The U.S. Treasury's Office of Financial Research issued its 2014 Annual Report to Congress, which analyzes potential threats to U.S. financial stability, documents OFR's progress in meeting the mission of the Office, and reports on key research findings. "Since our 2013 report, several financial stability risks have increased. The three most important are excessive risk-taking in some markets, vulnerabilities associated with declining market liquidity, and the migration of financial activities toward opaque and less resilient corners of the financial system," writes OFR Director Richard Berner in the opening letter. "Gaps in analysis, data, and policy also persist, despite progress in narrowing them. If left unaddressed, these threats could adversely affect financial stability," adds the executive summary. The 164-page report includes several points related to money market funds, including a recap of the SEC's MMF reforms. Money market funds are also addressed in the OFR's soon-to-be-published strategic plan. Also, there is a new initiative related to data gaps in the repo markets.
The OFR says, "One of OFR's top research priorities for its soon to be published 5-year Strategic Plan is to develop "a suite of additional monitors and dash-boards, focused on money market funds, hedge funds, and credit default swap markets." Later in the report, it explained more about this initiative. "The tools we are developing to assess risks to the financial system include [an]: Interactive Money Market Fund Monitor that examines holdings of individual funds and the industry as a whole on the basis of credit, interest rate, and liquidity risk." OFR is also developing [a] "Liquidity Library to monitor market liquidity conditions on a broad, high-frequency basis." In addition, they are working on a `Reference Guide on U.S. repurchase agreement (repo) and securities lending markets. "The guide will examine how dealers and their clients use these markets, building on the Office's ongoing research on the sources and uses of short-term funding, and will identify potential vulnerabilities and data gaps."
OFR will also address data gaps in the repo markets. They write, "Filling data gaps in the repo and securities lending markets is a top priority for the OFR. Availability of data about repo and securities lending activities has improved since the crisis. But much of the available data is not collected in a consistent manner, which would allow for comparison and aggregation, and most is not available to the public. In addition, there are still segments of these markets not covered by existing data collections. As part of the domestic efforts on this front, the OFR, the Federal Reserve Board of Governors, and the Federal Reserve Bank of New York are planning a joint pilot data collection based on these templates to improve our understanding of bilateral repo activities. These agencies have solicited voluntary participation and feedback on a proposed template from firms that are large participants in the repo market, with an aim to finalize this data template by the end of 2014. We anticipate a voluntary data collection focused on bilateral repo activity will begin in the first half of 2015. These data will also be shared with the SEC. Further work will be done on a securities lending data collection in 2015."
On the repo markets, it adds, "The degree of transparency about repo transactions and positions from a market-wide perspective depends on whether trades are settled centrally (triparty) or bilaterally. The triparty market is the most transparent part of the market. These trades are settled using the triparty repo settlement platforms at the clearing banks. Currently only two banks -- Bank of New York Mellon Corp. and JPMorgan Chase & Co. -- provide triparty repo services. The Federal Reserve Bank of New York collects data about trading activities in triparty repo markets from the two clearing banks, identifying the dealers, investors, and collateral by asset class. The Federal Reserve Bank uses this information for its own monitoring and analysis and publishes monthly triparty repo summary statistics on its website.... By contrast, there are limited market data available about repo trades that dealers settle bilaterally outside the triparty clearing banks. Anecdotal and survey evidence indicates this repo market suffered distress during the financial crisis."
It continues, "The 22 U.S. primary dealers that serve as trading counterparties to the Federal Reserve Bank of New York account for most trading in the U.S. repo market. These dealers confidentially report their market activities weekly to the Federal Reserve on Form FR 2004. This form collects information including position, transaction, financing, and fails data in U.S. government securities and other selected fixed-income securities. The Federal Reserve Bank of New York publishes on its website every week consolidated information about primary dealer positions based on Form FR 2004 data. However, Form FR 2004 does not cover activities of broker-dealers that are not U.S. primary dealers, and it does not differentiate triparty from bilateral trades. In addition, the form does not include important information such as haircuts, rates, and the identity of the counterparty, and the information it does contain is highly aggregated. As a result, significant data gaps exist at the transaction level of these trades, particularly in the repo activities of dealers who are not primary dealers and the repo activities that are not settled on the clearing banks' triparty settlement platforms. We can only produce rough estimates of the size of the bilateral repo market based on these data.... More information on repo transactions would also be valuable for our financial stability monitoring and analysis so we can better understand how the markets function, how they interact with one another, and how risks can build and shift in these markets."
