Federated Investors' hosted its latest quarterly earnings conference call on Friday. CEO Chris Donahue says, "Looking first to Cash Management, total money market funds assets increased $6 billion in the third quarter compared to the prior quarter. Average money fund assets decreased slightly in the quarter due mainly to tax seasonality in separate accounts. Money market mutual fund average assets were nearly the same as the prior couple of quarters. Money market total assets increased $9 billion, or 4%, in Q3 versus Q2 and our market share increased to over 9%. Growth in government money fund assets was partially offset by a very modest decrease in prime assets and by lower muni funds assets. Following my remarks, Tom will address the money fund fee waivers and Debbie will comment on the current money market conditions and our expectations going forward."
He adds, "On the regulatory front, money funds continue to be an active topic of discussion. We are engaged in discussions with the regulators as they study various ideas that have been suggested. We believe that money funds were meaningfully and sufficiently strengthened by last year's extensive revisions to 2a-7. We are seeing those changes work successfully in real time with money funds and European bank investments, money funds and debt ceiling discussions, money funds and loss of USA AAA rating. Investors are able to see fund positions with unprecedented clarity and we have seen very low movement of money from our prime funds."
Donahue explains, "The SEC now has a view into the recent holdings of all money funds. The funds have had ample of liquidity in compliance with the revised regulations. Overall the regulations and the structure of money funds are working quite well in the midst of challenging market conditions. They continue to offer excellent cash management services to both shareholders and issuers. We remain favorably disposed to improvements that would enhance the resiliency of money funds by addressing the primary issue faced during the financial crisis namely a market wide liquidity crunch. We are unable to make predictions on any particular outcome or timeline in this area."
He tells us, "As of October 26, managed assets were approximately $355 billion, including $272 billion in money markets, $30 billion in equities, and $53 billion in fixed income, which includes our liquidation portfolios. Money market mutual funds assets stand at about $247 billion. So far in October, money market fund assets have ranged between $244 billion and $249 billion, with [an] average of $246 billion."
Donahue says, "Regarding acquisitions and offshore businesses, we remain focused on developing an alliance to further advance our business outside the U.S. We continue to work, and to grow our current offshore businesses. We launched a new sterling-dominated money fund in Q3 and added the fund to a multiple of global portals that already offered our other Ireland-domiciled products. We expect to complete the addition of the product to two new portals this quarter and to develop retail distribution to a major clearing platform in the U.K. as well."
CFO Tom Donahue comments, "Money market funds continue to be a very important source of revenue for Federated. Even as the extraordinary market conditions cause us to waive a significant portion of our revenues in this area. Revenues from money market assets were $93 million in the third quarter, about 44% of total revenue, down from a 10-year average of about 50% of our total revenue. Money market revenue net of distribution payments accounted for about 37% of our total revenue … down from a 10-year average of about 41%."
He explains, "Waivers impacted money market as expected. Full details are on the press release. As we look ahead, we think these waivers could impact fourth quarter by around $26 million in pretax earnings, compared to the $23.2 million in the third quarter. The expected increase is due mainly to the growth in government money market assets, which have the lowest gross yield and highest waivers. Looking forward and holding all other variables constant, we estimate that gaining 10 basis points in gross yields will likely reduce the impact on these waivers by about 40% from these levels and a 25 basis point increase will reduce the impact by about 70%."
Money Market CIO Debbie Cunningham comments, "From a European debt perspective, Federated continues to use European banks, 8 different countries, several banks within each of those different countries, in a fashion that on a percentage allocation basis is not drastically different from our usage of those banks in the past. All year long that average has been between 40 and 45% in our prime funds for exposure to the European banks. That continues to be the case, with the average today right around 43%. Don't expect that to change much going forward."
She explains, "Our strategy, however, has shortened over the course of the last several years and continuing over the last several months. [We have] maturity restrictions on many of those institutions, many of those European banks, as such we are making decisions on whether to roll over that debt every day, and effectively have shortened maturities from somewhere in the three to six month range down to somewhere that is [closer to] about one month, two weeks for some institutions and up to three months for others. On average, our decision making process and our ability to change those decisions should our monitoring and surveillance of those issuers warrant that change is very quick and very short from a time perspective at this time."
Cunningham adds, "We continue to believe that the overall credit quality of those institutions is as high as it gets from a minimum credit risk perspective and our assessment of those institutions.... Again, reiterating, the institutions and the banking companies that we are using in Europe are all very well situated to deal with these write downs and continue to represent minimum credit quality, constrain and risks within our prime portfolio."
Finally, on the Q&A portion of the call, Federated was asked, "Are you guys making money on the management treasury money market funds? President Ray Hanley answers, "We don't calculate fund ability at asset class level, but from a revenue stand point the answer is clearly 'yes'. We have revenue from the management of treasury and agency product with the yield environment.... [T]hese funds have essentially not had [net] yields for about three years now, so [they're] managed with a bias toward liquidity which means there is a lot of repo there.... That allow us to continue to operate the fund to have net revenue from the funds and not subsidize them the way most people define subsidy, meaning actually supporting the cost of the product. We are not doing that."
ICI's latest monthly "Trends in Mutual Fund Investing: September 2011," as well as its latest weekly "Money Market Mutual Fund" series, show money fund assets were relatively flat in the latest month and week. The mutual fund trade association also released its latest "Month-End Portfolio Holdings of Taxable Money Market Funds statistics. ICI's September composition statistics showed a decline in Repos and CDs, and an increase in Treasury securities.
The Institute's weekly money fund release says, "Total money market mutual fund assets decreased by $20 million to $2.634 trillion for the week ended Wednesday, October 26, the Investment Company Institute reported today. Taxable government funds increased by $6.43 billion, taxable non-government funds decreased by $4.63 billion, and tax-exempt funds decreased by $1.82 billion." Month-to-date in October (through 10/26), Crane Data's Money Fund Intelligence Daily shows that assets are unchanged, while year-to-date money fund assets are down by $176 billion, or 6.3%.
ICI continues, "Assets of retail money market funds decreased by $6.80 billion to $937.38 billion. Taxable government money market fund assets in the retail category decreased by $500 million to $197.93 billion, taxable non-government money market fund assets decreased by $5.30 billion to $546.94 billion, and tax-exempt fund assets decreased by $1.00 billion to $192.52 billion. Assets of institutional money market funds increased by $6.78 billion to $1.697 trillion. Among institutional funds, taxable government money market fund assets increased by $6.93 billion to $697.79 billion, taxable non-government money market fund assets increased by $680 million to $904.83 billion, and tax-exempt fund assets decreased by $820 million to $94.39 billion."
The ICI monthly report says, "The combined assets of the nation’s mutual funds decreased by $582.3 billion, or 5.0 percent, to $11.040 trillion in September.... In the survey, mutual fund companies report actual assets, sales, and redemptions to ICI. Long-term funds -- stock, bond, and hybrid funds -- had a net outflow of $2.11 billion in September, versus an outflow of $36.20 billion in August. A $12.81 billion outflow from stock funds was largely offset by inflows to bond and hybrid funds. Money market funds had an outflow of $10.81 billion in September, compared with an inflow of $71.75 billion in August. Funds offered primarily to institutions had an outflow of $5.09 billion. Funds offered primarily to individuals had an outflow of $5.72 billion."
The statistics show total money fund assets at $2.630 trillion as of Sept. 30, which represents 23.8% of all mutual fund assets. ICI's "Net New Cash Flow" figures show money fund assets with an outflow of $10.8 billion in Sept. vs. an inflow of $71.8 billion in August. ICI's flows show outflows of $183.0 billion YTD 2011 vs. an outflow of $528.7 billion YTD in 2010 through Sept. ICI's survey tracks 432 taxable and 209 tax-free money funds (641 total) vs. 449 taxable and 217 tax-free money funds a year earlier (666 total).
ICI's separate "Month-End Portfolio Holdings of Taxable Money Market Funds" shows that Repurchase Agreements (Repo), the largest holdings of taxable money funds, decreased by $21.0 billion to $490.2 billion, or 20.9%. Certificates of Deposits continued their decline in September (down $18.1 billion, or 3.6%), dropping dropping to $480.4 billion, or 20.5%. (Eurodollar CDs, which we include in the above total, represent $88.7 billion, or 18.5% of all CDs, and they accounted for $7.4 billion of the drop in July.)
U.S. Government Agency Securities remain the third-largest holdings segment at 16.7%, or $392.1 billion; they increased $16.1 billion, or 4.3%, in September. Commercial Paper (CP) holdings, which remain in fourth place, decreased by $10.0 billion, or 2.7%, to $358.2 billion. ICI's numbers show Average Maturities remaining steady at 39 days in September, while the number of shareholder accounts outstanding fell to 27.00 million.
Today, we reprint the second half of our October Money Fund Intelligence "Fund Profile," which interviews SunGard Vince Tolve and Bob Ward. MFI: What is your biggest differentiator ... and your biggest challenge? Ward: SunGard is in a very unique position in the portal space as it is not a bank or a fund manager. Although we do operate as a broker-dealer to help service our customers' needs, we do not take receipt of cash or securities. This allows us to offer a completely independent, direct and fund-agnostic platform, providing our customers with the technology and information they need to make informed investment decisions in a secure, online and transparent environment.
Tolve: We are also not just a stand-alone portal, but one key component of a much larger integrated treasury ecosystem. By combining the SGN Short-Term Cash Management portal with our AvantGard Treasury solutions, SunGard can bring even more value to our customers in terms of operational efficiencies. Ward: The biggest challenge we face as we move forward is the extended low interest rate environment. However, money market funds will remain an important asset class for institutional investors.
MFI: What are your thoughts on the future of the portal market? Tolve: We believe the future will continue to be bright for money market funds and the portal business in general. We are investing resources in mobile technologies, enhanced compliance and research functionality, as well as expanding into new markets outside the US. By leveraging our global presence, we can achieve this much faster than a smaller stand-alone portal provider. We are also focused on adding value with our SunGard Global Services business, which offers consulting expertise in helping customers meet new regulations, improve risk management, and optimize their technology and process infrastructures.
MFI: Do you have any thoughts on the future of money market funds? Ward: Omnibus trading is an interesting one for us as we have never provided an omnibus model via SGN. All accounts on SGN are set up directly at the fund's transfer agent in the customer's name and not in the name of an intermediary bank. This model not only promotes transparency and improves communication between the fund and the shareholder, but also has the potential to spread counterparty risk across the funds. After the events of 2008, many customers came to us looking for a model that helped them accomplish those two goals.
