With the first Prime to Government fund conversions taking place this week (Franklin's money funds changed on Monday), and shifting into high gear next month when Fidelity Cash Reserves converts, we found JP Morgan's Securities' latest "Short Term Market Outlook and Strategy" most interesting. It takes a deep dive into these conversions. As we pointed out in our Oct. 29 News, "Pioneer, Nationwide Converting Prime to Govt; 2 More Exit MMF Space," approximately $232 billion in Prime funds are slated to switch to Government. JPM strategists say that ultimately, when investors flows are added onto these moves, the shift away from Prime could reach $600B to $650 billion. (For information on when and which conversions are taking place, see our next Money Fund Intelligence newsletter, which comes out Friday morning.) In other news, we also review a commentary, "Floating NAVs: The Impacts of the SEC's Adoption of MMF Reforms on Shareholder Servicing," from BNY Mellon Asset Servicing VP Charles Hawkins.
The "Prime to Govie" commentary by JPM Securities' `Alex Roever, John Iborg, and Teresa Ho, says, "Since Fidelity's initial announcement that it would convert the majority of its prime MMF into government MMF this year, several money fund complexes have followed suit in coming forward with their own strategies for dealing with impending MMF reforms. Both large and small complexes have released at least some outline for their plans, and strategies have varied. Due to the increased cost of doing business, several small funds have either been driven to merge with larger complexes, or have decided to leave the MMF business all together. Larger complexes have deliberated differing approaches, including offering 60-day or 7-day max-maturity funds, offering 2a7 alternatives such as short-term bond/enhanced cash funds, or deciding to convert at least a portion of their prime MMFs to government status. By far, the most impactful changes made by the MMF industry have been prime to government fund conversion plans."
They continue, "To date, $235bn or 16% of total prime fund AuM has been scheduled for conversion into government status. Regarding these conversions, we have received two frequently asked questions from our clients: 1) what will be the timing of these conversions? and 2) will the conversions have any meaningful impact on short-term credit and government rates as they occur? In short, we expect the remaining conversion process to be fairly orderly."
JPM explains, "To summarize, of the $235bn of AuM scheduled for conversion, $125bn or 53% is already invested in government MMF eligible assets. This leaves $110bn of credit product, mostly bank debt, which will eventually need to roll off as each fund's final conversion takes place. Additionally, according to each fund's SEC filings, the timing of most final conversions will occur around the end of 2015. That said, any resulting pressure that may arise in the short-term credit or rates markets would likely be felt the most during December."
Further, they write, "The next step of the exodus in assets away from the prime fund universe could be via investor outflows. With no sizable outflows experienced YTD, it is very possible that sizable outflows do not occur until the middle of next year as the final rules draw near. Prime institutional shareholders have a track record of being very deliberate and herd-like in shifting their cash. Indeed, flows in this investor base have not tended to be large unless prompted by some significant catalyst such as 2008 or the Eurozone crisis during 2011. Additionally, with short-term operational deposits under pressure at large banks and a Fed liftoff likely to result in higher fund yields, investors will have an increased incentive to stay in prime institutional funds as long as possible."
JPM's piece concludes, "All things considered, we still anticipate sizable investor outflows to eventually take place. With fund conversions and investor outflows combined, we now believe that the shift in assets away from prime MMFs could be as large as $600-$650bn. Having already discussed the implications of fund conversions on Libor, investor outflows may prove to be more impactful. Because investor driven outflows are unpredictable, prime fund managers will likely favor short maturities to prepare for a possible liquidation sale, pressuring rates higher and the curve steeper."
The BNY Mellon article, which originally appeared in the Securities Transfer Association's STA Newsletter is the third in a 3-part series. The first, published in January, "A Whole New World," examined shareholder servicing issues related to Retail Fund Eligibility, while the second, which ran in April, was on "Liquidity Fees and Redemption Gates." Part 3, which we review below, focuses on "Floating Net Asset Values." In the overview, it says, "From a shareholder servicing perspective, four reforms in particular will require money market fund transfer agents, and intermediaries, to design and implement solutions that involve enhancing systems and modifying operations processes. These reforms are: (1) Retail fund investor eligibility; (2) Liquidation fees; (3) Redemption gates; and (4) "Floating" net asset values ("NAVs")."
The piece on the Floating NAV requirement looks at a number of issues, including same day settlement. It says, "Traditional institutional money market funds provide same-day settlement for purchases and redemptions, where shareholder purchases and redemptions are settled by fed wire at intervals (sometimes as often as hourly) on trade date. Currently, the ability to achieve same-day settlement has been predicated on the predictability that the NAV will remain at a constant $1 per share. In order to facilitate intraday settlement, the SEC anticipates that funds will adopt procedures and controls that support the accounting systems to be able to calculate a floating NAV periodically each business day and to communicate that value to others in the distribution chain. These NAVs will be used by transfer agents and intermediaries each time the fund closes to price transactions and transmit redemption proceeds to shareholders. The frequency and intervals of these closes are not prescribed by the SEC, and are being driven by market forces."
BNY's Hawkins adds, "For transfer agents, the need to support multiple NAVs per day will require significant enhancements to facilitate the squeezing of a full day of operations and processing into multiple cycles per day. Most transfer agent recordkeeping and ancillary systems are designed to support only one NAV per day, and most transfer agent operations are set up to process, reconcile, and report activity to the fund once per day. In order to make the changes necessary to support multiple NAVs per day, new operating models are being developed that orchestrate the processes for pricing services, portfolio managers, fund accountants, transfer agents, and even the shareholders that hold fund shares directly or through an intermediary."
On broker-dealer sweep program, it says, "Just as the predictability of a $1 per share NAV is important for traditional institutional money market funds, so too is this predictability crucial for broker-dealers that provide cash sweep programs to their customers. These cash sweep programs typically conduct an overnight batch process that recognizes the cash credits and debits that occur in their customer's account throughout the day. Excess cash that remains in the customer's account is "swept" into the money market fund as a purchase, and if there is a negative cash position in the brokerage account, money is swept out of the money market fund as a redemption."
The BNY update continues, "In order to operate as designed, the brokerage sweep system needs to "know" that the NAV in the money market fund will be $1, so that the system will be able to compute the money market fund transaction necessary to sweep cash into or out of the brokerage account. Faced with this new money market fund floating NAV environment, many broker-dealers are considering redirecting their sweep programs away from non-government money market funds to government money market funds or other financial products. Consequently, it is likely that some non-government money market funds will lose significant assets, causing their sponsors to contemplate changes to their fund product line-ups."
Finally, it says, "Certain investors, such as partnerships or investment clubs, are defined by these new rules as being institutional investors, because the money market fund shares are not beneficially owned by natural persons. However, they neither want nor need intraday settlement using fed wires. Because these hybrid shareholders will not be eligible to remain in the retail money market fund they own today, they will likely to be forced to liquidate or voluntarily exchange their assets to a government money market fund or other financial product that will accept them."
