The EU’s top financial regulator has proposed sweeping reforms to safeguard the continent’s €1.4tn money market fund sector, which only narrowly avoided a crisis at the height of the pandemic last year.
Huge withdrawals were made from European money market funds in March 2020 as companies made a dash for cash in response to the announcement of lockdown measures by governments across Europe.
Acute problems also erupted at US money market funds, threatening to trigger a destabilising spiral across the world’s financial system, which was averted only by central banks introducing aggressive emergency liquidity measures.
“The Covid-19 crisis has been challenging for money market funds. A number of EU money market funds faced significant liquidity issues during March 2020, a period of acute stress, with large redemptions from investors and a severe deterioration in the liquidity of money market instruments,” said Steven Maijoor, chair of the European Securities and Markets Authority.
Regulators on both sides of the Atlantic have been scrambling over the past year to address vulnerabilities across the money market sector which provides a vital source of short-term funding for the corporate sector.
No European money market funds suspended withdrawals last year. But Esma will examine how suspensions or gates to prevent withdrawals could operate in periods of elevated stress.
Regulators remain concerned that a suspension could trigger a rush for the exit at other funds if investors fear the door could be slammed shut at short notice, akin to a run on a bank.
Money market funds have already shown they are vulnerable to destabilising runs when investors panic and exit en masse during market stress, as occurred when the Reserve Primary Fund “broke the buck” in 2008.
The regulator will also consider whether asset managers should adopt liquidity management tools such as swing pricing, a mechanism that can shield long-term investors from the added costs associated with high outflows.
Esma has also asked market participants whether the current prohibition should be lifted on banks and asset managers providing support to their money market funds in periods of stress.
US banks and asset managers were able to buy securities from their own money market funds in March last year, effectively providing bridging loans but this flexibility is not currently available to their European counterparts.
Peter Crane, founder of the Crane consultancy and a veteran analyst of the money market fund industry, said effective money market reforms were a “tough nut to crack.”
“We did not see ‘a run’ on money market funds in Europe in March 2020. It was more like a brisk walk. The problems were caused by governments announcing lockdowns and it is unclear why European regulators feel compelled to act when no money fund in Europe suspended withdrawals. But doing nothing, which is what regulators should do, appears to be out of the question,” said Crane.