Nine years ago almost to the day, the Reserve Primary US money market fund “broke the buck”. It told investors that it could no longer guarantee that they would get all of their cash back, an event that sparked widespread panic during the darkest days of the global financial crisis.
Investors rushed for the exits and withdrew nearly $350bn from other prime money market funds in the week after the Reserve Primary fund was forced to accept big losses on its holdings of Lehman debt when the investment bank imploded in September 2008.
This helped to transmit the crisis beyond financial markets and deep into the US economy, as money market funds provide a vital source of funding for many companies.
New US rules have been introduced to prevent any repeat for money market funds, but regulators across the world are still wrestling with how best to strengthen safety standards for traditional mutual funds. A variety of contentious proposals could prove both complex and costly for asset managers to implement.
US mutual funds with assets over this amount will be required to classify their portfolio holdings into four liquidity buckets
US mutual funds with assets of more than $1bn will be required to classify their portfolio holdings into four liquidity buckets, according to rules that come into force at the start of December.
Fund boards will also have to agree what percentage of assets should be “highly liquid” and which can be easily converted into cash within three days.
Roderick Fisher, head of risk solutions at State Street Global Exchange, the US financial services company, says asset managers are concerned that these new rules could affect the assets they are permitted to hold and the returns they can generate.
“There is no perfect measure for liquidity. Portfolio managers will need to look at subscription and redemption patterns as well as how portfolio holdings behave in stressed market conditions,” he says.
Michael Hanus, a partner at Oliver Wyman, the consultancy, says asset managers will have to develop new analytical approaches to comply with the rules and that agreeing procedures to correct deviations will add to operational and governance costs.
The rules require asset managers to provide monthly data on portfolio holdings, which will “make some funds on the margin unprofitable, potentially forcing closures and consolidation”, says Mr Hanus.
The Investment Company Institute, the association representing US asset managers, has appealed for a rethink. Paul Stevens, chief executive of the ICI, says US regulators should re-examine the requirement for fund assets to be classified into liquidity buckets, as these new rules will cost the US mutual fund industry at least $640m to implement.
ICI is also calling for the Securities and Exchange Commission, the regulator, to delay implementation of the new rules for a year and to require only quarterly instead of monthly reporting of portfolio holdings.
“We have deep concerns about the industry’s ability to meet the [December 1] compliance deadlines,” says Mr Stevens.
But a delay by the SEC appears unlikely, according to Mr Fisher, who adds that most managers will in reality have to perform daily liquidity assessments.
“Asset managers will need to put a comprehensive programme in place. All but the very largest managers will have to buy in liquidity scores from an independent third party,” he says.
Other supervisors are also intent on improving safeguards for investors and preventing problems at mutual funds from spiralling into a wider threat to the stability of global financial markets.
The International Organization of Securities Commissions (Iosco), the global umbrella body for securities regulators, launched a consultation in July in which it proposed that asset managers should conduct regular stress tests on their mutual funds to better understand how long it might take them to sell assets during periods of elevated market volatility.
BlackRock, the world’s largest asset manager, questions the effectiveness of stress tests. It says that the variety of investment strategies undertaken by mutual funds and differences in the business models of asset managers cannot be assessed properly using stress tests.
It also argues that mutual funds represent less than a fifth of all assets invested globally, while other large investors, such as pension funds and sovereign wealth funds, are not subject to transparency requirements, so the risks of their activities remain unclear.
However, BlackRock does support broadening the use of liquidity tools, such as temporary restrictions on redemptions during periods of market volatility, into countries where such practices are not currently allowed.
“Regulators should consider making the broadest set of liquidity tools available,” says Alexis Rosenblum, a director in the government relations and public policy team at BlackRock.
These issues have been given added urgency by a wave of Brexit-related UK property fund suspensions in 2016. Seven large funds holding a total of around £15bn had to close temporarily amid fears that they would not be able to meet redemption requests from investors following the UK’s vote in June last year to leave the EU.
The UK’s Financial Conduct Authority said in July that although the suspensions had helped to avoid market uncertainty from escalating, fund managers had not planned adequately and did not have clear policies and procedures for valuing their property portfolios under stressed market conditions. The regulator also said that property fund managers could be clearer in their communications with end investors after significant market disruptions.
Number of buildings Aviva Investors had to sell to meet redemption requests on one of its property funds
Aviva Investors, one of the managers affected, was unable to reopen its property fund for nearly six months, after raising £212m from the sale of 11 buildings to meet redemption requests.
Regulators have long been worried about the potential risks of open-ended property funds, which permit investors to withdraw cash daily, even though it can take months to buy and sell the buildings that make up a portfolio.
These concerns are reflected in Iosco’s discussion paper. It says that due consideration should be given to whether a fund should offer daily dealing, given the expected liquidity of its assets. Real estate funds that allowed frequent dealing should also consider whether to hold more liquid assets to meet redemption requests, because of the length of time that it could take to sell properties, says Iosco.
The regulator also wants asset managers to conduct tests to assess how redemption orders for a fund might be affected by problems at the parent group, as well as assessing how sell orders might be influenced by difficulties at a rival manager that is running a directly competing fund.
The Central Bank of Ireland recently carried out a survey of liquidity risk-management policies and stress-testing practices among 411 large Irish-domiciled funds run by 72 international asset managers. The survey found that the vast majority (around 93 per cent) of managers did conduct stress tests, but the methods and instruments used in these assessments varied widely.
“More work is required by central banks and regulators to assess the best definition and measures of liquidity for stress tests,” said Pierce Daly and Kitty Moloney, the authors of the CBI paper.