Federated Investors filed its Form 10-K Annual Report with the Securities & Exchange Commission last Friday, and the document contains a number of comments on factors impacting the money market fund business and regulatory issues. On the subject of "Historically Low Short-Term Interest Rates," Federated writes, "For several years, the Board of Governors of the Federal Reserve System (the Governors) have kept the near-zero federal funds rate unchanged and short-term interest rates continued at all-time low levels. In certain money market funds, the gross yield earned by the fund is not sufficient to cover all of the fund's operating expenses due to these historically low short-term interest rates. Since the fourth quarter 2008, Federated has voluntarily waived fees (either through fee waivers or reimbursements or assumptions of expenses) in order for certain money market funds to maintain positive or zero net yields. These fee waivers have been partially offset by related reductions in distribution expense and net income attributable to non-controlling interests as a result of Federated's mutual understanding and agreement with third-party intermediaries to share the impact of the waivers."
They tell us, "These voluntary fee waivers are calculated as a percent of AUM in certain money market funds and thus will vary depending upon the asset levels in such funds. In addition, the level of waivers are dependent on several other factors including, but not limited to, yields on instruments available for purchase by the money market funds, changes in expenses of the money market funds and changes in the mix of money market assets. In any given period, a combination of these factors drives the amount of fee waivers necessary in order for certain funds to maintain positive or zero net yields. As an isolated variable, an increase in yields on instruments held by the money market funds will cause the pre-tax impact of fee waivers to decrease. Conversely, as an isolated variable, an increase in expenses of the money market funds would cause the pre-tax impact of fee waivers to increase."
Federated writes, "With regard to asset mix, changes in the relative amount of money market fund assets in prime and government money market funds as well as the distribution among certain share classes that vary in pricing structure will impact the level of fee waivers. Generally, prime money market funds waive less than government money market funds as a result of higher gross yields on the underlying investments. As such, as an isolated variable, an increase in the relative proportion of average managed assets invested in prime money market funds as compared to total average money market fund assets should typically result in lower waivers to maintain positive or zero net yields. Conversely, the opposite would also be true."
They explain, "The negative pre-tax impact of fee waivers to maintain positive or zero net yields on certain money market funds increased in 2013 as compared to 2012 primarily as a result of lower yields on instruments held by the money market funds. During 2012, improved yields on instruments held by the money market funds caused a decline in these fee waivers as compared to 2011." (Federated showed fee waivers costing $105.1 million (pre-tax) in 2013 vs. $71.2 million in 2012. Revenue declined by $389 million vs. $291 a year earlier, but these totals were alleviated by reductions in distribution fees of $277 million in 2013 and $219 million in 2012. See page 6 of the annual report for more details.)
The Annual Report comments, "Federated's investment products are primarily distributed in four markets. These markets and the relative percentage of managed assets at December 31, 2013 attributable to such markets are as follows: wealth management and trust (45%), broker/dealer (31%), institutional (15%) and international (6%). Wealth Management & Trust. Federated pioneered the concept of providing liquidity management to bank trust departments through money market mutual funds in 1974, and has since expanded its services nationwide to institutional cash management and treasury professionals, as well as financial professionals.... The majority of Federated's managed assets from the wealth management channel are invested in money market funds.... In addition to bank trust departments and registered investment advisory firms, Federated provides products and services to capital markets clients (institutional brokerages generally within banks) and directly to cash management and treasury departments at major corporations and government entities.... As of December 31, 2013, managed assets in this market included $147.7 billion in money market assets, $14.4 billion in fixed-income assets and $7.5 billion in equity assets."
It adds, "Broker/Dealer. Federated distributes its products in this market through a large, diversified group of approximately 1,400 national, regional and independent broker/dealers and bank broker/dealers.... Federated also offers money market mutual funds as cash management products designed for use by its broker/dealer clients. As of December 31, 2013, managed assets in the broker/dealer market included $75.8 billion in money market assets, $17.2 billion in fixed-income assets and $25.4 billion in equity assets. Institutional.... As of December 31, 2013, managed assets in the institutional market included $37.2 billion in money market assets, $13.3 billion in fixed-income assets and $4.3 billion in equity assets. International. Federated manages assets from clients outside the U.S. through subsidiaries focused on gathering assets in Europe, the Middle East, and through a business initiative in the Asia-Pacific region launched in 2012.... As of December 31, 2013, managed assets in the international market included $11.2 billion in money market assets, $5.9 billion in a liquidation portfolio, $2.5 billion in fixed-income assets and $1.6 billion in equity assets."
