## iffspcea

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### Executive Summary — Growth, risks, and March 2020 amplification
- Growth and systemic relevance
  - The share of global financial assets held by nonbank financial institutions (NBFIs) grew to 50 percent.
  - Over a third of NBFI assets are accounted for by investment funds.
  - Passive OEFs and ETFs share almost tripled to 29 percent over the last decade.
  - Investment funds are key intermediaries in markets such as United States Treasuries and corporate bonds and drive global capital flows to emerging market and developing economies (EMDEs).
  - A key feature: most investment funds offer daily liquidity to investors, similar to banks’ demand deposits.

- Liquidity and maturity transformation risks
  - Funds expanded into corporate debt (including speculative-grade), real estate, and emerging market securities, raising liquidity and maturity transformation risks.
  - Investment funds generally lack public backstops (discount window access, deposit insurance), making promised daily liquidity fragile when assets become illiquid.
  - Documented vulnerabilities: fire sale externalities, illiquidity spirals, and occasional run risk.

- March 2020 market turmoil
  - COVID-19 accelerated in March 2020 triggering sharp drops in risk asset prices and massive sell-offs.
  - Significant redemptions from dollar-denominated nongovernment MMFs and redemption pressures on OEFs invested in high-yield corporate bonds and real estate.
  - Market pressures abated after the Federal Reserve announced liquidity backstops and outright purchases via special lending facilities (Fed’s “intensive new measures” Mar. 23).
  - Events highlighted amplification channels: investor outflows, asset sales by fund managers, and market illiquidity contributed to broader market stress, including in US Treasuries.

- Four key policy objectives
  - Increase the value of waiting to sell fund shares to address front-running incentives.
  - Analyze and mitigate tension between daily liquidity and exposure to illiquid assets.
  - Address frictions in key asset markets that exacerbate stress and amplification.
  - Mitigate cross-border spillovers to EMDEs.

### Policy tools, sequencing, and overall assessment
- Waterfall of liquidity management tools (LMTs)
  - Use a combination of LMTs of increasing intensity deployed sequentially.
  - First line: market-based solutions (dealer pre-commitments, trading arrangements).
  - Backstop: central bank emergency liquidity support in tail episodes.
  - Domestic macroeconomic and macroprudential policies complement these measures to lessen cross-border contagion.

- Advantages and distributional effects
  - Attenuating first-exit incentives increases investor returns in bad states by reducing likelihood of feedback loops.
  - Costlier tools lower in the waterfall (deferred/in-kind redemptions, gates) are less likely to be used if earlier tools succeed.
  - Benefits expected to more than offset adjustment costs for issuers and investors.

- Cross-border coordination
  - Policy measures should account for the global nature and fungibility of fund flows to avoid regulatory arbitrage and ensure consistency of global policy choices.
  - Ongoing FSB-led process with IOSCO and other standard setters is important.

*Source: Executive Summary, "Investment Funds and Financial Stability" (IMF staff).*

### Introduction — Objectives, mechanisms, and reform rationale
- Key objectives and policy priorities
  - Contain likelihood and magnitude of adverse investor-driven feedback loops.
  - Strengthen liquidity risk management to cope with large shocks.
  - Explore scope for more robust market backstops and trading arrangements.

- Shock amplification and investor behavior
  - Adverse feedback loop: investors reallocate after large shocks amplifying asset declines and market illiquidity.
  - First-exit motive: observable liquidity triggers (gates/fees tied to thresholds) can become coordination devices that increase run incentives.

- Data and cross-border reform rationale
  - Given global fund operations, reforms should be internationally coordinated through the FSB-led process and IOSCO involvement.

### Liquidity management tools and the “waterfall” (general design)
- Core design ideas
  - Increase liquidity buffers and usability to conserve liquidity and avoid fire sales.
  - Implement a waterfall of progressively aggressive measures sequenced to maintain fund functioning under stress.

- Suggested MMF waterfall (ascending intrusiveness)
  - First: increase liquid asset requirements and make them countercyclical.
  - Next: lock-in a proportion of investors’ shares for a minimum time (MBR).
  - Next: redemption-in-kind to institutional investors instead of cash.
  - Last: temporary gating of outflows as a macroprudential intervention if earlier measures fail.

- Suggested OEF waterfall (ascending intrusiveness)
  - Increase quantum and usability of liquidity buffers.
  - Sequential tools: redemption deferrals; redemption-in-kind for certain investors; market-wide fees or gates.
  - Broader balance-sheet matching: offer daily redemptions only to investors in sufficiently liquid assets with capped maturity while other fund segments invest in less liquid assets.

- Additional measures to address exit externalities
  - Swing pricing (dilution mechanism), minimum-balance-at-risk (MBR), anti-dilution measures.

### Market-based backstops, dealer commitments, and central banks
- Market-based backstops
  - Encourage dealer pre-commitments to repurchase in secondary markets and extend repo lines to MMFs to reduce reliance on central bank support.
  - Pre-commitments can reduce moral hazard relative to central bank interventions.

- Central bank role
  - Provide liquidity in extraordinary tail events via asset purchases and special lending facilities.
  - Central bank interventions should be contained to extreme events; reforms aim to make such intervention less likely.
  - Moral hazard mitigation: risk pricing, commitment fees, and regulation; pricing access to central bank liquidity at rates equivalent to discount window facilities.

### Data, reporting, supervision, and regulatory approach
- Recommended enhancements
  - Obtain comprehensive and regular information on fund risk-taking on a comparable basis across jurisdictions; may require a uniform measurement methodology.
  - Enhance reporting and disclosure on OEF liquidity and LRM frameworks.
  - Allow greater discretionary judgment to align a fund’s liability liquidity with asset liquidity from the outset; consider appropriateness of open-end structures for funds intermediating very illiquid assets.
  - Strengthen regulation and supervisory attention commensurate with sector risks.

### FSAP findings and supervisory challenges
- Common findings from FSAPs across jurisdictions
  - Asset managers and funds are highly interconnected via investments in other funds, bank-issued securities, and bank credit lines.
  - Data and analytical limitations persist; national data gaps and cross-border flow reconciliation challenges.
  - Bond funds active in HY and EME markets face recurring redemption shock management concerns due to liquidity mismatch with daily redemptions.
  - MMFs often domiciled in jurisdictions allowing CNAV; vulnerabilities from the GFC remain.
  - LMTs are not always available or widely adopted; legal barriers and lack of mandatory obligations hinder adoption.
  - Supervisory intensity on asset managers needs enhancement; resource gaps and limited regulator autonomy are common.

### Portfolio allocation, systemic signals, and selected numerical indicators
- Selected numeric findings preserved as in source
  - Passive OEFs and ETFs share almost tripled to 29 percent over the last decade.
  - Bond fund allocations have outpaced equity fund allocations since 2008.
  - EMDE debt exposure in fixed income funds surpasses corresponding allocation in the debt universe.
  - Figures and notes reference Q2:2020, Q2 2010, 2000 … 2020 ranges.
  - Funds with assets of more than $1.25 billion (figure note).
  - Panel coverage and sample thresholds: assets more than $½ billion; funds larger than $50 million in some panels.

*Source: iffspcea - Introduction.*

### MMF-specific analysis and policy options (Annexes)
- CNAV and strategic complementarities
  - CNAV MMFs maintain unchanging face value NAV (for example $1/€1 per unit/share) with amortized cost valuation.
  - CNAV MMFs are isomorphic to demand deposits from a capital-preservation perspective in normal times.
  - Absent deposit-insurance-like protection, CNAV MMFs face strategic-complementarity-driven runs.

- Empirical evidence from March 9–23, 2020 (Li and others, 2020)
  - WLA positions were insignificant in driving flows before March 9 but became the most significant determinant during March 9–23.
  - Outflows were significantly greater for funds with WLA below the sector median.
  - Sensitivity of outflows increased sharply once WLA fell below 40 percent.
  - Coupling of gates and fees to observable WLA thresholds was a key driver of redemption runs.

