The Investment Company Institute's latest "Trends in Mutual Fund Investing: July 2011," confirms that July was indeed a very bad month for money market funds, as assets declined by $118.0 billion, or 4.4%. This represented over half of the overall year-to-date (through 7/31) asset decline of $235.8 billion, or 8.4%. (Note that money fund assets have rebounded by $68.4 billion, or 2.8%, month-to-date in August through 8/29, according to our Money Fund Intelligence Daily.)
ICI's monthly report says, "The combined assets of the nation's mutual funds decreased by $219.2 billion, or 1.8 percent, to $12.009 trillion in July, according to the Investment Company Institute's official survey of the mutual fund industry. In the survey, mutual fund companies report actual assets, sales, and redemptions to ICI. Money market funds had an outflow of $118.89 billion in July, compared with an outflow of $41.05 billion in June. Funds offered primarily to institutions had an outflow of $125.92 billion. Funds offered primarily to individuals had an inflow of $7.03 billion."
The statistics show total money fund assets at $2.568 trillion as of July 31, which represents 21.4% of all mutual fund assets. ICI's "Net New Cash Flow" figures show money fund assets with an outflow of $244.2 billion YTD 2011 vs. an outflow of $515.5 billion YTD in 2010 through July. ICI's survey tracks 433 taxable and 209 tax-free money funds (642 total) vs. 455 taxable and 221 tax-free money funds a year earlier (676 total).
ICI's separate "Month-End Portfolio Holdings of Taxable Money Market Funds" shows that Certificates of Deposits showed the largest decline in July (down $42.5 billion, or 7.4%), but CDs remain the largest money fund allocation with $529.7 billion, or 23.3%. (Eurodollar CDs, which we include in the above total, represent $103.9 billion, or 19.6% of all CDs, and they accounted for $10.6 billion of the drop in July.)
Repurchase Agreement (Repo) holdings, the second largest holding of taxable money funds, increased slightly (up $1.7 billion) to $468.8 billion, or 20.7%, while holdings in the third-largest segment, Commercial Paper (CP) declined by $14.2 billion, or 3.9%, to $354.4 billion, or 15.6%. U.S. Government Agency Securities accounted for 15.2% of holdings, or $345.4 billion <b:>`_. Agency holdings fell by $21.4 billion, or 5.8%, in July. ICI also showed Average Maturities shortened to 40 day in July and the number of accounts outstanding fell to 27.07 million.
We learned from website IndexUniverse that Federated Investors has filed to launch Federated Active UltraShort Fixed Income ETF. According to the filing, "The investment objective of the Initial Fund will be to seek to outperform the 3-month LIBOR primarily by investing in fixed and floating rate fixed income instruments. The Initial Fund may invest in investment-grade and non-investment-grade corporate bonds, U.S. government securities and U.S. government agency securities (including mortgage-backed securities issued or guaranteed by U.S. government sponsored enterprises ('GSEs')) with a maximum effective duration of two years or less. The Initial Fund will only invest up to 20% of its total assets in non-investment-grade securities."
Since 2007, there have been a number of launches in the "enhanced cash" ETF space, though none have gained a substantial amount of assets to date. (Search for "ETF" on www.cranedata.com to see our previous Crane Data News stories. These include: More Ultra-Short ETFs on the Way: SPDR Lehmans from SSGA (3/13/07), Bear Stearns Launching Cash-Plus ETF, Bear Current Yield Fund (YYY) (5/2/07), "Dreyfus Lends Its Clout to Foreign Bond, Cash ETFs" writes WSJ (1/29/08), SSgA Files to Launch SPDR SnP Commercial Paper, First "Cash" ETF (6/17/08), Near Cash ETFs Rising PowerShares VRDO PVI Breaks 1 Billion 10/2/09, Body Count Rises in Enhanced Cash; Bear YYY ETF Exits Stage Left (9/11/08), Guggenheim Launches Enhanced Ultra-Short Bond ETF, Latest Cash+ (6/3/11), and PIMCO Joins Growing Near-Cash ETF Marketplace with Launch of MINT (11/17/09).
IndexUniverse says, "The fund would join index ETFs like Vanguard's Short-Term Bond Fund (BSV), the SPDR Barclays Capital 1-3 Month Treasury ETF (BIL) and a roster of iShares offerings in the short-term bond market. But it looks similar to the Pimco Enhanced Short Maturity Strategy (MINT), which has gathered more than $1.3 billion in assets since its November 2009 inception."
A recent McKinsey & Company report entitled, "The Second Act Begins for ETFs, says, "If active ETFs do take hold, we expect they will start from the fixed-income side of the market. Fixed-income funds are less vulnerable to front-running and therefore face less transparency risk. One segment of traditional fixed income funds that may be particularly exposed to active ETFs in the near term is the $3 trillion money market fund business. Money market funds lost their safe haven allure when several funds 'broke the buck' during the 2008 credit crisis, reminding investors that maintaining a $1 net asset value (NAV) was not guaranteed. This realization has opened a window of opportunity for variable NAV products with risk profiles similar to money market funds, but significantly lower expense ratios and markedly higher investment yields. Pioneer products in this category have already started gaining traction in the market. However, for ETFs to compete effectively with and match the scale of money market funds in the retail market, the current low to no commission environment among broker-dealers would have to remain in place for ETFs, since customers would be moving money in and out of these products frequently."
The European Securities and Markets Authority (ESMA), which was formerly known as CESR (Committee for European Securities Regulators) and which "fosters supervisory convergence both amongst [European] securities regulators," published "a set of Questions and Answers on European Money Market Funds on Friday. A statement says, "The purpose of this document is to promote common supervisory approaches and practices in the application of the guidelines on a Common Definition of European Money Market Funds developed by CESR by providing responses to questions posed by the general public and competent authorities. This document is intended to be continually edited and updated as and when new questions are re-ceived. The date on which each question was last amended is included after each question for ease of reference. Questions on the practical application of any of the requirements of CESR's guidelines on a Common Definition of European Money Market Funds may be sent to the following email address at ESMA: firstname.lastname@example.org."
The full Questions and Answers: A Common Definition of European Money Market Funds, which applies to Europe only and which is heavy on ratings questions, states, "I. Background 1. The revised Undertakings for Collective Investment in Transferable Securities (UCITS) Directive puts in place a comprehensive framework for the regulation of harmonised investment funds within Europe. The extensive requirements with which UCITS must comply are designed to ensure that these products can be sold on a cross-border basis. The UCITS framework is made up of the following EU legislation: a. Directive 2009/65/EC, which was adopted in 2009. It is a 'framework' Level 1 Directive which has been supplemented by technical implementing measures (see the Level 2 legislation in b. below). b. Directive 007/16/EC1; Directive 2010/43/EU2; Regulation No 583/20103; Directive 2010/42/EU4; and Regulation No 584/20105 (the Level 2 legislation). 2. National laws of Member States may apply to collective investment undertakings that are not UCITS."
The document explains, "On 19 May 2010, ESMA's predecessor (CESR) published guidelines on a Common Definition of European Money Market Funds (Ref. CESR/10-049). These guidelines apply to collective investment undertakings authorised under Directive 2009/65/EC and collective investment undertakings regulated under the national law of a Member State and which are subject to supervision and comply with risk spreading rules and which label or market themselves as money market funds. 4. ESMA is required to play an active role in building a common supervisory culture by promoting common supervisory approaches and practices. In this regard, ESMA has adopted this Q&A and will continue to develop other Q&As as and when appropriate."
The Q&A continues, "The purpose of this document is to promote common supervisory approaches and practices in the application of the guidelines on a Common Definition of European Money Market Funds developed by CESR by providing responses to questions posed by the general public and competent authorities. The content of this document is aimed at competent authorities to ensure that in their supervisory activities their actions are converging along the lines of the responses adopted by ESMA. However, the answers are also intended to help management companies by providing clarity as to the content of CESR's guidelines on a Common Definition of European Money Market Funds, rather than creating an extra layer of requirements."
Under "Status," ESMA writes, "The Q&A mechanism is a practical convergence tool used to promote common supervisory approaches and practices under Article 29(2) of the ESMA Regulation. Therefore, due to the nature of Q&As, formal consultation on the draft answers is considered unnecessary. However, even if they are not formally consulted on, ESMA may check them with representatives of ESMA's Securities and Markets Stakeholder Group, the relevant Standing Committee's Consultative Working Group or, where specific expertise is needed, with other external parties. ESMA will review these questions and answers to identify if, in a certain area, there is a need to convert some of the material into ESMA guidelines and recommendations. In such cases, the procedures foreseen under Article 16 of the ESMA Regulation will be followed."
Some of the questions include: "Question 1: `What are ESMA's expectations in terms of a management company's internal rating process? Answer: A management company assesses the credit quality of a money market instrument using its internal rating process. The assessment of the credit quality of the instrument by the management company should be conducted according to the provisions of Article 23 of Directive 2010/43/EU on due diligence requirements."
"Question 7: Should the WAM be calculated using the duration or final legal maturity for fixed rate instruments? Answer: According to the definition of WAM on page 5 of CESR's guidelines, the WAM for fixed rate instruments should be calculated using the final legal maturity of the instrument and not the duration. Question 8: Should the WAL be calculated for individual instruments? Answer: No. According to the definition of WAL on page 5 of CESR's guidelines, the WAL should be calculated as the weighted average of remaining life (maturity) of the securities held in the fund."
Question 12: Are short-term money market funds and money market funds allowed to invest in non-base currency cash without hedging the currency exposure? Answer: No. Paragraph 11 of Box 2 and paragraph 1 of Box 3 of CESR's guidelines require the currency exposure arising from investment in securities denominated in non-base currency to be fully hedged and should be understood as covering investments in non-base currency cash as well."
Yesterday, we excerpted from BlackRock's latest "Viewpoint" entitled "Money Market Funds: Potential Capital Solutions," which discusses the pros and cons of various regulatory reform options. Today, we excerpt from the sections describing the "Wide Spectrum of Possible Capital Solutions." These include: "Status Quo: Rule 2a-7 enhancements are sufficient; Redemption Fees: Institute an economic incentive to discourage runs; NAV Buffer: Establish an NAV buffer (or cushion) within individual MMF portfolios; Subordinated Share Class: Create a new share class to co-exist with common shares; Trust/Special Purpose Entity: House a buffer outside the individual portfolio(s); Hybrid Approach: Employ some combination of the prior three options; and, Floating NAV: Eliminate stable NAV and find new market equilibrium." BlackRock says, "Assuming that both the first and final options in this continuum (maintaining the status quo and floating the NAV) are unacceptable -- for the reasons noted above -- the following discussion focuses on various forms of capital solutions as well as the possibilities around redemption fees."
