Nancy Prior, President of Fidelity Investments' Fixed-Income unit, gave a keynote address, entitled, "Money Market Funds: Past and Future," at Crane's Money Fund Symposium, which began yesterday at the Renaissance Boston Waterfront (and which runs through Wed.). We excerpt from the text of the speech below. Prior comments, "At long last, it appears we're getting close to the much-anticipated, long-awaited announcement of new money market fund rules from the Securities and Exchange Commission. And, for a lot of us in this room today, the skies appear finally to be brightening after what seems like one long, gloomy winter. For the past five-and-a-half years, the money market mutual fund industry has been ... you can pick your metaphor here: Embattled, Under siege, Under a cloud.... I've seen all of those phrases in print at one time or another... Suffice it to say, the past few years have just not been a whole lot of fun. In addition to a very challenging, uncertain regulatory environment, we have had to manage through a prolonged and unprecedented period of extraordinarily low interest rates. Given all of this, it's not surprising that some financial writers predicted that money market mutual funds would not make it through this gauntlet."
She says, "While we obviously do not know all of the specifics as of yet, I think we all expect the SEC to issue new final rules that will significantly alter the way that many money market funds operate. But whatever these changes may be, we do know that we have a responsibility to fund shareholders to find a way to make the changes that will be required. MMFs will survive. Some will survive in a form we recognize; others will be very different. But they generally will continue to be a valuable investing option for millions of investors and a critical source of funding for governments and businesses."
Prior continues, "The near- and long-term future will not be without continued challenges, but I believe we have the potential to emerge stronger, and certainly more resilient, than ever. I'll get to specifics about that later, but before we talk about the future, I'd like to, briefly, take a step back and look at where we, as an industry, came from. After what we've all been through, I think we all deserve to take a moment and reflect on our hard work and on the values we all share -- which have helped to ensure the safety and stability of our product for so many years."
She tells us, "While we have all expressed our regulatory concerns in comment letters and are likely to have some strong misgivings about the new rules, there is, I believe, a clear silver lining: this extended period of regulatory uncertainty should soon be behind us. Now, these new rules are going to have a huge effect on our fund shareholders and our firms' operations. I don't want to dismiss that... it cannot be overstated. But, once they are issued and the work needed to meet their terms is assessed and underway, we can finally go back to focusing entirely on what we do best: managing our funds and serving our fund shareholders, which has always been the top priority for all of us here today."
Prior states, "So let's take a little walk down memory lane... Money market mutual funds are a relatively recent financial innovation. They were first introduced in the U.S. in 1971. From their inception, the goal of the funds was safety and security; and, just as they do today, MMFs invested only in issuers representing minimal credit risk. Then, as now, they were designed to provide investors with immediate liquidity, low market risk, and a market-based return. Preserving a stable net asset value of $1 per share was the bedrock goal of the funds. Before MMFs, smaller investors did not have easy access to professionally managed, high credit quality, highly liquid, short-term investment products. MMFs provided these smaller investors with access to a short-term investment with the higher yields that were previously available only to wealthy investors via direct purchases of commercial paper or certificates of deposit. The concept caught on quickly, and by the end of 1973, a number of MMFs were competing in the market, attracting more than $100 million in assets."
She continues, "I'm proud of our firm for many reasons, but one of them is that Fidelity's own Ned Johnson played a major role in spurring the growth and development of money market mutual funds. Fidelity was the first financial company to offer MMFs directly to investors as a retail product ... and in 1974, the company introduced check-writing from its money funds -- a previously unheard-of feature. Check-writing helped make saving and investing in money market mutual funds easy, accessible and convenient. It was a big hit. And, it turned out, MMFs were a big hit not just for Fidelity, but for the entire mutual fund industry. During the stock market doldrums that persisted throughout the '70s, MMFs offered both stability and, on balance, possibly the best returns that were available to most individual investors in the financial marketplace."