- Recommended MMF policy waterfall and lines of defense
  - First line: mandate higher asset-side liquidity in normal times (30 percent WLA floor may be insufficient; consider higher floor).
  - Regulatory flexibility: allow temporary breaches during stress if new liquidity or maturing holdings are placed into overnight sovereign debt repo until buffer floor is restored.
  - Second line: LMTs delaying redemptions or reducing incentives to sell (swing pricing less viable for immediate settlement MMFs; MBR proposed).
  - Third line: redemption-in-kind when buffers fall significantly below floor (may require statutory change; unavailable to retail prime MMFs).
  - Final line: temporary industry-wide gating triggered by supervisory or automatic actions, used only in extreme distress for short periods (such as a day) with clear ex-ante guidance.

- Additional MMF policy options (features, pros, cons — summary)
  - Decouple liquidity thresholds from fees and gates.
  - Reform conditions for imposing fees/gates (supervisory permission).
  - Minimum balance at risk (MBR).
  - Liquidity buffer and countercyclical liquidity buffer.
  - Floating NAVs for all nongovernment MMFs.
  - Swing pricing and macroprudential swing pricing.
  - Capital buffers, centralized external support (liquidity exchange bank).
  - Sponsor support rules, investor-concentration limits, reporting and disclosure enhancements.
  - Abolish nongovernment MMFs as a clean but disruptive option.
  - Liquidity-based redemption deferrals and limits on eligible assets for non-government MMFs.

- Sequencing and implementation priorities
  - Quick wins:
    - Decouple regulatory thresholds from fees/gates while allowing managers to gate redemptions and charge exit fees at critically low buffer levels.
    - Close data gaps with enhanced reporting harmonized across major jurisdictions.
    - Mandate improved stress testing by MMFs based on regulator-approved parameters.
  - Incremental short-term steps:
    - System-wide stress testing facilitated by enhanced reporting.
    - Roll out liquidity management lines of defense: mandatory strengthening of WLA buffer floor for normal times with crisis flexibility, MBR, redemption-in-kind, and limits on eligible assets for non-government MMFs.
    - Clarify sponsor support.
  - Major medium-term reforms:
    - Limit CNAV to government MMFs and consider constraints or prohibitions on daily dealing for prime MMFs.

*Source: iffspcea - Annex 2 and Annex 3.*

### OEF-specific options: swing pricing, LMT waterfall, and leverage
- Incentive issues and market frictions
  - OEFs delivering daily dealing and fast settlement face liquidity mismatch when investing in assets with low structural and procyclical market liquidity.
  - First-mover incentives persisted in March 2020 despite floating NAV.
  - Market frictions: low domestic market depth for EMDE securities; variation in OEF cash holdings; reduced bank dealer market-making since the GFC.

- Swing pricing
  - Mechanism: internalizes transaction costs by adjusting subscription/redemption prices.
  - Benefits: shields remaining shareholders, increases option value of waiting, counters first-mover incentives.
  - Evidence: Jin and others (2019) find fixed-income OEFs using swing pricing saw significantly reduced outflows in the United Kingdom during past stress episodes.
  - Operational challenges: partial vs full swing regimes, calibration of dilution factor, transparency vs stability trade-offs, need for supervisory guidance.

- OEF LMT waterfall (ascending intrusiveness)
  - MBR (moderate shocks).
  - Redemption-in-kind (moderate-to-large shocks).
  - Temporary gates (large shocks).
  - Align redemption frequency with underlying asset liquidity at fund initiation; consider moving away from daily liquidity for funds investing in illiquid assets.
  - Enhance disclosures and continuous reporting of LRM frameworks and liquidity profiles.

- Leverage-related vulnerabilities
  - Data gaps hinder full assessment.
  - Sample evidence: top quartile of 200 OEFs (combined asset holdings of $1½ trillion) had gross notional derivatives positions of 300 to 2800 percent of assets as of 2020.
  - Policy priorities: supervisors obtain regular leverage information with a uniform measurement methodology; implement IOSCO’s Leverage Framework.

- Supervisory resourcing
  - Supervisory oversight of OEF LRM and leverage is resource-intensive.
  - FSAP evidence points to under-resourcing; regulators need timely, granular information and in-house expertise.
  - Notable actions: US amended rules on derivatives and improved reporting via Form N-PORT; European UCITS have selected reporting in some countries but no EU-wide framework.

*Source: iffspcea - OEF and leverage sections.*

### Cross-border spillovers, BDIs, MSBFs, and recipient-country implications
- Scale and trends
  - Median EM portfolio debt stock now above a quarter of GDP compared with 11 percent of GDP in 2008.
  - Median EM portfolio equity stock has almost doubled since 2008.
  - Of the $900 billion cumulative inflows into EM sovereign debt since 2009, about 75 percent were intermediated by the OEF sector.
  - Benchmark-Driven Investors (BDIs) account for about 40 percent of the foreign investor base in EMDE sovereign debt.
  - The quantum of funds intermediated by BDIs has more than quadrupled in the past 10 years.
  - The number of countries in EMBIG doubled since 2007 to 70.
  - Funds with assets of more than $1.25 billion appear in figure notes and panel samples use assets more than $½ billion thresholds.

- BDIs and amplification
  - Benchmarks explain, on average, about 70 percent of country allocations even after controls.
  - Flows driven by EM benchmarks are about three-to-five times more sensitive to common global risk factors than balance of payments measures.
  - Rebalancing and index weighting rules can redistribute significant BDI flows; an estimated $300 billion total BDI, a 2 percentage points higher weight implies $6 billion additional BDI due to index rules.

- MSBF behavior and risks
  - MSBFs can hold concentrated positions and use derivatives and leverage.
  - Of total AUM $1 trillion, the 40 largest MSBFs’ EM investments ranged $100–$160 billion in recent years.
  - As of Q2: 2020, these EM investments amounted to $85 billion (sovereign) and $15 billion (state-owned enterprises).
  - During COVID-19, MSBF outflows responsible for an estimated pullback of $23 billion almost entirely out of local currency bond exposures.

- Frontier markets and market depth
  - Frontier markets now account for almost 20 percent of the EMBIG-Diversified index.
  - Median frontier financial market depth is 0.08; emerging median is 0.33; advanced median is 0.63.
  - High foreign participation in shallow frontier markets can induce significant volatility and contagion.

- Recipient-country policy recommendations
  - Foster domestic market development to deepen markets and broaden investor base.
  - Use debt management tools to diversify investor base and reduce concentration.
  - Apply Integrated Policy Framework tools: currency intervention, macroprudential measures, capital flow management measures when appropriate.
  - Reduce external vulnerabilities and strengthen buffers: reduce excessive external liabilities, reliance on short-term debt, maintain adequate fiscal buffers and foreign exchange reserves.

- Source-country and global policy recommendations
  - Strengthen OEF liquidity risk management and reduce bad coordination at the source.
  - Align redemption terms to asset liquidity and deploy reforms globally to avoid regulatory arbitrage.
  - Enhance transparency by index providers and dialogue among index providers, investment community, and regulators.

- Expected outcome
  - Combined measures would place nonbank intermediation of core markets and capital flows on a stabler footing and push the need for central bank emergency liquidity support into the tails of the shock distribution.

*Source: iffspcea — Portfolio, BDIs, MSBFs, and cross-border sections.*

### Empirical evidence on flows, selling pressure, and market liquidity (March 2020)
- Fund flows and portfolio liquidity
  - In March 2020 most fund sectors faced large outflows; portfolio liquidity deteriorated in proportion to outflows.
  - Outflows from US fixed income funds amounted to $481 billion during the March sell-off.
  - Bond funds met outflows by selling cash and cash equivalents, mechanically increasing exposure to corporate bonds.

- Selling pressure metrics and findings
  - Panels use sample of 390 fixed-income funds holding approximately 13,000 identifiable securities in March.
  - Selling pressure defined as fraction of flow-motivated trading in a security’s average monthly trading volume.
  - Higher redemptions meant fewer liquid assets, larger and longer underperformance; bid-ask spreads and cumulative returns under selling pressure worsened during Mar. 2020 and subsequent months.

- Data sources cited for figures and analysis
  - Board of Governors of the Federal Reserve System; Morningstar; Refinitiv Datastream.