Tolve: Maintaining a direct account in the name of the actual shareholder has some significant benefits.... As mentioned earlier, not only is the counterparty risk diversified by settlement occurring with the fund families on an individual basis, the direct model also adds protection from a business continuity perspective. In an extreme circumstance, imagine an investor lost internet connectivity and therefore could not access the portal to enter orders; and because of the disaster, could not reach our traders to trade via phone. Since the accounts are registered in the customer's name, the client could still access their cash by going to the fund directly to place an order.
Ward: The direct model also has notable benefits to the funds themselves, as the portfolio managers have clear visibility of the investors’ flows in and out of the funds. This transparency enables the fund manager to make more informed investment management decisions around cash forecasting, liquidity and maturity structure, which benefits the fund but more importantly, all shareholders of the fund.
Tolve: Lastly, it's very important to our customers, many of which are large multinational corporations, to have a rapport with the fund managers themselves as money market fund investment is a piece of a much larger banking relationship. At SunGard, we appreciate that these relationships are critically important and strive to promote direct communication between the fund and the shareholder while automating the execution, compliance and settlement side of the cash management process.
Ward: As for regulatory reforms in the U.S., we have seen some significant change driven by regulators as well as voluntary industry initiatives that have increased the liquidity, transparency and credit quality of money market mutual funds for all investors. We are encouraged by some of the additional reform activity in other countries to help make offshore funds more consistent and transparent. Note: Crane Data provides Portfolio Holdings information to SunGard's portal.
The October issue of Crane Data's Money Fund Intelligence newsletter in its latest "Fund Profile" features a major player in the "portal" space. We discuss the online money market fund trading business and recent developments with VP Vince Tolve and COO Bob Ward of SunGard's wealth management business. Our Q&A follows.
MFI: How long has SunGard been in the money fund "portal" business? Ward: SunGard entered the business when it acquired one of the first money fund portals back in November of 2002. SunGard's Short-Term Cash Management portal is part of the SunGard Global Network (SGN), which resides in the Financial Services business.
Tolve: Our Short-Term Cash Management portal has grown to become one of the largest platforms in terms of assets both here in the US and abroad. By adding resources in Europe and Asia, we have expanded the portal's international footprint. SGN now services investors on multiple continents in money funds denominated in seven major currencies.
MFI: How much does the company currently distribute in MMFs? Ward: In U.S. Dollar terms, our money market fund platform assets have consistently averaged more than $100 billion in total money fund assets for most of 2011, which includes our non-USD denominated funds. Our trade volume in Q3 2011 in USD terms has more than doubled since Q3 2007 with over $642 billion traded in Q3 2011 alone. We're on pace to surpass more than $2 trillion traded in calendar year 2011.
Tolve: The SGN Short-Term Cash Management portal was first launched in the U.S., so naturally domestic funds make up the lion's share of the assets at about 70% of the total. Prime funds remain the most popular by a significant margin with about 20% of our assets invested in Treasury and Government funds combined.
MFI: How many funds and fund families are on the platform? Ward: We currently service more than 350 funds from more than 50 fund complexes globally.
MFI: Tell us about the new enhancements. Ward: When SunGard first entered the portal space nearly a decade ago, institutional investor's needs were quite different. Customers were looking for automation, aggregation and improved operational efficiency, such as integration with treasury management systems. These portal benefits are still very important today, but now customers also need tools to help them manage investment risk, increase counterparty transparency, and remain compliant with their investment policies. This is where we have been investing our development resources recently.
Tolve: One positive result of the 2007-2008 credit crisis is that money market funds are much more transparent, disclosing their portfolio holdings information at least monthly. This has enabled SGN to consolidate this portfolio composition data into one master database for customers. We are also working with external data providers to enrich the portfolio data to help our customers view their aggregated exposure to data points like issuer and sovereign credit rating, counterparty, ultimate parent, country of domicile, security type, and security term.
Tolve: Before solutions like SGN, money market fund investors had to evaluate risk at the fund level with little visibility into underlying holdings. If they wanted to dig deeper, they had to gather the holdings manually, which was time-consuming and error-prone as the information was in different formats and limited to just few data elements. SGN is helping cash managers save time and manage headline risk efficiently, thereby freeing them up to focus on other important responsibilities.
Ward: With the first two phases of the SGN Short-Term Cash Management portal's credit risk analysis solution now in production, we will be launching a third phase of functionality in the coming weeks. This new release not only helps to improve our risk analysis capabilities, but also enhances our investment policy and compliance functionality. It will give customers the ability to build consolidated pie and bar graphs detailing portfolio composition by the data elements mentioned earlier. We are also rolling out updated controls to help enforce investment policy rules like share limits per fund, fund type, or fund family as well as percentage limits based on the funds total AUM or total portfolio. Many of these rules can be set up for pre- or post-trade validation with optional automated email alerts. Users also will be able to generate consolidated reports for auditors verifying compliance.
Look for more excerpts from our latest Q&A in coming days. Finally, note too that Crane Data provides Portfolio Holdings information to SunGard's portal.
Moody's Investors Service published a "Special Comment" yesterday entitled, "Money Market Funds: Decline of Eligible Assets Raises Challenges." The publication's "Summary Opinion" says, "Since 2007, prime money market fund (MMF) managers have seen a consistent decline in their short-dated, high-quality eligible investment universe. This follows three supply side developments: (i) a decline in product availability due to dislocations in the short-term structured securities market; (ii) reduced short-dated issuance from key sectors, namely financial institutions, due to official policy measures, regulatory developments and credit quality declines; and (iii) regional liquidity pressures that exacerbate relative supply challenges, predominantly for Euro-denominated MMFs. On the demand side, MMFs face more stringent regulatory requirements which limits investment flexibility, especially with respect to maintaining adequate liquidity in overnight and short-dated securities. Overlaying this constraint is the addition of further self-imposed limits that MMF managers maintain to mitigate against the risk of not satisfying investor liquidity demand."
The Moody's piece, written by VP & Senior Analyst Michael Eberhardt, continues, "The decline in the overall volume and number of eligible issuers presents a real challenge to maintaining a diversified investment portfolio. In our view, this challenge is manageable, provided MMF managers are willing to forego yield in pursuing recent increases in issuance of higher credit quality assets. Short-term money markets have actually seen a rise in issuance from several sovereign and supranational agency issuers, creating an opportunity for MMFs to increase their portfolio credit quality."
It explains, "At the same time, several credit positive trends are emerging in the MMF sector, such as (i) the intensified pursuit of various forms of collateralised lending (repurchase agreements backed by Aaa-rated sovereign debt); and (ii) investment in legacy covered bond issuances that provide a source of diversification and market pricing benefits. We also observe there is longer term potential for increased corporate commercial paper (CP) issuance. Top-tier corporates are able to issue cost-effective CP, which would provide a source for MMFs to diversify and reduce further their overweight exposure to financial institutions. We believe that these trends could partially offset the challenges to the MMF sector described above, though the overwhelming reduction in supply of qualifying assets will remain a real issue for the sector well into 2012."
Later in the piece, Moody's comments, "Consistent with the pursuit of quality, fund managers are also pursuing various forms of collateralised lending. The use of repos backed by Aaa-sovereign collateral has enabled funds to provide liquidity to counterparties with the reassurance of having access to high quality collateral in the event of a counterparty default. Figure 5 highlights the increasing use of repos in the representative U.S. prime MMF segment."
They write, "A final theme to highlight is our anticipation of increased corporate CP issuance over the longer term horizon. The extent of excess cash balances maintained by top-tier corporates would suggest corporate CP as an unlikely outlet for growth in CP supply in the near term. This may change as corporations consider dividend increases and look to renegotiate their short-term borrowing and revolving credit facilities."
Finally, Moody's says, "Historically, corporations have funded their working capital needs through lending facilities arranged with their relationship banks. Given regulation and the increase in capital costs by financial institutions assuming this credit risk, the roll-over of bank credit facilities may be on terms inferior to those available via the CP market. This dynamic, along with the attractive funding levels being achieved by top-tier corporates, sets up an environment supportive of increased supply of corporate CP on a longer term basis. In our view, this would be a credit positive for MMFs by allowing funds to diversify away from their overweight exposure to financial institutions."
The Investment Company Institute released its latest quarterly "Worldwide Mutual Fund Assets And Flows: Second Quarter 2011" last week, showing that while money funds globally experienced moderate outflows in mid 2011, six of the 15 largest markets showed asset increases. India, Ireland, and Australia showed sizeable inflows, while Mexico, Brazil and Switzerland also showed increases. Brazil surpassed Italy moving into the 8th largest spot, while the rest of the 10 largest markets remained the same.
ICI's release says, "Mutual fund assets worldwide increased 1.2 percent to $25.92 trillion at the end of the second quarter of 2011. Worldwide net cash flows into all funds rose to $106 billion in the second quarter, after posting $78 billion of net inflows in the first quarter of 2011. Flows into long-term funds rose modestly to $191 billion from $179 billion in the previous quarter. Equity funds worldwide had net inflows of $24 billion in the second quarter, down from $61 billion of net flows in the first quarter. Flows into bond funds were $100 billion in the second quarter, rising from $57 billion of net flows in the previous quarter. Flows out of money market funds slowed to $85 billion in the second quarter of 2011, after experiencing $101 billion of net outflows in the first quarter of 2011. The Investment Company Institute compiles worldwide statistics on behalf of the International Investment Funds Association, an organization of national mutual fund associations. The collection for the second quarter of 2011 contains statistics from 45 countries."
The ICI's release shows total Worldwide Money Market Fund assets fell $37.2 billion, or 0.7%, to $4.933 trillion from $4.970 trillion. It says, "Net outflows from money market funds slowed somewhat in the second quarter. Money market funds worldwide experienced $85 billion of net outflows in the second quarter of 2011, down from $101 billion of outflows in the first quarter of 2011. Money market funds in the Americas and in Europe experienced net outflows of $45 billion and $43 billion, respectively, in the second quarter after witnessing net inflows of $75 billion and $16 billion, respectively, in the previous quarter. In contrast, money market funds in the Asia and Pacific region posted net inflows of $5 billion in the second quarter, compared with $12 billion of net outflows in the first quarter." Money market funds account for 19% of all mutual fund assets worldwide, according to the release.
