PIMCO published, "Libor Rising and Money Market Reform: Five Key Questions," which explores elevated LIBOR rates and money market reforms. It says, "Anticipation of U.S. money market reform in October has pressured short-term funding rates higher. What are the implications for banks and investors?" In addition, Treasury Today features an article with Kyriba's Bob Stark on the possibility of an absolute exodus from prime to government funds. We discuss these below, and we also review the latest fund changes and liquidations.
The "Libor Rising" paper summarizes, "U.S. money market reform will take effect on 14 October 2016, and short-term interest rates such as Libor (the London Interbank Offered Rate) have been rising significantly in anticipation. Jerome Schneider, PIMCO's head of short-term portfolio management and Morningstar Fixed-Income Fund Manager of the Year (U.S.) for 2015, addresses five critical questions we're hearing from investors about what to expect next and the implications for portfolios."
PIMCO's piece asks, "Should investors and issuers be prepared for even higher Libor levels in the weeks and months to come, or have we already seen the most significant moves?" Schneider answers, "Anticipation of U.S. money market reform has pressured short-term funding rates higher as U.S. investors move toward money market funds that invest only in government securities and away from prime (credit) money market funds. As a result ... issuers of commercial paper and certificates of deposit, mainly non-U.S.-domiciled banks, have to pay more for funding as yields move higher and funding risk premiums widen. As a result, many funding benchmark rates, including U.S.-dollar-denominated Libor resets, have seen dramatic increases of more than 50 basis points (bps) over the past year – and less than half of that increase can be attributed to the 25 bp hiking action by the Federal Reserve last December."
It continues, "While prime money market funds have raised a lot of liquidity in preparation for the reforms, the "known unknown" factors remain steadfast: How much additional outflow can we expect, and over what timeframe – will 14 October be the turning point, or will outflows continue into 2017? To hedge these known unknowns, we think many prime fund managers will continue to buy shorter and shorter maturities and invest more and more in government-related paper to fund potential outflows. This should keep upward pressure on Libor during the weeks ahead."
PIMCO also asks, "Could the Libor rate be driven down, or at least stabilized, by increasing demand from investors outside the money market sphere?" Schneider responds, "It's important to remember that this is not simply a market reaction to a piece of data, but a structural reform that will change the way most investors allocate their cash liquidity over time. So while this year's spike in Libor reflects the initial market reaction to money market reform, it will take months if not several quarters for rates to recalibrate to lower levels again relative to perceived "risk-free" rates such as OIS or the fed funds rate."
The piece continues, "For investors focused on liquidity and short-term assets, does the increase in Libor signal a potential opportunity?" Schneider says, "It absolutely presents a unique opportunity for those investors willing to assess and adapt to this structural evolution.... Investors should also acknowledge how these structural changes are likely to affect their investment outcomes and risk profiles. Active and innovative management of liquidity ... will likely be critical to preserving not only liquidity, but also purchasing power for their capital over time."
In other news, U.K.-publication Treasury Today published the story, "Will treasurers abandon MMFs after SEC reforms?" It explains, "New rules for US MMFs mean there will be some tough decisions ahead for corporate cash investors. But Kyriba's Bob Stark is convinced that the value proposition of prime MMFs will endure the coming regulatory reform."
The article says, "In the US, a very large area of the financial markets - and one that is crucial to the work of corporate treasurers – is about to undergo substantial changes. Under the reforms to Rule 2a-7 ... prime institutional MMFs must abandon the practice of fixing share prices to $1 and move to a variable net asset value (VNAV) model, and will be subject to liquidity gates and redemption fees <b:>`_.... Government funds, meanwhile, will be able to continue using a stable net asset value (CNAV)."
It continues, "With the new rules due to take effect in October, there has been much speculation that corporate treasurers – many of whom prefer CNAV MMFs – will choose to abandon prime MMFs in favour of government CNAV MMFs in the coming months. That is not a baseless claim ... all the latest survey data, together with what we are already seeing in the market, suggests many treasurers are planning – and indeed doing – exactly that."
Treasury Today adds, "But Bob Stark, Vice President of Strategy at treasury software providers Kyriba is not convinced that this shift away from prime to government funds will be especially long-lived. Stark points out that the two most commonly cited priorities for institutional investors in MMFs – security and liquidity – should not be materially affected by the new rules. Although prime MMFs will henceforth be subject to redemption fees and liquidity gates he thinks it is doubtful that we will ever see these implemented."
Finally, with August month-end, we witnessed and processed another batch of fund changes. (See our pending MFI XLS for the full list.) Liquidated funds include: CNR CA Tax-Exempt MMkt Fund, CNR Prime MMkt Fund, Putnam MM Liquidity, SEI Daily Inc Trust Treas, SEI Daily Inc Trust Treasury II, Wells Fargo MMF B, Western Asset Inst Cash Res SVB, Western Asset Inst Liquid Res SVB, Western Asset Inst Liquid Res SVB Liq, Wilmington Prime MMF, and Wilmington Tax-Free MMF. UBS Select Tax-Free MM also changed its name to UBS Tax-Free Reserve.
