Citi's Vikram Rai writes in their latest "Short Duration Strategy" a piece entitled, "Why it is NOT "Prognosis Negative" for money funds. He says, "As the money fund industry continues to absorb the newly minted SEC reform rules there is significant dispersion in opinion among market participants regarding the impact of these changes on the overall money fund industry and specifically on the institutional prime money fund sector. Speculation regarding outflows from institutional prime MMFs (which have about $950 billion in AUM) has ranged from $50-$450 billion. While we might witness higher yields for commercial paper as the compliance date for rules comes nearer, which will act as a countervailing factor against outflows from institutional prime funds (as we discuss in more detail below), the yields increase is unlikely to be sufficient to clog the CP markets."
Rai writes, "Short term investors should jog their long term memory and recall that while the size of the institutional prime money fund industry has grown largely with the overall money fund industry, the CP market has declined significantly over the past decade. Thus, even if drastic outflows of $450 billion were to materialize, and we sincerely doubt that, the AUM for institutional prime funds would drop to about $500 billion, which is roughly the size of the sector in 2000. Now, in 2000, the size of the CP market was $1.6TR (vs. about $1TR now). If the CP markets weren't clogged then, it is unlikely that they would clog now, especially since asset scarcity is more prevalent now given the greater demand for HQLA."
The Citi piece continues, "While we do expect inflows into govt. MMFs at the expense of institutional prime MMFs, we wholly disagree with egregious estimates of $500 billion and expect net outflows to be a fraction of this number. While it is true that stable NAV funds are preferred by most corporate treasurers due to their investment guidelines, it is also well understood that just a change to reporting requirements will not change the fundamental nature of the fund. Additionally, short-term investors have shown flexibility and resilience when adapting to shocks in the past, for instance modifying AAA only mandates when US Treasuries were downgraded. Thus, an increase in this spread could incentivize corporate treasures and other investors to modify their guidelines such that they are able to invest in floating NAV funds and take advantage of higher yields."
Finally, Rai writes, "And, much as we would like to subscribe to the belief that demand for Tier 2 paper would increase, in our view, the changes should have limited impact on investment policies for most funds because: Most fund boards understand that a loosening of credit standards is unlikely to be one of the objectives of the new rules and they would prefer to avoid SEC scrutiny, especially since the SEC plans to keep an even closer watch on money funds with its enhanced disclosure rules. While the Tier 2 CP market has shrunk over the last 5 years, demand for such paper remains limited given that AAA funds constitute almost 2/3rds of the money funds universe."
In other Citi research, Andrew Hollenhorst writes in his latest "Short-End Notes" a brief entitled, "More repo regulation to come." He comments in his summary, "Regulators focused on reducing short-term funding - Boston Federal Reserve President Rosengren suggested a range of reforms to limit bank and broker-dealer reliance on short-term borrowing to fund longer term assets. We think minimum repo haircuts and a short-term funding "capital surcharge" remain the most likely reforms."
The piece adds, "Opportunity to shorten T-bill duration – Increased 1m bill auction size led frontend bills to sell off while geopolitical concerns brought down 12m bill yields. In our view this presents an opportunity to shorten duration. Fed minutes and Jackson Hole next week – We will look to the release of the July Fed minutes on Wednesday next week for any signals regarding an aggregate cap on the reverse repo facility."
In other news, an update entitled, "SEC New Money Market Fund Rules - Overview and Implementation Guidance was written by Peter Fariel of Rimon P.C.. It says, "On July 23, 2014, the Securities and Exchange Commission adopted final amendments to the rules governing money market mutual funds (MMFs). This article provides an overview of key provisions of the Rule and offers practical insights on next steps that MMF sponsors and fund boards should consider in implementing the Rule."
Fariel writes, "The Rule contains two key elements: Institutional prime and municipal/tax-exempt MMFs will be required to maintain a floating net asset value (NAV) for sales and redemptions that is generally based on the current market value of their portfolio securities rounded to four digits (e.g. $1.0000). All MMFs other than government money market funds will be subject to "default" rules that provide for permissive and mandatory use of fees upon redemptions ("liquidity fees") and temporary suspension of redemptions ("gates"). The Rule's application to a particular MMF hinges on two definitions: Retail Fund. A "retail fund" is a MMF that has policies and procedures reasonably designed to limit all beneficial owners to natural persons (referred to as the "natural person test") [and "Government Fund"]."
He continues, "The Rule also imposes enhanced disclosure, reporting, governance and investment requirements for MMFs, including a new report, Form N-CR on material events (e.g. the imposition of liquidity fees/gates), additional reporting requirements on Form N-MFP, immediate public availability of portfolio holding reports on Form N-MFP, stress testing of a MMF's ability to satisfy the weekly liquid assets requirement and stricter portfolio diversification requirements. The Rule also requires enhanced SEC reporting for private liquidity funds. Separately, the Internal Revenue Service and and U.S. Treasury Department issued guidance that simplifies MMF tax accounting and reporting to address the impact of the Rule. The compliance date for the floating NAV and liquidity fee/gate provisions is two years [the `Federal Register version was published Thursday, Aug. 14, and the effective date is 60 days from publication, so Oct. 14, 2016]."
