The U.S. Treasury's Office of Financial Research released its first annual "Financial Stability Report yesterday, which contains less on money market funds than last year's annual report, but which broadens out its scope to encompass liquidity pools. "Overall, threats to U.S. financial stability remain moderate, in other words, in a medium range, but they edged higher within that range over the past year," says OFR Director Richard Berner in a press release. He adds, "We see elevated and rising credit risks in U.S. nonfinancial business and in emerging‐market economies, the continued reach for yield in a climate of persistently low interest rates, and the uneven resilience of the financial system." Money market funds are cited a number of times in relation to repo, Fed RRP, stress-testing, and data collection.
The 138-page "Financial Stability Report 2015 comments on Repo and RRP. Under "Managing Short-Term Rates," it says, "The bifurcation between GCF repo rates and triparty repo rates is only one aspect of the way that post-crisis changes in money markets may add to the challenge of managing money market rates. This dynamic increases uncertainty about the trajectory for other market rates once the Federal Reserve raises the target range for the policy rate.... Strong demand may depress short-term rates on short-term government securities. The Federal Reserve has indicated that it will expand its reverse repo facility sufficiently to firm up the floor under short-term market rates once policy tightening commences, while avoiding a persistent and too-large footprint from that facility in financial markets that could affect financial stability."
It continues, "In 2013, the Federal Reserve expanded its list of authorized counterparties for its reverse repo operations beyond primary dealers to include selected money market funds, banks, and government-sponsored enterprises. As a result, the Federal Reserve has since become one of the largest repo counterparties for money market funds and its role is likely to remain substantial, subject to the current cap.... Money market fund reform, which requires prime institutional funds to shift to a floating rate net asset value structure, is expected to drive a substantial amount of assets from prime funds to government funds, according to market sources. Given the limited supply of short-term government securities, government money market funds are likely to increase their investments in the Federal Reserve's reverse repo operations."
On "Cash and Liquidity Management in Money Markets," OFR says, "Since the financial crisis, regulators have improved data availability on the management of cash and liquidity in short-term U.S. markets. The SEC introduced Form N-MFP in 2010 to collect data about money market mutual funds after regulators were unable to fully identify and respond to money market fund vulnerabilities during the crisis. Form N-MFP data are designed to analyze the portfolio holdings and risk characteristics of individual money market funds and industry trends."
They add, "The SEC adopted Form PF in 2011 to assess the potential systemic risk presented by large private fund advisors, a group that includes private liquidity funds. The SEC recently finalized amendments to Form PF to align the frequency and granularity of portfolio data required from private liquidity funds with those of money market funds. The change will be effective in April 2016 and will make it possible for the OFR to link the Form PF data with Form N-MFP data. A third dataset, collected by the OCC for banking supervision, requires national banks ... managing short-term investment funds to disclose monthly information about the funds.... The two data sources could be linked together."
The OFR report points out that MMFs are by far the largest cash management vehicle, with $3.0 trillion, followed by: "Parallel Managed Accounts" associated with Liquidity Funds ($359B), Liquidity Funds ($288B), State Banks short-term investment funds ($150B), and National Banks S-T investment funds ($135B). It adds, "At the international level, no European regulator collects granular portfolio holdings data needed for market monitoring. Data for European money market funds, which have about $1.2 trillion of assets under management, would enhance the OFR's analysis of the global allocation of short-term capital."
The report continues, "Form N-MFP data provide high visibility into the repurchase agreement (repo) market even though Form N-MFP was not specifically intended for this purpose. Money market mutual funds are among the most active investors in the repo markets and are required to report granular information on their repo holdings, including names of counterparties and collateral securities. No other financial firms report the same level of detail about repo activities as money market funds do on Form N-MFP."
It adds, "We are exploring linking the SEC's data on money market mutual funds and on private liquidity funds with the OCC's data on short-term investment funds in a prototype Money Market Fund Monitor to produce a more comprehensive analysis that could be shared with other regulators. This linking is made possible by the alignment of these three data sets by the SEC and OCC -- SEC's Form N-MFP, SEC's Form PF, and OCC's data on short-term investment funds."
The report also cites money funds in the section called "Asset Management Stress Tests." It says, "We focus primarily on money market funds, for which the SEC introduced a stress testing requirement in 2010 and an enhanced requirement in 2014.... For money market funds that allow investors to buy and sell shares at a fixed $1 share price, stress testing helps ensure that funds can meet the commitment to redeem shares at a fixed price.... The SEC's 2010 and 2014 rules for stress testing of money market funds require that results be presented to each fund’s board of directors at regular intervals. The rules do not, however, require reporting the results to regulators or the public."
OFR also comments on monitoring private "Liquidity Funds," "Form PF is not only a valuable tool for hedge fund analysis at the OFR, but also for analysis of liquidity funds. These private funds seek to generate income by investing in a portfolio of short-term obligations to maintain a stable net asset value per unit or minimize principal volatility for investors. Unlike money market funds, liquidity funds are available only to accredited investors. Liquidity funds are not subject to regulations imposed by the 1940 Investor Company Act and Rule 2a-7, including restrictions on portfolio maturity, liquidity, and concentration.... Given the recent speculation that institutional investors could move assets from prime money market funds to liquidity funds to avoid SEC amendments on floating NAV and redemption gates and suspensions, these funds will be important to continue to monitor."
The report also states, "A recently published OFR working paper shows evidence that U.S. broker-dealers owned by foreign banks engage in quarter-end "window dressing" of their U.S. triparty repo borrowing, which may help their overseas parent appear safer to foreign regulators. This activity leaves U.S. money market mutual funds with excess uninvested cash in the last days of the quarter. `Since late 2013, this excess cash has been placed into the Federal Reserve Bank of New York's Reverse Repurchase Program each quarter-end, providing money market funds with a de facto deposit account at the Fed, even though they are not banks.... This additional and predictable illiquidity, induced by window dressing, may have systemic implications, including an increased likelihood of fire-sale sell-offs or liquidity spirals."
Finally, OFR mentions a "Money Market Fund Monitor." They write, "To examine further risks in funding and liquidity, for example, we expect to make public our Money Market Fund Monitor, which we previewed at a public meeting of our external advisory committee in February 2015. The monitor employs monthly data provided to the Securities and Exchange Commission on Form N-MFP by money market funds registered under the SEC's Rule 2a7. Using this framework, we can examine portfolio statistics and holdings for individual funds and the industry as a whole on the basis of credit, interest rate, and liquidity risk. Over time, we expect to expand the fund monitor by incorporating aggregate data from non-2a7 funds with similar characteristics."