Regarding the "NAV Buffer," BlackRock writes, "Under this scenario, a "buffer" would be established within each MMF by siphoning a small amount of income from the portfolio to be set aside as an NAV cushion. The assumption is that a uniform "fee" would be set by regulators (e.g., 4 basis points). The buffer capital is regarded as an asset of the portfolio and, as such, is calculated into the NAV and results in a higher NAV for the MMF. The siphon would be turned on and off depending on the size of the buffer relative to the pre-determined minimum capital requirement. In other words, the portfolio would stop retaining income when the target buffer is reached. Shareholders of the MMF would "own" the buffer. Although this option appears to be embraced by many industry participants, regulators have signaled that this may be insufficient based on the challenges outlined below."
Under, "Key Benefits," they explain, "The NAV buffer concept would be relatively simple to implement.... It affords no advantage or disadvantage for large or small fund families; however, it would create a barrier to entry for new fund sponsors, as existing funds would already have established a buffer.... For shareholders who are worried about the NAV breaking the buck, the buffer affords a higher NAV that removes part of their incentive to redeem. In the event of a run, assuming the fund's NAV is above $1 per share, the NAV accretes, providing further disincentive for shareholders to redeem and again putting a brake on the run."
BlackRock says of the "Subordinated Share Class," "Under this approach, each MMF would have two share classes: senior and subordinated. The senior class would act much like current MMF shares, with investment income and dividends based on the underlying portfolio less an amount allocated to the subordinated share class. The subordinated share class would have a variable payout based on a fee charged to the total portfolio and distributed to the subordinated shareholders.... Given the nature of this new security, we assume the market will demand a yield similar to a low investment grade or a strong high yield issue."
The paper adds, "Given that MMFs have large inflows and outflows, the fund sponsor would need to be able to issue additional subordinated shares and/or redeem subordinated shares to right-size the subordinated share class relative to the overall size of the fund.... This approach sets a market price for the level of risk involved. Assuming efficient markets, poor risk managers will be disciplined by the market in that higher returns will be demanded of them for their inherently higher level of risk. The subordinated security is a new type of security that is quite complex, entailing variable interest as well as extension features. Investor appetite for this security will depend on the ability to obtain a rating and on the development of a liquid secondary market."
BlackRock's "Potential Capital Solutions" continues, "An alternative approach is a trust or special purpose entity (SPE) structure that would house the money market mutual fund. In many ways, the trust structure is similar to the subordinated share class, however, there are several key differences. While BlackRock initially considered the idea of one SPE per fund sponsor and potentially multiple funds supported by a single SPE, we have concluded that it would be much simpler (and pose fewer conflicts) if each MMF portfolio had its own SPE."
It also discusses, "Redemption fees could be established to create economic disincentives to redeem. The redemption fee would need to be applied using a clear set of rules. These rules could include a provision for di minimis withdrawals, and could provide for a notice period after which the fee would not apply. Any fees collected from redemptions would be retained within the MMF for the benefit of remaining shareholders. This type of 'circuit breaker' would further protect a fund from excessive redemptions. While not eliminating the need for capital, the presence of redemption fee features should mitigate the amount of capital required. Some institutional investors may be resistant to products with redemption fees and the triggering mechanism will be important to their analysis."
Finally, BlackRock writes, "Notably, the proposals outlined above need not constitute an all-or-nothing proposition. A hybrid approach that uses some facet of the aforementioned models could be a desirable solution. Rather than being overly prescriptive, regulators could allow for some market innovation -- specifying the minimum amount of capital and timeframe for capital to be in place, and then allowing each plan sponsor to address the problem in a way that best meets its needs. However, the benefits of flexibility need to be weighed against the cost of complexity. Ultimately, a hybrid approach may introduce too much complexity."
BlackRock just published an extensive and excellent overview of potential regulatory options entitled "Money Market Funds: Potential Capital Solutions." The paper, written by Barbara Novick, Rich Hoerner, and Simon Mendelson, says, "The money market fund industry has come under heightened scrutiny in the aftermath of the worst financial crisis in recent history. The events of 2008, including the historic 'breaking of the buck' by the Reserve Primary Fund in September of that year, exposed both idiosyncratic (fund-specific) and systemic (industry-wide) risks associated with money market mutual funds, and gave rise to several reform measures designed to mitigate such risks and enhance the overall value and viability of this important investment vehicle. The Securities and Exchange Commission (SEC) Money Market Reform rules, effective in May 2010, outlined more conservative investment parameters related to the credit quality, maturity and liquidity of money market fund portfolios, and prescribed enhanced guidelines around transparency to investors. Shortly after, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) imposed further safeguards that touch nearly every part of the financial industry."
They continue, "While these efforts have gone a long way toward strengthening the industry and enhancing investor protection, additional proposals related to money market funds (MMFs) remain highly topical today and were aired on May 10, 2011 at the "SEC Roundtable on Money Market Funds and Systemic Risk." In this ViewPoint, we review the objectives and constraints surrounding additional structural reform in the MMF industry and focus specifically on the capital solutions that remain topics of conversation today. Ultimately, we believe the goal of the investment community and policymakers is one and the same: to further reduce systemic risk without undermining money market mutual funds' important role as a source of value to investors and funding to the short-term capital markets."
BlackRock reviews the background of money funds, the 2008 crisis, and "The Regulatory Response," explaining, "Prior to the unprecedented credit crisis of 2008, MMFs successfully provided liquidity to the financial markets for nearly 40 years without requiring government intervention. During the height of the credit crisis and in its immediate aftermath, the concerted actions by policymakers were essential in restoring order and confidence to the markets in a time of great uncertainty. Following is a brief review of reforms that have been implemented and those proposals still under consideration."
They write, "In May 2011, the SEC assembled a panel to address "Money Market Funds and Systemic Risk." SEC Chairman Schapiro and Commissioners Casey, Walter, Aguilar and Paredes were in attendance, as were six representatives from the FSOC and a wide array of interested parties that included corporate Treasurers, institutional investors, academics, industry group representatives and regulators. During the roundtable, Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, along with other bank regulators, emphasized the floating NAV as a key means for limiting MMF-related systemic risk. Institutional investors and industry participants presented the opposing view."
The paper continues, "While floating the NAV was a central topic, other views were presented, including the idea of sponsor capital introduced by Seth Bernstein, Global Head of Fixed Income for JP Morgan Asset Management, and the concept of supplemental shareholder capital presented by Bob Brown, President of the Money Market Group for Fidelity Management & Research Company. In the President's Working Group Report, the ball was passed to the FSOC as the interagency group to take forward structural reforms to MMFs. The 2011 FSOC Annual Report published in July states, "To increase stability, market discipline, and investor confidence in the MMF market by improving the market's functioning and resilience, the Council should examine, and the SEC should continue to pursue, further reform alternatives to reduce MMFs' susceptibility to runs, with a particular emphasis on (1) a mandatory floating NAV, (2) capital buffers to absorb fund losses to sustain a stable NAV, and (3) deterrents to redemption, paired with capital buffers, to mitigate investor runs." Needless to say, regulators are focused on structural reforms for money market funds.
BlackRock says, "Issuers of commercial paper, fund managers and MMF investors have universally expressed concerns about the floating-NAV structure for a vehicle that for decades has been differentiated and prized for its stable-NAV feature. In response to the PWG report, and based on subsequent dialogue, a number of new ideas have been proposed. These include: an NAV buffer within each MMF portfolio, a trust structure or other special purpose entity (SPE) outside the individual MMF, a subordinated share class and/or the imposition of redemption fees. In this paper, we examine the pros and cons of each of these approaches."
Novick & Co. explain, "Before additional change can be made in the MMF industry, it is important that all interested parties agree on exactly what the problem is that requires solving and, to that end, which tools are available and which are off limits. Importantly, the solutions must work for all constituencies, including regulators, MMF sponsors, investors and commercial paper issuers.... We would identify two key and universally accepted objectives of structural change: (i) to maintain MMFs as a viable cash vehicle, and (ii) to strengthen Rule 2a-7 to enable MMFs to better withstand risks. We believe particular attention should be paid to fund-specific risks, including factors related to a fund's credit quality and liquidity, and its ability to withstand acute risks in the event of a systemic situation."
They say, "There are a number of meaningful obstacles to MMF reform that must be factored into the development of an acceptable solution. Among them: The status quo is not acceptable to regulators.... A floating NAV is not acceptable to investors, and the demise of MMFs as we now know them is likely to cause unintended consequences.... Access to the Federal Reserve discount window is not available.... Socialized or shared capital could result in idiosyncratic risk.... This effectively eliminates industry-wide insurance as well as government insurance as potential solutions. Segregating retail and institutional investors does not solve the MMF problem. Much like institutional investors, individual (or retail) investors also have been known to redeem MMF assets when trouble arises.... Importantly, it is also difficult to differentiate between institutional and retail investors."
The paper continues, "Capital solutions to the MMF debate can include multiple structures (or forms of capital) and multiple sources of capital.... Notably, the proposals outlined above need not constitute an allor-nothing proposition. A hybrid approach that uses some facet of the aforementioned models could be a desirable solution. Rather than being overly prescriptive, regulators could allow for some market innovation -- specifying the minimum amount of capital and timeframe for capital to be in place, and then allowing each plan sponsor to address the problem in a way that best meets its needs. However, the benefits of flexibility need to be weighed against the cost of complexity. Ultimately, a hybrid approach may introduce too much complexity."
In Conclusion, Novick, Hoerner and Mendelson comment, "When considering MMF reform, it is important to reflect on the role MMFs play in the overall short-term financing markets for corporations and municipalities and, by extension, the tremendous impact they have on the functioning of our economy. As additional structural change is considered, care must be taken to ensure that the reforms, both individually and collectively, achieve the objective of protecting MMFs and the shareholders who invest in them without inadvertently destabilizing financial markets. BlackRock has advocated "capital solutions" from the outset of the MMF reform discussions, and we are not surprised that many of these solutions remain under consideration today. We welcome the opportunity to continue to engage in finding the optimal solution that would both maintain MMFs as a viable cash vehicle and strengthen Rule 2a-7 to enable MMFs to better withstand risks."
Finally, they add, "Following are several important considerations: Amount of capital. The amount of capital required by MMFs to ensure a sufficient cushion is a critical discussion and one that is important regardless of the source of capital. We believe the amount of capital should reflect the level of risk in a given portfolio.... The SEC can further modify Rule 2a-7 to reduce liquidity risk even more through a requirement that MMFs limit concentration by not permitting any shareholder to purchase shares if, after such purchase, the shareholder would own more than 5% of the MMF's outstanding shares.... As discussed earlier, the inclusion of redemption fees in Rule 2a-7 could further protect a fund from a run and reduce the amount of capital required. Based on the capital guidelines that ultimately are established, some plan sponsors may decide that the amount is achievable, whereas others may choose to exit the MMF business.... MMF participants must focus on refining the remaining options. Setting out clear objectives and constraints will help all interested parties (investors, CP issuers, plan sponsors, regulators, trade associations) focus their efforts and energy on finding the best possible solution. Each of the remaining options has unresolved issues; however, an intense collaborative effort will be important in addressing these issues and strengthening and enhancing the MMF industry."
