J.P. Morgan Asset Management posted a "Liquidity Insight" titled, "Prime Time with John Donohue." The introduction explains, "John Donohue, CEO, Americas and Global Liquidity Head, J.P. Morgan Asset Management, discusses the role of prime money market funds, the impact of recent reforms, and the evolving landscape of the market. Learn how these funds are used by clients and the factors driving their demand in a changing interest rate environment." The Q&A asks, "Can you share your thoughts on the latest round of money market reform and what it means for prime money market funds?" Donohue comments, "Absolutely. The recent reforms are designed to improve the management of liquidity funds during times of market stress. They bring several significant changes that we believe will benefit both the market and investors."
He continues, "Prime money market funds (MMFs) typically offer higher yields than government MMFs by including short-term corporate and bank debt securities, adding incremental risk. They have a floating net asset value (FNAV) but with low volatility due to their high-quality, short-term investments. In addition to seeking superior credit quality, lower duration and a high percentage of daily and weekly liquidity (DLA and WLA) contribute to the NAV's reduced volatility compared to short-term bonds and short-duration funds."
Donohue tells readers, "Prime fund investors are typically institutions -- companies, pension plans, government entities, or large financial intermediaries. These investors often view cash as a unique asset class and segment that cash based on anticipated needs. For example, cash needed for daily operations might be held in a government MMF to ensure the highest level of liquidity. In contrast, more core or strategic cash can be invested in prime funds to potentially earn a higher return."
He says, "With rising interest rates, the demand for prime funds has surged, as they now offer significantly higher returns compared to government MMFs. Since early 2023, assets under management in prime funds have increased by over 50%.... The reforms bring several key changes. Previously, gates and fees might be applied when a fund's weekly liquidity fell below a threshold, which could exacerbate market turmoil during economic stress. We saw this during the COVID market stress. Now, these potential gates and fees have been removed."
The JPMAM Liquidity Head comments, "Additionally, funds must maintain greater daily and weekly liquid assets (DLA and WLA) than previously. A mandatory redemption fee will be applied only if redemptions exceed 5% of the total fund in a single day. This measure ensures fairness among all investors and will potentially improve market stability, helping to protect your investment. Overall, these changes provide a more equitable client experience and enhance the safety of MMFs."
The piece also asks, "Can you explain the impact of the mandatory redemption fee introduced by the recent money market reforms? Donohue responds, "The mandatory redemption fee is a fairer alternative to the previous gates and fees that applied to the entire fund. Now, only clients who redeem on a day when redemptions exceed 5% of the fund's total assets will be affected. This means that investors who remain in the fund are not penalized. This change mitigates the first-mover advantage during market stress, as those who withdraw funds will pay a fee for liquidity, benefiting the remaining shareholders. Essentially, it shifts the cost of liquidity to those who demand it, making the system more equitable."
He states, "Additionally, with the elimination of gates, you will always have access to your liquidity, even if you have to pay the fee. This ensures that your funds are never completely locked up, providing you with greater flexibility and peace of mind. The fee is designed to reflect the true cost of liquidity, ensuring it accurately represents market conditions at the time of redemption. Importantly, in a normal market environment, this fee could be zero if the cost of liquidity is minimal."
Donohue comments, "Due to the operational complexity of maintaining three strike prices per day, many prime MMF managers, including J.P. Morgan, have reduced the number of strike prices each day. This adjustment helps manage the new requirements more efficiently."
He says, "We've spent a lot of time evaluating the reforms and their potential impact on prime funds. We remain absolutely committed to offering prime funds for several reasons. Our clients want these funds, especially in a higher-for-longer interest rate environment. We have the resources and expertise to meet the specific needs and goals of prime MMF investors. Our team has years of experience in all kinds of markets and has weathered major financial crises."
Donohue states, "Some providers are making different decisions, potentially influenced by the size of their business or their product offerings. Notably, ten of the industry's largest firms have already announced the transition of their institutional prime assets to government money market funds (MMFs). In our view, consolidation in the prime market could have some interesting and potentially beneficial consequences. A core group of providers who are highly committed to prime funds may strengthen the market. Historically, the first signs of trouble during times of stress often appear at firms with less experience, fewer resources, or where prime funds are not a core focus."
He tells us, "Additionally, a more consolidated market could result in fewer buyers for typical prime MMF securities, which might push spreads wider. This could lead to higher yields for prime funds compared to more conservative MMFs. As a result, prime money market investors could benefit from both a stronger market and potentially higher yields.... The reforms will likely lead to a more consolidated base of institutional clients who are already comfortable using prime funds, understand their benefits, and have realized these benefits over the years."
Finally, Donohue adds, "While some clients may choose to switch to government MMFs due to operational changes, we see this as an opportunity to strengthen relationships with clients who are looking to maximize returns on their entire cash holdings. The new redemption requirements and increased liquidity will enhance the overall safety and client experience of money market funds (MMFs). Prime funds, with their potential for higher yields, can play a valuable role in a diversified portfolio, offering both stability and the opportunity for enhanced returns."
