The Financial Stability Oversight Council (FSOC) unanimously approved its third annual report April 25, underscoring several systemic threats facing the financial system of interest to treasurers, including market runs, cyberattack vulnerabilities, interest-rate reform and overreliance on intraday credit extensions.
The panel, made up of nine financial regulatory heads, holds expansive authority to identify and monitor entities it deems systemically risky to the financial system. “We need to strengthen markets that may be susceptible to destabilizing runs and fire sales,” chair of the council, U.S. Treasury Secretary Jack Lew, stated in his opening remarks.
Money market funds
The report returned to three proposed treatments of money-market funds (MMFs) that it sought public consideration for in November 2012. The FSOC argues that the three options—requiring a floating net asset value (NAV), preserving the stable NAV but implementing a 1 percent buffer and a 3 percent minimum balance at-risk 30-day redemption delay, or maintaining a stable NAV with a 3 percent buffer with additional enhancement measures—will improve capacity for potential loss absorption and mitigate risks of a run associated with the fund.
In their recommendations, the FSOC reiterated that the Securities Exchange Commission (SEC) “by virtue of its institutional expertise and statutory authority, is best positioned to implement reforms to address the risk that MMFs present to the economy.”
Tri-party repo markets
Given the large cash positions that MMFs hold in tri-party repurchase agreements, or repo markets, the FSOC found that both financial instruments leave one another systemically exposed to further potential fire sales and market runs. Repo markets, a source for collateralized overnight loans predominantly accessed by large banks, have received intense scrutiny from policymakers following their role in the 2008 Lehman Brothers collapse. The FSOC identifies overreliance by market participants on repo markets as well as concerns with the credit and liquidity risk management reliability of those participants, to be a continuing threat to overall market stability.
Libor and alternative benchmarks
“We must work with our foreign counterparts to reform the governance and integrity of financial benchmark reference rates like LIBOR and to consider transitions toward alternative benchmarks,” said Lew. Following a global interest-rate manipulation scheme that resulted in a $2.6 billion settlement from London’s major banks, the FSOC recommended financial markets move toward interest rate benchmarks directly tied to market transactions “entered into at arm’s length between buyers and sellers” rather than the estimates that sustain LIBOR rates.