Now that the clock is ticking on the implementation of money market reforms, money managers are starting to think about post-reform strategies. Some, like Fidelity and Goldman Sachs Asset Management, have already announced some reform-related changes, while others, like Federated Investors, have talked publicly about potential changes to their money fund lineups. Recently, Stephen Bonte, Senior Portfolio Specialist at BNY Mellon's Standish, wrote a paper entitled, "The Implications of Regulatory Reform on Your Cash: Life After Money Market Reform, Basel III, and Dodd-Frank," on the subject. Also, Fitch Ratings published an update this week, "Fund Managers Begin Positioning for Money Market Reform," in which they review some post-reform maneuverings. Below, we look at both.
In the Standish paper, Bonte writes, "Multiple regulatory reforms mulled post-GFC (Global Financial Crisis) have now been finalized, and are close to reaching their implementation phase. Their stated objective is to make the financial system more resilient both systematically and idiosyncratically. This section highlights those changes most likely to impact the makeup of deposit and short-term fixed income markets."
He continues, "Money market fund reform, voted on July 23rd, 2014, confirmed the move to a floating Net Asset Value (NAV) and triggers for liquidity gates and/or liquidity fees for institutional investors in Prime and Tax-Exempt 2a-7 Money Market funds by the end of 2016. We estimate that approximately 40% of the assets in the $2.6 trillion Money Market funds universe will be impacted. How much of these $600 billion end up being reallocated, and where, remains to be seen. The consensus is that the natural destination for these monies is Treasury and Government Money Market funds."
Bonte explains, "This demand-driven rebalancing should result in a relative re-pricing of the front end, with an increased yield differential between short credit (Commercial Paper, Certificates of Deposit) and U.S. Treasury Bills/Agencies Discount Notes. Indeed, there is little reason to believe that the U.S. Treasury will increase Treasury Bills issuance to meet the increased demand. In fact, the U.S. Treasury has been de-emphasizing reliance on short-term funding.... [T]he amount of U.S. Treasury Bills outstanding has stabilized at around USD 1 trillion."
Further, he adds, "We anticipate that reform will meet its objective of reducing systemic risk by strengthening the principal preservation and liquidity feature of popular cash vehicles such as 2a-7 Money Market Funds and bank deposits, but that these safe and liquid vehicles will now come at a price -- e.g. at lower yields relative to other short-end instruments. And those yield differentials could be significant; for example, back-of-the envelope calculations suggest that to maintain current profitability metrics (ROE/ROA) the required spread between Interest On Excess Reserves (IOER) and unwanted deposits could increase to a 0.40% to 0.60% range, from the current 0.17% value."
Finally, Bonte writes, "While banks are unlikely to pass those costs on directly in a zero rate environment, even a partial cost-sharing with depositors could significantly alter pricing dynamics in the front-end of the yield curve. We expect that the tiering of relative yields to come in earnest if the Federal Reserve lifts target rates off from the zero level in place since 2008. Given these developments, we believe that the flexibility of separately managed accounts (SMAs) will make them an attractive complement to bank deposits and money market funds going forward. It serves as a transparent and fee-efficient vehicle to optimize yield given principal preservation and liquidity constraints. Perhaps more importantly, it inherently diversifies credit risk and taps alternative sources of liquidity."
Fitch's latest release also looks at how money fund managers are adapting to reforms. "Six months after the SEC voted on reforms, money fund managers are beginning to take steps to comply with the new rules and position themselves to retain and attract clients. While clients continue to be patient and industry assets remain stable, fund managers are launching, closing, and merging funds, updating investment guidelines, and working through the operational aspects of reform."
It continues, "Despite widespread predictions of outflows from institutional prime money funds -- those most impacted by the reforms -- so far asset flows have been positive. According to iMoneyNet data, total money fund assets increased by 6.2% since July 2014, when the reforms were passed, with institutional government funds growing faster than prime, 11.0% to 4.8%. Money fund flows typically incorporate seasonal factors, and it is too early to tell if the stronger flows into government funds (which are less impacted by reforms) are indicative of clients repositioning their cash holdings in response to reform. Investors are likely to shift some cash out of institutional prime funds closer to the effective date of the main thrust of the reforms, in October 2016."
Fitch explains, "Money fund managers are also taking steps to restructure their funds to gain a competitive position. Fidelity recently announced that it will convert a number of large retail prime money funds (with assets north of $100 billion) to government funds. Fidelity said many of its clients had indicated that they would prefer the stable NAV and exemption from the fees and gates provisions of the reform that government funds offer. This was also Goldman Sachs' rationale when it noted recently that its government funds are now in compliance with the reforms and that they have opted out of the fees and gates provision. Finally, a number of money fund managers have announced they will be merging or liquidating funds that have not attracted enough assets, with some small managers like Touchstone Investments exiting the business as the burdens and costs of compliance with the new reforms prove too high."
It goes on, "While government funds are expected to take up most of the money leaving prime money funds, some cash will likely find its way to other short-term products, including ultra-short bond funds, private 3c-7 money funds, and separately managed accounts. Fund managers have been discussing these options over the past few months with clients that may not want to remain in prime money funds with a floating NAV. A few managers have launched new ultra-short bond funds in recent months as an alternative to prime money funds. The bond funds, launched by large money fund managers like Goldman Sachs, Invesco, and Western Asset, typically strive to offer higher yields than prime money funds, and take slightly more risk. For example, the Goldman Sachs Limited Maturity Obligations Fund, rated 'AAA/V1' by Fitch, is allowed by prospectus to have a weighted average maturity (WAM) of as much as 270 days, compared to a maximum of 60 days for money funds."