The Federal Deposit Insurance Corporation's latest "Quarterly Banking Profile" says, "Commercial banks and savings institutions insured by the Federal Deposit Insurance Corporation (FDIC) reported an aggregate profit of $28.8 billion in the second quarter of 2011, a $7.9 billion improvement from the $20.9 billion in net income the industry reported in the second quarter of 2010. This is the eighth consecutive quarter that earnings registered a year-over-year increase. As has been the case in each of the last seven quarters, lower provisions for loan losses were responsible for most of the year-over-year improvement in earnings." FDIC Acting Chairman Martin Gruenberg comments, "Banks have continued to make gradual but steady progress in recovering from the financial market turmoil and severe recession that unfolded from 2007 through 2009.... [T]his trend has expanded to include a growing proportion of insured institutions."
The FDIC writes, "Net operating revenue (net interest income plus total noninterest income) was lower than a year ago for the second quarter in a row, as net interest income declined by $1.9 billion (1.7 percent) and noninterest income fell by $1.1 billion (1.9 percent). The decline in net interest income was caused by lower asset yields at a number of the largest banks, reflecting growth in low-yielding balances at Federal Reserve banks. Net interest margins (NIMs) were lower than a year earlier at nine of the ten largest banks. Industry-wide, half of all banks (50.7 percent) had NIM declines, although only 39.4 percent reported declines in net interest income. The average NIM in the second quarter was 3.61 percent, down from 3.76 percent in second quarter 2010."
Under the section, "Large Noninterest-bearing Deposits Register Strong Growth," the FDIC quarterly says, "Total deposits increased by $163.1 billion (1.7 percent) in the second quarter. Deposits in domestic offices rose by $234.4 billion (2.9 percent), while foreign office deposits fell by $71.3 billion (4.4 percent). Noninterest-bearing domestic deposits increased by $165.6 billion (9.5 percent), and domestic deposits in accounts with balances greater than $250,000 rose by $279.6 billion (8.8 percent). Balances in large (greater than $250,000) noninterest-bearing transaction accounts that have temporary unlimited deposit insurance coverage through 2012 increased by $161.8 billion (15.4 percent). Most of the growth in large denomination deposits occurred at the largest banks."
It adds, "The 19 banks with assets greater than $100 billion reported an aggregate increase of $241.4 billion (12.6 percent) in domestic deposits with balances greater than $250,000 during the quarter. More than half of this increase ($127.7 billion) consisted of growth in large noninterest-bearing transaction accounts with unlimited deposit insurance coverage. All other insured institutions reported an aggregate increase of $35.1 billion (2.8 percent) in large-balance deposits. Time deposits declined for the 10th quarter in a row, falling by $41.3 billion (2.1 percent). Fed funds purchased and securities sold under repurchase agreements fell by $24.6 billion (4.6 percent). Advances from Federal Home Loan Banks declined by $16.9 billion (4.7 percent), and other secured borrowings fell by $30 billion (8.1 percent)."
The Quarterly adds, "Insured institutions had $1.9 trillion in domestic noninterest-bearing deposits on June 30, 2011, 64 percent ($1.2 trillion) of which was in noninterestbearing transaction accounts larger than $250,000. Of this total, $1.0 trillion exceeded the basic coverage limit of $250,000 per account, but was fully insured by the temporary unlimited coverage. Banks with under $10 billion in assets funded 3.6 percent of their assets with deposits receiving the temporary unlimited coverage, while these deposits funded 8.8 percent of assets at banks with more than $10 billion in assets. The total amount receiving temporary unlimited coverage increased by 17.2 percent ($153.8 billion) during the second quarter, following growth of 4.1 percent ($34.8 billion) during the first quarter."
A footnote explains, "The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), enacted on July 21, 2010, provides temporary unlimited deposit insurance coverage for noninterest-bearing transaction accounts from December 31, 2010, through December 31, 2012, regardless of the balance in the account and the ownership capacity of the funds. The unlimited coverage is available to all depositors, including consumers, businesses, and government entities. The coverage is separate from, and in addition to, the insurance coverage provided for a depositor's other accounts held at an FDIC-insured bank."
Fitch Ratings released a report entitled, "U.S. Money Funds and European Banks: Exposures Down, Maturities Shorter" which "updates its analysis of the exposures of U.S. prime money market funds (MMFs) to European banks." The company says in statement, "Based on a sample of the 10 largest U.S. prime MMFs, Fitch Ratings' study reveals that: MMFs reduced the maturity profile of their CD exposures to European banks in several countries (e.g., of the major European issuers, maturities of French bank CDs shortened the most); Exposure to European banks declined 9% (on a dollar basis) since the end of June and 20% since the end of May; and, Overall exposure to European banks remains significant, representing 47% of total MMF assets in Fitch's sample (down from 48.7% of MMF assets as of end-June)."
Fitch's update explains, "As of month-end July, the MMFs sampled reduced their total exposure to European banks by 9.0% on a dollar basis relative to the prior reporting period of month-end June 2011, and by 20.4% relative to month-end May 2011. European bank exposure currently represents 47.0% of total holdings of $658 billion within Fitch's sample of the 10 largest prime MMFs. This share is down from 48.7% as of month-end June, which was based on total MMF holdings of $698 billion." (See also Crane Data's Aug. 12 News piece, "French Banks Among Top 10 Holdings; MFs Hold 100 Bil. Cash in July".)
In other news, a separate press release says, "SunGard has added credit risk analysis capabilities to its SunGard Global Network (SGN) Short-Term Cash Management portal, a global compliance, trading and research solution for institutional cash investors. Gathering fund data from Standard & Poor's, Sector Treasury and Crane Data, the SGN portal's risk analysis solution provides corporate treasurers with actionable credit and counterparty data to help increase transparency, make critical investment decisions, reduce risk and exposure, and improve operational efficiency." (Crane Data is providing its monthly Money Fund Portfolio Holdings information to SunGard and a number of other "portals" and clients to form the core of various "transparency" database initiatives. E-mail us to request more information on our Holdings series.)
The SunGard release explains, "Investors in money market funds and other short-term cash vehicles need automated tools to help them manage risk more efficiently. Accessible and accurate information is vital to performing any type of risk analysis, yet consolidating and analyzing risk and return information across security types can be time-consuming and challenging. The SGN Short-Term Cash Management portal is a global, multi-fund trading platform that helps corporate treasurers increase efficiency in researching, analyzing and gathering relevant information to help optimize short-term investments. The portal's risk analysis solution helps firms measure risk quickly by providing aggregate, cross-asset counterparty and credit data from multiple data providers in a single location. This helps investors view funds' underlying holdings by characteristics such as country, security type, credit rating or maturity structure on a consolidated basis across their entire portfolio."
Finally, a number of other money fund ratings have been announced over the past few days. Standard & Poor's Ratings Services says, "[I]t has changed its fund ratings on four Luxembourg-domiciled money market subfunds of Aberdeen Liquidity Fund (Lux) to 'AAAm' principal stability fund ratings from 'AAAf/S1+' fund credit quality and volatility ratings. The subfunds are managed by Aberdeen Asset Management in London. 'AAAm' principal stability fund ratings have been assigned to the following funds: Aberdeen Liquidity Fund (Lux) – Canadian Dollar Fund; Aberdeen Liquidity Fund (Lux) – Euro Fund; Aberdeen Liquidity Fund (Lux) – Sterling Fund; and, Aberdeen Liquidity Fund (Lux) – US Dollar Fund."
Another release says, "Moody's Investors Service assigned money market fund ratings of Aaa-mf to four recently launched fund share classes offered pursuant to "hub and spoke" structures. All of the related entities are managed by Western Asset Management Company and each of the four hub funds are rated Aaa-mf by Moody's. The four share classes are as follows: Western Asset Institutional Cash Reserves, Investor Shares, Western Asset Institutional Government Reserves, Investor Shares, Western Asset Institutional U.S. Treasury Reserves, Investor Shares, and Western Asset Institutional TaxFree Reserves, Investor Shares."
We learned from a mention in FT Alphaville (an article "Shadow banking – from Giffen goods to Triffin troubles") about a recent IMF Working Paper entitled, "Institutional Cash Pools and the Triffin Dilemma of the U.S. Banking System by Zoltan Pozsar, which sheds some light about the institutional cash management space beyond money market funds, and proposes renaming the "shadow" banking system the "market-based financial system". The paper's Abstract says, "Through the profiling of institutional cash pools, this paper explains the rise of the "shadow" banking system from a demand-side perspective. Explaining the rise of shadow banking from this angle paints a very different picture than the supply-side angle that views it as a story of banks' funding preferences and arbitrage. Institutional cash pools prefer to avoid too much unsecured exposure to banks even through insured deposits. Short-term government guaranteed securities are the next best choice, but their supply is insufficient. The shadow banking system arose to fill this vacuum. One way to manage the size of the shadow banking system is by adopting the supply management of Treasury bills as a macroprudential tool."
Posner, who previously wrote about "shadow" banking at the New York Federal Reserve Bank, writes, "This paper aims to answer the question why the bulk of institutional cash pools are not invested directly in deposits in the traditional banking system but in deposit alternatives and primarily in the so-called "shadow" banking system. It analyzes the portfolio allocation rationale of institutional cash pools with the aim to better understand the systemic risks inherent in their allocations presently. To the best of the author's knowledge, this paper is the first to study the phenomenon of institutional cash pools and to ask why wholesale funding markets have grown, what the growing presence of institutional cash pools means for financial stability, and whether, in the context of the rise of institutional cash pools, the effectiveness of an official safety net for banks and deposits only has been eroding over time."
He explains, "The paper builds on other analyses that link the recent financial crisis to demand for safe assets (see Acharya and Schnabl (2009), Caballero (2010), and Bernanke (2011)). According to these views, the financial crisis was driven by an insatiable demand from the rest of the world for safe, high-quality (that is, AAA) debt instruments, which the U.S. financial system produced through the securitization of lower-quality ones. This paper adds two new dimensions to these views. `First, it differentiates between demand for long-term AAA assets (the focus of the above papers) and short-term AAA assets (the focus of the present paper). Second, it expands the discussion of the demand for AAA assets from foreign central banks' demand for long-term AAA assets, to U.S. domiciled, but globally active non-financial corporations' and U.S. domiciled institutional investors' demand for short-term AAA assets. Throughout this paper, the demand for short-term AAA assets is referred to as the demand for insured deposit alternatives (see Gorton (2010), Stein (2010) and Krishnamurthy and Vissing-Jorgensen (2010)), and demand for them is explained by the secular rise of institutional cash pools."
