Embracing Sponsor Support in Money Market Fund Reform

Jill E. Fisch is Perry Golkin Professor of Law and Co-Director of the Institute for Law & Economics at the University of Pennsylvania Law School.

Money market funds (MMFs) have, since the 2008 financial crisis, been deemed part of the nefarious shadow banking industry and targeted for regulatory reform. In my paper, The Broken Buck Stops Here: Embracing Sponsor Support in Money Market Fund Reform, I critically evaluate the logic behind current reform proposals, demonstrating that none of the proposals is likely to be effective in addressing the primary source of MMF stability—redemption demands in times of economic resources that impose pressure on MMF liquidity. In addition, inherent limitations in the mechanisms for calculating the fair value of MMF assets present a practical limitation on the utility of a floating NAV. I then offer an unprecedented alternative approach—mandatory sponsor support. My proposal would require MMF sponsors to commit to supporting their funds as a condition of offering a fund with a fixed $1 NAV.

Sponsor support of MMFs can take various forms. Sponsors can provide support by injecting cash into their funds, by purchasing distressed or illiquid assets from the fund, by providing guarantees or by purchasing insurance. A commonly overlooked form of sponsor support is the waiver of advisory fees. Since 2008, MMF sponsors have provided $24 billion in support through the use of voluntary fee waivers. Unlike some current reform proposals, this paper would not mandate a fixed type of support, recognizing that the most efficient support option will vary based on fund and sponsor attributes.

Hundreds of sponsors have supported their funds through past times of economic turmoil, and sponsor support has been a critical component of MMF stability. Yet critics denounce sponsor support as proof of MMF fragility. In this paper, I show that these criticisms are based on the flawed analogy between MMFs and banks. Unlike banks, MMF sponsors have assets and operations that are separate from the assets of the MMFs themselves. This asset partitioning serves a variety of functions, but, in a time of financial distress, offers a resource that is not available to banks.

The weakness of sponsor support is that, in the past, it has been both opaque and discretionary. This paper’s straightforward solution is to move sponsor support from the shadows by making the support requirement explicit.

The modest change has several advantages. First, by obligating sponsors to provide support, the proposal would require sponsors to internalize the cost of risky investment strategies, thereby reducing moral hazard. Sponsors would also have an incentive to limit the size of their MMFs and to screen for hot-money investors, both of which would enhance stability of the funds. Second, an explicit sponsor support requirement would encourage MMF investors to look to the sponsor for support rather than relying on an implicit government guarantee. This in turn would strengthen the role of market discipline in reducing the ability of financially-limited sponsors to attract investors. Third, the proposal would allow investors to substitute monitoring the sponsor’s financial viability for the difficult task of monitoring the value of fund assets directly. Finally, sponsor support would address MMF fragility while allowing MMFs to continue to meet investment demand for a safe and liquid cash management option.

The full paper is available for download here.

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