The International Organization of Securities Commissions (IOSCO) has today published its final report on policy recommendations for Money Market Funds (MMFs). The reports recommendations are the basis for common standards for the regulation and management of MMFs across jurisdictions.
The publication follows a statement by the organization in late August saying that it will continue its work on policy recommendations for MMF reform, regardless of the US SECs abandonment of moves to regulate the $2.6 trillion industry. The SECs proposed structural reforms were intended to reduce MMFs susceptibility to runs, protect retail investors and lessen the need for future taxpayer bailouts. IOSCO continues its work on the basis of the mandate given to it by the G20 Heads of State and the Financial Stability Board, to develop policy recommendations for strengthening oversight and regulation of the shadow banking system, including MMFs.
MMFs exist as a result of a special exemption granted by the SEC three decades ago, allowing them to seek to maintain a stable $1.00 net asset value by using penny rounding and amortized cost accounting. As a result of this exemption, these funds do not have to comply with the mark-to-market valuation standards required for all other mutual funds. Before long, retail investors were using them as substitutes for checking accounts -and institutional investors were using them as vehicles for their cash management. However, the $62.5 billion Reserve Primary Fund broke the buck in the fall of 2008, shattering the stability that was created since 1983. In a matter of days, panicked investors had redeemed not only massive amounts from the Reserve Fund, but more than $300 billion from prime money market funds across the industry. The short-term credit markets froze.
The IOSCO Committee on Investment Management met at the end of August to consider the extensive public feedback received to its consultation report Money Market Fund Systemic Risk Analysis and Reform Options of April 27 2012, and to elaborate draft final recommendations for addressing regulatory reforms to mitigate MMFs susceptibility to runs and other systemic risks. It then met in Madrid on Oct. 3-4 2012 to determine a further course of action.
As requested by the FSB, the current 15 recommendations for MMFs seek to supplement the existing frameworks where IOSCO considers there is still room for further reforms and improvements, following reforms undertaken on MMFs both in the United States and in Europe in 2010. Other reforms were also adopted in countries such as Canada, China, India and South Africa.
The organization makes the following recommendations for MMFs:1. MMFs should be explicitly defined in CIS regulation.
2. Specific limitations should apply to the types of assets in which MMFs may invest and the risks they may take.
3. Regulators should closely monitor the development and use of other vehicles similar to money market funds (collective investment schemes or other types of securities).
4. Money market funds should comply with the general principle of fair value when valuing the securities held in their portfolios. Amortized cost method should only be used in limited circumstances. In accordance with the general valuation principles applicable to collective investment schemes, responsible entities should ensure that the assets of the CIS are valued according to current market prices, provided that those prices are available, reliable, and up-to-date. Where market prices are not available or reliable, funds may value the securities held in their portfolios using the fair value principle.
5. MMF valuation practices should be reviewed by a third party as part of their periodic reviews of the funds accounts. Third parties should review the overall appropriateness of the procedures in place and notably the sourcing of prices for valuing assets and, if the amortized cost accounting is used, the conditions for its use and the processes for calculating shadow-NAV16. Responsible entities should ensure that prompt remedial actions are taken when weaknesses in valuation practices are identified.
6. Money market funds should establish sound policies and procedures to know their investors.
7. Money market funds should hold a minimum amount of liquid assets to strengthen their ability to face redemptions and prevent fire sales.
8. Money market funds should periodically conduct appropriate stress testing.
9. Money market funds should have tools in place to deal with exceptional market conditions and substantial redemptions pressures. Depending on the applicable legal and regulatory frameworks and on the specificities of their client base17, MMFs should be able to use tools such as temporary suspensions, gates and/or redemptions-in-kind, in order to manage a run on the fund.
10. MMFs that offer a stable NAV should be subject to measures designed to reduce the specific risks associated with their stable NAV feature and to internalize the costs arising from these risks. Regulators should require, where workable, a conversion to floating/ variable NAV. Alternatively safeguards should be introduced to reinforce stable NAV MMFs resilience and ability to face significant redemptions.
11. MMF regulation should strengthen the obligations of the responsible entities regarding internal credit risk assessment practices and avoid any mechanistic reliance on external ratings.
12. CRA supervisors should seek to ensure credit rating agencies make more explicit their current rating methodologies for money market funds.
13. MMF documentation should include a specific disclosure drawing investors attention to the absence of a capital guarantee and the possibility of principal loss.
14. MMFs disclosure to investors should include all necessary information regarding the funds practice in relation to valuation and the applicable procedures in times of stress.
15. When necessary, regulators should develop guidelines strengthening the framework applicable to the use of repos by money market funds, taking into account the outcome of current work on repo markets.
IOSCO proposes to conduct a review of the application of these recommendations within two years with a view to assess whether the recommendations should be revised, complemented or strengthened. It will also report on its progress on MMF reform at the G20 Finance Ministers meeting in November.
(JDC)