The Future of Money Market Funds
by Gail Le Coz, Chief Executive Officer, Institutional Money Market Funds Association
Money market funds have experienced monumental growth since they first appeared in the 1970s. Since the introduction of rule 2a-7 in 1983, funds under management in the US have increased by 2100%, and in Europe, funds under management as represented by the Institutional Money Market Funds Association (IMMFA) have increased by 975% since the creation of IMMFA in 2000.
One of the foremost challenges facing the industry is the regulatory response to the global market turmoil.
However, the experience of the industry since last autumn now places the product at a crossroads. There is increased attention by regulators and legislators of the product, its objectives and risks, and the role it plays in the wider monetary system. If the product is to continue to grow and offer a viable proposition to investors, the industry must react to the market turmoil and develop in response to the challenges that it faces.
One of the foremost challenges facing the industry is the regulatory response to the global market turmoil. A variety of regulatory bodies wish to restrict exposure of investors to loss, and ensure adequate market confidence and financial stability. A number of suggestions have been made, but as yet, no concrete proposals have been tabled.
These suggestions include those of the Group of Thirty – a private, international body of very senior representatives of the public and private sectors and academia, and chaired by Paul Volcker (who is also the Chair of President Obama’s Economic Advisory Panel). The G30 recommended that money market funds that continue to offer bank-like services, including withdrawals at par and a constant net asset value, should be regulated and supervised as special purpose banks.
The industry, on both sides of the Atlantic, is responding positively to the challenge of regulation which it currently faces. In the US, the Investment Company Institute (ICI) – the trade body representing the US mutual fund industry – established a Money Market Working Group in late 2008. The recommendations of this working group, published in March 2009, make proposals for ways in which the US money market fund industry can improve the product’s resilience.
The working group made the following key recommendations:
- to improve portfolio liquidity, a money market fund should hold as a minimum daily liquidity of 5% of net assets, and a minimum of 20% of net assets in securities accessible within seven days;
- the maximum weighted average maturity (WAM) should be reduced from 90 to 75 days. A new “spread” WAM should be introduced which is calculated using the final legal maturity of all instruments in the portfolio. This is designed to limit the effect of changes in interest rate spreads, and should be set at a maximum of 120 days;
- that a money market fund implement “know your client” procedures to understand the expected redemption practices and liquidity needs, or if such information is not available, mitigate possible adverse effects from any such unpredictability;
- money market funds should review, and if appropriate revise, the risk disclosure they provide to investors and markets to ensure adequate information is provided, with monthly disclosure of portfolio holdings; and
- a non-public reporting regime should be implemented to facilitate the provision of information to an appropriate government entity to allow adequate and effective oversight of financial markets.
These recommendations are, however, proposed by the industry. The Securities & Exchange Commission must now consider whether to implement these proposals or adopt different, and potentially more stringent, requirements. In addition, and somewhat contrary to the suggestion of the Group of Thirty, Ben Bernanke, the Chairman of the Federal Reserve, recently gave a speech in which he suggested that either tighter investment restrictions or some form of insurance would provide a suitable means to address the potential fragility of money market funds.
With the variety of opinion and comment circulating amongst market participants, it remains too early to predict the final format of the future regulation of money market funds in the US.
In Europe, IMMFA has also established a working party to consider revisions to the IMMFA Code of Practice. The IMMFA Code contains a series of qualitative and quantitative best practice standards to which members comply, with self certification of compliance. The intention of this review of the Code is to implement revisions that will improve the robustness of the product, and allow the Code to act as a standalone quality indicator. Whilst the IMMFA working party has yet to publish recommendations, these are likely to include proposals on liquidity, portfolio maturity and disclosure, and should be broadly consistent with those of the ICI.