Moody's Investors Service published a Special Comment entitled, "Money Market Funds: ABCP Investments Decrease," which says, "Since 2007, the investment allocations of Moody's-rated money market funds (MMFs) to asset-backed commercial paper (ABCP) have been decreasing continuously. The reasons causing leading portfolio managers to avoid ABCP investment are: (i) investors are averse to structured finance securities after losses related to Structured Investment Vehicles (SIVs) during the financial crisis; (ii) ABCP is viewed by some managers as contrary to a fund's objectives, which is to maintain liquidity; (iii) the overall credit quality of financial institutions providing liquidity to ABCP conduits has deteriorated; and (iv) the lack of disclosure of ABCP and opacity in terms of conduit structure prevents investors from fully understanding the risks of ABCP."
Moody's explains, "Although steps have been taken to scale back the funds' risk profiles and ABCP investments -- prompted by the prevailing credit conditions and euro-area sovereign debt concerns -- exposure to financial institution debt remains high. A credit-negative factor is that by 2007, the average long-term bank deposit rating of the global universe had deteriorated to A1 from Aa2. However, most MMFs managed down European bank exposures, often redeploying funds away from stressed European banking systems and into stronger European banks and banks in non-European countries."
They write, "In this challenging operating environment, we expect that conservative portfolio strategies will persist and, as a consequence, ABCP investments will remain limited. Besides the lower demand for ABCP, the exposure of MMFs to this asset class has also declined due to a decrease in the number of available conduits that meet the quality criteria of MMFs. Larger conduits can issue ABCP with relative ease, whilst smaller conduits -- backed by lower credit-quality financial institutions -- have found ABCP issuance more challenging."
Moody's explains, "We base our analysis on the prime Moody's-rated US and European MMFs. This homogenous universe comprises 82 European and 77 US MMFs -- all but one rated Aaa-mf -- whose assets under management totalled US$1.2 trillion at the time of our analysis."
The report, written by Vanessa Robert and Yaron Ernst, says, "When ABCP investments peaked in 2007, they accounted for nearly 25% of prime fund assets globally. Since then, MMF exposure to this asset class has trended downwards to 8.3% on average at the end of August 2011.... Some MMF managers have entirely eliminated ABCP from their approved list, although most managers have only limited their ABCP investment allocations. Of the rated funds, 45% have no ABCP exposure, whilst 72% have an exposure of less than 10%.... Some market participants still view ABCPs as very complex structures, discouraging them from investing, as they do not necessarily have the resources to analyse the underlying risks."
It adds, "With respect to demand-driven reasons, there is also a reduction in the number of available conduits that meet the quality criteria of the MMFs' credit teams, because the ABCP market has experienced "tiering". In other words, larger conduits have found it relatively easy to issue paper, whilst smaller conduits sponsored by lower credit quality financial institutions have found it difficult to issue."
Moody's comments, "However, some asset-management firms remain positive on the ABCP sector (19% of Moody's-rated prime MMFs have an exposure above 20%), as they believe that ABCP helps funds to reduce their risk profile. This is because they anticipate that the loss-given default would be limited due to the access to collateral. Generally, the market participants that hold this view are large, global players with significant credit resources.... Of the funds we rate, the most popular ABCP programs globally are those that are either large and stable, typically offered by top tier banks, or those that benefit from a sovereign guarantee. MMFs favour investments in fully supported programs sponsored by highly rated financial institutions that either (i) have a strong track record; or (ii) benefit from government support, such as Kells Funding and Straight A Funding. Generally, investment is made in structures that investors believe will be supported by banks, as opposed to standalone enterprises. Consistent with the reduction in their maturity profiles, the bulk of the prime funds’ investments in ABCP are within one month, at 72% of the investments."
Finally, the report writes, "Overall, macroeconomic conditions remain challenging for MMFs. Their operating environment is difficult, characterised by (i) historically low interest-rate levels; (ii) declining assets under management; (iii) global credit uncertainties; and (iv) a negative outlook on most financial institution sectors and/or banking systems. In addition, regulatory uncertainties persist. Although the SEC in the US and the CESR in Europe have tightened MMF regulations, further reform will be needed to address the systemic risk that MMFs pose. The Financial Stability Board's report on the shadow banking system released at the end of October 2011 clearly states that the role of MMFs in the financial markets will be heavily scrutinised by the International Organization of Securities Commission, which is due to report on the issue by July 2012. In our view, the key issue is the direction in which regulators choose to move that could include: (i) requiring shifts to variable NAV vehicles; (ii) imposing capital and liquidity requirements on constant NAV MMFs; and/or (iii) whether other approaches should be taken. Therefore, in the near term, MMFs will continue to operate in a tentative market and regulatory environment and any resurgence in MMF investment in ABCP is unlikely in the short term."