*Source: iffspcea — Fund flows, selling pressure, and figure notes.*

### Conclusions and international coordination
- Central conclusions
  - Investment funds’ growth and role in cross-border intermediation have significant benefits but also amplify risks to recipient EMDEs.
  - Policy goal: conserve benefits of cross-border flows while guarding against such intermediation becoming a transmitter of stress and volatility.

- Policy mix and coordination
  - Appropriate responses require a combination of recipient-country (market development, debt management, macroprudential and CFMs, FX intervention) and source-country (fund regulation and LRM) policies.
  - Global implementation reduces risk of regulatory arbitrage and race-to-the-bottom.
  - The FSB-led process with IOSCO and standard setters is essential to identify policy options and ensure coordinated global responses.

*Source: iffspcea — Conclusions and coordination.*

_Italic: Source — iffspcea (IMF staff "Investment Funds and Financial Stability", selected chapters and annexes from provided PDF)._

### Executive Summary ������������������������������������������������������������������������������������������������������

### Executive Summary

### Growth and systemic relevance of investment funds
- The share of global financial assets held by nonbank financial institutions (NBFIs) grew to 50 percent, with over a third of these assets accounted for by investment funds.
- Money market funds (MMFs) and open-end funds (OEFs) have become critical to intermediation in markets such as United States Treasuries and corporate bonds and are a crucial driver of global capital flows to emerging market and developing economies (EMDEs).
- A key feature of most investment funds’ business models is to offer daily liquidity to investors, similar to that offered by banks on their demand deposits.

### Liquidity and maturity transformation risks
- Funds have expanded beyond large-cap equity and advanced economy sovereign bonds into corporate debt (including speculative-grade), real estate, and emerging market securities, increasing liquidity and maturity transformation risks.
- Unlike banks, investment funds generally do not benefit from public backstops such as discount window access or deposit insurance, making promised daily liquidity fragile when assets become illiquid.
- Fire sale externalities, illiquidity spirals, and occasional run risk are documented vulnerabilities given these liquidity mismatches.

### March 2020 market turmoil: amplification and policy response
- The onset of the global COVID-19 pandemic starting in January 2020 and accelerating markedly in March 2020 triggered sharp drops in risk asset prices and a dramatic sell-off of risky assets.
- Investor risk aversion and portfolio reallocation toward safe assets led to significant redemptions from dollar-denominated nongovernment MMFs both in and outside the United States and redemption pressures on OEFs invested in high-yield corporate bonds and real estate.
- Market pressures abated only after the Federal Reserve announced a number of important liquidity backstops and outright purchases of US Treasury securities, corporate bonds, and certain money market instruments via special lending facilities (Fed’s “intensive new measures” Mar. 23).
- The events highlighted amplification channels where investor outflows, asset sales by fund managers, and market illiquidity contributed to broader market stress, including in US Treasuries.

### Four key policy objectives identified
- Address incentives of investors to front-run others when adverse shocks occur by increasing the value of waiting to sell fund shares.
- Analyze and mitigate the inherent tension between offering daily liquidity and exposure to illiquid assets.
- Address frictions in important asset markets that exacerbate stress and amplification.
- Mitigate cross-border spillovers to emerging market and developing economies.

### Policy tools and sequencing
- Investors’ early-exit incentives can be tackled by increasing the value of waiting to sell fund shares.
- Reduce liquidity and maturity transformation risks through a combination of liquidity management tools of increasing intensity to be deployed sequentially.
- First line of defense for liquidity backstops should be market-based solutions (for example, dealer pre-commitments or more robust trading arrangements), with central bank emergency liquidity support buttressing these measures in tail episodes.
- Domestic macroeconomic and macroprudential policies, combined with these measures, can lessen cross-border contagion.

### Cross-border implications
- Investment funds are important drivers of cross-border capital flows to EMDEs; abrupt withdrawals by international asset managers contributed to widening sovereign risk premia and financing gaps in EMDEs during the March 2020 shock.
- Policy measures should account for the global nature of the investment fund business and the fungibility of financial flows to avoid regulatory arbitrage and ensure consistency of global policy choices.

### Overall assessment
- The benefits of the recommended policy measures—principally reduced risk of market turmoil and financial instability—are expected to carry significant welfare gains for issuers and investors that would more than offset adjustment costs.
- The paper underscores the importance of the ongoing Financial Stability Board-led process involving national authorities, the International Organization of Securities Commissions, and other standard setters to identify policy options and ensure coordinated global responses.

*Source: Executive Summary, "Investment Funds and Financial Stability" (IMF staff).*

### Introduction

### Introduction

### Key objectives and policy priorities
- Three paramount objectives:
  - Contain the likelihood and magnitude of adverse feedback loops triggered by investors’ reaction to negative shocks.
  - Strengthen liquidity risk management to deal with adverse feedback loops and large adverse shocks.
  - Explore scope for more robust market backstops and trading arrangements to enhance liquidity of funds’ assets.
- Rationale:
  - The March 2020 events prompted a comprehensive reexamination of the need for further and definitive policy action.
  - Given the global nature of the business, policy reform should be achieved on an internationally coordinated basis through the FSB-led process and participation of IOSCO and other standard setters to ensure consistency and preclude regulatory arbitrage.

### Mechanisms of shock amplification and investor behavior
- Adverse feedback loop described:
  - Investors reallocate portfolios after large shocks (e.g., COVID-19), which can amplify asset valuation declines and market illiquidity.
  - Mass sell-offs can be generated by investors’ fear that other investors will sell, especially when market liquidity has been dented by the shock.
- First-exit motive and coordination devices:
  - Non-government MMFs offered to institutional investors experienced runs driven by fear that redemptions would be prohibited if fund liquidity dropped below pre-announced thresholds.
  - Hard, observable liquidity triggers can inadvertently become bad coordination devices, increasing incentives to run.

### Liquidity management tools (LMTs) and the “waterfall” approach (policy recommendations)
- Core design ideas:
  - Increase liquidity buffers and increase their usability to conserve liquidity and prevent value-eroding fire sales.
  - Implement a waterfall of progressively more aggressive measures, sequenced to ensure fund functioning under increasing stress.
- Suggested waterfall for MMFs:
  - First: increase liquid asset requirements and make them countercyclical.
  - Next: lock-in a proportion of investors’ shares for a minimum amount of time.
  - Next: offer redemption-in-kind to institutional investors instead of cash.
  - Last: temporary gating of outflows as a macroprudential intervention if earlier measures fail.
- Suggested waterfall for OEFs:
  - Move away from unqualified daily dealing by increasing quantum and usability of liquidity buffers.
  - Sequential tools: redemption deferrals; redemption-in-kind for certain investors; market-wide fees or gates.
  - Broader balance-sheet matching option: offer daily redemptions only to investors in sufficiently liquid assets with capped maturity, leaving funds to invest in liquid assets actively traded in secondary markets (e.g., certain large-cap equity and sovereign bonds), while remaining vigilant to changing liquidity characteristics.
- Additional measures to address exit externalities:
  - Swing pricing (a tax that reduces sales price for early exiters and benefits those who wait).
  - Minimum balance-at-risk and anti-dilution measures.

### Advantages and distributional effects of the waterfall
- Reduces and more evenly distributes adjustment costs of reform because:
  - Attenuating first-exit incentives increases investor returns in bad states by reducing likelihood of feedback loops and associated losses.
  - Costlier tools within the waterfall (deferred/in-kind redemptions, gates) are less likely to be deployed if earlier tools succeed.
  - Distributes costs more evenly across investor types (e.g., increasing buffers benefits liquidity-seeking investors but may be costly to return-seeking investors; managers gain headroom against fire-sales benefiting all investors and debt issuers).

### Market-based backstops and central bank intervention
- Complementary market-based solutions should be explored to improve liquidity of key asset markets (corporate bonds, commercial paper) to decrease reliance on central bank support.
- Role of central banks:
  - Central banks can provide liquidity during extraordinary tail events via asset purchases and special lending facilities.
  - Past effectiveness cited: Federal Reserve’s MMF liquidity facility and outright purchases; European Central Bank’s additional quantitative easing helped reverse redemption runs.
  - Central bank intervention should be contained to extreme events; reforms aim to make the investment funds sector more stable and central bank intervention less likely to contain moral hazard.
- Contrast with banking:
  - Banks benefit from established backstops and deposit insurance, complemented by extensive prudential supervision and regulation to contain moral hazard.

