Working Paper, pp. 11–13. They therefore reduce the objectives of the reform to four key objectives being: ‘(1) reduce the incentive of MMFs to take on excessive portfolio risk ex ante, (2) reduce the incentive for MMF investors to run ex post, (3) reduce the impact of a MMF run on the global financial system and economy if a MMF run does occur, and (4) reduce the incentive for large financial institutions to rely excessively on unstable, short-term funding from MMFs’ (p. 13).

For a comparative analysis of the different proposals that have been floating around: S.G. Hanson, D. Scharfstein and A. Sunderam, (2015), An Evaluation of Money Market Reform Proposal, HBS and NBER Working Paper, July, mimeo (published in IMF Economic Review, 2015, Vol. 63, Issue 4, pp. 984–1023); S. Alnahedh and S. Bhagat, (2017), Shadow Banking Concerns: The Case of Money Market Funds, Working Paper, mimeo.

Ibid.

C. Lewis, (2015), Money market Fund Capital Buffers, Owen Graduate School of Management, Working Paper, April 6, mimeo.

This interpretation is consistent with the empirical data reported in the relevant RSFI study but other competing explanations exist. One plausible alternative is that retail investors simply were slower to react. The SEC’s Division of Risk, Strategy, and Financial Innovation (‘RSFI’) has since changed its name to the Division of Economic and Risk Analysis; See in detail: Division of Risk, Strategy, and Financial Innovation, U.S. Securities and Exchange Commission, 2012, Response to Questions Posed by Commissioners Aguilar, Paredes, and Gallagher, November 30, 2012.

C. Lewis, (2015), Ibid. p. 5.

C. Lewis, (2015), Ibid. p. 6.

C. Lewis, (2015), Ibid. p. 7.

C. Lewis, (2015), Ibid. pp. 31–32.

See, for example, D. Duffie, and K. Singleton, (2003), Credit Risk: Pricing, Measurement, and Management, Princeton University Press, Princeton NJ.

See on sponsor support in the MMF industry: S.A. Brady, et al., (2012), The Stability of Prime Money Market Mutual Funds: Sponsor Support from 2007 to 2011, Federal Reserve Bank of Boston, Risk and Policy Analysis Working Papers, RPA 12–3.

L. Schmidt, et al., (2013), Runs on Money Market Mutual Funds, University of Maryland Working Paper, mimeo; also A. Shelifer, and R. Vishny, (2011), Fire Sales in Finances and Macroeconomics, Journal of Economic Perspectives, Vol. 25, Issue 1, pp. 29–48.

C. Parlatore, (2014), Fragility in Money Market Funds: Sponsor Support and Regulation, Wharton Working Paper, January 6 (reprinted as ECB Working Paper Nr. 1772, March 2015). The model she developed takes into account the main characteristics of MMFs: the ability of investors to redeem their shares on demand, the stability of the NAV and the provision of sponsor support, the liquidation of the funds after breaking the buck, and the fluctuation in the value of the funds’ assets (p. 25).

The canonical run was first explored by Diamond and Dybvig, see D.W. Diamond, and P. H. Dybvig, (1983), Bank Runs, Deposit Insurance, and Liquidity, Journal of Political Economy, Vol. 91, Issue 3, pp. 401–419.

C. Parlatore, (2014), Ibid. p. 3.

See on strategic complementarities: Q. Chen, et al., (2010), Payoff Complementarities and Financial Fragility: Evidence from Mutual Fund outflows, Journal of Financial Economics, Vol. 97, pp. 239–262.

C. Parlatore, (2014), Ibid. p. 3. The understanding behind the strategic complementarity and the fact that it can lead to runs is that ‘[i]f an individual manager expects all other managers to offer support to their funds, he expects a high demand for the asset in the interim period and high liquidation prices. These, in turn, imply a low cost of offering support and may increase the individual manager’s incentives to offer support. On the other hand, if the manager expects all other managers not to offer support, he expects a low liquidation price for the asset, and high costs of offering support, which may justify him not supporting his fund. The provision of support generates externalities: by providing support to their funds, managers support a high liquidation price of the risky asset and provide liquidity to the economy’.

J. Fisch, and E. Roiter, (2011), A Floating NAV for Money Market Funds: Fix or Fantasy?, Scholarship at Penn Law., Paper Nr. 390.

