State Street Global Advisors released a new white paper and a revamped set of papers into a 51-page document entitled, "Yielding to a New Regulatory Reality." They write, "Previously, we've shared our perspectives on the new, post-crisis banking regulations and their impact on cash management. To help you prepare for upcoming implementation deadlines, our series of whitepapers now includes "What Liquidity Means Now." This latest read drills deeper into how regulators have redefined the concept -- and how markets and managers can adapt. This joins our six-part series ... recently abridged and redesigned to help you more quickly and easily review the new regulations and get actionable ideas for reassessing your cash investments."
SSGA continues, "Individual paper links are below: `No More Bank Bailouts: What New Banking Regs Mean for Money Mkt Investors, Capital: Pillar I of Post-Crisis Bank Regs, Liquidity & Funding: Pillar II of Post-Crisis Bank Regs, Resolution Planning: Pillar III of Post-Crisis Bank Regs, What Liquidity Means Now, and Meeting the Challenges: 6 Strategies for the New World of Cash. For deeper background, check out the whitepaper that sets the stage for the series: New World of Cash."
The compendium says, "Post-Global Financial Crisis regulations order banks to boost capital, liquidity and funding duration. This imposes a tug-of-war between regulatory compliance and banks' longstanding business model of borrowing short and lending long. Money market portfolio managers face a similar conundrum, with mandates requiring them to hold very short-term, high-quality liquid investments that are in scarce supply due to the new banking rules. The enclosed white papers will help you understand the implications and how to navigate them as you optimize your portfolio for 2016."
SSGA's latest addition, "What Liquidity Means Now," tells us, "The previous paper in this series, Pillar III of Post-Crisis Banking Regulations: Resolution Planning, summed up the net effects the new regulations enacted under these pillars are likely to have on the short-term fixed-income markets. They include low yields on money market securities and the funds that hold them; potential opportunities in nongovernment debt; greater competition for retail and small business deposits; reduced market liquidity, with an accompanying rise in transaction costs; and the likely development of new, innovative cash products that may contain unappreciated risks."
It explains, "The new regulatory regime also has changed the very meaning of liquidity in the short-term markets. There was a time when "liquidity" essentially meant the same thing to all market participants. It referred to the ease and quickness of issuing (from the suppliers' perspective) or selling (from the buyers' side) a particular instrument. Today, that is no longer the case. Regulators seeking to forestall a recurrence of the global financial crisis have imposed new restrictions and requirement throughout the system, with the goal of ensuring liquidity in any market environment.... The system as a whole is undeniably safer as a result, but -- regardless of where you interact with markets today -- the flow can look very different than it once did."
State Street writes, "Prior to 2008, money market fund (MMF) managers determined themselves the amount of liquidity required to meet shareholder redemptions. Typically, a retail money market fund would hold five to 10 percent in one-day (overnight) maturities, and would not pay much attention to seven-day liquidity. Today, the SEC's rule 2a-7 mandates 10 percent one-day liquidity and 30 percent seven-day liquidity for all funds. As a result, fund managers now use this level as a floor and hold an additional buffer on top of it to ensure they meet requirements."
They add, "The regulations appear to be succeeding at making the financial markets healthier. Yet they result in a severe mismatch between supply and demand. Money funds want and need more short-term assets. Yet banks are forced by regulations to issue less of their own short-term debt— including the reverse repurchase agreements that made up much of the overnight market -- and to hoard government paper. The drop-off in supply pushes down yields on government and many kinds of corporate debt, making it difficult for investors to generate income from their cash. Investors looking to secure higher yields have to accept somewhat higher volatility or lower liquidity than they have been accustomed to from cash holdings."
The paper also says, "Investors are widely anticipated to shift out of money market prime funds and into money market government funds during 2016. A widening of the spread between the prime and government money market fund yields will follow as the reduced demand for credit debt causes those yields to rise. This will provide a good opportunity for prime money market fund managers, who will now have the chance to be more choosy and to push back on offerings that look too expensive. We have had many conversations with our clients that lead us to believe that, for some, there will be a spread that will entice them to stay in an institutional prime fund and accept the variable NAV and potential for redemption gates and fees imposed by money market fund reform."
It tells us, "Many changes will come to the short-term fixed income market over the near term. Because portfolio managers now equate liquidity with maturity, money market funds will continue to hold more very-short-term securities than they have historically. If the 30 percent weekly fund liquidity requirement is the new minimum, then portfolio managers are likely to run money market funds with significant liquidity buffers above that level. Broker/dealers will continue to extend maturities and re-shape the face of short-term investing by making today's compressed issuance and decreased inventory the new standard. And regulators will maintain their focus on all participants in the short end of the curve, continuing to drill down on risk measures and introducing new measures as the market evolves."
Finally, SSGA comments, "But as history has shown, the market and its participants will evolve to find new solutions and products to work in the new world of cash. We are already seeing new investment options and fund structures. Clients remain open to ideas to solve their investment needs, while portfolio managers are eager to explore new opportunities and structures to find ways to best serve their clients' objectives."