### Cross-border spillovers, EMDEs, and policy coordination
- EMDEs’ exposure:
  - EMDEs have benefited from growth of capital flows intermediated by investment funds, but reversals pose financial-stability risks.
  - Reallocations from risky to safe assets by global asset managers create cross-border spillovers of market volatility that EMDEs must manage.
  - Evidence: international asset managers are increasingly sensitive to global risk factors; this sensitivity has been rising over time.
  - Concentration risk: small portfolio shares for large managers can be disproportionately large inflows for small emerging markets, raising contagion and sudden-stop risks.
- Policy levers:
  - Recipient-country tools: Integrated Policy Framework guidance on interventions in currency markets, macroprudential and capital flow management; foster domestic market development and use of debt management tools.
  - Source-country role: strengthen OEFs’ liquidity risk management and reduce bad coordination to lower amplification potential at the source.

### Data, reporting, supervision, and regulatory approach
- Recommended enhancements:
  - Obtain comprehensive and regular information on fund risk-taking on a comparable basis across jurisdictions, which may require prescribing a uniform measurement methodology to the industry.
  - Enhance reporting and disclosure practices related to OEFs’ liquidity to ensure continuous visibility of liquidity risk management frameworks, practices, and challenges.
  - Give greater room to discretionary judgment to align liquidity of a fund’s liabilities with its assets from the outset, including considering whether open-end structures are appropriate for funds intermediating into very illiquid assets.
  - Strengthen regulation and increase supervisory attention commensurate with sector risks to financial stability.
- Rationale for revisiting regulatory approach:
  - Investment funds’ expanding role in credit provision and increasing intermediation of less liquid assets, combined with offering daily liquidity without explicit backstops, suggests the current regulatory approach should be revisited to calibrate tail-event central bank interventions to an appropriate frequency.

### Portfolio allocation, systemic risk signals, and numerical indicators (selected findings)
- Growth and allocation trends:
  - The share of assets managed by passive OEFs and ETFs in the global funds industry almost tripled to 29 percent over the last decade.
  - Bond fund allocations have outpaced equity fund allocations since 2008.
  - EMDE debt exposure in fixed income funds surpasses the corresponding allocation in the debt universe.
- Data points and labels from figures and notes (preserved wording as presented):
  - Q2:2020 (used in figure references).
  - Panels reference: panel 1, panel 2, panel 3, panel 4.
  - Funds with assets of more than $1.25 billion (figure note).
  - References to time series and countries are presented in accompanying figures (e.g., “Q2 2010” and “Q2 2020” labels, and “2000 … 2020” ranges in charts).

*Source: iffspcea - Introduction (iffspcea - Introduction).*

### 1. Asset Class Portfolio Shares of Fixed-Income Funds and Selected Indices

### 1. Asset Class Portfolio Shares of Fixed-Income Funds and Selected Indices

### Search for Yield Tendencies (Figure 4)
- Figure title: Search for Yield Tendencies.
- Context: Fixed-income funds increased their exposure to EM debt, with bond funds growing faster than equity funds.
- Chart axis labels (as presented): 0, 10, 20, 30, 40 and 0, 5, 10, 15.

### Capital Allocated to Funds
- Metric: Trillions of US dollars, monthly.
- Finding: Fixed-income fund increased their exposure to EM debt ...... with bond funds growing faster than equity funds.

### Assets of Leveraged and Inverse ETFs
- Metric: Billions of US dollars.
- Finding: The leveraged ETF industry revived after 2014 again ...... as funds also started to increase positions in derivatives.

### Offset Cash Positions for Derivative Exposures of Leveraged and Inverse ETFs
- Metric: Percent of assets.
- Finding: The leveraged ETF industry revived after 2014 again ...... as funds also started to increase positions in derivatives.

### Amplification Risks from Investment Funds’ Business Model
- Funds offering stable or low volatility net asset value (NAV) are susceptible to run risk generated by an early-exit premium incentive similar to fractional reserve banking.
- Pass-through-risk products like US institutional prime MMFs and OEFs are susceptible to run risk because (near)-same-day redemption generates strategic complementarities of exit via a first-mover advantage in stressed markets (IMF 2015, 2019).
- When funds intermediate flows into less liquid assets and rely on leverage, the early-exit premium can increase significantly (Choi and Kronlund 2018).
- In stressed markets, fund NAV falls between the date an investor redeems and the date by which an equivalent market value of underlying assets is liquidated; the less liquid the asset, the longer the time differential between redemption and liquidation and the greater the negative externality on investors delaying exit.
- Leveraged funds amplify losses for remaining investors if derivatives positions move unfavorably in stress.
- Growing use of passive-index and benchmark-driven investment funds increases exposure to common shocks, potentially increasing adverse feedback loops when exposures to assets with lower and more procyclical liquidity rise.
- Greater costs of maintaining liquidity buffers in a low yield environment put pressure on liquidity cushions even outside passive funds.

### Market Liquidity Provision and Wrong-Way Risk
- Net supply of liquidity from bank broker-dealers has fallen in steady-state terms after the GFC, reflecting factors including enhanced internal risk management and prudential oversight (Adrian and others 2017).
- During periods of stress, collateral haircuts and repo funding rates increase and the supply of liquidity from broker-dealers falls at a time when it is needed most.

### Implications for Regulatory Oversight
- Traditional regulatory focus: investor protection and market conduct, emphasizing the relationship between securities firms and clients and information disclosure.
- Evolution: IOSCO’s Objectives and Principles of Securities Regulation now include a specific principle on the importance of systemic risk in regulators’ mandates and standards related to Collective Investment Schemes, focusing on valuation, liquidity and leverage.
- FSAP emphasis: incorporating financial stability into securities regulators’ mandates and focusing policy analysis on prudential issues relevant to financial stability.
- National authorities actions: more granular data collection, incorporating stress testing by investment funds into regular monitoring, and enhancing the regulatory toolkit.
- Implementation challenges:
  - Growth in sector complexity strains supervisory resources.
  - Many jurisdictions are still unable to deliver adequate onsite inspections or fully exploit granular data.
  - Not all countries have expanded LMTs beyond full redemption suspensions; legal limits can prevent authorities from requiring LMTs or triggering their use.
  - Even where LMTs exist, absence of mandatory obligations means the industry may not adopt them actively.
- Recommendation: Widen the tool-kit available to fund managers and consider a more prescriptive approach to their adoption.

### FSAP Findings (Box 1 summary)
- Basis: Drawn from systemic risk assessments in three countries and regulatory assessments in 11 others in FSAPs between 2015 and now across advanced and emerging economies.
- Common findings:
  - Asset managers and funds are highly interconnected with the financial system via investments in other funds, bank-issued securities, and credit lines from banks.
  - Data and analytical limitations persist, including national data gaps and challenges reconciling cross-border flows.
  - Bond funds active in HY and EME markets face recurring concerns about redemption shock management due to liquidity mismatch with daily redemptions.
  - While many bond funds had sufficient buffers to withstand redemption shocks, there were widespread liquidity shortfalls in examples that required drawing down bank credit lines or selling assets.
  - MMFs are predominantly domiciled in jurisdictions allowing CNAV; vulnerabilities from the GFC remain. Prohibition of CNAV-MMFs in some countries primarily diverted flows to countries permitting CNAV products.
  - LMTs (swing pricing, fees, gates, side pockets) are not always available or widely adopted; legal and practical barriers to their use persist.
  - Supervisory intensity on asset managers needs enhancement to ensure coverage of key risk areas; resource gaps in securities regulation remain inadequately addressed and, in some countries, regulators lack sufficient autonomy to determine necessary resources.

### Key Policy Priorities
- Better alignment of investor incentives.
- Strengthening MMF risk management.
- Addressing market frictions.
- MMF-targeted options split into:
  - Measures addressing strategic complementarities in investor redemptions.
  - Measures increasing the range of funds’ liquidity risk management tools (LMTs).
- Proposal: A waterfall structure of LMTs—less intrusive options first, more intrusive for larger shocks or persistent runs—has two advantages:
  - More effectively contain potential costs of reform and mitigate unintended adverse impact on functioning of short-term funding markets (STFMs).
  - Push the need for central bank emergency support farther into the tails of the shock distribution.