C. Parlatore, (2014), Ibid. p. 4.

She illustrates: ‘[a] clear example of this is the banking industry. If there is no recapitalization after a negative shock to the value of banks’ assets, banks may be forced to liquidate assets to meet depositor redemptions. This, in turn, would increase the downward pressure on the asset price and, in fact, make recapitalization too costly to be undertaken’ (p. 27). The recapitalization plays the role of the sponsor support in the case of the MMF industry.

C. Parlatore, (2014), Ibid. p. 28.

J. Bao, et al., (2015), The Runnables, FEDS Notes, Washington, Board of Governors of the Federal Reserve System, September 3.

Proposal for a regulation of the European Parliament and of the Council on Money Market Funds, /∗ COM/2013/0615 final - 2013/0306 (COD) ∗/ of September 4, 2013.

IOSCO, (2012), Policy Recommendations for Money Market Funds, October 9.

See for the most recent overview of worldwide MMF legislations in place and their evaluation: IOSCO, (2015), Peer Review of Regulation of Money Market Funds; Final Report, FR19/2015, September. The typical evaluation areas are: (1) Scope, (2) Limitations of Assets and Risks accepted, (3) Valuation, (4) Liquidity management, (5) Stable versus floating NAV, (6) Ratings and disclosures and (7) Use of repos and other risk management and hedging tools. See also E.F. Greene and E.L. Broomfields, Promoting Risk Mitigation, not Migration: a Comparative Analysis of Shadow Banking Reforms by the FSB, USA and EU, Capital markets Law Journal, Vol. 8 Nr. 1. They point at a one size fits all kind of trend when tackling the shadow banking market from a regulatory point of view. Schwarcz points at the role of lawyers in this context: S.L. Schwarcz, (2013), Lawyers in the Shadow: The Transactional Lawyer in a World of Shadow Banking, 63 American University Law Review, Nr. 1, Issue 4, pp. 157–172.

See also E. Bengtsson, (2012), Shadow Banking and Financial Stability: European Money Market Funds in the Global Financial Crisis, Working Paper Sveriges Riskbank, Stockholm.

EU Parliament, (2015), Impact Assessment of Substantive EP Amendments, PE 545.547, European Parliamentary Research Service, Research Paper by Europe Economics, March, p. 7.

H. Mai, (2015), Money Market Funds – an Economic Perspective, Deutsche Bank Research, February 26, p. 17.

H. Mai, (2015), Ibid. p. 17.

Committee on Economic and Monetary Affairs regarding Proposal 2013/0306(COD): (1) Econ Amendments 472–800 of January 9, 2015, (2) Econ Amendments 224–471 of January 12, 2015, and (3) Econ Amendments 97–223 of January 12, 2015.

Amendments adopted by the European Parliament on April 29, 2015, on the proposal for a regulation of the European Parliament and of the Council on Money Market Funds (COM(2013)0615 – C7-0263/2013–2013/0306(COD)

A. Mooney, (2015), Luxembourg ‘Blocking’ Money Market Reform, Financial Times, November 29.

A. Mooney, (2015), Luxembourg ‘Blocking’ Money Market Reform, Financial Times, November 29.

In the period 2011–2012: FSB, (2011), Shadow Banking: Strengthening Oversight and Regulation, October; IOSCO, (2012), Policy Recommendations for Money Market Funds, October

Of the Investment Company Act of 1940. See, for example, O. Akay et al., (2015), Changing Rule 2a-7 and the Risk Profiles of Money Market Mutual Funds, Journal of Applied Finance, Nr. 1, pp. 1–15.

A government MMF is defined as any MMF that invests 99.5% or more of its total assets in cash, government securities and/or repurchase agreements that are collateralized solely by government securities or cash. A retail MMF is defined as an MMF that has policies and procedures reasonably designed to limit all beneficial owners of the MMF to natural persons: see FSB, (2018), Global Shadow banking Monitoring Report 2017, March 5, pp. 21–22, box 2-2.

K. McLoughlin, and J. Meredith, (2017), The Rise of Chinese Money Market Funds, RBA Bulletin, Reserve Bank of Australia, March, pp. 75–84.

People’s Bank of China, (2017), China Financial Stability Report 2017, September.

The rules will apply to new funds as of July 21, 2018 and existing funds from January 21, 2019.