Pozsar continues, "In the context of the global savings glut, institutional cash pools' demand for short-term AAA assets can be viewed as the flipside of foreign central banks' demand for long-term AAA assets. In turn, cash pools' demand for short-term AAA assets is the principal source of marginal demand for maturity transformation in the financial system. The paper has five conclusions. First, insured deposit alternatives dominate institutional cash pools' investment portfolios relative to deposits. The principal reason for this is not search for yield, but search for principal safety and liquidity. Second, between 2003 and 2008, institutional cash pools' demand for insured deposit alternatives exceeded the outstanding amount of short-term government guaranteed instruments not held by foreign official investors by a cumulative of at least $1.5 trillion; the "shadow" banking system rose to fill this gap. From this perspective, the rise of "shadow" banking has an under-appreciated demand-side dimension to it."
He adds, "Third, institutional cash pools' preferred habitat is not deposits, but insured deposit alternatives. This is to say that institutional cash pools' money demand is satisfied by non-M2 types of money. This is because institutional cash pools' money demand is not for transaction purposes, but for liquidity and collateral management as well as investing purposes, which aren't best met by deposits, but by Treasury bills and repos. Fourth, the larger institutional cash pools and their demand for insured deposit alternatives grows relative to the supply of short-term government guaranteed instruments in the financial system, the less effective deposit insurance and lender of last resort access for banks only will be as stabilizing forces in times of crises. Fifth, an elegant way to solve the financial system's fragility due to the rise of institutional cash pools and "shadow" banking would be to issue more Treasury bills and to explicitly incorporate the supply management of bills into the macroprudential tool kit. While not without costs or alternatives, this approach is less troublesome and complicated than the alternative of intense real-time monitoring and regulation of the shadow banking system."
Finally, the intro explains, "The paper has six remaining sections. Section II measures the size of institutional cash pools in the non-financial corporate sector in the U.S. and globally, and among institutional investors in the U.S. Section III discusses the philosophy of how institutional cash pools attain security for their funds. Section IV discusses the portfolio allocation details of institutional cash pools and -- in light of these details -- highlights the gap between the accounting concept of cash equivalents and the scope of traditional monetary aggregates. Section V discusses the U.S. banking system's Triffin dilemma. Section VI provides policy recommendations and asks whether Basel III, higher deposit insurance limits and the repeal of Regulation Q will adequately deal with the secular rise of institutional cash pools and the systemic risks their safety preferences engender. Finally, Section VII concludes with offering an alternative, "non-arbitrage" explanation of the raison d'etre of the "shadow" banking system, and accordingly, proposes to rename it the market-based financial system."
Today, we continue with our excerpts from Money Fund Intelligence's interview with Morgan Lewis's Buddy Donohue. MFI: What do you expect to see? What would you like to see? Actually what I expect to see is not that far different from what I would like to see. I think one proposal, and there could be multiple proposals that the Commission comes out with, but here is the proposal that I think has legs and one that I think would be beneficial. First, limit the ownership of shares of money market fund by an individual or its affiliates to less than 5%. You then have a decreased risk that an investor deciding to pull money from a money market fund can have a harmful effect on other shareholders.
Second, require greater transparency from omnibus and similar accounts, enabling the money market fund to better evaluate liquidity and other needs. If omnibus accounts don't provide that transparency then the omnibus account itself will be subject themselves to the 5% limit. We've heard that from several of the money market fund providers that if they're not going to have to maintain liquidity in excess to what they probably really need, they need greater transparency to into who the beneficial owners are of their funds.
Third, require money market funds which desire to maintain a stable $1.00 NAV to have two classes of shares. This is an idea I have been interested in for quite a period of time. I'll give you a concept that I think works, which is that you have income shares, and those would be your traditional money market fund shares that are now provided to investors and they would continue to have a stable NAV of $1. Then you'd have capital shares. These would be sold to the investment advisor, and would constitute a certain percentage of the fund.
The fund itself would be mark-to-market, so you wouldn't have the criticism that the total fund is not subject to the discipline that regime imposes on financial institutions. The proposal would enable the investment advisor to actually recoup capital that's committed to the fund to support the $1.00 NAV. During the crisis there considerable capital used to support money market funds, and the adviser (or an affiliate) would have to just write checks and had no ability to recoup it. With this new approach, if you're a capital share owner over time you have the opportunity to take capital gains and recoup some of your losses.
So that is one of the ideas, I think, that is out there. It's similar, in part, to the Squam Lake proposal, although if I recall correctly they didn't necessary have the manger having to own the shares. I thought the manager owning the shares is actually the best way to go.... It aligns the manager's interest with regards to how much risk they are willing to take for the fund. It limits the growth of the fund to the manager's capabilities of supporting it.... It has the capital support for the stable $1.00 NAV inside the fund, so you don't have to rely on anything or anybody outside of the fund make the fund income share owners whole. It happens automatically. I think it has a lot to argue for and of course if somebody doesn't want to do that, they can provide a floating net asset value fund for investors.
It addresses many of the concerns raised about stable NAV. It will enable money market fund investors to know how much support the fund has from the adviser, making the implicit support explicit. It significantly reduces the likelihood that a money market fund will 'break the buck'. It lessens the incentive for income investors to flee the fund, as there is a level of support for the investor shares provided by the capital shares and the adviser has a disincentive to allow hot money in the fund.
Something we all should be mindful about when evaluating the buffer proposal is that if the buffer is too great it's probably not economically feasible, and if it is too small it is probably more dangerous than not having any buffer. It may be providing a false level of security to investors and regulators. As I have indicated previously, I don't think there are any easy answers here but it is important that we address the issues in a manner that works, that is economical and that preserves the benefits that money market funds have provided to investors, issuers and the capital markets.
The following is excerpted from this month's Money Fund Intelligence, which interviewed Andrew 'Buddy' Donohue, a Partner at Morgan Lewis & Bockius and the former director of the Division of Investment Management at the U.S. Securities and Exchange Commission (SEC). We asked him about the future of money funds and pending regulation, and discuss recent developments in money fund oversight.
MFI: What are your thoughts on the status of possible regulatory changes? Donohue: As we're thinking about potential changes, I think it is helpful to understand the history of where we are and how we got here. I'm not going back to the financial crisis but rather to what has transpired since the financial crisis. In early 2009 the ICI Working Group issued its report recommending regulatory reforms to strengthen money market funds. Then in June of 2009, we had the SEC propose changes to rule 2a-7. In addition to the proposals, the SEC solicited comment on the floating NAV and redemption in kind, recognizing that they hadn't addressed, in their proposal, all of the issues that needed to be addressed. The SEC then adopted 2a-7 in February 2010.
At that time, the Chairman was quite candid in saying that this was but the first step, and that more needed to be done. The PWG report then came out, in October of 2010, and set forth many of the concerns regulators had and some of the alternative means of addressing those concerns. I thought the PWG report was very well balanced, although I have to confess that my group had a fair amount to do with the drafting of that report.
That report discussed a number of alternatives for consideration that dealt with the susceptibility of money market funds to runs -- the floating NAV; private emergency liquidity facility; mandatory redemption in kind; insurance; two tiers of money market funds; and, the possibility of treating mmfs with the stable NAV as special purpose banks. There also was recognition of the challenge [involving] unregulated alternatives to money market funds. [T]here may be a need to do more than to just address 2a-7.
In the PWG report they discuss the susceptibility of MMFs to runs. They attribute it really to a number of different factors -- the maturity transformation that funds provide, the stable $1.00 NAV, credit and interest rate risks, and the discretionary response of capital support. I think the PWG was balanced regarding the benefits and the detriments of the different approaches that they had identified. I think that the report clearly showed that while the issues were quite important there are no easy answers. And as I like to tell people, if there was an easy answer the SEC would've already done it.
After the President's Working Group report came out, the SEC asked for comments and received a significant number of them. Then, the SEC held a roundtable, [and subsequently] the ICI had a similar roundtable on money market funds. Then just very recently, last month, the FSOC came out with their annual report to Congress and in their recommendations they highlighted that there was a need for additional reforms to address structural vulnerabilities for money market funds.
The FSOC report had a particular emphasis on a mandatory floating NAV, capital buffers to absorb fund losses to sustain a stable NAV, and 'deterrents to redemption' paired with capital buffers to mitigate investor runs. So there has been a fair amount of work done by the regulators and the industry in this area. Money market funds have also been the focus of attention in the press, particularly as money market fund exposures to the risks of potential downgrades or defaults in Europe from sovereign debt have been highlighted, and more recently with regard to our own Government securities. As an aside, it is the high level of transparency around their portfolio holdings provided by money market funds on a monthly basis in regulatory filings and on their websites which enables this healthy discussion. Another thing not to lose sight of is that we are approaching the third anniversary of Lehman. So I think more is going to happen. I think the SEC will be making an additional proposal, and I think it'll be sooner rather than later. I am also concerned that if the SEC does propose further reform other members of FSOC may feel that they may need to act.
MFI: Do you think recent reports have it right, that they're focusing on the floating NAV and buffers? In response to the PWG report and [SEC] roundtable, it was very interesting [to see] the comments.... There seemed not to be an agreement with regard to what should be done. But there were some new ideas that were floated, many by industry participants, in terms of ways to strengthen money market funds.... [I]f you look across the landscape of the different proposals that came in, you had one proposal that was recommending that the fund itself built up a buffer over time of up to probably about 50 bps to help make the fund itself less susceptible to runs and to credit events and interest rate events.... Another proposal from the industry was that money market funds should be managed by entities that could be special purpose entities with their own capital requirements and access to the federal reserve. Another industry idea that came back was the suggestion that unless you have some capital support for the stable $1.00 NAV in some form, then you shouldn't have a stable net asset value, you should have a floating NAV.
Another participant proposed that the funds, in times of stress, should impose a redemption fee, to make the fund whole, for the costs of somebody leaving the fund during times of stress, and mandating redemptions in kind at a certain level. There was not widespread agreement, although there seemed to be a fair amount of support for the liquidity bank. From the outside, you had proposals such as the Squam Lake, where the proposal was that there should be some form of explicit support for money market funds. If my recollection is correct, Squam had suggested it could be via a subordinated share class, the commitment or dedication of other securities to support the money market fund, or alternatively insurance.
And of course there were some proposals for floating NAV. What did come through in many of the forums where money market funds were being discussed was that mandating a floating NAV might have significant consequences for the funds, their investors and therefore potentially for the various enterprises that money market funds finance. And a challenge for a floating NAV funds would also be, 'How do you transition from a stable to a floating NAV money market fund without encouraging everybody to leave before you do that?' However, floating rate NAV money market funds could, I believe, be encouraged by the regulators as an alternative to stable $1.00 NAV money market funds. (To be continued tomorrow.)