### Motivation for Policy Action
- Intense, sustained redemptions from non-government MMFs during March 2020 that ultimately took government intervention to stem raise questions regarding the adequacy of post-GFC reforms.
- The 2020 crisis was an illiquidity episode, unlike 2008 when the Lehman bankruptcy resulted in the Reserve Prime Fund breaking the buck.
- Post-GFC US reforms focused on two key measures targeted at reducing bank-run like risk confronting prime MMFs, including the removal of the CNAV structure for institutional prime MMFs to reduce strategic complementarities in investors’ exit decisions.

*Source: iffspcea - 1. Asset Class Portfolio Shares of Fixed-Income Funds and Selected Indices*

### Annex 2 details MMF policy reform undertaken in the European Union, Asian countries, and the United

### 1. Cumulative Daily Net Flows into Funds (Relative to January 2, 2020)

### 1. Cumulative Daily Net Flows into Funds (Relative to January 2, 2020)

### Fund flows and liquidity management (Q1–Q2 2019–20)
- In March most fund sectors faced large outflows.
- Portfolio liquidity deteriorated in proportion to outflows.
- Bond funds met outflows by selling cash and cash equivalents, thereby mechanically increasing exposure to corporate bonds.
- Panel 1 coverage at the end of June 2020: 45 percent of equity funds, 43 percent of fixed-income funds, 30 percent of mixed funds, and 78 percent of MMFs reported by the International Investment Fund Association at the global level, including funds of funds.
- Sample period: January 1–August 12, 2020.
- Panel 3 and 4 samples: balanced samples of funds with assets more than $½ billion (excluding funds that entered or exited during January 2017–April 2020).
- In panel 3, cash equivalents include US Treasury securities and other securities maturing in fewer than 92 days.
- Panel 1 note: asset-weighted average cumulative daily net flows for other economic flows larger than $½ billion and all money market funds (MMFs) and open-end hedge funds with alternative strategies larger than $50 million.

### Bid-ask spreads and liquidity indicators
- Bid-ask (BA) spreads are computed based on Refinitiv composite end-of-day bid and ask prices.
- Cash and cash equivalents are assumed to have no BA spread.
- Panels 1 and 2 basis: portfolio holdings data for 390 fixed-income funds holding approximately 13,000 identifiable securities in March.
- Selling pressure during March is defined as the fraction of flow-motivated trading in a security’s average monthly trading volume (Coval and Stafford 2007).
- Flow-motivated trading: difference between a security’s purchases by funds experiencing inflows higher than 90 percent of their peers and sales by funds facing outflows higher than 90 percent of their peers.
- A security experiences selling pressure if it is in the bottom decile of the inflow distribution and experiences no pressure if inflows are positive.

### Selling pressure and fire sales (March 2020 and after)
- Higher redemptions meant fewer liquid assets and larger and longer underperformance.
- Figure 7 panels:
  - 1. Bid-Ask Spreads of Securities under Selling Pressure Held by Fixed-Income Funds (Percent).
  - 2. Cumulative Returns of Securities under Selling Pressure Held by Fixed-Income Funds (Percent).
- Time series markers shown include: Mar. 2020, Apr. 20, May 20, June 20, July 20.

### Sources for data used in figures and analysis
- Board of Governors of the Federal Reserve System; Morningstar; and Refinitiv Datastream.

---

### Incentive issues and market frictions confronting OEFs
- Policy targets similar to those for prime MMFs, with important differences reflecting wider asset classes, fund structures and investors in the OEF universe.
- Liquidity management challenges concentrated in funds delivering daily dealing and fast settlement while offering exposure to assets with low structural and highly procyclical market liquidity.
- Despite floating NAV, first-mover incentives for exit remained prominent for OEF investors in March 2020.
- Additional market frictions making LRM more challenging:
  - Low depth of domestic financial markets decreases liquidity of EMDE securities and makes it more procyclical.
  - Variation in OEFs’ cash holdings across asset classes suggests managers may prefer fire-sales to deal with redemption spikes in municipal and speculative-grade corporate bonds and in syndicated loans.
  - Large direct and indirect holdings of corporate bonds by ratings-sensitive investors (e.g., (life) insurers) can increase procyclicality of corporate bond market liquidity and OEF NAV.
  - Market-making by bank dealers has decreased significantly after the GFC due to regulation and risk management, placing liquidity provision under maximum pressure when needed most.

---

### Swing pricing to address strategic complementarities
- Swing pricing internalizes externalities on OEF NAV by increasing subscription price for inflows and lowering redemption value for outflows.
- Potential effects:
  - Shields remaining shareholders from transaction costs and NAV externalities.
  - Increases the option value of waiting relative to immediate redemption, countering first-mover incentives.
- Empirical evidence:
  - Jin and others (2019): fixed-income OEFs using swing pricing saw significantly reduced outflows in the United Kingdom during past stress episodes.
  - US fund managers have not widely used swing pricing despite regulatory permission in 2018; European OEFs have not universally adopted it.
  - Luxembourg Commission de Surveillance du Secteur Financier (CSFF) increased swing adjustment factors beyond prospectus levels in March 2020.
- Design and operational complexities to address:
  - Choice between partial and full swing pricing: partial regimes can fail to remove strategic uncertainty and thus fail to prevent runs.
  - Need for sufficiently large dilution factor when swing mechanism triggers or investors may coordinate on immediate runs.
  - Trade-off between transparency and stability when using publicly known triggers.
  - Need for prescriptive supervisory guidance for stressed periods.
  - Difficulty in accounting for expected market-wide liquidity conditions when setting swing parameters.
- Implementation implications:
  - Mixed adoption suggests potential need for regulatory intervention to guarantee industry-wide adoption.
  - Funds could be asked to take market-wide redemption and liquidity conditions into account when calibrating swing factors; supervisory action may be required for coordinated adaptation.

---

### Policy options to enhance OEF liquidity risk management (LRM)
- Effective approach: mandate or make available a waterfall of LMTs to OEFs.
- Suggested LMT waterfall (ascending intrusiveness):
  - MBR (moderate shocks).
  - Redemption-in-kind (moderate-to-large shocks).
  - Temporary gates (large shocks).
- Supervisory and legal considerations:
  - Ensure LMTs are reflected in relevant laws and regulations.
  - Regulators should ensure appropriate LMTs are allowed in documents of incorporation and provide guidance to managers on expectations regarding tool use.
- Aligning redemption frequency with underlying asset liquidity at fund initiation:
  - IOSCO LRM recommendations discuss using the design phase to ensure OEFs can meet redemption obligations.
  - Consider moving away from daily liquidity for funds investing in illiquid assets; may require amending legal frameworks in some countries.
  - Limiting redemption frequency at initiation can improve investor expectations and supervisory oversight.
  - Secondary markets for fund shares could complement restricted redemptions by providing investor access to liquidity.
- Enhance reporting and disclosure practices:
  - Continuous visibility of LRM frameworks, practices, and challenges is vital to supervisors and investors.
  - IOSCO’s LRM recommendations detail desirable attributes of OEF disclosures.
  - Jurisdictional experiences implementing reporting frameworks will inform enhanced oversight.

---

### Addressing leverage-related vulnerabilities
- Some OEFs may be using significant leverage; data gaps prevent full vulnerability assessment.
- Sample evidence: top quartile of a sample of 200 OEFs with combined asset holdings of $1½ trillion had gross notional derivatives positions of 300 to 2800 percent of assets as of 2020.
- Funds reporting adequate details in 2017 appeared to be using derivatives to boost returns rather than purely for hedging.
- Policy priorities:
  - Put in place arrangements for supervisors to obtain regular information on leverage and prescribe a uniform measurement methodology.
  - Regulatory frameworks should embed reporting, data analysis, monitoring, and disclosure requirements.
  - Implementing IOSCO’s Leverage Framework would improve visibility of leverage by enabling aggregation and providing additional information on leverage for funds in jurisdictions not currently making this public.
  - Current framework limitations: different measurement options, lack of cross-jurisdiction comparability (netting and hedging), and inconsistent availability of gross and net leverage information and stress tests.

