The Financial Stability Board, an "international body that monitors and makes recommendations about the global financial system," recently published a report titled, "Enhancing the Resilience of Non-Bank Financial Intermediation," which contains a series of recommendations on global money market fund regulations. The group explains in their summary, "Conjunctural and structural developments in the global financial system over the past decade have increased the reliance on market-based intermediation. Non-bank financial intermediation (NBFI) has grown to almost half of global financial assets and become more diverse. As a result, the importance of NBFI for the financing of the real economy has increased. However, the experience of the 2008 global financial crisis, the March 2020 market turmoil and more recent episodes of market stress demonstrated that NBFI can also create or amplify systemic risk." (See the FSB's press release, "FSB Chair calls for further progress implementing non-bank financial intermediation reforms," and their letter, "FSB Chair's letter to G20 Finance Ministers and Central Bank Governors: July 2024.")
The report explains, "Drawing on the lessons from these events, the FSB developed a work programme to enhance the resilience of the NBFI sector. This is intended to ensure a more stable provision of financing to the economy and reduce the need for extraordinary central bank interventions. In particular, the aim of policies by the FSB and standard-setting bodies (SSBs) has been to reduce excessive spikes in the demand for liquidity; enhance the resilience of liquidity supply in stress; and enhance risk monitoring and the preparedness of authorities and market participants. To date, these policies have involved largely repurposing existing policy tools rather than creating new ones, given the extensive micro-prudential and investor protection toolkit already available."
It continues, "A number of policy deliverables have already been agreed under the FSB's work programme, including to enhance money market fund resilience (2021) and to address liquidity mismatch in open-ended funds (2023). Policies have also been proposed by the FSB and SSBs in early 2024 to enhance margining practices and the liquidity preparedness of non-bank market participants for margin and collateral calls. A key area of current policy focus is to enhance the monitoring of, and address financial stability risks from, leverage in NBFI. To this end, the FSB expects to publish by the end of 2024 a consultation report with proposed policy approaches for authorities."
The summary says, "The design and implementation of NBFI policies continues to advance, albeit at an uneven pace across jurisdictions. Progress is hampered by a number of challenges, including the heterogeneity of the sector; the diversity of institutional frameworks and market practices across jurisdictions; and common data challenges that impede a full assessment of NBFI vulnerabilities and the formulation of effective policy responses. The global financial system remains vulnerable to further liquidity strains, as many of the underlying vulnerabilities and key amplifiers of stress in the NBFI sector during recent market incidents are still largely in place. It is therefore critical to finalise and implement international reforms to enhance NBFI resilience, so that market participants internalise fully their own liquidity risk -- rather than rely on extraordinary central bank and other official sector interventions -- and authorities are better prepared for stress events."
It tells us, "The report concludes by outlining further work to assess and address systemic risk in NBFI that the FSB, in collaboration with the SSBs, will carry out. The work is structured in three main areas: in-depth assessment and ongoing monitoring of vulnerabilities in NBFI; the development of policies to enhance NBFI resilience; and the monitoring of the implementation and assessment of the effects of NBFI reforms. This work will help the FSB determine whether collectively the reforms have sufficiently addressed systemic risk in NBFI, including whether to develop additional tools for use by authorities."
The section titled, "Resilience of money market funds and short-term funding markets," states, "MMFs are important providers of short-term financing and are used by investors to invest excess cash and manage their liquidity.... The FSB published in 2021 a report on policy proposals to enhance MMF resilience (2021 FSB Report), with policy options to address MMF vulnerabilities by imposing on redeeming investors the cost of their redemptions; enhancing the ability to absorb credit losses; addressing regulatory thresholds that may give rise to cliff effects; and reducing liquidity transformation."
It comments, "A recent FSB peer review took stock of the measures adopted or planned by FSB member jurisdictions in response to the 2021 FSB Report. The main vulnerability identified in the review continues to be the mismatch between the liquidity of MMF asset holdings and the redemption terms offered to investors, which makes MMFs susceptible to runs from sudden and disruptive redemptions.... This vulnerability can be amplified by the presence of a high share of institutional investors and a stable or low-volatility net asset value, and by rules that may give rise to threshold effects that provide incentives for investors to pre-emptively redeem their MMF holdings in times of stress."
The FSB report explains, "While MMFs in most jurisdictions exhibit a strong home bias in both their asset portfolios and investor bases, there are some cases of significant cross-border funding and investing flows -- particularly in Europe -- that can transmit vulnerabilities across borders and markets. These vulnerabilities are often difficult to assess given data gaps on MMF investors and on the issuers of the instruments in which the MMFs invest. The existence of these cross-border flows, as well as differences in availability or calibration of policy tools, creates the potential for regulatory arbitrage and cross-border spillovers, raising the need in such cases for international cooperation in closing data gaps and implementing policy reforms to ensure resilience."