The ICI's full Worldwide tables shows that the United States remains by far the largest money fund market, with $2.686 trillion, or 54.5% of total worldwide assets. U.S. money fund assets declined by $41.2 billion in the second quarter. France remained the second largest money fund market with $531.9 billion, or 10.8% of assets, while Ireland remained the third largest market with $491.8 billion, or 10.0%. French money fund assets declined by $18.6 billion, or 3.4% in Q2, while Irish assets increased by $15.3 billion, or 3.2%. Luxembourg holds the fourth most money fund assets ($385.9 billion, or 7.8%), and Australia ranks fifth with $287.1 billion, or 5.8%. Note that Ireland and Luxembourg are the domiciles for most "offshore" or "IMMFA" money market funds, which are geared towards multinational corporations (as opposed to domestic investors). (These have similar guidelines to U.S. money funds, while some European money funds, like France, do not.)
Mexico ranked sixth among worldwide money market mutual fund markets with $64.4 billion, or 1.3%; Korea ranked seventh with $49.8 billion, or 1.0%; Brazil ranked eighth with $47.8 billion, or 1.0%; Italy ranked ninth with $46.1 billion, or 0.9%; and, South Africa ranked 10th with $40.9 billion, or 0.8%. The 11th through 25th largest money fund markets include: Canada ($33.8 billion), India ($31.9B), Japan ($26.2B), Switzerland ($25.8B), Taiwan ($24.0B), China ($18.4B), Norway ($18.4B), Finland ($15.2B), Chile ($14.7B), Sweden ($14.1B), Turkey ($14.1B), Germany ($12.0B), Spain ($10.6B), Hungary ($7.3B), and United Kingdom ($5.1B).
Note that the Investment Company Institute also recently announced the launch of ICI Global in a speech by President & CEO Paul Schott Stevens entitled, "A New Voice for Global Investment Funds." Stevens commented, "Over the past two decades, the world has witnessed the rise of asset managers as global financial intermediaries.... Against this backdrop, the Institute's Board of Governors has determined that our organization should significantly broaden its international engagement. ICI Global, an exciting new initiative just launched by the Investment Company Institute, is set to fill that role.... It will advance the interest and promote public understanding of global investment funds, their managers, and investors." (E-mail Pete to request our full Largest Money Market Mutual Fund Markets Worldwide Excel file, which was created using ICI's Worldwide tables, or to request our latest Money Fund Intelligence International, a daily XLS that tracks Dublin and Luxembourg-registered money funds.)
A press release informed us yesterday that, "Fitch Ratings has released a report, "U.S. Money Funds and European Banks: French Exposure Down," updating its analysis of the exposures of U.S. prime money market funds (MMFs) to European banks as of end-September." It says, "Based on a sample of the 10 largest U.S. prime MMFs, Fitch Ratings' study reveals that: Exposure to European banks declined by 14% (on a dollar basis) since the end of August and 37% since the end of May; French bank exposure continued to roll off, falling by 42% (on a dollar basis) since end-August; and, MMFs increased exposure to banks in several countries including Japan, Australia, and Canada, which now represents the largest single country exposure at 10.7% of total MMF assets.” (See also Crane Data's Oct. 14 News, "Canada Surpasses France as 2nd Largest, French Banks Out of Top 10".)
The Fitch report explains, "As of month-end September, U.S. prime money market funds (MMFs) have reduced their total exposure to European banks by 14% on a dollar basis relative to the prior reporting period of month-end August 2011, and by 37% relative to month end May 2011. European bank exposure currently represents 37.7% of total holdings of $654 billion within Fitch's sample of the 10 largest prime MMFs, a decrease from 42.1% of fund assets as of month-end August. The current exposure level is the lowest in percentage terms for European banks within Fitch's historical time series, which dates back to the second half of 2006. This share is down from 47.2% as of month-end July, which was based on total MMF holdings of $658 billion."
They continue, "Exposure to French banks decreased significantly from 11.2% to 6.7% of MMF assets, which on a dollar basis corresponds to a 42% decline over the past month, and a 62% decline since month-end May. At its peak in the second half of 2009, exposure to French banks represented 16.4% of all MMF assets. Exposure to U.K. banks decreased from 8.8% to 8.7% of MMF assets over the past month, a dollar-basis decline of 5%. Exposures to Nordic banks increased by 4% (on a dollar basis) since end-August and currently represent 7.2% of total MMF assets, more than France but below the U.K. level. Globally, the MMFs sampled increased their exposure to banks in several countries, including Canada, which is currently the largest single country exposure at 10.7% of total MMF assets. Since the end of August, exposures to Japanese banks increased by 22% and exposures to Australian banks increased by 4%."
Fitch also tells us, "In recent months, the MMFs sampled have reduced the maturity profile of their CD exposures to European banks in several countries. As of the end of September, the proportion of MMF exposure to French bank CDs in the shortest maturity bucket (seven days or fewer) remained elevated at 27%. Additionally, there has been an evident shift in CD maturities out of the longest term bucket (61 days or greater), which now represent just 20% of French bank CDs down from more than half as of the end of June. Within the U.K., bank CDs experienced a proportionate decrease of about 10% from the longest-term bucket, with corresponding increases of roughly 5% in both the short-term and medium-term buckets. The maturity profile of banks in the Netherlands was stable, with slight increases in both the short-term but also in the longest-term buckets."
Finally, the report comments, "The 15 largest exposures to individual banks, as a group, comprise approximately 43% of total MMF assets. There are three new entrants in the top 15 relative to the prior reporting period: Bank of Tokyo Mitsubishi, Citibank, and Commonwealth Bank of Australia. The six European institutions within the top 15 (down from nine institutions in the top 15 as of the end of August) account in aggregate for roughly 18% of total MMF assets."
Fitch's table "Largest MMF Exposures -- Financial Institutions" (as of Sept. 30) includes the following issuers/counterparties (along with the total in CD, CP, Repo, Other as a % of MMF Assets): Deutsche Bank (3.5%), Westpac (3.5%), Barclays (3.5%), Rabobank (3.3%), Bank of Nova Scotia (3.1%), Royal Bank of Canada (3.0%), Credit Suisse (3.0%), BNP Paribas (2.8%), Sumitomo Mitsui (2.7%), JP Morgan Chase (2.6%), National Australia Bank (2.5%), Bank of Tokyo Mitsubishi (2.5%), Svenska Handelsbanken (2.2%), Citibank (2.2%), and Commonwealth Bank of Australia (2.1%).
BlackRock, the 7th largest manager of U.S. money funds with $140.4 billion and the 2nd largest manager of "offshore" money funds with $87.7 billion (according to Crane Data's Money Fund Intelligence XLS and MFI International, respectively), reported third quarter 2011 earnings yesterday. As usual, the company's management made a couple of comments on the money market mutual fund business during the conference call's Q&A section. BlackRock Chairman & CEO Larry Fink responded to one question, "We are actually having some very really good dialogue with the regulators. We are trying to be above the line with them and really working with them in helping them understand the difference between asset management and organizations that work on their own balance sheet.... We have been very rigorous, and an outlier in the money market fund industry, in terms of suggesting that capital should be put in to place to buffer any NAV declines."
He explained, "We do believe regulators are going to begin to focus on the money market fund industry.... [T]hey believe money market funds do present risk in the system, and there's going to have to be some ways of protecting the system. We are trying to work with regulators in terms understanding the type of risk that is being presented and the best to effectuate and minimize that risk."
Fink added, "In terms of our everyday business, until we get more dialogue and more certainty on how they are going to implement some of these strategies, it's hard for us to say how that will further impact BlackRock or how we work with our clients. It is a moving dialogue and I can promise you we are involved in the dialogues with the regulators. When they want to hear our opinions, we are offering them a loud as possible. I think as you know, we do have an office now in Washington working alongside regulators we have one of our biggest business working in Washington.... We are one of the lone sheep working in Washington in trying to protect investors' rights."
Bill Katz of CitiGroup asked, "What I'm hearing is that the Squam Lake proposal seems to be dead on arrival, so we're back to the drawing board.... How do you see the most likely course for reform going forward and what would be the impact on the economics of the business?"
BlackRock CFO Ann Marie Petach answered, "On the Money Market Reform as you know, we have been going back and forth around a variety of possibilities. The Squam Lake proposal is one that is interesting, although I think the discussions on it most recently have focused on whether or not it is really practical, given that it requires subordinating capital to be raised for each fund, for each issuer. At the same time we are not really hearing that a capital buffer is favored either."
She added, "So I think regulators are still engaged in an active discussion with industry participants, and we are very much at the forefront of that. We have been helping think through different alternatives for how we might support this business. And as you know, and as Mary Shapiro testified before the Congress, the floating rate NAV is still out there as a possibility as well. If that comes to pass, the business will find a new level but it will still be a valuable business for investors. We continue to work with them, but there is not a lot of clarity out there."
Money market fund professionals continue to express outrage and disappointment over The Wall Street Journal's latest attack on money funds, yesterday's "Hidden Dangers Lurking In Money-Market Funds". (See yesterday's "Link of the Day.") The Investment Company Institute's Senior Director for Policy Writing and Editorial Mike McNamee posted a response entitled, "The Facts Missing From a Wall Street Journal Column on Money Market Funds." He writes, "Misinformation lurks in a recent column from Wall Street Journal Money & Investing editor Francesco Guerrera, "Hidden Dangers Lurking in Money Market Funds." Given the vital role that money market funds play in our economy, regulators and investors alike need the best information possible on this topic. So let's correct the record with a few key facts."
ICI says, "Fact: Money market funds are transparent, and their risks are clearly disclosed. Guerrera writes that "Individual investors and companies perceive money-market funds as 'safe'... This attitude overlooks the fact that, unlike banks, these deposits aren't federally insured so in the event of a run, investors are at risk of losing money." Yet nearly every communication from a money market fund tells investors that these funds not insured or guaranteed. Investors receive thorough disclosure of their risks. And with current portfolio disclosure -- every money market fund is required to list every security it owns -- money market funds are by far the most transparent investment available."
The piece continues, "Fact: Investors value money market funds because of their convenience, stability, diversification, and regulatory framework. Despite what they know about those risks -- and despite yields stuck near zero for months -- investors still have entrusted $2.5 trillion to money market funds. Why? Corporations, state and local governments, and nonprofit institutions, as well as groups representing individual investors, have told regulators again and again that they value money market funds for convenience, stability, diversification, and regulatory protections. You can find their voices at preservemoneymarketfunds.org."
McNamee also writes, "Fact: Managers of money market funds are managing risks. Guerrera writes that investors in Europe's banks are "spooked" by the pullback of funding from U.S. money market funds and frets that those banks are too dependent on short-term financing. Look at the level of sovereign debt in some European countries, the political crisis those debts are causing, and the amount of those debts on the books of European banks. It takes quite a stretch of the imagination to assert that those banks' stocks are falling because U.S. money market funds are adjusting their holdings."
