Shadow Banking / Money Market Funds (MMFs)

 

Background

Considered part of the shadow banking sector, Money Market Funds (MMFs) are mutual funds that invest mainly in short-term debt issued by banks, (local) governments or corporations. The instruments that the funds invest in include government treasury bills, commercial loans or certificates of deposit. Money Market Funds also invest in certain types of securitized (see our dossier on Securitisation) financial instruments, backed by company debt or trade receivables, subject to certain conditions on minimum credit and liquidity thresholds. MMFs are often perceived by investors as a safe and more diversified alternative to bank deposits. However, a key difference with bank deposits is that their value fluctuates with that of their underlying investments, and that investors are not protected by deposit guarantee schemes.

On 19 March 2012, the European Commission published a Green Paper on shadow banking. After a consultation of the Commission and a non-legislative report on the Green Paper by the Parliament (adopted in November 2012), on 4 September 2013 the Commission published a proposal for MMFs regulation. The Commission’s proposal aimed at ensuring that MMFs can better withstand redemption pressure at times of market stress by enhancing their stability and strengthening investor protection. This is because MMFs are systemically relevant: almost 40% of short-term debt issued by the banking sector is held by MMFs, so a run on the sector could cause difficulties at banks and corporates alike.

MMFs are one of five areas to be examined under the Financial Stability Board’s shadow banking work programme and the first to see a Commission legislative proposal, which seeks convergence with recommendations from the Financial Stability Board (FSB) and the European Systemic Risk Board (ESRB). Shadow Banking is as well linked to the CMU dossier.

Actions of Finance Watch

 We strongly support the Commission’s Proposal for a Regulation on Money Market Funds (MMFs), as it is one of the few concrete legislative initiatives addressing the risks of shadow banking to financial stability. The role that MMFs play in funding the banking system creates a strong risk of contagion in the event of a run on MMFs.

The MMF proposal also reinforces investor protection. With the collapse of Lehman Brothers in 2008, some MMF investors realized that they were exposed to major counterparty risks, for example if a bank whose debt the MMF had bought became unable to fulfil its commitments. Consumers and professional investors who buy MMFs should have appropriate protection from such risks. Only a few member states have a developed CNAV MMF market at the moment. If MMFs are to be sold across all 28 member states under the MMF Regulation, we must ensure there is no detriment to consumer protection.

We concretely advocated for much stricter restrictions on eligible assets, Buffers for CNAVs (Article 29-34) and conversion to VNAV, restrict external support and ban external ratings. Some of our points were taken into account, but it is difficult to predict the outcome, since the MMF file is still into trialogue.

Key risks

The role that MMFs play in funding the banking system creates a strong risk of contagion in the event of a run on MMFs. We have suggested in our response to the 2012 Commission consultation on UCITS that MMFs should be divided into short term MMFs, which would be restricted from investing in long-term assets and structured financial instruments. If so, longer term MMFs would be free to invest in those assets but should be subject to redemption gates. The popularity of MMFs as a means of financing the real economy has also been addressed in our response to the shadow banking consultation.

The Commission’s proposal included positive elements such as rules defining which assets MMFs can invest in (“eligible assets”) and a restriction on the provision of external support by a fund sponsor in times of stress. We prefer that “eligible investments” do not include securitised assets, as these increase the indirect exposure or leverage of MMFs.

With the collapse of Lehman Brothers in 2008, some MMF investors realized that they were exposed to major counterparty risks, for example if a bank whose debt the MMF had bought became unable to fulfil its commitments. Consumers and professional investors who buy MMFs should have appropriate protection from such risks.

However, unfortunately, problems in the shadow banking sector go far beyond MMFs only. Although some other initiatives have been taken such as the Securities Financing Transactions Regulation, shadow banking continues largely unregulated, and continues to grow as tightened regulation creates incentives to move activities away from the regulated banking system.

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