Liquidity concerns put money market funds under the microscope

March 2020 sell-off exposed underlying vulnerabilities and potential systemic threat to UK economy


Money market funds (MMF) look set for a shake up after the Financial Conduct Authority and Bank of England, with the backing of HM Treasury, published a discussion paper this week seeking views on reform proposals.

As low-risk cash management products, MMFs have long been a place for investors to park their money rather than grow it. The open-ended investment funds offer credit risk diversification and aim to give investors a return in line with short-term money markets.

To do this, they invest in short-term debt securities such as government bills, commercial paper and certificates of deposit, reverse repurchase agreements and bank deposits.

Individual retail investors account for a small proportion of overall MMF shareholders by assets. The biggest users are insurers, pension funds and other institutional investors.

Dash for cash leaves regulators worried

The March 2020 market shock “increased selling pressure, volatility and illiquidity”, the FCA said. “MMFs came under severe strain across major currencies, including in sterling, as investors quickly sought access to cash.”

MMFs are not guaranteed and, as they offer daily redemptions on demand, have an inherent liquidity mismatch. As a result, some funds struggled to maintain the required liquidity levels as set out in law and regulations.

Quantitative easing helped steady the ship back in March 2020, but the market shock succeeded in focusing the minds of regulators on what could have happened: namely fund suspensions.

MMFs are by no means the only investment product at risk of gating – lest we forget the liquidity issues faced by property funds – but they have a greater inter-connectivity with the broader UK economy as they are involved in government debt markets.

This is done via two main channels: investments in short-term government debt and reverse repurchase agreements (reverse repos) backed by gilts.

Even though the danger has passed, the UK watchdog and other members of the Financial Stability Board, which spans 25 international jurisdictions, are concerned “that underlying vulnerability within MMFs and threats to financial stability remain”.

As a result, financial regulators have agreed to assess and address the vulnerabilities MMFs pose in their respective countries.

“[This] could have potentially had wide repercussions across the real economy and financial sector. It could have led to companies failing to make business critical payments, such as payroll, or to financial market participants being unable to meet margin calls, leading to the technical default of those institutions,” the FCA said in its discussion paper.

“While the shock itself did not originate in the financial system, there is evidence that certain structural features of MMFs amplified and reinforced the initial liquidity shock.”

Resilient, strong and robust

Through the discussion paper, the UK watchdog is seeking to achieve the following:

  • – Strengthen the resilience of MMFs and the financial system in supporting the UK economy
  • – Reduce the need for future extraordinary central bank interventions of the kind that occurred in March 2020
  • – Support the provision of sustainable and robust cash management financial services that meet the needs of users including at times of financial stress

The discussion paper is open until 23 July.

Responses “will help inform the calibration of potential policy changes to asset liquidity requirements and MMF redemption terms that address systemic risk whilst taking into account potential impacts on the provision of services to investors”, the FCA added.


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