---

### Supervisory resourcing
- Supervisory oversight of OEFs’ LRM frameworks and leverage levels is resource-intensive.
- FSAP evidence points to under-resourcing at supervisory authorities, including in major markets.
- Regulators need timely, sufficiently granular information to analyze liquidity and leverage by in-house experts.
- Supervision should ensure OEFs use their LRM framework and tools appropriately, beginning with discussions at fund initiation.
- Resource allocation to supervise the sector should continue to grow in line with the sector’s impact on macro-critical risk.
- Notable jurisdictional actions:
  - United States: amended rules on use of derivatives by investment funds and improved reporting via Form N-PORT (including monthly portfolio composition).
  - European UCITS: detailed reporting requirements in some countries on a selected basis; no EU-wide reporting framework.
  - IMF’s Financial Soundness Indicators Guide (2019) presents a uniform measurement methodology for key financial indicators for MMFs.

---

### Role of investment funds in cross-border spillovers
- Since the GFC, benchmark-driven asset managers intermediated a surge in cross-border portfolio flows into EMEs and frontier markets.
- Potential benefits: growth for recipient countries and higher returns/diversification for international investors.
- Need to guard against cross-border spillover of stress and market volatility that can exacerbate vulnerabilities in recipient countries.
- Trends and magnitudes:
  - Median EM portfolio debt stock now above a quarter of GDP compared with 11 percent of GDP in 2008.
  - Median EM portfolio equity stock has almost doubled since 2008.
  - Of the $900 billion cumulative inflows into EM sovereign debt since 2009, about 75 percent were intermediated by the OEF sector.
  - The proportion of foreign NBFI investors more than doubled since the GFC.
  - These trends vary across countries; foreign non-bank investors account for almost 50 percent of total investors in some countries (e.g., Peru and Uruguay) and are relatively marginal in others (e.g., China and India).

*Source: iffspcea - 1. Cumulative Daily Net Flows into Funds (Relative to January 2, 2020), IMF.*

### 1. Portfolio and Cross-Border Loan Liabilities IIP

### 1. Portfolio and Cross-Border Loan Liabilities IIP

### Rising Role of Cross-Border Nonbank Investors
- Portfolio investment has grown for most emerging and frontier market economies, led by debt flows.
- Foreign nonbank investors now account for a significant proportion of sovereign debt in emerging markets.
- There is significant variation across countries, with Peru, Uruguay, and Romania having the highest foreign NBFI ownership.
- Schematic breakdown: cross-border investors into benchmark-driven investors and unconstrained investors (benchmark-driven vs. unconstrained).

### Benchmark-Driven Investors (BDIs): Trends and Scale
- BDIs account for about 40 percent of the foreign investor base in EMDE sovereign debt.
- The quantum of funds intermediated by BDIs has more than quadrupled in the past 10 years.
- The number of countries in the main EM indexes (EMBIG) doubled since 2007 to their current level of 70.
- The number of countries in the main local-currency bond index (GBI EM) increased from 12 to 18.
- Passive OEF investor share has increased but remains low compared to developed markets.
- Active-share evidence:
  - Active share estimated greater than 30 percent in 2010 and 17 percent estimated for 2014.
  - Active share has fluctuated around the lower 2014 estimate through 2019.
- A rising amount of assets involves tracking EM-dedicated fixed-income benchmarks.

### Financial Stability Implications of BDIs
- Benchmarks explain, on average, about 70 percent of country allocations even after controlling for macroeconomic, industry, and country-specific effects.
- Inclusion/exclusion from benchmarks can significantly impact cost and supply of financing and domestic financial market volatility.
- Estimates suggest China’s inclusion in global benchmarks could boost flows to China by $300–450 billion.
- BDIs induce greater correlation in portfolio flows across EMs:
  - Flows driven by EM benchmarks are about three-to-five times more sensitive to common global risk factors than balance of payments measures of portfolio flows.
  - This sensitivity has been rising over time.
- Benchmark weighting rules can reduce weight of larger issuers and redistribute to smaller countries:
  - For local currency government bonds, benchmarks limit the maximum weight to 10 percent.
  - Brazil’s weight is capped 8 percentage points lower than it would be under market capitalization weights.
  - Smaller issuers such as Colombia, Hungary and Peru experience an increase in their weights by 1 to 2 percent.
- Rebalancing effects can redistribute substantial BDI flows; an estimated $300 billion total BDI, a 2 percentage points higher weight would mean $6 billion additional BDI due to index rules.

### Frontier Markets and Cross-Border Spillovers
- Frontier debt issuers have become an important part of the EM debt asset class; they now account for almost 20 percent of the EMBIG-Diversified index.
- Foreign participation in local bond markets is broadly comparable across frontier and emerging markets.
- Frontier markets have significantly shallower investor base and market depth:
  - Median frontier financial market depth is 0.08.
  - Emerging financial market depth median is 0.33.
  - Advanced financial market depth median is 0.63.
- Egypt, Nigeria, and Ghana have the highest weights in the EMBI-GDI at 2.6, 1.5, and 1.5 percent respectively.
- Because frontier markets are shallower, high foreign investor participation can induce significant volatility and increase potential for contagion.

### Unconstrained Multi-Sector Bond Funds (MSBFs): Risks and Behavior
- MSBFs, unconstrained by benchmarks, can hold highly concentrated positions and actively use derivatives and leverage.
- MSBFs have accounted for greater than 20 percent of the foreign investor base in sovereign bonds of some jurisdictions.
- Of total assets under management of $1 trillion, the 40 largest MSBFs’ EM investments ranged from $100–$160 billion in recent years.
- As of Q2: 2020, these EM investments amounted to $85 billion (sovereign) and $15 billion (state-owned enterprises).
- MSBFs have a median active share that has exceeded 70 percent.
- During periods of high risk aversion, concentrated MSBF portfolio reallocations out of EMs can be associated with underperformance, particularly in local currency bond markets.
- During the COVID-19 outbreak, outflows from MSBFs were responsible for an estimated pullback of $23 billion, almost entirely out of local currency bond exposures.
- MSBFs rebalanced portfolios into safer assets and sold positions in response to redemptions, often shedding exposures in more liquid large issuers (e.g., Brazilian local currency bonds) while keeping illiquid exposures (e.g., Argentina), potentially increasing liquidity mismatches.

### Mechanical and Amplification Channels
- Popular EM benchmarks use weighting methods (including a 10 percent cap for local government bonds) that can amplify reallocations toward smaller issuers.
- Index reclassifications and inclusion events can produce significant reallocation effects across multiple EMEs, including estimated drops in fund allocations for some EMEs (USD $1—$3 bn due to China’s inclusion in GBI-EM).
- BDIs are significantly more sensitive to external shocks than other investors:
  - Sensitivity of debt flows to external shocks and sensitivity of BDI flows to external shocks have increased over time.
  - Example shock channels include US interest rates (10-year Treasury), risk aversion (BBB spread), and VIX.

### Policies to Support Stability of OEF Cross-Border Funding
- Policy approach must weigh benefits (higher returns, diversification, support for productive investments) against risks (volatility, sudden stops, delayed reforms, excessive leverage).
- Appropriate responses require a combination of recipient and source country policies.

Recipient country policies and reforms:
- Foster domestic market development to increase resilience and depth.
- Use appropriate debt management tools.
- The Integrated Policy Framework (IMF 2020d, 2020e) gives guidance on the mix of tools including:
  - Intervention in the currency market,
  - Macroprudential measures,
  - Capital flow management measures.

Source country policies and reforms:
- Regulation and supervision of investment funds to help mitigate cross-border spillovers.