It also tells us, "The report finds that progress in implementing the 2021 FSB policy proposals has been uneven across jurisdictions. Authorities in all jurisdictions report that they had implemented policies aimed at addressing MMF vulnerabilities prior to the 2021 FSB Report. Since then, some jurisdictions have introduced new policy tools or recalibrated existing ones (China, India, Indonesia, Japan, Korea, Switzerland, US), while others are still in the process of developing or finalising their reforms (EU, South Africa, UK). Given the vulnerabilities reported in individual jurisdictions, further progress on implementing the FSB policy toolkit would be needed to enhance MMF resilience and thereby limit the need for extraordinary central bank interventions during times of stress. In particular, the extent to which minimum liquidity requirements are calibrated appropriately to address MMF vulnerabilities has not been examined but there is a significant variation between jurisdictions and MMF types."
The FSB writes, "Based on these findings, the peer review report made three recommendations. First, FSB jurisdictions that have not yet done so should review their policy frameworks and adopt tools to address identified MMF vulnerabilities, taking into consideration the 2021 FSB policy proposals. Where relevant tools (such as minimum liquidity requirements) are already available, FSB jurisdictions should consider whether these need to be re-calibrated to ensure their effective use and to maintain a sufficient level of MMF resilience, including by taking account of experience with previous stress events, potential cross-border spillovers and regulatory arbitrage. Second, the FSB will take the findings of this peer review into account in its monitoring of the vulnerabilities and policy tools for MMFs. Finally, IOSCO should consider the review's findings when it revisits its 2012 Policy Recommendations for MMFs in light of the 2021 FSB Report."
They then comment, "The 2021 FSB Report had noted that policies aimed at enhancing the resilience of MMFs could be accompanied by measures that aim at improving the functioning of the underlying short-term funding markets, though it cautioned that such measures, while useful, might not change the limited incentives of market participants to trade or of dealers to intermediate, particularly during stress periods. The FSB, in consultation with IOSCO, followed up on those findings by analysing commercial paper (CP) and negotiable certificates of deposit (CD) markets in core funding jurisdictions (EU, Japan, UK, US), including by exploring potential market reforms to improve the functioning and potentially the resilience of these markets."
The report says, "The size, microstructure and legal framework of CP and CD markets vary significantly across jurisdictions.... The US market is the largest globally, while Europe has different market segments across issuer domicile and currency as well as two international markets – the London-based Euro Commercial Paper (ECP) and Paris-based Negotiable European Commercial Paper (NEU CP). The overall size of US and EU markets remains much smaller than its all-time high in 2007, while the Japanese market (where all issuance is JPY-denominated) has grown since 2007."
It also tells us, "With regard to vulnerabilities, the analysis largely confirmed the findings of previous FSB work -- namely, that these markets, although subject to inefficiencies, tend to generally function well in normal times but are susceptible to illiquidity in times of stress. The vulnerabilities in these markets pertain to the short-term nature of CP and CDs that results in a buy-and-hold market; concentration of investors and dealers; susceptibility of some key investors, such as MMFs, to large and sudden redemption requests in times of stress, thereby exacerbating liquidity demands; the opacity of these markets, which may exacerbate illiquidity due to information asymmetry and contribute to reliance on dealers; limited adoption of electronification and digitisation in these markets; and high interconnectedness of these markets with other funding markets, meaning that stress can be transmitted within the financial system and across borders."
The FSB report adds, "Potential market reforms that can be considered by industry and public authorities are grouped into three areas, which may be interlinked: Improving market microstructure, e.g. through digitalisation, shorter settlement conventions and streamlined generation processes for transaction identification; Enhancing regulatory reporting and public disclosures, e.g. through increased regulatory reporting in areas such as amount outstanding per issuer, investor profiles on an aggregated basis, and post-trade information such as pricing; Expanding private repo markets for CP and CD collateral, to provide a channel for investors and intermediaries to generate liquidity."
Finally, they comment, "The report notes that while such reforms may have a positive impact on CP and CD market functioning in normal times -- particularly if used in combination and appropriately tailored to each jurisdiction -- they would likely not, on their own, significantly enhance the resilience of these markets. The idiosyncratic nature of these markets means that not all potential reforms in the report may be appropriate or relevant for all jurisdictions. Jurisdictions should therefore consider the relative merits of these reforms for their own CP and CD markets, including how they could complement other policies such as to address vulnerabilities in MMFs, while market participants need to manage their liquidity risk accordingly. Authorities should also consider whether and how they may be able to help catalyse or support industry initiatives to improve market functioning, particularly for primary CP and CD markets."
For more, see these Crane Data News pieces: "FSB Report Looks at Vulnerabilities in CP and CD Markets in US, Europe" (5/29/24), "FSB's Thematic Review on Money Fund Reforms Reviews Global Markets" (2/28/24), and "ESMA, FSB Push European Money Fund Reforms; New HSBC ESG Euro MF" (3/27/23).