Prior comments, "Throughout the rest of the decade, the MMF segment continued to grow, and during the high interest rate environment of the late 1970s and early 1980's, MMFs became an even more popular investment, with returns for investors that were substantially higher than the regulated rates available in bank savings accounts. This continued until 1983, when a new federal law permitted banks to offer their own, FDIC-insured money market accounts, which helped to stem the flow of funds from the banks into MMFs. From that point on, the purpose and role of MMFs started to evolve. They became less of an alternative savings vehicle, and more of a cash management vehicle."
She adds, "Recent surveys of our retail customers show that more than 80% use MMFs as a "parking place" for cash awaiting future investment -- in stocks, bonds, mutual funds and other vehicles. These customers use MMFs as a complement to bank products, such as checking and savings accounts, not as a replacement for FDIC-insured products. In fact, 98% of the retail MMF customers that we surveyed had bank checking accounts in addition to their MMFs. Meanwhile, institutional investors rely on MMFs for a variety of cash management purposes."
Prior explains, "Especially over the past 20 years or so, MMFs have played an essential role in fueling the American economy ... providing millions of American investors -- large and small, sophisticated and novice, institutional and retail -- with a convenient and reliable way to invest in the short-term markets. And also providing low-cost financing for states, cities, and nonprofit organizations alike. They have continued to do so since the financial crisis of 2008 -- and today there is more than $2.5 trillion held in MMFs, despite the extraordinarily difficult operating environment we've faced over the past five-plus years."
She says, "I don't need to fill in the details of the post-2008 period for this audience, since we've all been living it. In response to the financial crisis, the SEC significantly strengthened MMF regulation in 2010, and issued a further rule proposal in June of 2013. Fidelity and many of the firms represented here today subsequently filed comment letters. In many cases, multiple letters. Speaking on behalf of Fidelity, it was our view that the 2010 amendments to Rule 2a-7 had made all MMFs safer, more resilient to market stress, and more transparent.... And that the regulations had been tested in the summer of 2011, with the European debt crisis, the U.S. debt ceiling showdown, and the eventual downgrade of the United States by S&P -- and had passed these tests with flying colors."
Prior continues, "Based on these and numerous additional studies -- including one by the SEC itself -- our position was clear: based on the facts, data and empirical evidence, we saw no justification, or benefit, for further across-the-board regulation of ALL MMFs. We continue to feel strongly that any further rules should not apply to any funds -- including government, municipal and retail prime funds -- that have not been shown to be susceptible to destabilizing runs. This position was widely shared by many others closely following the debate over further regulation. So it is with great concern that we await the issuance of the new final rules, which we fully expect will include some, possibly many, provisions with which we substantively disagree, which the data does not support, and for which we see no need."
She adds, "That said, the SEC deserves credit for overseeing an open, transparent forum, one which included multiple public hearings and studies, and opportunities to comment. Thanks to these hearings and comments we hope that the SEC understands what differentiates the asset management industry from other types of financial services, and that its subsequent ruling will provide an appropriate capital markets solution for a capital markets product. Even so, it's almost certain that the new rules will present new and difficult challenges. But come what may, I believe that now is the time to be forward-looking and focused on our future. As I said at the top, it is a future that will be different from the past, but one that does look brighter than it has in some time."
Prior tells us, "In brief, we now can see beyond the horizon ... and the two black clouds that have loomed over us the past several years -- regulatory uncertainty and agonizingly low interest rates -- both appear to be parting at the same time. Let me talk a little bit about each of these issues separately, beginning with the regulatory side. When the final rules are issued, we and everyone else in this room will closely study and evaluate them. Given our engagement with policymakers over the past several years, we are hopefully well-prepared for the new rules and ready to make any changes to our product offerings and fund operations that may be needed to comply with these rules."
She says, "The expected multi-year implementation period will help give all of us the opportunity to consider our options, and then to communicate with our shareholders about what to expect as the changes eventually take effect. We fully expect that the new rules will entail significant, structural changes, even for some fund types like retail municipal and retail prime funds where the data does not support such changes. And we know, unfortunately, that many investors will not be happy with some of the changes. This will most likely negatively impact the shareholder experience for many."