He adds, "It's true that the Europe debt crisis has put a spotlight on U.S. money market funds' role in funding those banks. But fixing the banks' funding formulas is a matter for bank regulators to address. Money market funds, as we've documented, are doing their job of managing risks for their investors."
The ICI response continues, "Fact: The fund industry is working with regulators to advance sound ideas to make money market funds more resilient without harming their value to the economy. Since 2008, the fund industry has been deeply engaged in constructive dialogue with regulators. The first result was a package of reforms, completed in 2010, that brought higher credit quality, shorter maturities, more transparency, and higher levels of liquidity to money market funds. The industry continues to work toward strengthening this essential component of America’s economy and finances. See our record at www.ici.org/mmfs."
Finally, it says, "Fact: Forcing money market funds to "float" their value is the worst possible idea for reform. Guerrera gets this one right, and we're glad to see the Wall Street Journal looking for "more viable" solutions. We just wish the good sense wasn't buried amid so much misinformation." (See other Comments to the Journal's article here, including one from Crane Data's Peter Crane.)
Below, we excerpt from the article "BNY's Cecere Says MMFs Ready to Transact in Non-$1," which we featured in the October issue of Crane Data's Money Fund Intelligence newsletter. We wrote: On October 31, the last directive contained in the SEC's February 2010 "Money Market Fund Reform" amendments to Rule 2a-7 of the Investment Company Act of 1940 will come into effect. Funds must be in compliance with a "Processing of Transactions" mandate that "require[s] that a fund (or its transfer agent) have the capacity to redeem and sell its securities at a price based on the fund's current net asset value per share, including the capacity to sell and redeem shares at prices that do not correspond to the stable net asset value or price per share." Below, we discuss this issue with BNY Mellon Asset Servicing's Jim Cecere, managing director for global product management for U.S. financial institutions.
Q: Are money funds prepared for the new SEC mandate to price shares in other than $1.00? Cecere: I think generally speaking the answer to that is "yes". In our discussions with clients, we've been not only reviewing the impact from a process perspective and from a needs perspective, but also as it pertains to having to update, prepare, and enhance our systems and our reporting requirements. Communications protocols are also probably one of the most critical areas in the event that the buck has broken.
Q: What was the biggest challenge? Was this like a "mini-Y2K" issue for funds? Cecere: The "mini Y2K" has probably been between 2008 and now.... When in 2008 the Reserve Fund broke the buck, fund complexes, fund servicers, asset servicers really honed in and had to focus in on very quickly what that impact was and to prepare for that as the market effectively was melting down. Since that point, both fund companies and asset servicers have spent a lot of time not only understanding the implications of that but also enhancing the systems, operational protocols, etc, in order to prepare for a similar circumstance.
With the new regulations, it became clear those changes would need to be solidified. This was recently brought into the spotlight when the U.S. Government debt was downgraded. There was speculation at that point as to what could potentially happen and one of the 'what if' scenarios was that money market funds could potentially break the buck. Generally speaking, the industry took a hard look at their systems and procedures, and had effectively ramped up for this scenario, along with others, of course. Today, in terms of preparing for the new regulation coming into effect, I think the industry is generally prepared.
Q: Is there a decimal point mandate? Do they have to go out to three or four? Cecere: The regulation reflects a requirement to be able to go out to three decimal points. We actually have the ability to support a NAV up to and beyond three decimal points, which I'd speculate is the case in most firms. So if you parse out the challenges, the first question to answer is "Can we support the trade of a NAV other than a buck?" and the second is, "Can we support a NAV beyond three decimal points?" These represent some of the key challenges that we and other firms have had to address.
Q: Are there any issues outstanding? Cecere: No, not that I am aware of. Again, this really isn't a new topic or something that the industry was not expecting. Between the originally announced regulation and the fire drills, I think the industry is generally prepared. In the unlikely event that a fund does break the buck, fund companies not only have to be operationally prepared, but also have to have a solid communication plan in place depending upon the action they choose to take within the construct of the regulations. There is also some added flexibility. In the event they do not want to allow the NAV to fall below a dollar, they have the option to liquidate, and changes regulations have given guidance on the ability suspend redemptions and to take the necessary steps to liquidate in an orderly fashion.
Q: Are there other products that you guys are looking at? Cecere: Regulatory change is a driver for additional products. The impact of impeding changes is probably one of the top issues we regularly discuss with clients across the board. These regulatory changes continue to pressure fund operations to do more, and often with flat to decreasing investment dollars. We actively look to identify product opportunities that provide solutions for our clients. A great example is money market stress testing, which we rolled out with Investor Analytics. We are in the process of rolling that out also in Europe, as similar regulations are driving the need for a similar service. If you look at the spate of regulations -- whether it's Dodd-Frank, AIFMD, UCITS IV/V, etc., it is critical that we look at dealing with these impending changes as a strategy. It has, simply put, forced us to think differently.
"Money Market Funds' Prudent Response to European Challenges", a new commentary posted Friday by Investment Company Institute economists Sean Collins and Chris Plantier, says, "The ongoing debt crisis in the eurozone poses challenges for portfolio managers of U.S. prime money market funds, as those managers actively continue to adjust their holdings to meet new developments. The latest monthly data on money market funds' holdings demonstrate that these funds are carefully managing their risks in Europe, and have been gradually reducing eurozone holdings for some time now."
ICI explains, "New data show that U.S. prime money market funds reduced their exposure to issuers in the eurozone -- the 17 countries that use the euro as their currency -- by $54 billion in September. As a result, securities of eurozone issuers accounted for 18.9 percent of total assets of U.S. prime money market funds at the end of September, down from 23.4 percent in August and 26.6 percent in July.... [E]urozone holdings' share of money market fund portfolios began to decline steadily this summer as credit concerns increased, after remaining fairly stable for several months."
They continue, "But these prudent moves, intended to maintain minimal credit risk in money market funds' portfolios, have opened up a new -- and contradictory -- complaint: that U.S. money market funds are contributing to the European crisis because their pullback is squeezing banks' funding. For example, Eric Rosengren, President of the Federal Reserve Bank of Boston, in a recent speech, expressed concerns about U.S. money market funds' role in "dollar shortages." And The Economist wrote last week that "American money-market funds have almost completely withdrawn dollar funding from European banks over the past few months.""
Collins and Plantier tell us, "However, the data certainly do not bear out the notion that money market funds have withdrawn all funding from European banks (see table from full piece). And the gradual nature of the reduction suggests that any "shortages" more likely reflect the unwillingness of some European banks to pay higher rates or to offer shorter-term paper as credit concerns mounted. The lack of demand for three-month dollar funds at the tender by the European Central Bank (ECB) this week indicates that eurozone banks are finding other ways to meet their short-term needs for U.S. dollar funding. More generally, U.S. money market funds were just a small part of a months-long, market-wide withdrawal from deteriorating financial conditions and rising credit concerns for eurozone sovereigns and banks."
They say, "By design and regulation, U.S. money market funds cannot be a source of long-term funding for European banks or any other issuers. Instead, fund managers are required to invest in high quality, short-term U.S. dollar securities, with an average portfolio maturity of 60 days or less. Managers have a fiduciary duty to manage risks on behalf of their shareholders. Their actions with respect to their eurozone exposures over the past two years have reflected that fiduciary duty."
ICI writes, "U.S. money market funds' reduction in overall eurozone holdings in September was not a sudden move: they have working down their exposure to eurozone risks for more than a year. ICI surveys show that U.S. money market funds have held no public or private debt from Portugal or Greece since May 2010, and that these funds eliminated any holdings issued by Irish financial institutions earlier this year. Since last winter, money market funds have gradually reduced their exposure to Italian and Spanish banks. Based on Crane data, holdings of Italian and Spanish securities were reduced to zero and $1.1 billion, respectively, by the end of September."
They add, "The data show that funds are also limiting their risks by shortening the maturity of the European securities they hold, focusing their lending on securities that mature in 30 days or less. According to Crane Data, as of the end of September, 60 percent of U.S. prime money market funds' holdings of French issuers will mature in 30 days or less, compared to 37 percent of their holdings at the end of June. Similar but smaller moves were seen in Germany and the UK. Shortening maturities reduces funds' risks, because shorter-dated paper can be redeemed sooner if the issuer's financial condition worsens. Also, shorter maturities help money market fund managers prepare for potential redemptions by fund investors."
ICI tells us, "These funds' reduced European holdings are driven in part by their own declining assets. Assets in prime money market funds fell $182 billion from May to September, as fund investors redeemed shares during the period spanning the downgrade of U.S. government debt as well as growing concerns about Europe's finances. When money fund investors redeem shares, fund portfolio managers must shed assets to meet those redemptions. In this case, fund managers chose to reduce their eurozone holdings. This response makes sense given the deteriorating financial conditions in the eurozone."
The commentary explains, "These prudent moves to reduce money market fund shareholders' risks have raised concerns in some circles that U.S. money market funds could exacerbate the European banking crisis by squeezing the banks' dollar-denominated funding. But this argument would suggest that investors should not react to evolving credit conditions in the market. Not surprisingly, money market funds' actions reflect a market-wide reassessment of European risks. Press reports indicate that hedge funds, U.S. banks, and certain sovereign wealth funds have been quietly reducing their exposures in Europe or have been unwilling to engage in derivatives transactions with certain European issuers."
Collins and Plantier add, "The significant increase in European banks' borrowing from the ECB this summer -- especially by Italian and Spanish banks -- dwarfed the pullback by U.S. money market funds. From June to August, gross bank borrowing from the ECB in Spain and Italy increased by more than $100 billion -- vastly outstripping the $19 billion reduction in money market funds' lending to these banks over the same period. The ECB's recent interventions in the Italian and Spanish government bond market further suggest that the withdrawal from Italy and Spain involved far more lenders than just U.S. money market funds."
Finally, they say, "Money market fund managers, faced with a fiduciary duty to manage risks on behalf of their shareholders and a deteriorating financial situation in Europe, have prudently reduced the amount and shortened the average maturity of their holdings of securities issued by European governments, banks, and other issuers. In doing so, funds are part of an ongoing market-wide reassessment of the current risks of investing in Europe."
Crane Data's latest Money Fund Portfolio Holdings series, which will be released to subscribers of our Money Fund Wisdom database and product suite, shows that French banks are no longer represented among the 10 largest "issuers" to money market funds and that Canada now represents the second largest "country" exposure after of course the U.S. Among "Prime" money market funds, which represent $1.35 trillion, or 54.9% of all the money fund assets tracked by Crane's Money Fund Intelligence XLS, U.S.-parented firms account for 36.1% of all assets, Canadian-parented firms account for 9.9%, U.K-affiliated issues account for 9.0%, and French-parented firms now account for 6.9%.