The Mutual Fund Director's Forum wrote a news brief yesterday entitled, "Congress Questions SEC About Floating NAV for Money Market Funds," we learned from Attorney Joan Swirsky. The independent fund director's organization writes, "In a letter dated August 12, 2011, House Financial Services Chairman Spencer Bachus and Subcommittee Chairman Scott Garrett, joined by 14 other committee Republicans, questioned SEC Chairman Mary Schapiro about the SEC's consideration of floating NAV money market funds. The letter was sent in response to her testimony before that subcommittee on June 24, 2011 that the SEC was "actively discussing floating NAVs" as a way to ensure that we do not have a "run on money market funds." The letter asks Chairman Schapiro to respond to nine questions, all of which appeared designed to highlight the dangers of floating NAVs for money market funds."
The letter from the U.S. House of Representatives' Committee on Financial Services says, "On June 24, 2011, the Subcommittee on Capital Markets and Government Sponsored Enterprises held a hearing entitled, "Oversight of the Mutual Fund Industry: Ensuring Market Stability and Investor Confidence." This hearing ... included extensive discussion of the numerous issues facing the mutual fund industry."
It explains, "One of the issues discussed during the hearing was the advisability of requiring money market mutual funds to have floating net asset values (NAVs). On this issue, the majority of the witnesses cautioned against such an approach. For example, Professor Mercer Bullard of the University of Mississippi School of Law stated that "requiring [MMMFs] to float their NAVs would eliminate an investment option chosen by tens of millions of investors as the best option for their safe money, only to re-create precisely the same problem in floating NAV funds that these funds were intended to solve." Paul Stevens, the President & CEO of the Investment Company Institute, also expressed skepticism ... stating that "[t]here is compelling evidence that a substantial portion of money market fund investors either would be unable or unwilling to use a floating NAV money market fund" and "the primary effect of requiring money market funds to float their NAVs would be a major restructuring and reordering of intermediation in the short-term credit markets, which would not reduce -- and might well increase -- systematic risk."
The Bachus and Garrett letter continues, "Given the testimony received by the Subcommittee on June 24, it was somewhat surprising when you told the Senate Banking Committee on July 21, 2011 that the Securities & Exchange Commission was "actively discussing floating NAVs" as a way to ensure that we do not have a "run on money market funds." To assist the Committee in reconciling the views expressed by many of the witnesses at our June 24 hearing with the Commission's active consideration of proposals to "float the NAV," we would appreciate your answers to the following questions."
The letter asks, "Do investors understand that money market mutual funds pose some risks and are not insured deposits? If not, could the SEC enhance existing disclosures which explain money market mutual fund risks? Do all investors know that a money market mutual fund's net asset value has the ability to fall below one dollar? Are there ways to increase transparency around a fund's net asset value without the floating NAV? Do all money market mutual funds pose the same risks to the U.S. financial system?"
It also queries, "What has been the success or failure of the SEC's 2010 reforms to the money market fund Rule 2a-7? Do investors and the capital markets have better information about the product as a result of the changes? Have the Rule 2a-7 reforms changed the behavior of money market mutual fund providers, boards and investors? What would happy to the long-term viability of money market mutual funds if the Commission required the net asset value to float? Would requiring money market funds to float their net asset values have negative consequences on the ability of both the public and private sectors to meet their short-term funding needs?"
Finally, the Committee asks, "What empirical evidence does the Commission have to support a floating net asset value for money market mutual funds? Could the Commission prevent future stress on money market mutual funds with enhanced oversight by using its authority to require a fund provider to de-leverage certain assets, or is the floating net asset value the Commission's only option to prevent a run on one or more funds?"
The letter concludes, "Money market mutual funds play a very important role in our economy, holding approximately $2.7 trillion in assets, and thus any action on the Commission's part to alter the composition of these products must ensure that the end result is a viable and stable market, and that U.S. companies and states and municipalities continue to have access to necessary sources of short-term funding. We look forward to receiving your responses to the above questions by August 26, 2011."
Columbia Law School Professor Jeffrey Gordon posted a Comment Letter on the President's Working Group Report on Money Market Fund Reform on Friday, which discusses an alternate variation of the so-called Squam Lake proposal, a "buffer" option with a senior tranche of share classes designed to shoulder any default losses. (There haven't been many comments added recently, but see here for all the PWG Report letters.) Gordon says, "This letter offers a specific proposal for the regulation of Money Market Funds (MMFs). The proposal responds to comments made at the Commission's Roundtable Discussion on May 10, 2011 and the public comments on the President's Working Group report on Money Market Fund Reform, per Investment Company Act Release No. IC-29497. I respectfully request that this correspondence be included in the record of the Commission's rule-making in this area."
Gordon continues, "I will assume without further argument a general consensus that the Commission's prior Money Market Fund reforms -- which require more liquidity and portfolios of shorter maturity and higher quality -- are insufficient to address the systemic risks of this particular financial intermediary. These Reforms do not address a central weakness: the inability of MMFs to bear the default of any portfolio security.... Unless the Fund's sponsor steps in to buy the defaulted security at par, the Fund will 'break the buck.' The Reforms at best partially address the limited capacity of MMFs to bear market risk associated with increased default risk of assets on MMF balance sheets, which can reduce the market value of a Fund's portfolio below the permitted lower bound under penny-rounding."
He explains, "In response to the proposals discussed in President's Working Group, three main reform proposals have emerged. The first is to permit net asset values (NAV) to float, in order to desensitize investors to relatively small valuation fluctuations in money market funds. The second is to create a liquidity back-up facility that could lend against money market fund assets at par, to avoid asset fire sales that would depress values. The third is to provide a capital cushion that could absorb losses in respect of a default on a portfolio security or upon the below-par sale of a portfolio asset. In my view the third general proposal, for a capital cushion, is the best approach for addressing the systemic risks of money market funds, given existing practical constraints, including the desirability of a proposal that can be effectuated under existing statutory authority."
Gordon says, "This letter offers a specific proposal designed to achieve goals of systemic stability and simplicity in implementation. The proposal in rough form is this: All money market funds will issue two classes of equity, Class A, designed to retain a fixed NAV, and Class B, whose value will float to cover outright defaults or depreciation in market value of portfolio securities. Class B issuances must equal (or exceed) the largest single portfolio position permitted by regulation or by the fund's fundamental policy (a self-imposed limitation) plus an additional amount to reflect the risk of a general decline in money market asset values outside of such a default. Because Class B is loss bearing, Class A will be able to retain a fixed NAV in virtually all circumstances. The proposal treats institutional funds and retail funds differently as to the source of the Class B capital. For institutional funds, the investors in the fund must buy the class B shares; for retail funds, the sponsor must buy the Class B shares. The following discussion therefore treats these two types of funds separately. The discussion also separately treats government funds."
He continues, "Others such as the Squam Lake group have proposed a two class structure to provide an equity cushion. The novel element of my proposal is the source of the equity: investors in institutional funds will provide the additional equity, as follows. An investor will initially be required to buy a 'unit' that consists of Class A and Class B shares. However, the investor's subsequent purchases and redemptions of Class A shares need not be accompanied by the purchase of additional Class B shares so long as the investor's Class B ownership is at least as large as the required initial ratio."
Gordon writes the SEC, "The unit concept therefore provides an additional element of systemic stability beyond proposals that just call for a capital cushion. A capital cushion cannot, by itself, fully protect against runs. Even if the capital could absorb the loss of the largest portfolio position, another default could break through the Class B. Thus in periods of financial instability, runs remain a threat despite first loss protection, because the run strategy presents no downside for the individual running investor. A Class A/Class B unit changes the dynamic. Default risk, especially risk of multiple defaults that break through the Class B, is fact low. By contrast, given a run, the chance of fire sale losses is much higher. A holder of matching Class B shares now sees downside in the decision to run, with a much greater probability of loss because of the run itself. The combination of the capital layer and the unit approach should significantly increase money market fund stability."
He adds, "In the debate around the President's Working Group report, institutional users of money market funds have strenuously argued on behalf of fixed NAV as an essential feature. Fixed NAV makes money market fund transactions as smooth as cash transactions at a bank, avoiding the accounting and tax issues that would burden MMF transactions with costs and inconvenience.... Think of it this way: Money market funds permit institutional users to outsource the cash management function while obtaining money market rates that have been higher on average than bank rates. MMFs provide efficient diversification and credit investigation in money market instruments. If MMFs did not exist, large institutions would have to assemble their own staffs to perform such functions. Purchase of the Class B shares is an efficient alternative to such on-going costs; it can be seen as a relatively small one-time commitment that provides indefinite benefits, not unlike being required to maintain a minimum balance in a bank account to obtain its benefits."
Finally, Gordon says, "The guiding principle of this proposal is straightforward: Money market mutual funds impose systemic risk costs on the entire financial system. The costs should be internalized. These proposals for institutional MMFs and retail MMFs should achieve that goal while preserving the key attributes of fixed NAV, relative simplicity, and access to money market rates that make the MMF attractive in the marketplace."
The Investment Company Institute recently published its quarterly "Worldwide Mutual Fund Assets And Flows" for the First Quarter 2011, which "compiles worldwide statistics on behalf of the International Investment Funds Association, an organization of  national mutual fund associations." The report shows that the U.S. continues to represent over half of the global total at 54.9% and that U.S. money fund assets declined by $76.6 billion, or 2.7% in Q1. France, which ranks second with $550.5 billion (11.1%) of the global total, increased its assets by $23.4 billion (4.4%), and 4th-ranked Luxembourg, at 8.0% of assets, also increased assets (by $14.8 billion, or 3.8%). Ireland, which just began breaking out money fund assets on the latest report, ranks 3rd among all money fund managing nations (due to its huge "offshore" or multi-national business) with $476.5 billion, or 9.6% of assets.
The press release on ICI's quarterly report says, "Mutual fund assets worldwide increased 3.7 percent to $25.61 trillion at the end of the first quarter of 2011. Worldwide net cash flows into all funds slowed to $78 billion in the first quarter, after registering $152 billion of net inflows in the fourth quarter of 2010. Flows into long-term funds slowed modestly to $179 billion from $196 billion in the previous quarter. Equity funds worldwide had net inflows of $61 billion in the first quarter, down from $92 billion of net flows in the fourth quarter. Flows into bond funds were $57 billion in the first quarter, up from $31 billion of net flows in the previous quarter. Flows out of money market funds accelerated to $101 billion in the first quarter of 2011, after experiencing $45 billion of net outflows in the fourth quarter of 2010."
The report continues, "The growth rate of total mutual fund assets reported in U.S. dollars was boosted by depreciation of the dollar. For example, on a U.S. dollar–denominated basis, mutual fund assets in Europe increased 5.4 percent in the first quarter, compared with a decrease of 0.9 percent on a Euro-denominated basis. On a U.S. dollar–denominated basis, equity fund assets rose 5.0 percent to $11.1 trillion at the end of the first quarter of 2011. Balanced/mixed fund assets were up 5.9 percent and money market assets were down 0.5 percent in the first quarter. Bond fund assets increased 3.7 percent in the first quarter to $5.6 trillion."