Prior comments, "It is sometimes very hard for financial companies to convince regulators that we are acting out of anything but self-interest.... But I believe that I speak for all of us in saying that throughout the MMF regulatory debate, we have acted out of a strong, even passionate, belief in how we manage these funds, and in the tremendous benefits potential they offer investors, issuers and our economy. We have fought hard to protect these funds, because that is what our customers wanted us to do. There is no question that we have a lot of work ahead of us... But going forward, will our investment or fund management goals change? No. Our priorities have always been providing safety, liquidity, and return, in that order, and they will remain so. Post reform, the question becomes what types of money market products will be best suited to achieve these goals, while remaining compliant with the new rules? We will need to be adaptive and creative, but the bottom line for investors it that we know how important MMFs are to them, we understand their needs, and we will respond to the new environment with strategies that meet those needs."
She continues, "On interest rates, we are also hopeful. There's nowhere to go but up -- right? Since 2007, the market environment for our products has been extraordinarily challenging. And since December of 2008, of course, short-term interest rates as set by the Federal Reserve have been nearly as low as they can possibly go. I suppose that we have grown used to living with diminished expectations: when you are in a one-basis-point environment, any bounce is a bounce higher! But, here too, we are beginning to see a brighter horizon. The Fed's accommodative policies are winding down. The tapering of quantitative easing is well underway, and is expected to conclude in the fourth quarter of this year. And while no one can predict exactly when rates will rise, key market indicators – Fed Funds futures and Eurodollar futures – currently point to the second half of 2015 for the first Fed rate hike."
Prior says, "The good news is that MMF investors may not have to wait to take advantage of the expectation of higher rates. The MMF yield curve will steepen, and shift higher, as expected rate hikes fall within the one-year investment horizon of MMFs, and current investments will benefit from higher yields. In addition, as we know, the rule changes in 2010 shortened the allowable portfolio-weighted average maturity to 60 days -- and depending on the fund type, most funds are currently positioned meaningfully shorter than that. Further, funds are maintaining substantial amounts of daily and weekly liquidity to conform to the requirements, and to effectively manage liquidity risk in the current environment. So, with short maturities and sizable liquid balances, MMFs are well positioned to invest at higher prevailing market interest rates as they become available, and fund yields generally will reflect higher market rates fairly quickly. In plain words, the return profile potential of MMFs is going to become more attractive ... while the funds will continue to play the same role, and will continue to be an effective cash management vehicle for investors focused on safety and liquidity. In a national and international market where volatility can spike and intensify at any time, MMFs will continue to be an accessible flight to relative safety."
She adds, "So let me close today by reiterating our industry's commitment to ensuring the safety, stability and viability of money market mutual funds. Our MMF portfolio management teams are focused each and every day on researching and analyzing the short-term markets to help ensure that our funds deliver -- today and tomorrow, in stable and volatile markets -- the principal stability, ready liquidity and market-based return that our shareholders count on. We have all been actively engaged in the regulatory debate for several years now, working closely with investors, issuers, providers, academics and policymakers. We have each done our best to represent the interests of fund shareholders throughout this process. The end of this lengthy journey is in sight. And we have made it through. It was long and difficult -- and long, did I mention long? – but we made it through. Over the coming months, we will have many decisions to make – individually and collectively -- about how to proceed, and how best to serve fund shareholders."
Finally Prior comments, "This is a product that was created to provide smaller investors with access to financial instruments and benefits that were previously available only to the wealthy. A product created with a noble intent to give investors a benefit they couldn't get elsewhere. And despite the many headwinds it has faced of late, MMFs have succeeded beyond all measure to become an indispensable cash management tool for individuals, institutions and governments. When new rules are issued, we know we will not agree with all of them.... And we will all have some hard work ahead of us... But I believe that if we continue to serve our customers faithfully, and continue to tailor our products to meet their evolving needs, we will come out on the other side stronger than ever. The future I foresee is one we can all be proud of, and that we can all be optimistic about. Thank you for your attention. I'd be glad to take a few questions."