The top 15 "issuers" of securities (of affiliated with securities) to Prime funds include, in order of size: U.S. Treasury ($75.8 billion), Barclays Bank ($55.6B), Deutsche Bank ($47.6B), Federal Home Loan Mortgage Co ($43.9B), Federal Home Loan Bank ($41.5B), Bank of America ($40.9B), Credit Suisse ($40.5B), Rabobank ($40.3B), Bank of Nova Scotia ($38.4B), Westpac Banking Co ($37.3B), RBC ($36.7B), Federal National Mortgage Assoc ($36.3B), JPMorgan ($34.2B), BNP Paribas ($34.1B), and Svenska Handelsbanken ($30.3B). Societe Generale ranked 28th this month with $15.5 billion and Credit Agricole ranked 34th with $13.2 billion.
Certificates of Deposit remain the largest segment of Prime money fund holdings, according to our Sept. 30 Portfolio Holdings series, with $441 billion, or 32.2%. Financial Company Commercial Paper ranked 2nd with $176.8 billion, or 12.9%, and Asset Backed Commercial Paper ranked 4th with $101.7 billion, or 7.4%. Government Agency Debt ranked 3rd among Prime holdings with $137.0 billion, or 10.0%. Government Agency Repurchase Agreements were the fifth largest category (based on the SEC's mandated categories) with $95.8 billion, or 7.0%, Other Repurchase Agreements ranked 6th among sectors with $84.9 billion, or 6.2%, and Treasury Repurchase Agreements accounted for just $14.1 billion, or 1.0%. Treasury Debt accounted for $76.0 billion (5.5%), Other Notes accounted for $81.1 billion (5.9%), and Other Instrument (Time Deposit) accounted for $30.7 billion (2.2%).
Bloomberg also did some portfolio holdings analysis, writing, "U.S. Money Funds Cut Loans to French Banks by 44% Last Month." It says, "The eight largest U.S. money-market funds reduced their lending to French banks by 44 percent last month as the European sovereign debt crisis worsened. Holdings in BNP Paribas SA, Societe Generale SA, Natixis SA and Credit Agricole SA dropped to $23.2 billion at the end of September from $41.5 billion the previous month, according to filings compiled by Bloomberg and published in today's Bloomberg Risk newsletter. The biggest falls were for Natixis, at 74 percent, and Credit Agricole, at 64 percent, the data showed."
The article adds, "The money market data are based on the most recent portfolio disclosures from Fidelity Cash Reserves Fund, JPMorgan Prime Money Market Fund, Vanguard Prime Money Market Find, Fidelity Institutional Money Market Portfolio, Fidelity Institutional Prime Money Market Portfolio, BlackRock TempFund, Wells Fargo Advantage Heritage Money Markets Fund and Federated Prime Obligations Fund. The figures include repo loans that are backed by government collateral."
The Financial Stability Oversight Council (FSOC), which is charged under the Dodd-Frank Act to provide "comprehensive monitoring to ensure the stability of our nation's financial system," met earlier this week to discuss, among other things, the criteria of how "Certain Nonbank Financial Companies," (including presumably some or all money market funds) would be designated as systematically important financial institutions (SIFIs) subject to additional regulations. FSOC's website explains, "The Council is charged with identifying threats to the financial stability of the United States; promoting market discipline; and responding to emerging risks to the stability of the United States financial system. The Council consists of 10 voting members and 5 nonvoting members and brings together the expertise of federal financial regulators, state regulators, and an insurance expert appointed by the President."
The Council explains, "The Dodd-Frank Act mandated that the FSOC ensure that all financial companies whose failure could pose a threat to the financial stability of the United States -- not just banks -- will be subject to strong oversight. Using the considerations set forth in the Dodd-Frank Act, as well as taking into account public comments on a previously issued Advance Notice of Proposed Rulemaking, the FSOC today approved a proposed rule outlining the criteria that will inform the FSOC's designation of such firms and the procedures the FSOC will use in the designation process. Under the FSOC's proposed rule, if designated, the largest, most interconnected and highly-leveraged companies would face stricter prudential regulation, including higher capital requirements and more robust consolidated supervision. The NPR will have a 30-day public comment period, with FSOC action on the final designation criteria and process expected later this year."
The FSOC published several new documents, including an updated "NPR Regarding Authority to Require Supervision and Regulation of Certain Nonbank Financial Companies." The Council says, "Section 113 of the Dodd-Frank Act authorizes the Council to require a nonbank financial company to be supervised by the Board of Governors of the Federal Reserve System and be subject to prudential standards if the Council determines that material financial distress at the nonbank financial company, or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the nonbank financial company, could pose a threat to the financial stability of the United States. The proposed rule describes the criteria that will inform, and the processes and procedures established under the DFA for, the Council's designation of nonbank financial companies under the DFA. The Council, on October 6, 2010, issued an advance notice of proposed rulemaking regarding the designation criteria in section 113."
The FSOC's Notice continues, "The proposed rule lays out the framework that the Council proposes to use to determine whether a nonbank financial company could pose a threat to the financial stability of the United States. It also implements the process set forth in the DFA that the Council would use when considering whether to subject a firm to supervision by the Board of Governors and prudential standards.... As discussed in Part I, there were several themes in the ANPR commentary regarding how the Council should analyze these factors in the designation process.... With respect to the criteria for designation, one theme was that that the Council should give significant weight to the following factors in making a determination: leverage, liquidity risk, interconnectedness, degree of primary regulation, and substitutability. Further, responses emphasized the importance of looking at the scope, size and scale of nonbank financial companies through a variety of lenses to best understand the underlying risk."
It adds, "Commenters also noted leverage for its importance and encouraged the Council to distinguish between different types and sources of leverage. Commenters viewed both the degree to which a firm is already subjected to regulation or consolidated regulation, as well as the substitutability of an institution and its activities, as important factors in making a determination. It was generally argued that firms already subject to prudential regulation are less likely to pose systemic risk than those that operate outside a formal regulatory umbrella."
While we're not clear on whether some or all money funds are more or less likely to be deemed systematically important following this update, a $50 billion threshold is clearly one factor. Currently, a list of the 10 largest taxable money fund portfolios includes just 6 that clear this hurdle. The 10 largest portfolios are: Fidelity Cash Reserves ($119.3 Billion); Vanguard Prime MMF ($114.3B); JPMorgan Prime MM ($108.3B); JPMorgan US Govt MM ($62.9B); Fidelity Instit MM: MM Port ($61.1B); Fidelity Instit MM: Prime MMP ($54.7B); Federated Prime Obligations ($47.5B); BlackRock Lq TempFund ($45.7B); Wells Fargo Adv Heritage ($36.9B); and Federated Government Obl ($36.4B).
For an attempt at deciphering the FSOC's deliberations, see also yesterday's New York Times article "Fed Oversight of Nonbank Financial Companies Is Weighed". It says, "Financial companies that are not banks but have more than $50 billion in assets and $20 billion in debt could be regulated by the Federal Reserve and required to meet tougher standards, according to a proposed rule issued Tuesday by the nation's top financial regulatory board."
Wells Fargo Advantage Funds' latest "Overview, strategy, and outlook", which we mentioned in our "Link of the Day" yesterday, contains a section on "Headline Risk" that we thought worth quoting. Wells' Dave Sylvester says, "All of this "noise" is not without effect. The frequent, minor rating changes, and the widening of CDS spreads in anticipation of and subsequent to these changes provides fodder for a seemingly endless series of negative press about the ongoing "credit crisis." After numerous articles about the negative implications of the review of French banks by Moody's, how many articles heralded the affirmation of BNP's rating? It was reported, but not in a series of page-one news stories unfolding over weeks and months."
He continues, "This negative news cycle contributes greatly to investor anxiety. In an effort to assuage investors, money funds manage their "headline risk" by avoiding issuers who are in the news. It only makes sense from the funds' perspective. Not only are these issuers subject to widening spreads due to selling resulting from the negative coverage, but owning them may prevent some investors from buying the funds' shares. Those who talk of money funds cutting off credit from borrowers do not seem to give sufficient weight to the role that the funds' investors play, or appreciate that, to a large degree, the funds' actions simply reflect the preferences of their shareholders. Is it not desirable that money market funds strive to be responsive to the expectations and preferences of their shareholders? Was this not the purpose of requiring funds to be more transparent about their holdings?"
Sylvester explains, "The problem with managing headline risk this way is that, as the supply of eligible investments continues to dwindle, replacement investments are not so easily found these days. At some point, money market participants may end up incrementally increasing real risk -- perhaps in quality, perhaps in concentration, perhaps in duration -- in order to reduce headline risk. At some point, there will be no pure "risk off" trade. Since they have a voice in how their funds are invested, money fund shareholders must ask themselves if this is the outcome that they want to further. Will they someday regret casting aside issuers of fundamentally high credit quality, like the French banks, for the sake of appearances?"
The Wells monthly concludes, "Low rates and negative news are wearing on the markets and contribute to the pervasive negative psychology. Investors are concerned about credit quality, but some of that concern may stem from over-active rating agencies and a reliance on CDS spreads as a measure of credit quality. As the negative press continues, funds will attempt to manage their "headline risk" in order to avoid those issuers that might have real problems or may simply drive customers away. Much of this negative feedback loop is now focused on the European banking sector."
Finally, Sylvester writes, "We recognize that there are significant challenges ahead for European political and financial leaders. The Euro-skeptics who said that monetary union without fiscal discipline was doomed may yet be proven right. We believe that the effects of the sovereign debt problems on the eurozone banks will be large, but they are not, at this point at least, unmanageable. We are glad to see that the focus of the European authorities seems to have changed from propping up the sovereigns to protecting the banks in an orderly wind-down of peripheral debt. However, we also recognize that the problem facing Europe is one of contagion, and that this contagion is exacerbated by the negative psychology that pervades the markets, especially the money markets. We believe that the constant barrage of negative news stemming from relatively minute changes in credit ratings, along with the increased volatility that investors see in the CDS market, are significant contributors to this negative psychology. Unfortunately, as seems to be the case with the economy, the patient's psychological symptoms may prove harder to cure than the fundamental illness itself."
J.P. Morgan Securities LLC's released a special "US Fixed Income Strategy Short-Term Fixed Income Markets Research Note" entitled, "Update on prime money fund holdings for September 2011," which shows that money market funds continued to reduce their exposure to European holdings in September." The piece, written by Alex Roever, Teresa Ho, and Chong Sin, says, "We estimate that prime money market funds (MMF) cut holdings of Eurozone bank debt by $72bn during September 2011 across CP, CD, ABCP, repo, time deposits, and other notes. Since the end of May 2011, prime MMF cut their Eurozone exposures roughly in half, allowing $237bn of net exposures to mature. At the end of September, prime MMF continued to hold $242bn of Eurozone bank credit."
