A recent study authored by Federal Reserve economists concluded that rules currently being proposed to prevent money market fund runs could instead have the opposite effect. Restrictions on immediate redemptions, known as gates, and fees during periods of shortened liquidity, the study cautions, “may threaten financial stability by setting up the possibility of preemptive runs.”
Fees and gates were introduced as part of a two-piece proposal by the Securities and Exchange Commission (SEC) in July of last year. They had previously been a component of broader recommendation options issued to the SEC by the Financial Stability Oversight Council, or FSOC, an executive panel of top financial regulators that includes the Federal Reserve.
A preemptive run, described as an anticipatory run prompted by the possibility of a subsequent redemption restriction, would likely ensue through the behavior of an ‘informed investor,’ according to the study.
During a financial shock without gates and fees, informed investors might defer redemption until “uncertainty is resolved” or sufficient information materializes. Whereas under a shock scenario with gates and fees, those same investors may be left with little behavioral recourse but redemption to avoid the future possibility of restrictions. Furthermore, because money market funds are composed similarly to one another, preemptive redemption from a single fund may set off a large-scale run among funds.
In its annual report in early-May, the FSOC reaffirmed its concern that money funds remain susceptible to runs. The panel has been considering whether large asset managers should be designated as systemically-risky and placed under Fed supervision. As recently as Monday, it held a public roundtable seeking input from academic and industry experts on the matter. Should FSOC decide to exercise authority over asset managers, the money market funds they offer may also be deemed systemically-risky.
A final SEC vote on the July 2013 proposal is expected within the near year, according to reports. However, as of yet, deliberation continues to appear in the throes. As part of that deliberation, in March, the SEC released four staff-devised studies on money market funds, seeking for public comment. The deadline for the supplemental studies ended late last month, possibly signaling a final rule to soon follow.