It explains, "After slowing considerably in the third quarter of 2010, net outflows from money market funds accelerated for the second consecutive quarter. Money market funds worldwide experienced $101 billion of net outflows in the first quarter of 2011, up from $45 billion of outflows in the fourth quarter of 2011. Money market fund in the Americas and in the Asia and Pacific region experienced net outflows of $75 billion and $16 billion, respectively, in the first quarter after both regions posted net inflows of $5 billion, respectively, in the previous quarter. In contrast, net flows out of European money market funds slowed to $12 billion in the first quarter, compared with $55 billion of net outflows in the fourth quarter."
ICI also says, "At the end of the first quarter of 2011, 43 percent of worldwide mutual fund assets were held in equity funds. The asset share of bond funds was 22 percent and the asset share of balanced/mixed funds was 11 percent. Money market fund assets represented 19 percent of the worldwide total. The number of mutual funds worldwide stood at 70,358 at the end of the first quarter of 2011. By type of fund, 40 percent were equity funds, 23 percent were balanced/mixed funds, 18 percent were bond funds, and 5 percent were money market funds."
The 10 largest countries (among the 40 reporting money fund assets), with their total asset translated into dollars in billions (and market share), include: United States $2,727.3 (54.9%), France $550.5 (11.1%), Ireland $476.5 (9.6%), Luxembourg $399.6 (8.0%), Australia $272.4 (5.5%), Mexico $59.9 (1.2%), Korea $55.8 (1.1%), Italy $46.9 (0.9%), Brazil $44.0 (0.9%), South Africa $42.4 (0.9%), Canada $35.5 (0.7%), Japan $26.0 (0.5%), Taiwan $24.8 (0.5%), Switzerland $24.3 (0.5%), China $20.8 (0.4%), Norway $18.0 (0.4%), India $16.5 (0.3%), Chile $15.1 (0.3%), Turkey $15.0 (0.3%), and Finland $14.8 (0.3%).
French banking giants BNP Paribas, Societe Generale, and Credit Agricole remained among the largest investment positions in money market funds according to Crane Data's most recent Money Fund Portfolio Holdings report. Exposure to the three banks actually increased slightly in July, with gains in BNP Paribas and Societe Generale compensating for a $10.8 billion drop in Credit Agricole debt. Our latest Money Fund Portfolio Holdings report, which will be released later Friday to subscribers to Crane Data's Money Fund Wisdom product suite, also shows that money funds held over $100 billion in uninvested and "cash" assets as of month-end July.
Excluding U.S. Treasury debt holdings (which total $311.7 billion) and U.S. Government Agency securities ($319.9 billion), the 25 largest holdings among taxable money market mutual funds (as of July 31, 2011) include: Barclays Bank ($86.8 billion), BNP Paribas ($85.5B), Deutsche Bank AG ($75.7B), Societe Generale ($51.1B), RBS ($49.3B), Credit Suisse ($43.0B), Bank of America ($41.3B), Rabobank ($39.5B), Credit Agricole ($38.3B), Westpac Banking Corp. ($37.8B), RBC ($37.4B), JP Morgan ($36.6B), UBS AG ($36.1B), ING Bank ($35.9B), Goldman Sachs ($33.2B), Bank of Nova Scotia ($31.8B), Citi ($31.8), National Australia Bank Ltd. ($30.1B), HSBC ($27.1B), Svenska Handelsbanken AB ($24.3B), Nordea Bank ($24.0B), Bank of Tokyo-Mitsubishi UFJ Ltd. ($23.1B), DnB NOR Bank ASA ($18.4B), Commonwealth Bank of Australia ($18.3B), and Natixis ($17.2B).
France continues to represent the largest non-U.S. parented holdings in money market mutual funds with approximately 7.3% of the $2.1 trillion in taxable holdings tracked by Crane. Canada has moved into second place (5.6%), followed by the U.K. (4.0%), Netherlands (3.4%), Japan (2.7%), Germany (2.3%), Switzerland (2.2%), Sweden (1.9%), Finland (1.2%), and Norway (0.9%). Money funds reduced their already small positions, but continued to have marginal exposure to Spain (0.24%) and Italy (0.04%). Total Eurozone holdings accounted for 13.9% of all taxable holdings, while a broader count of all of Europe (including the U.K., Switzerland and the Nordic countries) totalled 24.3%. (Note of course that money fund holdings turn over rapidly, so the July 31 numbers many have changed substantially by now.)
Certificates of Deposit remained the largest component of taxable money fund holdings in July with $474.0 billion (22.6%), while Repurchase Agreements rank second with a total of $439.0 billion (20.9%). (The SEC breaks Repo into Government Agency Repurchase Agreement, 9.7% of assets, Other Repurchase Agreements, 5.7%, and Treasury Repurchase Agreements, 5.5%.) `Commercial Paper totalled $339.1 billion (Financial Company Commercial Paper accounts for 9.0%, Asset Backed Commercial Paper accounts for 5.1%, and Other Commercial Paper accounts for 2.1%). Government Agency Debt totalled $319.9 billion (15.3%) and Treasury Debt totalled $311.2 billion (14.8%), and a number of "Other" holdings (including Insurance Company Funding Agreement, Investment Company, Other, Other Instrument, Other Instrument (Time Deposit), Other Municipal Debt, Other Note, and Variable Rate Demand Note) totalled 10.2%.
Total assets in our Money Fund Portfolio Holdings taxable collection dropped by $189.2 billion in July, while our Money Fund Intelligence XLS monthly shows total assets in funds dropped by $103.0 billion. We presume the $86.2 billion difference in "uninvested cash" or assets not listed among the usual portfolio holdings. An additional $17 billion appears on various fund listings as "Cash", so we estimate that $103.2 billion in total was held in unlimited FDIC insurance noninterest bearning transaction accounts at custodial banks. (This was one of the reasons behind BNY Mellon's recent decision to charge additional fees on "extraordinary deposits" -- see our Aug. 5 News "Media Feeding Frenzy Over BNY Mellon Extraordinary Deposits Charge".)
Note that Crane Data has been tracking and publishing Money Fund Portfolio Holdings since the SEC began mandating standardized monthly postings of holdings on fund company websites. We exclude Treasury and Government Agency Repurchase Agreements from the above totals, but include Other Repurchase Agreements, Certificates of Deposits, and Commercial Paper (Asset Backed, Financial Company and Other). We recently added "Country" and "Issuer" tagging to the SEC's mandated fields, and we continue to refine and revise our categorization schemes.
Also, in other news, see Bloomberg's "Legg Mason Says It Won't Renew French Debt Held in Money Funds", which quotes Western Asset Portfolio Manager Kevin Kennedy, "Despite the fact that the banks are money good and there's no credit risk, within the money fund world we are susceptible to headline risk.... France has been identified as the big risk going forward should the dominoes start to fall."
Following yesterday's market concerns over French banks, Reuters wrote story entitled, "Top U.S. money funds stood by French banks in July". They write, "Major U.S. money market mutual funds continued to hold securities issued by top French banks in July, new data show, underscoring the close ties between the funds and the latest part of the financial system under stress. The data comes at a time of increased nervousness on the outlook for French banks over their exposure to other European economies. On Wednesday shares in Societe Generale fell 15 percent, while rivals Credit Agricole and BNP Paribas closed down 12 percent and 9.5 percent respectively."
This follows the publication late Tuesday of a J.P. Morgan Securities' "Short-Term Fixed Income Markets Research Note" entitled, "Update on prime money fund holdings for July 2011," which puts a different spin on the question of money funds' holdings of French banks. It comments, "Over the course of July, US prime money market funds again cut their exposures to Eurozone banks. Month over month, holdings of Eurozone paper (CP, ABCP, CD, and repo) declined by $38bn to $340bn, a 10% drop, and are now at the lowest level since we started tracking money fund holdings early last year. In June, prime funds had already reduced their exposures by $58bn."
Reuters continues, "[M]money funds have largely defended their French bank holdings since questions about them began this summer. The fact that they stood by the banks through July, despite major outflows from the funds' own investors during the period, might lend support to arguments that the French banks are sound now. Holdings are closely watched because money funds support so much of the global financial system. A pullback by the funds could in theory lead to a loss of liquidity for the French banks or other lenders."
The article explains, "So far no major pullback seems to be under way, said Alex Roever, head of short term fixed income strategy at JPMorgan Chase & Co, in an interview." They quote Roever, "I think the perception that money funds are trying to liquidate their foreign bank commercial paper positions is not quite right. This story of the banks being 'hungry for dollars' is overdone."
The piece also quotes Deborah Cunningham, Chief Investment Officer of Money Markets at Federated Investors, "We are definitely supportive of the view that the French banks ... continue to meet our assessment of high quality and represent minimal credit risk." It adds, "She said the company has not changed its positioning since the end of July."
The JPMorgan update adds, "Not surprisingly, of all the Eurozone exposures, French banks took the biggest hit with French unsecured bank paper declining by $27bn. Interestingly, the reduction was offset by an $11bn increase in French repo balances, likely reflecting investors' preference for shorter maturities. Indeed, the percentage of French holdings maturing less than 30d jumped from 28% to 48% last month." (Note that Crane Data will be publishing its comprehensive monthly Money Fund Portfolio Holdings series with data as of July 31 tomorrow around noon.)
With seeming disregard for its impact on savers, money markets and the money fund business model, the Federal Reserve Board changed its "extended period" of low Federal funds rates language to a pledge to hold rates at zero "at least through mid-2013" following its latest Open Market Committee meeting. In addition to likely dooming the economy to years more of its low-rate induced deep freeze, the Fed has also delivered money market funds another body blow when they can least afford it. Of course, funds have survived on gross yields of just over one-quarter of a percent and fund investors have survived on effectively zero yields for approaching three years now, so what's another two?
The Committee's statement says, "Information received since the Federal Open Market Committee met in June indicates that economic growth so far this year has been considerably slower than the Committee had expected. Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up. Household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Temporary factors, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan, appear to account for only some of the recent weakness in economic activity. Inflation picked up earlier in the year, mainly reflecting higher prices for some commodities and imported goods, as well as the supply chain disruptions. More recently, inflation has moderated as prices of energy and some commodities have declined from their earlier peaks. Longer-term inflation expectations have remained stable."
The Fed continues, "Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting and anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, downside risks to the economic outlook have increased. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations."
They explain, "To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee currently anticipates that economic conditions -- including low rates of resource utilization and a subdued outlook for inflation over the medium run -- are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate."
Finally, the Fed writes, "The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate. Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action were: Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period."
A statement released by S&P early yesterday says, "Standard & Poor's Ratings Services said today that the funds to which it has assigned principal stability fund ratings (PSFRs) are unaffected by the lowering of the long-term rating on the United States of America to 'AA+' on Aug. 5, 2011 (see "United States of America Long-Term Rating Lowered To 'AA+' On Political Risks And Rising Debt Burden; Outlook Negative")."