Regarding "Regulatory Matters," Federated's report says, "In January 2010, the SEC adopted extensive amendments to Rule 2a-7 aimed at enhancing the resiliency of money market funds. These amendments included a series of enhancements including rules that require all money market funds to meet specific portfolio liquidity standards and rules that significantly enhance the public disclosure and regulatory reporting obligations of these funds.... In Federated's view, the amendments of 2010 meaningfully and sufficiently strengthened money market funds. Recent experience demonstrated that the amendments of 2010 were effective in meeting heightened requests for redemptions occurring in connection with the U.S. debt ceiling debate and subsequent downgrade of the country's credit rating in 2011, the European debt crisis in 2011/2012 and its ongoing fallout as well as the U.S. debt ceiling debate in 2013."
It continues, "Since January 2010, the SEC has been working to develop a proposal for additional reforms related to money market funds. On June 5, 2013, the SEC issued such a rule proposal for public comment. The SEC's proposal was lengthy (approximately 700 pages) and included two principal alternative reforms that could be adopted alone or in combination. One alternative would require a floating net asset value (NAV) for institutional prime money market funds and other money market funds (such as, for example, municipal money market funds) other than government and retail money market funds. The other alternative would allow a fund's board to use liquidity fees and redemption gates when the fund fails to maintain the prescribed liquidity threshold. In addition, in the case of either alternative, the proposal would eliminate the amortized cost method of valuation of securities maturing in more than 60 days while permitting the use of the penny rounding method to maintain a stable share price for money market funds not required to have a floating NAV. The proposal also included additional diversification and disclosure measures that would apply under either alternative."
The Report explains, "Federated supports liquidity fees and redemption gates in certain contexts. Federated believes the floating NAV, if enacted, would significantly reduce the utility and attractiveness of money market funds for investors who, in Federated's view, value money market funds in their current form as an efficient and effective cash management investment product offering daily liquidity at par. The elimination of the amortized cost method of valuation of securities also could impact the usefulness of money market funds as a cash management product. If ultimately enacted, the floating NAV would be detrimental to Federated's money market fund business and could materially and adversely affect Federated's business, results of operations, financial condition and/or cash flows."
It adds, "Management does not expect final rules to be adopted prior to the second or third quarter of 2014 given, among other things, the number of industry comments and the complexity of the proposed rule amendments, as well as the SEC's regulatory agenda published in late 2013, which specifies an October 2014 timetable for final action on the SEC's proposal. Federated is unable to assess the degree of any potential impact the SEC proposed reforms may have on its business, results of operations, financial condition and/or cash flows until any rule amendments are finalized, as the final amendments could vary significantly from the form in which proposed. Moreover, the SEC's proposal also contemplates that, once the final amendments become effective, there would be staggered compliance dates: (1) if the fluctuating NAV alternative is adopted, an additional two years after the effective date for any reforms relating to that alternative; (2) if the liquidity fee and redemption gate alternative is adopted, an additional one year after the effective date for any reforms relating to that alternative; and (3) any reforms not specifically related to either the fluctuating NAV nor liquidity fee and redemption gate alternatives would have a compliance date of nine months after the final amendments become effective. FSOC may recommend new or heightened regulation for "nonbank financial companies" under Section 120 of the Dodd-Frank Act."
They also say, "In a Congressional Appropriations Committee conference report that accompanied the Consolidated Appropriations Act, 2014, which was signed into law by President Obama on January 17, 2014, Congress instructed the SEC to undertake a "rigorous economic analysis" before promulgating its final money market fund proposal, and indicated that the "Committee expects that the final rules will take into account the substantive concerns of stakeholders who use these products for short-term financing needs." In the conference report, Congress also expressed that "[i]mpairing or restricting the use of money market funds could potentially result in a decrease in the ability of these products to provide liquidity, potentially resulting in hundreds of market participants issuing longer-term debt, significantly increasing their funding costs, slowing expansion rates, and depressing jobs and economic growth." In addition to underscoring the importance to the capital markets of money market funds as currently structured, management believes that the conference report reflects Congress' view that the regulation of money market funds is within the purview of the SEC, not FSOC."
Finally, they add, "European-based money market funds face regulatory reform pressure in Europe similar to that faced in the U.S. The European Commission released its money market fund reform proposal on September 4, 2013. The proposal would permit either floating NAV money market funds or constant NAV money market funds subject to capital requirements. Under the proposal, a constant NAV money market fund generally must either build a capital buffer of 3% or convert to a floating NAV money market fund. The proposal is subject to the approval of the European Parliament and European Council and the final regulation could vary materially from that of the proposal. Management does not anticipate agreement on a final regulation before late fourth quarter 2014."
