The London-based Institutional Money Market Funds Association, or IMMFA, which is the association representing the triple-A rated money market fund industry in Europe, has stepped up its lobbying efforts to counter some of the assumptions being made by regulators in Europe and worldwide. They've recently posted three papers -- "Bank Runs Money Market Funds and the First Mover Advantage," "The Use of Amortised Cost Accounting," and "IMMFA Summary Paper on Money Market Funds" -- that appear to be aimed at dispelling some of the more harmful persistent myths that bank regulators have been propagating. The first paper, written by former Barclays Global PM Mark Hannam, says, "Several recent reports from regulatory bodies have recommended that money market funds should be required to move from stable to variable net asset valuation pricing, to reduce the risk of first-mover advantage and the risk of a run on the fund. Most money market fund sponsors doubt that this proposal will reduce either run risk or first-mover advantage."
He explains, "Thirty years of academic research on bank runs has concluded that the best protections against bank runs are retail deposit insurance or the suspension of convertibility. There are no arguments within the academic literature in favour of changing the terms of the demand deposit contract, from stable to variable value: it is quite remarkable that the preferred solution for MMFs is one without precedent in banking regulation. Money market funds are different from banks in four fundamental respects. These differences concern their legal form but also, importantly, their economic function. Money market funds do not engage in fractional reserve banking and they do not perform liquidity creation. Money market funds, like other capital markets products, are vulnerable to the unanticipated actions of investors during periods of market distress. At such moments there is a risk that money market funds might contribute to the amplification of systemic risk."
The Abstract adds, "In a period of heightened systemic risk, the ability of money market funds to suspend the standard terms under which shareholders are able to redeem fund units for cash, is the mechanism most likely to eradicate the possibility of a first mover advantage and thereby to reduce the risk of a run. In the absence of a credible deposit insurance policy for the money market fund industry, suspension of convertibility should be the preferred option: for regulators, for fund sponsors and for investors."
IMMFA's second paper tells us about amortized cost accounting, saying, "Much of the recent debate about money market funds (MMFs) has focused on the purported advantages of variable net asset value (VNAV) funds over constant net asset value (CNAV) funds. Yet CNAV and VNAV funds share much in common. Both are collective investment schemes, the objective of which is to provide investors with security of capital and high levels of liquidity, and which seek to achieve that objective by investing in a portfolio of high quality, low duration money market instruments. If a CNAV or VNAV fund meets its objective -- which it usually does -- then a redeeming investor will receive repayment of their original investment plus an income return which reflects the prevailing rate in the money markets. If a CNAV or VNAV fund does not meet its objective -- and there is no guarantee that it will -- then a redeeming investor may not receive full repayment of her original investment, even net of the income return, perhaps due to a default by one of the fund's underlying portfolio investments."
It explains, "Despite these fundamental similarities, the convention of distinguishing CNAV and VNAV funds persists, in particular because some regulators have argued that CNAV funds pose greater risks that VNAV funds. They have therefore proposed restrictions on the mechanisms that CNAV funds use to maintain a constant price, including the use of amortised cost accounting to value their assets. The objectives of this paper are to: explain why MMFs use amortised cost accounting; assess the risks arising; and explore potential remedies."
IMMFA's draft adds, "In summary, in the absence of traded or quoted prices, amortised cost accounting is a pragmatic way for MMFs to evaluate the fair value of money market instruments. Amortised cost accounting is widely used in the EU (where it is often used as a proxy for fair value) and in the financial statements of MMFs in the USA (and has been accepted by the Financial Accounting Standards Board as compliant with generally accepted accounting principles). Amortised cost accounting (and equivalent valuation techniques) is also used in the financial statements of banks to value loans and certain other assets."
Finally, the third paper (IMMFA Summary Paper on Money Market Funds) comments, "European domiciled money market funds (MMFs) provide a valuable service to investors, issuers and the real economy: investors value MMFs for their credit diversification, transparency, ease of use and because they are bankruptcy remote; and MMFs provide a small but relatively stable source of cross-border funding for European banks. Whilst European banks continue to obtain most of their US dollar funding from wholesale markets, including US domiciled MMFs, regulation of European domiciled MMFs is ill-suited to address this specific issue."
IMMFA explains, "Regulators have concluded that MMFs did not cause the financial crisis in 2007/2008 but remain concerned over the role MMFs played in transmitting the financial crisis via client redemptions and sponsor support. IMMFA recognizes these concerns. We believe that further transparency, liquidity buffers and "know your client" requirements, combined with, redemption gates and liquidity fees in stressed market conditions, will be most effective in mitigating the impact of client redemptions in the future. In addition, we recommend that transactions between a mutual fund and its sponsor be clearly defined in regulation and either prohibited or require explicit pre-approval."
Finally, they add, "IMMFA strongly believes that this combination of reforms meets the FSB's requirement that safeguards for stable value MMFs ('CNAV MMFs') "be functionally equivalent in effect to the capital, liquidity and other prudential requirements on banks that protect against runs on their deposits". Other potential risk mitigants -- such as a restriction in the use of amortised cost accounting, the mandatory conversion from CNAV to variable NAV MMFs ('VNAV MMF') or capital -- will not reduce systemic risk but will reduce significantly the size of MMF in Europe with unintended consequences for investors and issuers. European investors would increasingly turn to bank deposits, other short term investment funds and to CNAV MMFs domiciled outside Europe. The European economy’s reliance and direct exposure to wholesale bank funding would increase."