*Source: IMF staff illustration and analysis in "1. Portfolio and Cross-Border Loan Liabilities IIP" from the provided chapter.*

### 1. MSBF Local Currency Bonds

### 1. MSBF Local Currency Bonds

### MSBF flows and market reaction during COVID-19 (through 2020:H1)
- Charts report MSBF (Multi-sector bond funds) flows to Emerging Markets (EM) in local currency bonds and hard currency bonds, measured in "Billions of US dollars" across quarters "2019:Q4", "2020:Q1", "2020:Q2".
- Key findings:
  - "During the COVID-19 outbreak, MSBFs cut most of their EM investment in local currency bond markets ..."
  - "... while hard currency holdings also experienced a (small) dip, it was followed by a quick recovery."
- Latin America specifics (charts labeled "MSBF Latin American Local Currency Bonds" and "MSBF Latin American Hard Currency Bonds"):
  - "Brazilian local currency bonds bore the brunt of the reduction in Latin America ..."
  - "... while hard currency bond exposures were stable."

### Implications for recipient countries and recommended recipient policies
- Market development and investor base:
  - "Market development can improve the ability of domestic long-term institutional investors, such as insurance and pension funds, to absorb sudden changes in capital flows (April 2020 GFSR, Chapter 3; IMF 2021)."
  - "Debt management policies aimed at achieving a diversified investor base will help reduce risk related to country-specific shocks. (IMF 2014, April 2020 GFSR, Chapter 2)."
- Policy tools and limits:
  - "Where capital flow management measures (CFMs) are deployed for financial stability reasons, and well targeted to mitigate financial risks, such 'CFM/MPMs' (CFM/Macroprudential measures) can help achieve stability of funding for the corporate sector."
  - Caveat: "However, such policies are costly and should not be considered as a substitute for necessary macroeconomic adjustment."
  - "In face of large capital outflows, relaxation of MPMs tools can also reduce impact of shocks on market conditions, while foreign exchange intervention can mute excessive foreign exchange volatility in countries with adequate reserves."
  - Example: "Indonesia’s corporate prudential foreign exchange regulation which requires a minimum rating and hedging of short-term external debt to help moderate risks from corporate external debt."
- Sequencing of reforms for EMs and LICs (specific measures listed):
  - "(1) developing efficient money markets,"
  - "(2) strengthening primary market practices to enhance transparency and predictability of issuance,"
  - "(3) developing a robust market infrastructure,"
  - "(4) bolstering market liquidity,"
  - "(5) establishing a sound legal and regulatory framework for securities (IMF 2020)."
- External vulnerability reduction:
  - "Countries should also reduce external vulnerabilities and strengthen buffers by reducing excessive external liabilities and reliance on short-term debt, while maintaining adequate fiscal buffers and foreign exchange reserves."

### Source-country and global policies to reduce spillovers
- Redemption terms and global coordination:
  - "Aligning redemption terms to the liquidity of assets is important to manage risks in the event of fund outflows."
  - Global deployment: "Policies that mitigate redemption risks in the investment funds of source countries are also beneficial to recipient countries, but to be most effective they should be deployed globally."
  - Risk of fragmentation: "Global implementation of such policies would reduce the risk of a race-to-the-bottom, where a policy tightening in one country leads to shifts of funding elsewhere."
- MSBF-specific regulatory gaps and suggested actions:
  - "MSBFs need improved regulation on concentration risks and disclosure standards."
  - Current regulatory detail: "Neither the Undertakings for Collective Investments in Transferable Securities (UCITS) Directives, nor the 1940 Investment Company Act, have any specific constraints on the amount of a particular bond issue that a single fund family can hold."
  - Possible regulatory approach: "Regulators could set limits on a fund family’s investment in a country’s total debt, by setting a cap on the primary and secondary exposure. Such a measure would require global regulatory coordination..."
  - Disclosure enhancements: "Disclosure requirements on MSBFs’ use of leverage and derivatives needs to be enhanced (as discussed in Chapter 4)."

### Index providers, transparency, and market functioning
- "With the importance of benchmark-driven portfolio flows increasing, a close dialogue is needed between index providers, the investment community, and regulators."
- "Enhanced transparency by index providers, such as on eligibility criteria for index inclusion and advance communication of forthcoming index changes, can help promote greater consistency and less flow volatility."

### Fund oversight and structural measures to enhance stability
- Shift in supervisory emphasis:
  - "The oversight of the investment funds sector must continue moving beyond conduct and investor protection to placing greater emphasis on financial stability risks."
- Measures that attenuate first-exit incentives and enlarge usable liquidity buffers:
  - Measures to reduce first-exit incentives:
    - "decoupling liquidity gates from regulatory thresholds,"
    - "removing CNAV (MMFs) and swing pricing (OEFs)."
  - Measures that provide fund managers a waterfall of LMTs (liquidity management tools) and liquidity buffers:
    - "higher and countercyclical liquidity requirements and MBR for MMFs,"
    - "liquidity matching and asset eligibility requirements for OEFs,"
    - "redemption-in-kind and gates for both."
- Supporting policies to enhance market resilience:
  - "Liquidity backstops in the form of ex-ante commitments from dealers and alternative trading arrangements are potentially promising options for assets such as commercial paper."
  - "Flexibility of investment mandates and a through-the-cycle approach to cash equivalent accounting treatments could facilitate making investment positions of some institutional investors less flight prone."
  - "Increase the range and granularity of disclosures regarding leverage and ensuring that supervisory resources and skills keep pace with expanded and more demanding mandates and tasks."
- Expected outcome:
  - These measures together "would put nonbank intermediation of core markets and capital flows on a stabler footing" and "serve to push the need for central bank emergency liquidity support to markets firmly into the tails of the shock distribution."

### Conclusions and coordination
- Central conclusion:
  - "The growth of BDI flows has an increasingly prominent place in financial stability considerations for EMDEs."
  - Policy goal: "Conserve significant benefits brought about by these flows while guarding against any risk of such a mode of capital flow intermediation becoming a cross-border transmitter of stress and market volatility that can exacerbate pre-existing vulnerabilities in recipient countries."
- Policy mix:
  - "Appropriate responses will require a combination of recipient and source country policies."
  - Recipient focus: "continued deepening of domestic markets, appropriate use of debt management tools, and the use of macroeconomic, prudential, capital flow management, and foreign exchange intervention tools."
  - Source focus: "Policies that mitigate redemption risks in the investment funds of source countries... should be deployed globally."
  - Transparency: "Increasing transparency and disclosures by funds and index providers is an important additional measure."
- International process and coordination:
  - "The paper’s analysis underscores the importance of the ongoing Financial Stability Board (FSB)-led process of identifying policy options involving national authorities and the International Organization of Securities Commissions (IOSCO) and other standard setters."
  - "The global nature of the investment fund business and fungibility of financial flows makes it vital to ensure consistency of global policy choices that can secure financial stability by precluding regulatory arbitrage."

*Source: iffspcea - 1. MSBF Local Currency Bonds, canonical PDF content provided.*

### Annex 3. Detailed Presentation of MMF Policy Options

### Annex 3. Detailed Presentation of MMF Policy Options

### Policy options: key features, pros, and cons
- Decouple liquidity thresholds from fees and gates
  - Key features: This option allows funds to impose fees or gates when doing so is in the best interests of the fund.
  - Pros: Decreases incentives for redemptions and reduces the likelihood of gates
  - Cons: In absence of formal threshold, investors may apply their own threshold

- Reform of conditions for imposing redemption fees/gates
  - Key features: Funds required to obtain permission from regulatory authorities prior to imposing fees/gates
  - Pros: Supervisor able to intervene to secure best interests of investors
  - Cons: May lead to undue delays in application of fees/gates; Supervisors may not have sufficient data to allow informed decision on permitting/denying imposition of fees/gates

- Minimum balance at risk (MBR)
  - Key features: A portion of each shareholder’s recent balances in a MMF is available for redemption only with a time delay to ensure that redeeming investors remain partially invested in the fund over a certain time period
  - Pros: Decrease incentives for redemptions and potential for fire sales; Reduces likelihood of suspensions
  - Cons: Changes investor perception of MMF as cash-like; MBR could be higher for institutional investors; Swing pricing and/or capital buffers may have similar beneficial effects with less complexity.