S&P explains, "Funds with PSFRs seek to maintain a stable or accumulating net asset value. PSFRs are closely linked to the short-term ratings on the U.S. government because for a fund to be eligible for an investment-grade rating, all investments must carry a Standard & Poor's short-term rating of 'A-1+' or 'A-1'. Because we affirmed the 'A-1+' short-term rating on the U.S., the lowering of the long-term rating does not directly affect the ratings on these funds; the credit quality of the U.S. still meets the credit quality standards for all PSFR categories. (For details about our criteria, see "Methodology: Principal Stability Fund Ratings," published June 8, 2011.)"
The release adds, "Stable net asset value (NAV) funds issue and redeem shares at $1.00, provided that their marked-to-market NAV per share is between $0.995 and $1.005. Although the U.S. sovereign debt downgrade has no direct impact on our PSFRs, we will closely monitor any potential price volatility associated with the lower long-term rating on the marked-to-market NAVs of our rated funds. A decline in the prices of U.S. Treasury and government securities (and other short-term money market instruments) could cause money market funds to experience a decline in their NAVs. We will track movements (if any) in a rated fund's NAV to see if it remains within the criteria metrics for their specific rating category (i.e., +/- 0.25% for 'AAAm', which translates to $0.9975-$1.0025)."
Finally, they add, "A PSFR, commonly referred to as a money market fund rating, is a forward-looking opinion about a fixed-income fund's ability to maintain principal value (that is, a stable NAV). PSFRs have an "m" suffix (for example, 'AAAm') to distinguish the principal stability rating from Standard & Poor's issue or issuer credit ratings."
The Investment Company Institute released a statement on Saturday entitled, "Standard & Poor's Downgrades U.S. Government Debt on the impact of Friday's action, and the mutual fund trade group also published a piece on Thursday entitled, "The Debt Ceiling Debate and Its Impact on Money Market Funds." We excerpt from both pieces below. ICI Senior Director for Policy Writing and Editorial Mike McNamee writes, "On Friday, August 5, Standard & Poor's Corp. downgraded the long-term sovereign credit rating on the United States of America to AA+ from AAA. The agency reaffirmed the U.S. government's A-1+ short-term rating, which is the rating that money market funds use in making their investment decisions. Moody's Investor Services and Fitch Ratings Ltd. have reaffirmed their Aaa and AAA ratings for long-term U.S. government debt."
McNamee continues, "This action by S&P does not change the analysis that ICI has offered in recent weeks on the impact of the U.S. debt and deficit issues on money market funds. In particular, it remains highly unlikely that this downgrade could force a money market fund to dispose of its U.S. government securities or 'break the dollar'."
The piece adds, "For more information on money market funds and the U.S. government credit rating, please see: "It's Highly Unlikely that Money Market Funds Will 'Break the Dollar' in U.S. Debt Crisis," "Frequently Asked Questions About Money Market Funds and Credit Ratings on U.S. Treasury Securities," and "Let's Preserve America’s Financial Standing in the World."
ICI's previous update, "The Debt Ceiling Debate and Its Impact on Money Market Funds," was written by Economists Chris Plantier and Sean Collins. It says, "Data on money market funds flows continue to draw attention, especially with today's report that net outflows totaled $66 billion in the week ending August 3. As ICI Chief Economist Brian Reid explained last week, several factors have been influencing recent flows. His analysis found that the standoff over the U.S. debt ceiling, concerns about Eurozone debt, and recent regulatory changes are among the major factors that could be affecting investors."
The piece continues, "While it's still difficult to sort out which of these factors is having the most impact on the flows during the last three weeks, the weekly and daily data from July 27 to August 3 indicate that uncertainty about the debt ceiling was the primary force affecting money market fund assets during the past week. Taking a closer look at the data -- both ICI's weekly figures and daily numbers from other providers -- offers some indications of the effect of the August 2 deadline for raising the U.S. government's debt ceiling and the tense days of uncertainty that preceded the debt-and-deficit agreement signed by President Obama by the deadline."
It explains, "ICI's weekly data show money market funds held roughly $2.6 trillion in assets as of August 3. That reflects $66 billion in net outflows from all types of money market funds during the past week -- more than is typical at this time of year -- with $77 billion flowing out of institutional money market funds. By contrast, retail money market funds saw inflows of $11 billion in the week ending August 3. It appears that a large amount of this week's net outflow was related to concerns over the U.S. debt ceiling negotiations. That's supported by daily data from Crane Data Money Fund Intelligence for the same week, which show that institutional money market funds posted outflows on July 28, 29, and August 1. These funds then gained small inflows on August 2 and 3 once it was clear that the debt ceiling would be raised." (Crane Data showed very large increases on August 4 and August 5 too.)
Finally, ICI writes, "What might be overlooked in a focus on the data is just how well money market fund managers prepared for and managed another period of market stress. The past week's net outflows amounted to almost 5 percent of the total assets of institutional money market funds. The 2010 SEC amendments to money market fund regulations require funds to hold at least 30 percent of their assets in securities that will be liquid within five business days -- a buffer that makes money market funds much more resilient when faced with redemptions. And money market fund managers have operated their funds above and beyond SEC requirements during this time of potential stress.... In summary, recent money market fund flows continue to reflect the uncertain and fluid nature of U.S. and global markets and events. Throughout this period, money market fund managers continue to manage portfolios to ensure they are positioned to weather these storms."
We were startled by the huge media interest in a two-page draft memo from Bank of New York Mellon indicating that the bank will begin charging fees on "sudden, significant" increases in deposits. Why banks charging fees or passing through negative yields would be big news was confusing to us, but we're happy to take any good news for money funds we can get. (Though it's mixed news -- money funds should benefit from corporate and institutional money shifting towards funds, but they'll also lose their own "safe harbor".) Money funds already appear to be benefitting from this news as assets surged by $24.9 billion yesterday, according to our Money Fund Intelligence Daily. We quote some of the coverage below, and look for more news in our August Money Fund Intelligence which e-mails to subscribers later this morning.
The Wall Street Journal appeared to be the first to cover the BNY Mellon charge, writing, "BNY Mellon to Charge for Deposits Above $50 Million." It says, Bank of New York Mellon Corp. is preparing to charge some large depositors to hold their cash, in the latest sign of the worries roiling global markets. The biggest U.S. custodial bank said this week in a note to clients that it will begin slapping a fee next week on customers that have vastly increased their deposit balances over the past month. The bank cited the massive dollar deposits it has received over recent weeks, as investors and corporations retreat from financial markets amid Europe's debt crisis and the recent debate over U.S. government borrowing."
The Journal adds, "Over the past two weeks, money-market funds, corporate treasurers and investment houses have pulled money out of securities that mature in more than one day in favor of stashing their cash in accounts at Bank of New York and other custody banks like J.P. Morgan Chase & Co. These accounts earn no interest, but are insured by the Federal Deposit Insurance Corp. Bank of New York said that it will charge 0.13%, plus an additional fee if the one-month Treasury yield falls below zero on depositors that have accounts with an average monthly balance of $50 million "per client relationship," according to a letter reviewed by The Wall Street Journal."
Bloomberg, in "BNY Mellon to Charge for Large Deposits", says, "Bank of New York Mellon Corp. (BK), the world's largest custody bank, will charge institutional clients a fee for "extraordinarily high" cash deposits to stem a flight of capital into the safety of bank deposits.... The rising deposits at custody banks represent mostly 'hot money' and some banks have begun to pass on the burden of insuring it to their large, institutional investors, Joseph Abate, money-market strategist at Barclays Plc in New York, wrote in a note to clients."
The article quotes, "If other banks follow BNY Mellon's example, investors may shift some of their cash into money-market mutual funds, said Peter Crane, president of money-fund research firm Crane Data LLC in Westborough, Massachusetts. The funds have faced a challenge in past months in finding enough securities they are eligible to buy and without lowering their yield."
Our Tuesday Crane Data News excerpted from Federated Investors' Q2 earnings conference call (see "Squam Lake Buffer Not Practical Solution Says Federated's Donahue"). Today, we quote from the Q&A section of the call, often the most interesting part of any earnings call. When asked about building capital for the possibility of future regulatory requirements, President & CEO Chris Donahue commented, "We've been looking at these ideas for several years now and it is a constant situation, where because money market funds are not perfect, people keep coming up with ideas. And there's a lot more ideas that people could come up with, that will still be studied."
He continued, "So I would say that it would be wise for somebody like Federated to not allow that to restrain us from moving forward. We don't think they're going to be doing anything that would kill the money market fund business in any event. All of the ideas are always couched in terms of 'study more' and then even the FSOC recently mentioned things like, 'in order to increase stability, market discipline and investor confidence, things should be studied'.... I think when the verdict comes in of all of the studies, you will find the money market funds standing there, though ... imperfect, demonstrating the resiliency they have to customers and in the marketplace."
Donahue also said, when asked about what proposals are more likely, "Well, it is very hard as I said for us to make a judgment about which one of these things can work when we don't initially perceive their workability. They didn't like the polite capital ideas that Fidelity had with 40 or 50 basis points of buffer. They didn't like the liquidity bank, which took care of the major problem that occurred in 2008, mainly the liquidity of the whole system. So they get down to ideas which have not shown themselves to be workable. Several percentage points of capital is neither economic nor viable in terms of maintaining the existence of prime funds. So it is really hard for me to try and say which one of these things is ahead of the other."
He continues, "If you do, however, look at some of the phrases they have used, they talk about something called 'deterrence to redemption.' I don't know exactly what they mean by that, that's a quote out of FSOC, but if what they are talking about are some pretty legitimately ideas that we think could work. For example, the way we did the Putnam deal back in the day.... [The] Putnam board decided to hit pause on redemptions for a week, and then turned the whole fund over to us, and there was plenty of liquidity in the system because the Fed opened up the windows to buy good paper. So notice there was no credit maneuver here it was all on liquidity. Well, if you give the board the right to do that without forcing a liquidation that would be an interesting one."
Donahue explained, "Another one on that would be, 'Well, what about redemption in kind?' It's been discussed many times. There is an example of a fund, the AMR fund, who basically said they were going to do a redemption kind and that ended the redemptions. I don't know if that is what they have in mind or not.... One other idea which was put out earlier on ... was to simply say that if you run into a reserve fund then take the 3% and set that aside and give everybody else daily liquidity at par of the 97% of the fund that is there and proceed down that road. Maybe that's what they mean by 'deterrence to redemption'. But at this point there is a lot of work that has to be done if they're thinking about doing the things that Squam Lake has been talking about."
Finally, Donahue was asked whether recent events would bolster the case for minor changes to money funds. He said, "The answer to that is yes. I think you already have seen it for 40 years of withstanding a lot of stuff in the marketplace. And I believe that money market funds came through the 2008 crisis very, very well, though dented. And I think they came through very, very well and are coming through very well all the noise associated with the Greek and the European situation. I think when we're able to look back on this, on the debt ceiling issue, that you will find the same thing. And part of the reason for that is the underlying resiliency of the funds themselves coupled with the desire of the investing public to use these funds for their cash management purposes. And these are two powerful ingredients in helping the overall economy."