See ESMA, (2017), Final Report: Technical Advice, Draft Implementing Technical Standards and Guidelines under the MMF Regulation, ESMA34-49-103, November 13. See regarding the practicalities of stress tests for investment funds: A. Bouveret, (2017), Liquidity Stress Tests for Investment Funds: A Practical Guide, IMF Working Paper Series Nr. WP/17/226, October 31. Practical aspects related to the calibration of the redemption shock, the measurement of liquidity buffers and the assessment of the resilience of investment funds are discussed. The integration of liquidity stress tests with banking sector stress tests and possible bank-fund interlinkages are also covered. S. Malik and P. Lindner, (2017), On Swing Pricing and Systemic Risk Mitigation, IMF Working Paper Series Nr. WP/17/159, July.

See FSB, (2018), Global Shadow Banking Monitoring Report 2017, March 5, pp. 22–23.

A quick reminder on the underpinnings of net asset values in the context of MMFs see H.M. Ennis, (2012), Some Theoretical Considerations Regarding Net Asset Values for Money Market Funds, Economic Quarterly, Vol. 98, Nr. 4, Q4, pp. 231–254.

AMF, (2017), The Use of Stress Tests as Part of Risk Management, Guide for asset management companies, Autorité des marchés financiers, February, p. 5. It involves risk mapping, establishing relevant risk factors and design alert mechanisms.

A. Bouveret, (2017), Liquidity Stress Tests for Investment Funds: A Practical Guide, IMF Working Paper Series Nr. WP/17/226, October 31, p. 6.

See for a discussion and case studies: A. Bouveret, (2017), Ibid. pp. 7–12.

The first method uses aggregated data which are not always available or reliable (e.g. dealer inventories or turnover) or rely on security-level data. In this case, sophisticated models are used to estimate the price impact of trades at the individual security level, which can be resource-intensive or expensive, when such a task is outsourced to a third party. Therefore, the emphasis is on the tiered approach, where assets are grouped by liquidity buckets. Within the tiered approach two models are available: (1) the HQLA approach is closely related to the Liquidity Coverage Ratio (LCR) used for banks under Basel III liquidity regulatory requirements, and (2) the cash and short-term debt securities model. Liquidity is measured in the latter by isolating the assets with a residual maturity of less than one year. See for details: A. Bouveret, (2017), Ibid. pp. 12–17.

Liquid Assets/Net Outflows.

A. Bouveret, (2017), Ibid. pp. 17–22.

A. Bouveret, (2017), Ibid. pp. 22 ff. for details, case studies and specifications of channels. Direct channels and indirect channels are envisaged.

M. Kacperczyk and P. Schnabl, (2013), How Safe are Money Market Funds, The Quarterly Journal of Economics, Vol. 128, Issue 3, August 1, pp. 1073–1122. See also regarding the dynamic interactions between investors with differing levels of sophistication within the same money fund and the relationship between observable characteristics and possible tail outcomes (i.e. causing run-like behavior) within intermediated asset pools: L. Schmidt et al., (2016), Runs on Money Market Mutual Funds, American Economic Review, Vol. 106, pp. 2625–2657.

Shareholder runs are essentially driven by a key contractual property of (illiquid) MMFs’ NAV: they are flexible but not perfectly forward looking (i.e. they do not take into account the assets sale ex ante a run. See Y. Zeng, (2017), A Dynamic Theory of Mutual Fund Runs and Liquidity Management, ESRB Working Paper Nr. 42, April, pp. 21–30, 35. Also observe the burgeoning literature list on the topic: pp. 36–37.

Mutual funds that internalize more of their price impact hold larger cash buffers and use these buffers more aggressively to accommodate inflows and outflows. As a result, stocks held by these funds have lower volatility, and flows out of these funds have smaller spillover effects on other funds holding the same securities. See S. Chernenko and A. Sunderam, (2020), Do Fire Sales Create Externalities, Journal of Financial Economics, Vol. 135, nr. 4, pp. 602–628.

From a policy point of view that triggers the need to observe the dynamic interdependence of shareholder runs and MMF liquidity management. Ibid. p. 35. Also L. Schmidt et al., (2016), Runs on Money Market Mutual Funds, American Economic Review, Vol. 106, pp. 2625–2657.

See for how swing prices can be best designed to avoid fund failure and increasing redemptions: A. Capponi et al., (2018), Swing Pricing for Mutual Funds: Breaking the Feedback Loop between Fire Sales and Fund Runs, OFR Working Paper Nr. 4, August 28. Properly designed swing pricing transfers liquidation costs from the fund to redeeming investors and, by removing the nonlinearity stemming from the first-mover advantage, it reduces these costs and prevents fund failure. Achieving these objectives requires a larger swing factor at larger levels of outflows. The swing factor for one fund may also depend on policies followed by other funds.