JPMorgan's update, the first to analyze September holdings data, explains, "The pace of redemptions from prime MMF was slower in September than June and July but picked up compared to August. In aggregate, prime MMF assets under management declined by 2.3% during September, slower than the declines seen in June and July (5.2% and 4.0%, respectively) but faster than declines seen in August (0.5%). Through last Friday, October 7, prime funds are down $190bn or 11.6% since May. All of this has come out of institutional class shares ($194bn), while retail funds have experienced small gains in assets since May. Since the increase in the US debt ceiling on August 2, government securities focused MMF have seen $122bn of inflows, as institutional shareholders have rotated out of prime funds and into government funds."
The piece continues, "French banks remained the largest national concentration within the Eurozone, registering $93bn at the end of September. However, during the month, prime funds took $61bn away from allocations to French banks and have chopped $147bn (61%) since the end of May. The average final maturity for French banks' CP and CD was only 39 days at the end of September or about half of what it was at the end of May."
It also says, "Outside of the Eurozone, prime funds generally added to bank exposures last month. While concentrations to non-Eurozone European banks were basically flat, Japanese and Canadian bank exposures grew at $17bn and $7bn, respectively. These exposures predominantly grew through unsecured CP and CDs. Exposures to US banks were little changed, suggesting that Moody's September 21 downgrades of BAC, C, and WFC had little immediate impact on investors."
Finally, Roever & Co. tell us, "We think the September data illustrate the degree to which Eurozone headline risk continues to dominate MMF manager activity. Institutional class shareholders remain wary of Eurozone credits, given the ongoing lack of resolution to the peripheral sovereign debt crisis. In spite of the ECB's unlimited liquidity backstop of Eurozone banks, we believe MMF managers will continue to avoid these banks for fear of losing more shareholders. We doubt prime MMFs will return in the earnest to the sector until a clear and credible resolution to the root fiscal crisis is achieved. In the meantime, vague agreements-to-agree on a solution are unlikely to stop the bleeding of private credit away from Eurozone banks. But, with over half of the remaining Eurozone bank credit held by prime funds set to mature before the end of October, even an immediate resolution may not forestall further declines."
In a separate piece, Deutsche Bank's William Prophet also did some early sampling of September holdings in his piece this morning, "Bad for Business." Prophet writes, "Whereas it was once their number one asset, U.S. money funds have very obviously decided that unsecured loans to European banks are just bad for business. And more specifically; the month-end holdings now confirm that risk reduction along this front continued during September.... The trend that has us most concerned is the maturity transformation within money fund CD portfolios. Just to cite one example; whereas 35% of their French bank CD holdings had a maturity over three months back in June, now almost none of them do.... There was a time—when Euro-region CD's were the number one asset on U.S. money fund balance sheets. Over the past few months however, these holdings have been cut by over 40% -- and the trend is showing no sign of letting up."
On Friday, Bloomberg published "Worst Time for Money Funds as Europe Crisis Adds to Woes," (not available online yet), which discusses the multiple pressures on the money fund business. It says, "Kevin Kennedy says it's tougher now to be a money-fund manager than at any point in his three decades in the business. The industry's annual revenue has fallen 62 percent since 2008 to $4.5 billion, according to Crane Data LLC in Westborough, Massachusetts. Funds charge half as much per dollar invested, and assets have shrunk 23 percent. Europe's debt crisis is squeezing the supply of securities available for purchase."
The article quotes Western Asset Kennedy, "who helps manage $114 billion in cash funds for the unit of Baltimore's Legg Mason Inc.," "I haven't seen an environment like this in my lifetime."
Bloomberg writes, "Money-market mutual funds, with $2.64 trillion in assets in the U.S., are confronting their biggest challenges since they first appeared in 1971. Having survived mass withdrawals of assets by investors following the September 2008 collapse of the $63 billion Reserve Primary Fund, they now face Treasury yields near record lows, a shrinking supply of available debt and potential new restrictions from regulators. Most managers have been forced to cut fees to keep customer returns above zero, and some have abandoned the business."
It continues, "Firms that have sold or shuttered funds include Atlanta-based SunTrust Banks Inc., which dealt assets run by its RidgeWorth Capital Management unit to Pittsburgh's Federated Investors Inc. last year, and San Jose, California-based EBay Inc.'s PayPal, which closed its money fund in July. The number was also reduced by mergers and acquisitions such as San Francisco-based Wells Fargo & Co.'s 2009 takeover of Wachovia Corp. Charles Schwab Corp., the largest independent brokerage by client assets, closed its $23.7 billion U.S. Treasury Money Fund as a sweep option for new account holders."
The article continues, "Funds have struggled with low yields on their investments since the Federal Reserve began lowering its benchmark interest rate in 2007 to spur lending and economic growth. When short-term rates neared zero in December 2008, they initially affected only fund customers by reducing returns. Eventually, fund yields fell so far that most providers were forced to cut fees to prevent negative returns. The average annual fee charged by money funds tracked by Crane Data fell to 0.18 percent in August from 0.37 percent three years earlier."
Bloomberg also writes, "European bank debt, which money funds turned to in order to lift their yield, has become too risky for many providers as the region struggles to keep the Greek sovereign debt crisis from spreading. Funds reduced securities from the Euro area by $50 billion in August, bringing their holdings tied to institutions in the region to $316 billion, said Alex Roever, head of short-term fixed-income strategy at New York-based JPMorgan Chase & Co.... The European sovereign crisis has worsened a supply shortage of safe, short-term debt that money funds can invest in. The amount of securities money funds can buy fell from a peak of $12 trillion in 2008 to $9.1 trillion, according to a September report by the International Monetary Fund. Much of the reduction has come in segments that gave money funds their highest-yielding holdings."
They write, "The U.S. Securities and Exchange Commission's staff is expected to propose changes by early 2012 that providers say will increase costs and may spoil the appeal of money funds. The agency favors a plan that would force funds to create capital buffers equaling 1 percent to 3 percent of assets to protect against losses, three people familiar with the regulator's deliberations said in July. The extra expense would be borne by fund companies or passed on to investors. Staff may also propose that funds abandon their fixed share price in favor of one that fluctuates with the daily market value of holdings, a move industry leaders have said would destroy the appeal of money funds. Any proposal would be followed by a public comment period and then require approval by SEC commissioners."
Finally, Bloomberg says, "Declining yields and falling revenue won't deter investment firms focused on staying in the business long-term, said Joseph Lynagh, head of retail money funds at Baltimore's T. Rowe Price Group Inc." They quote Lynagh, "It's a troubled product at this point, and we're not making much money on it. But if you take a longer-term perspective, this, like all cycles, will change."
Note: The October issue of Crane Data's Money Fund Intelligence newsletter will be sent to subscribers this morning, as will our products with monthly data as of Sept. 30, 2011.... Fitch Ratings issued a press release entitled "Regulatory Proposals to Strengthen U.S. Money Market Funds Should Enhance Credit Profiles and a brief report entitled, "U.S. MMFs: New Reforms on the Horizon." yesterday. The ratings agency's statement says, "Regulatory proposals that further strengthen U.S. money market funds (MMFs) would likely be a net positive from a credit perspective depending on the specific details of ultimate changes, according to a special report published by Fitch Ratings. The industry, regulators and other market participants have presented a range of proposals to reform the industry, including: the establishment of a capital or liquidity buffer to absorb future losses or redemption pressures; redemption fees or other limits on redemptions; or adoption of a floating net asset value (NAV)."
The release continues, "Fitch notes that not all of the proposals are mutually exclusive, and maintaining the existing regulatory framework, which was strengthened in 2010 following the 2008 financial crisis, is also a potential outcome. A subordinated share class designed to absorb a limited amount of losses ahead of MMF investors could be viewed by Fitch as similar to hybrid capital such as contingent convertible notes (CoCos), used by banks and insurance companies. Rating such subordinated shares, especially at the investment-grade level, would depend on variety of factors, including total leverage, redemption terms, alignment of interests, and structural protections."
It adds, "Depending on the ultimate outcome of the reform discussions, Fitch would factor into its ratings any new conflicts of interest that may arise due to different classes of shareholders, unintentional incentives to reach for yield, or changes in how Fitch views the sponsors' implicit or explicit commitment to the fund. Fitch would also evaluate how any regulatory-related added costs affect the economics of managing a MMF."
Managing Director for the U.S. Fund and Asset Manager Ratings Group Nathan Flanders comments, "Fitch's existing money market fund ratings are not under review and not contingent on further regulatory change and Asset Manager Ratings Group.... Fitch does not endorse any specific proposal and will adjust its criteria and ratings accordingly if necessary." The release adds, "Economic uncertainties and the current low yield environment present challenges and constraints in contemplating different regulatory proposals. Fitch notes capital buffers and/or back-up facilities come at a cost that could prove to be uneconomic in the current interest rate setting."
We noticed when browsing Charles Schwab & Co.'s revamped website a piece entitled, "FAQs about the closure of Schwab U.S. Treasury Money Fund as a Sweep Option for New Accounts. The Q&A, updated Sept. 26, says, "Q: Why did Schwab decide to close the Schwab U.S. Treasury Money Fund (SWUXX) as a sweep option for new accounts? A: Due to the historically low yields and the tight supply of U.S. Treasuries, as well as the substantial growth of the Schwab U.S.Treasury Money Market Fund (SWUXX) in 2011, Charles Schwab & Company, Inc. decided to close SWUXX as a sweep option for new accounts to limit the inflow of new assets, which in the current market environment, can negatively impact the aggregate yield available to investors."
It continues, "Q. How long will the Schwab U.S. Treasury Money Fund be closed as a sweep option to new accounts? A. There is no specific time frame for when the Fund will reopen as a sweep option for new accounts. Q. What does the fund's closure as a sweep option mean to existing accounts that have SWUXX set as their Interest Bearing Feature (IBF) in Client Central? A. Existing accounts enrolled in the Schwab U.S. Treasury Money Fund as of 12:01 am PST on the day of the soft close 09/26/2011 will not be affected by this closure and will continue to have their un-invested cash automatically invested in the Fund."