Money market mutual fund assets rebounded on Tuesday following some of the worst daily asset declines in recent history. Crane Data's Money Fund Intelligence Daily shows money fund assets rose by $6 billion yesterday, after falling by $37.3 billion on Monday and $41.9 billion on Friday, the last day of July. (Note that some of Crane's daily asset totals use the prior day's data due to our early morning publication time.) Assets fell by almost 5.0% in the week through Monday, a drop of $121.7 billion, though the weekly drop has now been cut to $106.6 billion. Money funds declined by approximately $107.9 billion in July, the largest drop since April 2010.
Treasury money funds, led by Institutional funds, showed the largest percentage declines in the week through August 1, falling 8.2%, or $28.6 billion (to $321.5 billion), but they bounced the most yesterday (up $2.2 billion). Government money funds also dropped sharply in the 7 days through 8/1, down 6.6%, or $27.8 billion (to $392.5 billion), while Prime funds too saw declines (down 4.3%, or $63.5 billion to $1.399 trillion). Tax-Exempt money fund assets inched down by 0.7% ($1.9 billion), and Retail Taxable assets overall also showed minimal declines (-0.7%, or $5.2 billion).
Treasury Bill rates have moved inversely to Treasury money fund assets over the past week-and-a-half. According to the Treasury, the rate on a 4-week T-bill rose from 0.01% on July 20 to a recent high of 0.17% on Friday. Rates declined to 0.14% on Monday and plunged back to 0.05% yesterday. The brief spike in yields is already gone, though money fund yields may inch higher in coming days as the jump works its way through some funds. (Our Crane 100 Money Fund Index, an average of the 100 largest taxable money funds, recently inched up to 0.04% from 0.03%.) Finally, Fed funds rates remained elevated yesterday, however, closing at 0.16% after peaking at 0.17% Monday.
Following the debt ceiling limit increase, Reuters wrote "Money fund managers breathe easier on debt deal", which says, "Pressures on money-market mutual funds have ebbed now that a deal to raise the federal debt ceiling has been reached in Washington, fund industry executives said on Tuesday."
The article quotes John Donohue, CIO for money market funds at JPMorgan Chase & Co's asset-management arm, "A lot of the uncertainty was just cleared up, so that's a positive." Reuters adds, "He and others expressed confidence money that left the funds because of the recent uncertainty would return."
Reuters' also quotes Sue Hill, senior portfolio manager for Federated Investors, "Investor concerns have certainly lessened considerably," said Hill said flows within the company's money funds had returned to "typical" levels since Monday after the outlines of a deal were announced." "We're glad to have this deal signed," she said.
Note: For more detailed information on money fund asset flows and for more coverage on recent events, see the pending August issue of Money Fund Intelligence and our latest MFI Daily publication. (Subscriptions are required.)
On Friday, Federated Investors hosted its second quarter earnings conference call and, as is usually the case, President & CEO Chris Donahue and Taxable Money Market CIO Debbie Cunningham commented extensively on various issues involving money market mutual funds Donahue said, "On the regulatory front, money funds continue to be an active topic of discussion. Based on comments from the SEC, and the FSOC, the regulators believe that further changes should be considered and are under review. We are unable to make any predictions on any particular outcome or a particular timeline. We do note, however, that the industry, issuers, and investors in money funds are opposed to a fluctuating NAV. In our view, there is no evidence that a floating NAV would positively impact investor redemption patterns or improve the resiliency of money funds. In fact, we believe fluctuating NAVs would have the opposite effect."
He continued, "Capital buffers are not necessarily responsive to the severe liquidity crisis that negatively impacted money funds and other investors in 2008. Our initial reaction to ideas like the Squam Lake capital buffer, before the results of the voluminous studies necessary to adequately research such a concept with this level of complexity, is that it's probably not a practical solution. One outcome could end up being to compress or even eliminate the spread between Prime and Government fund yields which would be just another way of ending Prime funds which is not the goal of the entire operation."
Donahue explains, "We believe that money funds were meaningfully and sufficiently strengthened by last year's extensive revisions to 2a-7 and we're seeing those changes help now as we deal with the noise created around the perception of risk in Prime money funds from European bank exposure. 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."
On the earnings call, Federated CFO Tom Donahue added, "Conditions for money market funds continued to be challenging in the second quarter and into the third quarter. Money fund yield waivers reduced pre-tax income by $19.4 million for the quarter compared to $13.1 million in the prior quarter.... Yields decreased during the quarter which led to waivers exceeding the April calculation, based on then current market conditions. Yields have generally trended lower as the market deals with the debt ceiling issue and concerns over European debt. Based on recent market conditions and asset levels, these waivers could reduce income by approximately $23 million in Q3 for Federated. More recently we've seen an uptick in rates for Repo and T-Bills which impacted waiver levels in the government funds. We expect these rates to move off of the extremely low levels in the first couple weeks of July as we move toward some resolution of the debt ceiling issue. We have seen some upward movement over the last couple of days. Looking forward, we estimate that gaining 10 basis points in gross yields will likely reduce the impact of these waivers by about 1/3 from the current levels and a 25 basis point increase would reduce the impact by about 2/3."
Cunningham explained on the call, "From a European bank perspective, a couple things have happened [recently]. The stress tests for those banks by the EU have been completed with some amount of success.... The package for Greek debt restructuring has also been reached, and although it is not a quick fix in the marketplace it has received fairly good market impact. And by that, I look at the spreads that we see in European banks and again we use 22 different banks, high quality banks within the Euro zone.... These banks have stayed the same from a spread perspective in the marketplace from widening maybe two to three basis points. From a Federated prime fund exposure, we have currently and are still maintaining somewhere in the neighborhood between 40 and 45 percent of our prime funds exposure to these European banks. We have no direct exposures to the Greek banks. But the European banks that we use do have some exposure on a secondary basis to the Sovereign Greek nation. We continue to be comfortable with the ownership of these banks. We post that on our website every two weeks so you can get the most quarterly information there when you're looking for it."
She continued, "The third item is the debt ceiling issue and concerns in the market place about default, a downgrade and ... liquidity in the marketplace. From a default perspective, we think this is a very remote likelihood. It would require, if the actually did happen, action by the fund's board of directors. We would need make, as an advisor, recommendation to the board of directors based on the underlying credit quality of the nation itself, market evaluation, the fact that this is a in insolvency issue but rather a willingness to pay and a political theater issue. At this point, if it had to ... our recommendation would be to maintain the ownership of these technically defaulted instruments at that point. Again, thinking this is a very remote possibility."
Cunningham said, "We think [the possibility of a downgrade] is less remote, obviously as the default. But still we don't think this is probable. The first thing to note is the [possible] downgrade is ... for long term ratings only, not short term ratings. So nothing would be affected from the short term ratings perspective for the securities that are held within money market funds.... Treasury securities are still the largest with the most volume, with the most liquid, highest quality instrument in the world ... and certainly not surpassed by bank deposits, where in fact the backing of those banks comes from the U.S Government. These would still maintain their liquidity in the market place, but with a price volatility that would be a little more ... than what it has been in the past."
Finally, she added, "From a Federated fund perspective, despite the outlook for negative potential downgrade for the long term ratings for the US government debt, the Federated money market fund has been affirmed with their AAA ratings. So even if the U.S. debt was downgraded to AA, AA+, AA- whatever would happen to be, at this point the AAA ratings for Federated funds would be maintained.... We have positioned ourselves well to what we think is a second half steepening of the yield curve and it provides ourselves with a lot comfort to the shareholders in the context of liquidity that might be needed."
Fidelity Investments, the largest manager of money market mutual funds with over $422 billion, posted an article earlier this week entitled, "Debt-ceiling countdown: We answer your FAQs." The "Fidelity Viewpoints" piece, which includes comments from money fund manager Tim Huyck, says, "Six Fidelity experts weigh in on the outlook and potential implications for investors. Will Democrats and Republicans find common ground on a deficit reduction plan in time to extend the U.S debt ceiling -- and avoid a potential U.S. government default? No one can say for sure, but Fidelity experts strongly believe Congress will ultimately act to avert a default. The questions: when, how, and what it will mean to investors worldwide."
Fidelity asks, "How might this issue impact investments in money markets and money market funds? Tim Huyck, portfolio manager for Fidelity's money market portfolios, answers, "Fidelity believes that the government will ultimately increase the debt ceiling. Nonetheless, we have been preparing contingency plans that relate to how our money market mutual funds are positioned, as well as to our overall operations. I believe Fidelity's money market funds, including our Treasury money market funds, are appropriately positioned for a potential severe disruption in the markets. We have stress tested our money market mutual funds, and we believe they can withstand significant market volatility -- far more than the historical largest one-day move in three-month bills that occurred in the last 40 years."
He continues, "If the United States were to be downgraded to AA from its current AAA rating, money market mutual funds would not be forced to sell their government securities. Indeed, the funds could continue to purchase U.S. government securities, provided that the securities were determined to represent minimal credit risk. Overall, we believe money market mutual funds are more resilient than ever before. Since the changes to money market regulations were implemented over a year ago, these funds have greater liquidity, frequently far in excess of the 10% daily and 30% weekly liquidity requirements, and also maintain shorter weighted average maturities. Money market funds are also much more transparent, prominently disclosing holdings on a monthly basis."
The article also asks, "If the credit rating agencies downgrade the long-term rating would they also downgrade the short-term rating? Huyck says, "The U.S. Treasury has the highest short-term credit rating. Even if the long-term rating were downgraded, we do not expect a downgrade of the short-term rating. Moreover, a downgrade of the short-term rating from the highest category to the second-highest category would have no impact on a money market mutual fund's ability to hold or purchase U.S. government securities."
Fidelity also queries, "If the U.S. government were to default, what would it mean for money market funds? Huyck responds, "If a money market mutual fund held securities on which the U.S. Treasury defaulted on the payment of interest or principal, then the fund would be required to dispose of those securities, unless the fund's board of trustees determines that disposing of the securities would not be in the best interests of the fund and its shareholders. The board may consider market conditions, among other factors, in making that decision. Given that a default would likely result in a significant downgrade, many U.S. government securities would no longer be eligible for money market mutual funds. If the debt ceiling were subsequently raised and the U.S. Treasury was upgraded and determined to represent minimal credit risk, then U.S. Treasuries would again be eligible securities for money market funds."
Finally, the piece asks, "Is my Fidelity money market fund investment safe? The money fund manager comments, "We can state unequivocally that Fidelity's money market funds and accounts continue to provide security and safety for our customers' cash investments. Our funds invest in money market securities of high quality, and our customers have full access to their investments anytime they wish. Most importantly, we have been vigilant in keeping our money market funds safe and in protecting the $1.00 net asset value (NAV), which has always been our No.1 objective in managing these funds."