Swing pricing allows a fund to reduce the payout to investors when redemptions are large. This, in principle, discourages investors from selling out at short notice—but little is known about how effective the tool is in practice. Lewrick and Schanz assess the effects of swing pricing by comparing open-end bond funds in Luxembourg, where swing pricing is allowed, with similar funds in the US, where it is not. We find that, during normal times, flows out of Luxembourg funds are less sensitive to bad fund performance than those out of US funds not using swing pricing. This tallies with the expected impact of swing pricing on investor incentives. Yet during periods of market stress, such as the 2013 US taper tantrum, they find no such effect. One possible reason is that funds do not use the tool enough to discourage withdrawals during times of stress. They also show that Luxembourg funds benefited from higher returns during the taper tantrum, as expected, although prices were more volatile. In addition, they find that Luxembourg funds tend to hold less cash than their US counterparts, since swing pricing acts as a substitute for maintaining high reserves. This reduces the stabilizing effect of swing pricing. Swing pricing dampens outflows in reaction to weak fund performance, but has a limited effect during stress episodes. Furthermore, swing pricing supports fund returns, while raising accounting volatility, and may lead to lower cash buffers. See in detail: U. Lewrick and J. Schanz, (2017), Is the Price Right? Swing Pricing and Investor Redemptions, BIS Working Paper Nr. 664, October 11, via bis.​org. U. Lewrick and J. Schanz, (2017), Liquidity Risk in markets with Trading Frictions: What Can Swing prices Achieve? BIS Working Paper Nr. 663, October 11, via bis.​org. They study how a fund should set the price for investors that want to redeem shares or subscribe to new shares, and how much cash the fund should hold. They find that the best results are achieved if the fund lowers the price when redemptions are large, charging to redeeming investors at least some of the trading costs that the fund incurs. The higher the fund’s trading costs, the lower the settlement price. Correspondingly, the fund raises the price if redemptions and trading costs are low or when it experiences inflows. That said, the difference between the optimal settlement price and the market price of the fund’s assets remains relatively small. This is to discourage costly arbitrage trades that aim to exploit a large difference between the two prices. The fund should also hold a large enough cash buffer to meet expected redemptions. Reading both their papers together you might conclude that on a theoretical level swing prices can help in easing the risk of runs, but that in practice many obstacles stand between that optimum and realizing it.

Ibid. p. 35. That would however require a change in contract design as MMF participants currently cannot commit to future NAVs. That is currently not possible as MMFs promise to provide daily liquidity to their participants. It would be hard to implement as the rational investor would prefer holding the securities directly in the absence of a daily liquidity promise.

This regulation forces all prime and municipal MMFs to adopt a system of redemption gates and fees and institutional prime and muni MMFs to also operate under a floating NAV. In full, see SEC, (2014), Money Market Fund Reform, Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13 RIN 3235-AK61, October 14, sec.​gov.

M. Cipriani et al., (2017), Investors’ Appetite for Money-Like Assets: The Money Market Fund Industry after the 2014 Regulatory Reform, Federal Reserve Bank of New York Staff Reports, Nr. 816, June.

European Parliament, (2017), Money Market Funds Measures to Improve Stability and Liquidity, Briefing- EU Legislation in Process, July, pp. 3–7.

Opinion of the European Economic and Social Committee on the Proposal for a Regulation of the European Parliament and of the Council on Money Market Funds COM(2013) 615 final—2013/0306 (COD), OJ C 170, 5.6.2014, pp. 50–54.

Commission Implementing Regulation (EU) 2018/708 of April 17, 2018, laying down implementing technical standards with regard to the template to be used by managers of money market funds when reporting to competent authorities as stipulated by Article 37 of Regulation (EU) 2017/1131 of the European Parliament and of the Council, O.J. 119 of May 15, 2018, pp. 5–28.

See EP, (2016), Money Market Funds: Council agrees its Negotiating Stance, Press release, June 15.

See EP, (2016), Money Market Funds: Council Confirms Deal with EP, Press Release, December 7 for further details.

Regulation (EU) 2017/1131 of the European Parliament and of the Council of June 14, 2017, on money market funds, L169/8, O.J. June 30, 2017, pp. 8–45. Further implementing regulations have been taken ever since.