Schwab adds, "The Fund will continue to accept additional investments from existing accounts for which the fund serves as the sweep feature -- allowing dividend reinvestment, automatic liquidation of shares to cover purchases or check-writing within the account and automatic investment in the sweep money fund of clients' "free credit balances". Advisors will not be able to select the Fund as the sweep feature on new accounts nor will they be able to change the sweep feature on an existing account to the Schwab U.S. Treasury Money Fund. If you change a client's sweep feature from the Schwab U.S. Treasury Money Fund to another sweep feature, you will not be able re-select the Schwab U.S. Treasury Fund as long as it remains closed as a sweep option to new accounts."
The Q&A also asks, "Q. What does the fund's closure as a sweep option mean to new accounts? A: The closure prevents Schwab from adding the Fund as a sweep feature for new accounts, including new accounts of existing investors, and existing accounts where the Fund is not the interest bearing feature on the account as of the Fund close date. Q: What other sweep money market funds are currently available at Schwab? A: Schwab offers the following additional sweep money market funds: Schwab Government Money Fund, Schwab Cash Reserves, Schwab Advisor Cash Reserves, and A broad array of Schwab sweep municipal money funds."
The Schwab piece writes, "Q: Why are the yields in the Schwab U.S. Treasury Money Fund (SWUXX) so low? A: Due to the market-wide demand for U.S. Treasury securities and decreased supply, Treasury yields have dropped to record lows. As securities in the portfolio mature, the money is being reinvested at historically low yields. The combination of higher yielding assets maturing and the reinvestment of assets at low yields applies downward pressure on the aggregate yield of the portfolio. Q: If yields for the Schwab U.S. Treasury Money Fund continue to decline, will Schwab continue to waive expenses? A: We are waiving fund expenses to help maintain a positive net yield. These fee waivers are voluntary and could be discontinued at any time. There is no guarantee that a fund will be able to avoid a net negative yield."
It explains, "Q: Is a net negative yield the same as "breaking the buck"? A: No. It's important not to confuse a fund's "yield" with its net asset value (NAV). NAV is the total value of all the securities in the portfolio divided by the number of shares outstanding. Money market funds are designed to maintain a stable $1 NAV. The fund's yield, however, is the current income produced by the securities in the portfolio."
Finally, the Q&A says, "Q: What non–U.S. Treasury securities does the Schwab U.S. Treasury Money Fund invest in? A: In accordance with SEC rules and the Fund's prospectus, the Schwab U.S. Treasury Money Fund may invest up to 20% of its net assets in non–U.S. Treasury securities. These securities include: (i) obligations that are issued by the U.S. government, its agencies or instrumentalities, including obligations that are not guaranteed by the U.S. Treasury, such as those issued by Fannie Mae and Freddie Mac; and (ii) obligations that are issued by private issuers that are guaranteed as to principal or interest by the U.S. government, its agencies or instrumentalities."
BofA Global Capital Management recently produced a Perspectives on Liquidity "white paper" entitled, "Putting Risk Under the Microscope." Subtitled, "Now More Than Ever, Investors Need to Evaluate the Risks in Money Market Funds," the piece was written by Head of Portfolio Management, Money Market Funds Dale Albright. It says, "Over the past several years, money market fund investors have been barraged by market disruptions ranging from the fall of Lehman Brothers and the subsequent collapse of the Reserve Primary Fund to the Greek debt crisis and fears of wider contagion in Europe. Little wonder, then, that 77% of treasury professionals recently surveyed by the Association of Financial Professionals cited principal protection as their top priority, while almost 80% reported they were keeping the vast majority of their cash in historically "safe" bank deposits, government debt and money market funds."
Albright explains, "Given their heightened risk aversion, it only makes sense that investors would emphasize traditionally stable investments. Yet for all of their sensitivity to risk, many investors place significant sums in money market funds -- a key component of many cash investment programs -- without fully vetting the funds' risks. Some may avoid that exercise because they're daunted by the challenges inherent in parsing portfolio risk. Others may believe that enhanced regulations limiting risk-taking by fund managers obviate the need to conduct such due diligence. The reality, however, is that both the amount and type of investment risk vary from fund to fund, and with headline risk roiling the financial markets, you need to understand the risks you're assuming when you invest in a money fund."
He tells us, "When we speak of evaluating a money market fund's "risk," we're talking primarily about assessing the three major components of portfolio risk -- credit risk, liquidity/redemption risk and interest rate risk. The major drivers of performance and portfolio volatility, these risks can be difficult to analyze because they are increasingly inter-connected. That said, it is vital to conduct at least a rudimentary analysis of them when screening funds for your investment portfolio. This is especially true during the current low-rate environment, which could incent fund managers to take on additional risk to boost yield."
The white paper continues, "In the fixed income space, credit risk refers to the probability of an issuer defaulting on principal or interest payments or of suffering a credit rating downgrade that would decrease the value of its outstanding debt. An obvious example of a security with high credit risk is the sovereign debt of Greece, which investors fear is in danger of default due to the country's deteriorating finances and anemic economy. In contrast, Germany is considered to have much lower credit risk -- as evidenced by its stronger credit rating and lower risk premium relative to that of Greek issues."
It says, "A money market fund's credit risk is a function of the credit quality of its individual holdings. A fund with a heavy allocation to U.S. Treasuries, federal agency debt and AAA-rated U.S. corporate debt typically would be considered less risky than a fund with a smaller allocation to those securities and a larger exposure to credits with a higher risk of default or downgrade, such as Irish and Spanish sovereign debt or Eurozone banks with large exposures to the sovereign debt of those countries."
Albright continues, "The risk of default or downgrade is but one facet of credit risk. A more subtle and somewhat more arcane element of credit risk is "duration of credit risk." The key measure of a fund's duration of credit risk is its weighted-average life (WAL), which reflects the weighted-average final maturity of all the securities in the fund's portfolio. All things being equal, a money market fund portfolio with a long WAL is more risky than one with a shorter WAL because in the event of significant spread widening, the former would be more vulnerable to declines in the prices of its holdings."
He writes, "Recognizing the impact duration of credit risk has on the stability of money market funds, the Securities and Exchange Commission (SEC) and the Institutional Money Market Fund Association (IMMFA), which establishes guidelines for rated European money market funds, have limited the maximum WAL to 120 days. Additionally, the SEC pared the amount of credit risk funds can assume by reducing the maximum amount of Tier II paper they can hold to 3% of total assets and by limiting the maturity of that paper to 45 days or less."
BofA Global's piece also says, "Liquidity/redemption risk measures the probability of a fund being able -- or unable -- to meet investor redemptions when requested. To effectively evaluate a money market fund's liquidity risk, you must review several key metrics: The absolute levels of daily and weekly liquidity; The ratio of daily and weekly liquidity to the sum of the fund's largest shareholders (shareholder concentration); The liquidity characteristics of the fund's holdings; and, The fund's WAL. Daily and weekly liquidity clearly are important because they provide the cash necessary to meet redemptions. That said, absolute levels of available liquidity are not the best metric of a fund's liquidity risk because that measure does not capture the probability of a significant liquidity drawdown due to large redemptions."
It explains, "A fund's liquidity profile will reflect, to some degree, the liquidity profile of its holdings. If, for example, a fund has a large allocation to widely traded assets for which there is a deep market -- U.S. Treasuries and high-quality corporates come to mind -- it likely would be viewed as having better liquidity than a fund with large exposures to less liquid assets. (This assumes that other drivers of liquidity -- shareholder concentration, for example -- are the same for both funds.) In addition, money market funds may have an allocation to securities that are very liquid, e.g., federal agency coupon notes, but not liquid enough in the view of the SEC to meet the agency's definition of a security offering overnight or weekly liquidity."
Albright writes, "Another important metric of a fund's liquidity is its WAL, which, again, is the weighted-average final maturity of the securities in the fund's portfolio. Portfolios with short WALs, say 60 days, likely would have a large exposure to short-dated notes, i.e., those with 30-, 60- and 90-day maturities. Additionally, portfolios with relatively low WALs tend to have less exposure to floating-rate securities, notes that reset to the interest rate of a daily, monthly or quarterly index."
He also tells us, "Interest rate risk refers to the probability of a security's (or a portfolio’s) value rising or falling due to a change in absolute rates or a change in the relationship among rates. For purposes of illustration, assume the Federal Reserve increases the federal funds rate by 50 basis points. The price of existing short-term debt would drop because investors theoretically would sell their holdings to swap into new credits offering yields that reflect the Fed's rate increase. The primary metric of a money market fund’s interest rate risk is its weighted-average maturity (WAM), which measures the average time until the holdings in a fund portfolio can reset to higher levels, either because the portfolio's floating-rate securities reset or because its other credits mature."
Finally, Albright adds, "Prior to the global financial crisis, most investors believed money market funds were as much a safe haven during volatile markets as U.S. Treasuries. The breaking of the buck by the Reserve Primary Fund and the subsequent run on money funds in 2008 reminded them that no investment -- not even a money fund -- is inherently "safe." Today many investors assume that the more stringent regulations imposed upon fund managers over the past two years have all but eliminated risk differentials among funds. That notion could well become a casualty of the next crisis as investors learn the hard way that the risk appetites of fund managers still vary. The fact remains that when weighing your investment options, you still need to ascertain the amount and composition of funds' portfolio risk. To do less is to risk discovering during the next market disruption that your fund manager's tolerance for risk is not in sync with your own."
While outside prognosticators continue to predict consolidation among money market mutual funds, providers continue to resist wholesale exits from the space in favor of fund lineup tweaks Several fund changes have occurred recently, and all are relatively minor. Milestone Treasury Obligations recently shifted its advisory agreement from Milestone Capital Management to NorthStar Financial Services Group, manager of the AdvisorOne family of funds. The core management team of the Milestone funds remains intact. (See the Prospectus Supplement.) Also, BofA Global and American Beacon both made small changes to their money fund lineups.
The Milestone Treasury Obligations filing says, "At its meeting on August 3, 2011, the Board of Trustees of the Portfolio unanimously voted to terminate the investment advisory agreement between The Milestone Portfolios, on behalf of the Portfolio, and Milestone Capital Management, LLC. At the same meeting, the Board approved an interim advisory agreement with CLS Investments, LLC, a wholly owned subsidiary of NorthStar Financial Services Group, LLC. Under the Interim Agreement, CLS will provide investment advisory services to the Portfolio for the same fee the Portfolio was obligated to pay under its agreement with Milestone and under terms that are materially identical to the agreement with Milestone."
It adds, "At the meeting, the Board also considered, approved and recommended to shareholders a long-term advisory agreement with CLS to provide investment advisory services to the Portfolio for the same fee Milestone was entitled to receive. The Final Agreement will become effective upon approval by shareholders.... At the August 3, 2011 meeting, the Board approved the merger of the Portfolio with the Milestone Treasury Obligations Portfolio, a newly organized series of the AdvisorOne Funds, in a tax-free reorganization, subject to shareholder approval."
