Thursday, May 23, 2013

Money Market Funds and Repo Remain Vulnerabilities to the System

Treasury Secretary J. Lew still sees money market funds and tri-party repo as unfinished business in the nation's quest to control risks to financial stability. In May 21, 2013 testimony before the Senate Committee on Banking, Housing, and Urban Affairs, Lew delivered the Financial Stability Oversight Council's (FSOC) annual report to Congress. Secretary Lew summarized the conclusions and recommendations made by the FSOC in its third annual report, assessing significant financial market and regulatory developments, potential emerging threats to financial stability, and recommendations to strengthen the financial system. Among the conclusions, Secretary Lew testified that FSOC remains very worried about the risks posed by wholesale funding markets, particularly, money market funds and tri-party repo. Despite the long list of rules, regulations, and structural changes already implemented in other areas, money market fund tri-party repo regulations are still a work in progress. According to Lew, this leaves the financial system still very vulnerable to destabilizing fire-sales in the money fund and tri-party repo markets. Such events can rapidly cross borders and economies, and wreaking havoc on fragile economic recoveries.

While the FSOC has made some efforts to curb the risk-run vulnerabilities of money funds, these efforts either do not go far enough or have not yet become effective.  Not only will the FSOC concentrate on money funds going forward, but also will consider whether similar reforms should be implemented across other cash management vehicles.

The Council remains concerned that vulnerabilities in wholesale funding markets could lead to destabilizing fire sales. Specifically, run-risk vulnerabilities related to money market mutual funds (MMFs), which became apparent during the financial crisis, still remain, despite an initial set of reforms implemented in 2010. In November 2012, the Council issued proposed recommendations for public comment to implement structural reforms of MMFs to reduce the likelihood of runs. Council members should also examine whether similar reforms are warranted for other cash management vehicles.
Secretary Lew and the FSOC also see tri-party repo as a major source of concern. Though market participants have made efforts to reduce reliance on discretionary intraday credit devices, Lew urged a more coordinated international effort to focus on the risks associated with tri-party repo, particularly in preparing for the failure or sudden weakness of larger players in the repo markets.

Vulnerabilities to fire sales also remain in the tri-party repo market, particularly with respect to borrowers such as securities broker-dealers. The Council’s report recognizes the positive steps that have been taken in the last year to reduce the reliance on discretionary intraday credit, but recommends coordinated efforts by market participants and financial regulatory agencies to address the risks associated with the tri-party repo market, notably by better preparing investors and other market participants to deal with the consequences of the distress or default of a dealer or other large borrower.
Though the FSOC annual report discussed far more than just money funds and tri-party repo, Secretary Lew's remarks make it quite apparent that the FSOC expects action in these areas in short order.