The OFR report also dedicated a page to money market reform. "The financial crisis illustrated the vulnerability of money market funds to mass redemptions and prompted regulators to implement a series of reforms in this market.... The SEC announced reforms in July 2014 addressing those concerns. Its rule requires institutional prime money market funds to implement a combination of floating net asset value, redemption restrictions, and liquidity fees by October 2016. The rule also made enhancements to the SEC's existing stress testing regime by requiring a fund to test its ability to maintain weekly liquid assets of at least 10 percent and to minimize principal volatility in response to certain specified hypothetical stress scenarios."
It goes on, "With the implementation of floating net asset values, institutional investors may leave prime money market funds for government money market funds, which invest mostly in government securities, cash, or repurchase agreements backed by government securities. Under the SEC rule, these funds retain their ability to transact at a stable net asset value. Investors may also increase their bank deposits and holdings of other cash products offered by banks. Some large institutional investors might also switch to separately managed cash accounts, which could be harder for supervisors to monitor."
The OFR adds, "The rule also sought to address potential preemptive runs by allowing boards of directors of funds the discretion to apply redemption restrictions. Redemption restrictions, often referred to as "gates," have been adopted in many overseas markets to limit fund outflows during financial crises. However, in Europe these gates are always in place as described in fund offering documents, but only rarely used. Some research has suggested shareholders might run preemptively if they feared redemption restrictions would be imposed, meaning discretionary gates could worsen a run. Others have argued that liquidity fees may exacerbate institutional investor runs during a crisis. The benefit of the new rule cannot be evaluated until the money market industry again faces strain and run risks. The ongoing concentrations of money market fund assets within a few large asset managers may raise more systemic stability concerns and require enhanced monitoring of potential cash reallocation."
Later it adds, "Money market funds will be required to disclose detailed information on their websites daily, including net asset values rounded to the fourth decimal place, daily liquid assets, weekly liquid assets, net inflows and outflows, imposition of fees and gates, and any use of affiliate sponsor support. In addition, the SEC will introduce a new form, Form N-CR, for reporting material fund events." (Note: Most of these new disclosures will begin in April 2016.)
On separate accounts, the report says, "Separately managed accounts that invest only in short-term assets collectively have about $330 billion under management in 347 accounts, according to the [SIFMA] survey.... Without access to market-level data, regulators cannot evaluate shifts in activities and their impacts on broader markets. For example, a potential shift of cash management away from money market funds in response to regulatory reform could accelerate the growth of separately managed cash accounts.... These market developments cannot be effectively understood and monitored so long as gaps remain."
Regarding corporate cash, OFR explains, "Nonfinancial corporations had about $1.8 trillion in cash at the end of the first quarter of 2014, a record according to available data. But regulators have limited information about how nonfinancial corporations invest their cash. This represents an important gap in our ability to understand what drives growth and risk in short-term wholesale funding markets. Specifically, we need data to help us analyze both the sources and uses of funds in these markets.... In a recent survey by the Association for Financial Professionals, 81 percent said they expect their cash and short-term investment balances to grow or remain at the current level.... Such surveys are currently the only available data source of corporate cash investments. No complete standardized dataset on corporate investments of financial assets is available to aid regulators and policymakers in monitoring any potential shifts in corporate investment preferences."
Finally, in a review of 2014 market developments, the report states, "Accommodative global monetary policy, coupled with the Federal Reserve's purchases of large amounts of low-risk assets and changes in risk sentiment, helped to compress volatility and risk premiums (the returns in excess of the return earned on a risk-free investment). These conditions encouraged investors to increase their holdings of long-dated securities and products with riskier credit attributes in a search for higher returns. Over the past five years, investors moved out of money market instruments and into riskier assets such as leveraged loans, high-yield corporate credit, eurozone peripheral bonds, and emerging market equities."