A recent communication entitled, "BofA Funds Streamline Share Class Offerings," told Crane Data, "BofA Global Capital Management, LLC (BofA Global Capital Management) continuously looks for ways to refine its product line to provide the best possible investment opportunities. In keeping with this objective, on April 25, 2011, the Board of Trustees of BofA Funds Series Trust approved BofA Global Capital Management's plan to modify certain BofA Funds' share class offerings through a variety of terminations, conversions, additions, re-openings and re-namings. Each of these changes is described in further detail ... in supplements to the BofA Funds' registration statement. The Board determined that certain share classes with nominal assets and/or limited distribution potential should be terminated and/or converted into existing share classes. In addition, new share classes are being introduced to position the BofA Funds in such a way that they are better aligned for specific distribution channels as well as to provide customers with the best possible products and services we are able to offer. These changes are scheduled to take place on or about the close of business on September 30, 2011."
Finally, the American Beacon Funds recently announced the liquidation of its American Beacon Money Market Mileage Fund. The filing said, "On August 10, 2011, the Board of Trustees of American Beacon Mileage Funds approved a plan to liquidate and terminate the American Beacon Money Market Mileage Fund, upon recommendation by American Beacon Advisors, Inc., the manager to the Fund. Due to the prolonged low interest rate environment and costs associated with maintaining a positive yield in the Fund, the Manager does not believe that it can continue to conduct the Fund's business and operations in an economically efficient manner. As such, the Board concluded that it would be in the best interests of the Fund and its shareholders to liquidate and terminate the Fund.... On or about September 30, 2011, the Fund will distribute cash pro rata to all remaining shareholders who have not previously redeemed all of their shares. Once the distribution is complete, the Fund will terminate."
The Mileage class had a mere $20 million as of Aug. 31 and American Beacon continues to manage approximately $1 billion in its `American Beacon Money Market Select share class and its American Beacon US Govt Select fund. Look for more information and a recap of recent Fund Liquidations, Changes and Mergers in our October Money Fund Intelligence, which will be send to subscribers on Friday morning. We also list fund changes in our monthly Money Fund Intelligence XLS in a separate "Changes" worksheet tab.
As we mentioned last week, Eric Rosengren, President & CEO of the Federal Reserve Bank of Boston gave a speech entitled, "Towards Greater Financial Stability in Short-Term Credit Markets where he "discuss[ed] the role that MMMFs play in providing short-term funding, including serving as an important source of short-term financing for European banks [and] highlight[ed] that the current structure makes MMMFs particularly susceptible to credit shocks that can turn into liquidity problems for the whole industry -- and ... suggest[ed] some ways that the industry could be made more resilient." Today, we focus on his comments on possible future regulatory changes, and we quote from some unfavorable industry reaction.
Rosengren says, "No one wants to see a repeat of 2008, nor should we. The industry and all participants can get to a better place. For example, an examination of the publicly available monthly reports on portfolio holdings of MMMFs highlights that a few MMMFs hold financial paper that has not been downgraded but nonetheless is seen by the market as posing more credit risk than could seem appropriate for entities that are allowed to maintain a fixed net asset value. MMMFs have been required to provide a monthly report of holdings and have increased their liquidity. Still, we are passing the three-year anniversary of the failure of Lehman and the run on the MMMFs and it remains important to explore the ways that the industry, which plays a pivotal role in short-term credit markets, can address its susceptibility to a credit shock that could in turn be transmitted to short-term financial markets. I am not saying anything that has not been expressed before, but want to highlight the opportunities we all have to move thoughtfully but expeditiously to a more stable place."
He continues, "Given all this, I believe a more proactive regulatory approach may be necessary. While the monthly reporting has been helpful, given the very short maturity of many of the assets, I believe the reporting should be more frequent to avoid the possibility of "window dressing" at the end of the month. Also, reducing a fund's maximum permissible exposure to any one firm could reduce the potential loss that would occur from a credit event involving only one counterparty. Consideration might also be given to whether the assets of riskier firms (for example those with very high market credit default swaps ('CDS') prices are appropriate investments for MMMFs, which are expected to maintain a low risk profile."
Rosengren explains, "There have been a variety of proposals recommending more substantial changes in this arena. However, three years after a systemically significant episode, no one proposal has been settled on. My own preferred approach would be to require MMMFs to have a meaningful capital-like buffer that exceeds, for example, their single-issuer concentration exposure limits -- perhaps on the order of 2 to 3 percent -- that, if violated, automatically leads to a fund' s conversion to a floating net asset value. Examples of how to structure such a buffer include having the MMMF's sponsor directly fund the creation of the buffer, or creating a separate class of loss-absorbing shares that could be marketed to investors willing to bear some risk in exchange for a higher return than that provided by the stable value shares. If in some appropriate period of time a satisfactory plan for such a capital buffer is not produced and accepted, then those prime funds would be required to float their net asset value."
Finally, he adds, "All in all, though, given the systemic importance of the MMMF industry, it is critical that one way or another we make the industry less susceptible to credit shocks and liquidity runs. While many in the MMMF industry have been reducing their exposure to troubled financial institutions, some continue to take what some observers might consider outsized credit risks. The experience of 2008 showed the potential for a MMMF's problems to precipitate redemptions that are ultimately destabilizing to short-term credit markets, and contribute to economic difficulties. I am certainly not predicting any such outcome but noting that policymakers, market participants, and the industry can and should make steady progress on these matters."
J.P. Morgan Securities' Alex Roever, Teresa Ho, and Chong Sin comment in this week's "Short-Term Fixed Income," "Eric Rosengren has positioned himself as a voice in favor of curbing systemic risk in the money markets. As the head of the Boston Fed during the 2008-09 market meltdown, he oversaw the administration of the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) which arguably was the single most effective tool in arresting the precipitous run on money funds that took place following the collapse of Lehman Brothers. Three years after Lehman, Rosengren is using some of his speeches to advocate for further reform of money markets and money market funds."
They say, "[Rosengren] acknowledges the reforms put in place by the SEC last year are helpful, but notes there's room for improvement around the edges. He suggests increasing the frequency of fund holdings reports (currently monthly) to help avoid month-end window dressing. Further limiting a fund's exposure to a single counterparty could help reduce loss upon default (prime funds are currently capped at a 5% max). He also suggests linking eligibility to an issuer's credit default swap pricing since MMMFs are supposed to maintain a low risk profile. While the first two of these options strike us as reforms that could work, the CDS tying idea is ill-considered. MMMF managers employ many experienced professional credit analysts as well as risk and portfolio managers that understand their products and limitations. Tying credit analysis to CDS -- markets that are often thinly traded and subject to speculators pushing a view that may or may not be valid -- both undermines money fund management and destabilizes borrowers' access to the markets. Such a rule could potentially cut off a firm's commercial paper funding just because some hedge fund manager gets bearish."
Roever and JPM add, "Versions of the buffer have been discussed between regulators and the industry for months, but Rosengren's description is the clearest unofficial articulation yet by someone on the regulatory side. We believe regulators are working towards introducing an official proposal for something quite like this in the next several months. Not surprisingly, the buffer idea is very controversial in the markets for several reasons. Let's consider a few of these: Existing reforms are working. Many MMMF managers have indicated the current set of rules have gone a long way toward mitigating systemic risks posed by money funds.... In the past year, the Japanese earthquake, the US debt debacle, and the ongoing Eurozone crises have all been major tests for prime funds and the funds have managed through $204bn of shareholder liquidations since March 2010 with no problems. Moreover, they have been proactively managing exposures to Eurozone banks lower for well over a year, albeit at a quickened pace during the last 3 months."
They continue, "A buffer won't eliminate credit shocks or liquidity runs. To some degree, all financial institutions are subject to credit shocks and liquidity runs. Focusing on "better credits" or shifting to a variable NAV format can't change this. Consider two recent examples. This past summer, between July 14 and August 1, taxable money funds backed by US government securities (about as risk-free an asset as there is ) experienced a liquidity run as result of heightened default concerns tied to the federal governments failure to raise it's statutory debt limit. Government funds saw 9% of their assets flow out in just about 3 weeks, as yields on government securities climbed. If constant NAV funds full of t-bills are subject to run risk, how can a fund full of marginally riskier assets not also be susceptible? So is variable NAV the answer? As the House Republicans have asked the SEC1, what empirical evidence is there that suggests a variable NAV will prevent on a run on money funds?"
The "Short-Term Fixed Income" piece adds, "The buffer is very costly. Implementing a buffer equal to 2-3% of assets will smother economic incentives for existing shareholders and fund sponsors, and may lead many to leave the prime fund business. The reforms that have already been implemented via the recent changes to rule 2a-7 have lowered risk and also lowered potential returns, and further risk-reducing reforms will do the same. In the current low interest rate environment the economics of adding a buffer funded by a third-party investor are highly suspect since the gap between the average prime fund's gross and net yields is below 20bp and falling as yieldy Eurozone bank paper continues to mature out of portfolios. If raised from outside sources, Rosengren's proposal implies the $1.5tn prime fund industry would need to raise $30-45bn of buffer capital. And given the probable timing of the reform, money funds may well have to compete with global banks that are simultaneously trying to raise capital."
It says, "As outlined by Rosengren this week, we are skeptical that a buffer of this scale can be implemented on an industry wide basis. If the regulators' fallback position is that, in lieu of a buffer, forcing prime funds to convert to VNAV will eliminate systemic risk in the funding markets, we think they are mistaken on a few fronts. First, faced with a choice between a VNAV prime fund and a CNAV government fund, we believe there will be massive flows into government funds. Indeed, since early August, we have seen a major rotation by institutional shareholders from prime funds into government funds, demonstrating shareholders' ability and willingness to shift. While other prime shareholders might try to shift to banks, most of the large banks they would shift to may not want their money given the high regulatory burden it brings. We do think there is a market for prime-like VNAV liquidity funds that will invest in the same sorts of credits prime funds invest in now. But we think this is much smaller than the existing prime fund market. As a result, banks and other borrowers relying on prime funds are likely to find credit greatly reduced. In this way, the buffer proposal may pose its own systemic risk."
Finally, they say, "The buffer is unlikely to substantially reduce credit or liquidity risks associated with prime funds. It's a fig leaf for regulators that will let them claim that they reduced systemic risk and without actually doing so. In the current environment, the buffer's cost is onerous and ultimately may only chase money and risk into less regulated corners of the money markets."