What's in store for money market funds in 2015? The outlook for MMFs is "stable" according to Fitch Ratings in its new report, "2015 Outlook: Money Market Funds." Fitch sees three major themes emerging next year: regulatory clarity, supply challenges, and interest rate divergence between the U.S. and Europe. The report says, "Fitch Ratings' Stable Outlook for money funds globally is underpinned by the funds' active, conservative management of credit, market and liquidity risks. The Outlook also reflects our view that [the] status quo will hold in the short term for money fund regulations globally, as reform will take time to implement. Nevertheless, Fitch recognizes that money fund reforms will have far-reaching implications for funds and investors in the US and Europe over time."
On reforms, Fitch discusses the long road to implementation. "The two-year implementation period that the SEC has provided for the main aspects of reform gives money fund managers and their institutional clients sufficient time to adjust to the new rules or opt for new alternatives. Investors have thus far taken a wait-and-see approach, and US money fund assets have been largely stable since the reform announcement."
Across the pond, the debate is just heating up. Fitch writes, "In Europe, the discussions about money fund regulation continue between the European Parliament, the Council of the European Union, and the European Commission, and may be finalized in 2015. Recent proposed amendments, dated 12 November 2014, from the rapporteur for the Economy and Monetary Affairs (ECON) Committee to the European Parliament are in many respects close to the US approach and would support some global regulatory consistency. The proposed regulation, which is due to be debated by ECON, is an amended version of the European Commission's original text. The main changes include allowing some money funds that invest mainly in EU public debt or are only available to retail investors, public authorities and non-profit organizations to continue to operate as constant net asset value (CNAV) funds without the need for a 3% capital buffer."
They add, "The proposal would also provide funds with the ability to apply amortized cost accounting for assets maturing within 60 days as well as, in times of liquidity stress, impose liquidity fees or redemption restrictions. The European Council is also reviewing the Commission's original text and will propose its own amendments. The proposed rules would probably drive some outflows as corporate treasurers accustomed to CNAV funds may look for alternative places to park their cash. However, we believe the impact may not be as dramatic as some participants initially feared, as a recent Fitch poll shows many investors will not change their cash management strategy, in part because alternatives are limited."
Fitch also expects supply challenges to persist in 2015. The Outlook explains, "Changing assumptions about the likelihood of sovereign support are placing downward credit pressure on banks, and in some cases removing their eligibility as investments for money funds.... Basel III regulations are constraining supply for money funds and cash investors. Although the new Basel III capital and liquidity rules do not take full effect for a few years, banks have been under pressure to achieve compliance much sooner. Basel III liquidity coverage ratio and leverage ratio requirements are putting pressure on the availability of short-term bank debt, deposits and repo.... This may partly offset the market supply issues but does not address the need for daily and weekly liquid assets. Callable and putable commercial papers (CPs) are examples of such new products."
But there are some supply opportunities out there. "Money funds are considering selective investments in issuers from Asia-Pacific and the Middle East, and to a lesser extent Latin America.... They primarily stem from Singapore, China, South Korea, the United Arab Emirates, Qatar and Chile. Money fund allocations to non-US sovereigns and quasi-sovereign entities, such as supranationals and government agencies, have risen but remain a function of available supply and the level of yield offered.... The US Treasury issued new floating-rate notes (FRNs) this year, and so far Treasury money funds have been the main buyers, surpassing investments by prime and government funds that have more alternatives to choose from.... The Fed's reverse repo program (RRP), introduced in September 2013, has been helpful for US money funds as a source of new supply. Demand for the RRP has been robust among US money funds and US Treasury money funds in particular."
Fitch also looks at interest rates and the impact on portfolios. They say, "Fitch expects the monetary policies of the eurozone, the UK, and the US to diverge in 2015. Low interest rates are likely to persist in the eurozone for the foreseeable future, with the ECB keeping policy rates unchanged until at least 2017. Policy rates are, however, expected to increase in the UK, with the Bank of England raising its policy rate in 1Q15, and in the US, with a possible Fed Funds target rate hike in mid-2015."
In the US, yields may start rising, but not in Europe. Fitch comments, "Euro money fund yields will remain low and are likely to turn negative in the year, while sterling and US dollar money funds may see their yields picking up timidly in 2015 as a result of expectations for slow interest-rate rises in these markets. Euro money funds are close to posting negative yields, as average euro money fund yields declined to 1bp at end-November 2014. With euro short-term rates negative for most high-quality issuers, funds are reinvesting the proceeds of maturing higher-yielding assets at lower, often negative rates. This will eventually turn euro money-fund yields negative."
Fitch also expects further consolidation, writing, "Fitch believes there is potential for further industry consolidation in 2015. Sustained low yields and resulting margin pressure, combined with potential corporate cash outflows, may cause some smaller managers to reconsider their commitment to the cash management business. Asset managers willing to be leading active players in liquidity product management will drive product innovation and/or customization to meet investors' needs for their short-term and strategic cash. Examples of new or growing alternative liquidity products include: 'cash plus' funds (funds with more duration and/or credit risk than a AAAmmf-like fund); repo-backed products (pooled funds investing in repos or notes backed by repo contracts or other collateral pools); direct investments in money market instruments for the largest and more sophisticated cash investors; unregulated pooled products; or separately managed accounts."
Finally, Fitch adds, "Global money fund assets under management totaled USD $4.7 trillion at end-June 2014, according to latest ICI data. This is higher than a year before, stable in most regions but Asia where Chinese money funds have grown considerably, reaching USD $257B from USD $50B. This was primarily driven by the fast development of a single Chinese money fund, which began accepting money direct from online payment services accounts. Around 90% of money fund assets are domiciled in just six countries: the US, France, Ireland, Luxembourg, Australia, and China. The remainder are domiciled in multiple other countries, notably Korea, Brazil, Mexico, Taiwan, Canada, South Africa, and India. Fitch expects global money fund assets to continue to be dominated by the US and core European domiciles (France, Ireland and Luxembourg). However, money funds in developing markets, notably in Asia, may rise as demand for such products is likely to continue to grow, albeit at a slower pace than this year."
