SEC Suggests Stress Tests For money Market Funds

Four years after the $62.5 billion Reserve Primary Fund infamously “broke the buck,” i.e. the net value per share of the huge money market fund fell below $1 due primarily to the Lehman bankruptcy, regulators are still mulling ways to avoid the repetition of such events. The collapse of the Primary set off a run on other money funds, and a series of events that helped perpetuate a freeze in global credit markets. Prime money market mutual funds currently hold about $1.41 trillion worth of assets, which are generally low-risk securities against which they are not required to hold any capital balances.

Concerned about the effect of their collapse on the economy in the event of an unexpected economic shock, regulators such as the SEC’s Chairman Mary Schapiro have suggested changes for money market mutual funds such as a removal of the traditional $1 face value or a requirement to have significant capital reserves in place. Given that there have been almost 300 instances where the sponsors of these funds have had to step in to shore up funds’ capital to avoid a breaking of the buck, it is clear that some regulatory measures have to be put in place.

Federal Reserve Bank of Boston President Eric Rosengren, speaking at the Conference on Post-Crisis Banking hosted by the central bank of the Netherlands, said banks’ stress tests should include the support they would require to meet potential losses from their sponsored money market funds, according to Reuters.

Rosengren said using the stress test route could “illuminate the impact of various scenarios on fund sponsors, many of which are banks or financial institutions,” adding it was “an admittedly partial approach, in the absence of more comprehensive reforms that I hope will occur.”

On the suggested modality for analyzing the impact of a money market fund on the sponsor, he suggested, “Based on the historical experience of their money market funds, the historical experience of similar funds, and their money market funds’ exposures, sponsors could calculate the likely capital support needed from the organization in a stress scenario.”

Pending the introduction of more comprehensive reforms, this approach could, in the interim, strengthen banks and be a means of informing investors as to which money funds are best capitalized to meet a crisis should one occur.