See for a full overview of all aspects including post-publication of the main regulation events: Autorité des marches financiers, (2018), Q&A on Money Market Funds. Guide for Asset management Companies, July, Paris.

See in extenso: M. Bocci et al., (2014), ‘Gold-Plating’ in the EAFRD. To What Extent Do National Rules Unnecessarily Add to Complexity and, as a Result, Increase the Risk of Errors?, European Parliament Policy Department D, Budgetary Affairs, Study, Brussels.

And as of 2020 at least 80% of their assets in EU public debt instruments. That seems largely unrealistic as things stand now.

Matheson, (2018), EU Money Market Fund Reform Finally Published, pp. 4–8; Matheson, (2019), EU Money Market Fund Reform Deadline Set, both via matheson.​com

See in detail: FitchRatings, (2018), European Money Market Fund Handbook, April, pp. 22–23.

Li details that as key lenders in the shadow banking sector, prime money market funds (MMFs) provide funding for banks through various instruments, with maturities up to one year. Post-crisis regulations apply stricter liquidity rules to both MMFs and banks, likely generating contradictory effects, as MMFs are encouraged to do more overnight lending and banks to borrow longer term. She further finds that MMFs and banks seem to resolve this dilemma by developing a ‘bundling’ strategy across multiple funding markets. In particular, MMFs substantially increase their investments in long-term debt issued by banks that have recently accommodated MMFs’ overnight investment needs and charge significantly lower rates on those long-term debts issued by accommodative banks. It has created a strong and reciprocal bond between banks and MMFs. See Y. Li, (2018), Reciprocal Lending Relationships in Shadow Banking, Working Paper, January, mimeo.

FitchRatings, (2018), European Money Market Handbook, April, p. 24.

Many (euro-denominated) MMFs apply share cancellation mechanisms to maintain a stable net asset value per share while passing negative market yields to investors, Ibid. P. 9. The ESMA commented on this specific point already in 2017 following the approval of the new regulation: ESMA, (2017), Final Report Technical Advice, Draft Implementing Technical Standards and Guidelines under the MMF Regulation, November 13, p. 6.

J. Thompson, (2018), Brussels Rules Out Share-Cancellation Mechanism for Money Market Funds, Financial Times FTfm, August 1. See the EC letter: EC, (2018), Implementation of the Money Market Fund Regulation, January 19. The argument is effectively the other way around. Since the reversed distribution is not mentioned in the MMF regulation, the EC argued, in line with the ESMA on the matter, that the reversed distribution mechanism cannot legally comply with the regulation. That is rather strange as it doesn’t clarify the position of the MMF regulation, but only concludes that it cannot go hand in hand with the regulation that stays silent on the matter. Seems more a matter of hasty work.

FitchRatings, (2018), European Money Market Handbook, April, p. 8. For MMF funds of this type in other currencies there seems to be no immediate issue.

Ibid. p. 8.

OJ L 177, 13.7.2018, pp. 1–8.

H. Mai, (2017), New EU Money Market Fund Regulation: Will Growth Continue?, DB research, September 13.

The base document is the ESMA, (2018), Guidelines on Stress Test Scenarios Under Article 28 of the MMF Regulation, which puts out the parameters. The ESMA put the process further in motion with a consultation paper on the matter: ESMA, (2018), Consultation Paper, Draft Guidelines on Stress Test Scenarios under the MMF Regulation, September 28, in which it became more specific on the variables and proposed some adjustments. Also ESMA, (2019), Consultation Paper, Draft Guidance regarding Liquidity Stress Tests of Investment Funds – applicable to alternative investment funds (AIFs) and Undertakings for the Collective Investment in Transferable Securities (UCITS), February 5, via esma.​europe.​eu. Preferably to be read in conjunction with the final guidelines of IOSCO on the matter: IOSCO, (2018), Recommendations for Liquidity Risk Management for Collective Investment Schemes, Report FR01/2018, February 1, via iosco.​org.(see also chapter 7, Vol. 2)

G. Bua and P.G. Dunne, (2019), Monetary Policy and Money Market Funds, via voxeu.​org, June 26. Also M. Di Maggio, and M. Kacperczyk, (2017), The Unintended Consequences of the Zero Lower Bound Policy, Journal of Financial Economics, Vol. 123, pp. 59–80.