Recently, the results of the "2016 Citigroup Money Market Industry Survey," which polled a number of money market professionals about their post-reform expectations, were released. Citi's Steve Kang writes, "This week, we present the results of our recently conducted money market reform survey. The survey was conducted to gauge investor expectations after the reform date. We sent it to a diverse set of market participants who follow short-end markets regularly ... from Sept 30 to Oct 6. 102 participated in the survey." We review Citi's results below, and we excerpt from a paper from S&P on "Banks Feel the Pinch from MMF Reform".
Citi explains, "Here is our summary of the aggregated results. 1. Most survey respondents expect that major outflows are behind us and expect a slow move back to equilibrium, which is expected to be reached around 2H2017. 2. The equilibrium for Prime institutional size (currently 200bn) is expected to be either around the current levels (100-400bn) or slightly larger (400-700bn). These are still smaller than what they used to be before 2016 (around 900bn). 3. Over the course of next year, Prime institutional WAM is expected to increase modestly to 20-30 days. This is higher than the current 9 days but lower than the historical average of around 40-50 days."
The summary continues, "4. There was no clear consensus on the required length of stable floating NAV for substantial inflows to Prime institutional funds to materialize. Most respondents expect either 1y or longer (28%) or 3-6 months (26%). 5. Assuming stable floating NAV, the right yield spread of Prime to Government is expected to be 20-30bp, higher than the historical average of around 12bp. 6. There was no clear consensus on the direction of 3M LIBOR-OIS in the near term (by the end of this year). However, most respondents expected it to tick down over the course of next year."
Kang tells us, "In terms of the nature of outflows, about half of the respondents believed that the decline in non-government assets is mainly due to both FNAV and gates and fees. Some respondents (22%) answered that gates and fees singularly was the primary determinant of outflows, followed by floating NAV (14%) and policy changes on conversions and closures (8%). Overall, the survey respondents are expecting outflows to slow after the reform date.... The modal expectation is for flat flows going into this year-end (between 50bn inflows to 50bn outflows to Prime) with some bias for further outflows (skewed to the right). As for the flows next year, the investor base is also expecting flat flows with some bias for inflows to prime (skewed to the left)."
He adds, "The flows so far have been more dramatic for institutional Prime funds due to uncertainty around FNAV -- currently Prime funds hold only about $200bn, a $700bn decline from a year ago. The respondents had a consensus for the timing of the equilibrium to be around 2H 2017.... In terms of the resulting size of the Prime funds, most participants expected the size of institutional Prime to stay around where we are (100-400bn) or rise slightly (400-700bn). By the end of 2017 (when most respondents expect the market to reach the equilibrium point), the modal expectation for Prime institutional WAM was 20-30 days, lower than historical averages around 40-50 days (Figure 7)."
Finally, Citi says, "Assuming stable FNAV is established, the respondents expect 20-30bp as a stable yield differential where investors feel indifferent between institutional Prime to Gov funds. This is substantially higher than historical averages of 12bp, but not out of reach as CD/CP has cheapened. The spread between 30-day CP and 1M T-bills remained around 15-25bp this year. The spread rises to 30-40bp for 3M tenors. The potential rate hike from the Fed would also help Prime funds attain higher yield spreads."
In other news, S&P Global Ratings published, "Banks Feel The Pinch From U.S. Money Market Reform, But It Won't Be Too Painful." The update explains, "U.S. Securities and Exchange Commission (SEC) reform of money market funds (MMFs) intended to boost their resiliency will take full effect on Oct. 14, 2016. One change will require institutional prime MMFs, which primarily invest in corporate debt securities, to maintain a "floating" net asset value (NAV) instead of a "stable" one. The measure aims to increase transparency in the funds' underlying assets. And in times of extreme volatility, institutional prime MMFs will be able to charge liquidity fees and restrict uncontrolled redemptions."
It continues, "Banks have traditionally used prime MMFs to raise U.S. dollar funding. In the past several months, however, investors have pulled billions of dollars from these funds ahead of the new SEC regulations. At the end of August 2016, prime MMFs outstanding had lost US$723 billion year to date after years of very stable investment volumes. Many U.S. institutional investors have moved into government MMFs, which are typically invested in debt issued by the government and government agencies, since these funds are not subject to the new rule."
The piece explains, "Despite the exodus, S&P Global Ratings does not foresee a funding shortage for banks in the U.S., Europe, Japan, and Australia. Anticipation of the MMF reform has already driven up certain short-term funding rates, such as the three-month U.S. dollar LIBOR rate, but we believe the overall impact will be limited. For banks in some countries, however, rising dollar funding costs will further strain net interest margins as they struggle amid low or even negative interest rates in their domestic markets."
It continues, "In the U.S., banks' reliance on MMFs for funding has fallen significantly from pre-crisis levels and, as a result, we think the outflow from prime to government MMFs will not significantly affect the ability of banks to fund ongoing business initiatives. The sustained low-rate environment, which has resulted in a large inflow of bank deposits, has partly helped U.S. banks to reduce their reliance on MMFs for funding. Indeed, we estimate that deposits have grown cumulatively since 2006 through the second quarter of 2016, increasing approximately 60% while loan growth rose only approximately 28%.... Given the large amount of deposits parked in U.S. banks, these institutions are not currently reliant on MMFs to fund their businesses."
S&P writes, "U.S. MMFs have historically invested in banks' short-term debt. As investors flee prime MMFs, banks need to find alternative funding to permanently or temporarily replace funding sources that have shriveled due to the new SEC regulations. However, we think banks in Europe, Japan, and Australia are unlikely to face a shortage of U.S. dollar funding. For instance, when U.S. MMFs abruptly withdrew their exposures to French banks in 2012, the banks, while they did face a squeeze in dollar funding, subsequently decided to deleverage materially from banking activities that need in U.S. dollar funding (for example, trade or commodities financings)."
They add, "Banks in Europe, Japan, and Australia rely on U.S. MMFs to fund only part of their dollar obligations, and dependency has generally declined in recent years.... Stakeholders have anticipated the full MMF reform since the SEC adopted the first amendments to its regulations in 2010.... Banks have alternative funding sources. These include borrowings in the repurchase (repo) market leveraging their high-quality liquid assets, issuing dollar-denominated securities with longer maturities, or raising dollar deposits. More generally, we think U.S. funding market sources are deep enough, and banks are able to tap other funds and buy-side counterparts. Should there be a dollar funding crisis, the Federal Reserve has established dollar swap lines with other central banks across the globe; ultimately, these central banks would in turn lend dollars to their domestic banks as a backstop."
Finally, the article tells us, "While the SEC's reforms are set to change the landscape of the U.S. MMF market, and anticipation of the changes have pushed up short-term funding costs, we believe the overall impact on banks in and outside the U.S.--in particular, Europe, Australia, and Japan--will likely be limited. They have boosted other funding sources over the past few years and a limited portion of their funds is made up of U.S. dollars sourced from the prime MMF market. For banks in some countries, however, rising dollar funding costs will further stress their net interest margins, which are already hurting from low or even negative domestic interest rates."
