The impact of regulation on money market funds

This dissertation comprises three empirical studies that aim to investigate the role of financial regulation in curtailing the systemic risk posed by shadow banks. The focus of this work is on money market funds (MMFs), a type of shadow bank. In the first empirical study, we examine prime MMFs after the introduction of the minimum liquidity requirements mandated in the 2010 Amendments to rule 2a-7 of the US Investment Company Act of 1940. We show that liquidity requirements have considerably increased the resilience of prime funds. We also show that funds increase their liquidity to meet expected redemptions. But liquidity does not shelter risky funds from lower inflows in a crisis. In the second empirical study, we assess the response of MMFs and their investors to the 2016 Amendments to rule 2a-7. We show that following the segregation of retail and institutional prime MMFs required by the new rules, these funds have become different in their liquidity positions, maturity structure, competitiveness and risk management. Institutional prime MMFs maintain higher liquidity and tend to increase their liquidity actively as they increase the credit risk of their portfolios. On the contrary, retail prime MMFs have become more relaxed in their liquidity management, possibly because of lower market discipline that was previously enforced by the presence of institutional investors in their shareholder mix. In the third study, we look at the changes in MMFs after the introduction of floating net asset value (NAV) requirements as mandated by the 2016 Amendments. We show that the floating NAV is seen by institutional investors as a new indicator of performance that they utilize to make investment decisions. Institutional investors prefer funds that maintain higher NAV in order to benefit from capital gains. Furthermore, we observe that to increase NAV, funds tend to keep liquidity low, invest in longer maturity, higher risk securities. So, to boost NAV a fund must take on more risk, which could lead to amplification of risk during crisis periods

Liquidity and shadow banking

Using a unique dataset of the detailed portfolio holdings of US money market funds, we study the behaviour of such funds in the context of the European sovereign debt crisis. These important players in the shadow banking sector were particularly vulnerable to liquidity shocks before the introduction of minimum liquidity requirements. We analyse the impact of these requirements and show that they have considerably increased the resilience of prime funds. We also see that prime funds increase their liquidity to counter expected investors’ redemptions in crisis periods. However, liquidity does not shelter risky funds from lower inflows