- Liquidity buffer
  - Key features: New, stricter requirements on liquid assets imposed (higher thresholds and/or shorter durations for less liquid assets)
  - Pros: More stringent requirements on WLA would increase availability of liquidity during periods of market stress
  - Cons: More liquid assets is good per se from regulatory (c.f. commercial) perspective but may not suffice in period of extreme stress

- Countercyclical liquidity buffer
  - Key features: Liquidity buffer rises or falls automatically in certain circumstances, such as when net redemptions are large
  - Pros: Addresses problems associated with minimum thresholds of WLA
  - Cons: Complex calibration required; Depending on precise approach adopted, subject to reliability of stress tests

- Floating NAVs for all nongovernment MMFs
  - Key features: Nongovernment MMFs required to move to become VNAV MMFs; NAVs move in line with market prices
  - Pros: Removes first-mover advantage; Risks borne by investors clearer
  - Cons: Nongovernment MMFs would no longer be cash-equivalent

- Swing pricing
  - Key features: MMF adjusts the dealing price for inflows or outflows to take into account the costs of purchasing or selling assets of the fund
  - Pros: Reduces redemption requests under stressed conditions; Reduces first mover advantage; Concrete evidence of positive effects on OEFs; Legal basis already exists in major jurisdictions (EU/US)
  - Cons: Choice between full and partial swing and calibration of swing can be complex; Not possible for CNAV; Successful implementation depends on availability of data on spread and cost information for MMIs (but introduction of swing pricing could encourage efforts to improve that data)

- Macroprudential swing pricing
  - Key features: Regulators impose and calibrate swing pricing ex ante
  - Pros: Removes stigma effect for MMFs; Takes account of systemic risk; Less extreme than other LMTs, for example, suspensions
  - Cons: Calibration of tools requires significant data set on inflows/outflows and portfolio liquidity; Could act as disincentive to investors in MMFs generally; Full disclosure of trigger thresholds could strengthen run incentives

- Capital buffer
  - Key features: Dedicated resources within or alongside fund to absorb losses
  - Pros: Allows losses to be absorbed without recourse to extraordinary CB intervention; Reduces incentives for redemption by limiting risks of large losses to shareholders and first-mover advantage
  - Cons: Not clear where resources for buffer would come from; Application to VNAV MMFs would require calibration (for example only when NAV drops by large amount)

- Centralized external support (liquidity exchange bank)
  - Key features: Centralized and pre-funded facility for MMFs to transact with during a crisis
  - Pros: Gives greater confidence to market that all MMF types able to withstand crisis scenario; Could reduce first mover advantage
  - Cons: Would need to be applied across all major MMF jurisdictions to prevent arbitrage between covered and non-covered funds

- Sponsor support
  - Key features: Prohibition of, or clarification of permissibility of, support from sponsor or related party
  - Pros: Outright prohibition would be neater solution; Allows greater predictability in crisis scenario
  - Cons: If sponsor support allowed, may unduly favor MMFs that belong to large banking groups

- Adjust liquidity buffers according to the share of funds’ institutional investors
  - Key features: Liquidity buffers adjusted according to funds’ structural exposure to funding risk (institutional investors more likely to run)
  - Pros: Reduces first-mover advantage by recognizing greater propensity of institutional investors to run
  - Cons: Implementation more complex for funds with both retail and institutional investor base; Data on liability side may be insufficient; Burden on regulators to set increase/decrease of buffer

- Greater transparency on MMIs
  - Key features: Improved data on issuance and outstanding amount of MMIs in primary and secondary markets
  - Pros: May increase market liquidity and facilitate price discovery
  - Cons: No cons as such (greater transparency is always +ve)

- Enhance MMF reporting framework
  - Key features: More harmonized, detailed and frequent reporting from MMFs to authorities
  - Pros: Gives authorities—both central banks and securities regulators—better overview of industry
  - Cons: No cons as such (greater transparency is always +ve) but market participants often argue that regulators do not use reporting data sufficiently to justify the extra costs involved

- Abolish nongovernment MMFs
  - Key features: MMFs limited to government MMFs only
  - Pros: Clean, neat solution—reduces credit and liquidity risks significantly
  - Cons: Short-term bond funds not plausible alternative due to lack of cash-equivalence

- Liquidity-based redemptions deferrals
  - Key features: MMF portfolio holdings are classified according to their liquidity; redemption is aligned with the fund’s liquidity profile
  - Pros: Reduces liquidity mismatch; Less risk of fire sales; Introduces clearer link between asset and liability side
  - Cons: May be some complexities in calibration

- Limits on eligible assets for non-government MMFs
  - Key features: Stricter requirements on holdings of illiquid assets
  - Pros: Reduces liquidity mismatch
  - Cons: Issues around cash equivalence definition; Defining liquid vs. ineligible assets may be challenging

- MMF investor concentration limits
  - Key features: Limits on percentage of MMF shares held by a given investor
  - Pros: Reduces likelihood of suspension triggered by small number of investors
  - Cons: Application depends on quality of data on liabilities

- Improved disclosure on STFM investor base
  - Key features: Holdings of main categories of investor made available per type of issuer, currency, and maturity
  - Pros: Aids regulators’ oversight of market
  - Cons: No cons per se; may be complex to implement

- Stress testing by managers
  - Key features: More frequent and sophisticated stress tests undertaken according to parameters specified by authorities
  - Pros: Allows early identification of vulnerabilities; Useful information for supervisors; Strengthens IOSCO Recommendation 8
  - Cons: Discretion on parameters left to MMF managers

- Stress testing by authorities
  - Key features: Systemwide stress testing of entire MMF sector
  - Pros: Same as for previous option but allows for regulators to prescribe more rigorous approach; Gives genuine sector-wide picture
  - Cons: Dependent on access to/quality of data; Follow-up of stress tests results depends on regulatory approach

- Removal of stable NAV
  - Key features: All MMFs required to have floating NAV
  - Pros: Removes threshold effects; Investors should become more aware of market risk
  - Cons: Removes important category of cash management vehicles

- Prohibition on daily dealing for nongovernment MMFs
  - Key features: Only government MMFs allowed to offer daily redemptions
  - Pros: Addresses liquidity mismatch in prime MMFs; Removes link between MMF withdrawals and margin calls (but risk potentially displaced elsewhere for example if MMF investors chose to rely instead on lines of credit for immediate cash needs)
  - Cons: Reduced appetite for MMFs could lead to loss of funding source for MMI issuers

- Redemptions in kind
  - Key features: Institutional investors receive share of portfolio securities instead of cash
  - Pros: Reduces first-mover advantage and incentives for large redemptions in times of stress
  - Cons: Cannot be used with retail investors; Some funds currently do not allow redemption in kind proportionate to investor holdings in fund

### International standards and recent developments on OEFs (Annex 4 summary)
- Global and regional work
  - The FSB issued policy recommendations in 2017 focused on: (i) liquidity mismatch between investments and redemption terms and conditions; (ii) leverage within funds; (iii) operational risk and challenges at asset managers in stressed conditions; and (iv) securities lending activities of asset managers and funds.
  - IOSCO issued key documents in 2018 and 2019 covering liquidity risk management (LRM) and leverage:
    - Recommendations for LRM for Collective Investment Schemes (2018): build on the 2012 Principles; elaborate on suitability of dealing frequency to align assets and liabilities; disclosure of funds’ liquidity profiles; operability of liquidity management tools; fund level stress testing; and contingency planning.
    - Recommendations for a framework to assessing leverage in investment funds (2019): develop a two-step framework to monitor leverage—step 1 uses measures of leverage to identify and analyze funds that may pose financial stability risks, followed by further analysis; IOSCO is expected to collect leverage data from its membership to implement step 1.
  - IOSCO’s work on OEFs extends beyond these summaries.

- Limitations and need for supplementary guidance
  - IOSCO recommendations remain high-level due to sector complexity, diversity, and differences in national legal frameworks, leaving key issues open to discretion.
  - Some recommendations apply only to the extent that regulatory frameworks permit, weakening effectiveness.
  - Supplementary, more concrete guidance to supervisors on specific areas relevant to financial stability would improve international standards.
  - Areas flagged for more concrete guidance include aligning liquidity and frequency of redemptions at the design phase, widening availability of LRM tools, and broader use of swing pricing.

*Source: Annex 3. Detailed Presentation of MMF Policy Options — iffspcea - Annex 3. Detailed Presentation of MMF Policy Options*

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_Source: https://www.imf.org/-/media/files/publications/dp/2021/english/iffspcea.pdf_