As we mentioned in a "Link of the Day" earlier this week ("Bloomberg on BIS Repo Study"), the Bank for International Settlements, or BIS, writes in its latest Annual Report about "Banks' window-dressing: the case of repo markets." The source BIS piece tells us, "Window-dressing refers to the practice of adjusting balance sheets around regular reporting dates, such as year- or quarter-ends. Window-dressing can reflect attempts to optimise a firm's profit and loss for taxation purposes. For banks, however, it may also reflect responses to regulatory requirements, especially if combined with end-period reporting." We review this brief below, and we also report more on the recent Senate testimony on bill S.1117.
The BIS writes, "One example is the Basel III leverage ratio. This ratio is reported based on quarter-end figures in some jurisdictions, but is calculated based on daily averages during the quarter in others. The former case can provide strong incentives to compress exposures around regulatory reporting dates – particularly at year-ends, when incentives are reinforced by other factors (eg taxation)."
They tell us, "Banks can most easily unwind positions around key reporting dates if markets are both short-term and liquid. Repo markets generally meet these criteria. As a form of collateralised borrowing, repos allow banks to obtain short-term funding against some of their assets – a balance sheet-expanding operation. The cash received can then be lent via reverse repos, and the corresponding collateral may be used for further borrowing. At quarter-ends, banks can reverse the increase in their balance sheet by closing part of their reverse repo contracts and using the cash thus obtained to repay repos. This compression raises their reported leverage ratio."
The report continues, "The data indicate that window-dressing in repo markets is material. Data from US money market mutual funds (MMMFs) point to pronounced cyclical patterns in banks' US dollar repo borrowing, especially for jurisdictions with leverage ratio reporting based on quarter-end figures.... Since early 2015, with the beginning of Basel III leverage ratio disclosure, the amplitude of swings in euro area banks' repo volumes has been rising – with total contractions by major banks up from about $35 billion to more than $145 billion at year-ends."
It adds, "While similar patterns are apparent for Swiss banks (which rely on quarter-end figures), they are less pronounced for UK and US banks (which use averages). Banks' temporary withdrawal from repo markets is also apparent from MMMFs' increased quarter-end presence in the Federal Reserve's reverse repo (RRP) operations, which allows them to place excess cash.... Despite the implicit floor provided by the rates on the RRP ... there are signs of volatility spikes in key repo rates around quarter-ends.... Such spikes may complicate monetary policy implementation and affect repo market functioning in ways that can generate spillovers to other major funding markets, especially if stress events coincide with regulatory reporting dates."
In other news, we mentioned the Bond Buyer's article, "Why issuers want to undo money market mutual fund rules," in our June 27 Link of the Day, and said to watch for more comments on this topic from Federated Investors CEO Chris Donahue from this week's Money Fund Symposium in coming days. But we also discovered a link to the Webcast and supporting documents from recent Senate Committee testimony in support of S.1117: The Consumer Financial Choice and Capital Markets Protection Act of 2017.
The Senate's statement says, "Committee on Banking, Housing and Urban Affairs will meet in open session to conduct a hearing entitled, 'Legislative Proposals to Increase Access to Capital.' The witnesses will be Mr. Raymond J. Keating, Chief Economist, Small Business & Entrepreneurship Council; Professor Mercer E. Bullard, Butler Snow Lecturer and Professor of Law, The University of Mississippi School of Law; and Mr. Chris Daniel, Chief Investment Officer of the City of Albuquerque, New Mexico, on behalf of the Government Finance Officers Association. All hearings are webcast live and will not be available until the hearing starts."
U.S. Senator Mike Crapo (R-Idaho), Chairman of the U.S. Senate Committee on Banking, Housing and Urban Affairs, issued this Statement" on "Legislative Proposals to Increase Access to Capital," "`Today's hearing will focus on several legislative proposals that will encourage capital formation and reduce burdens for smaller businesses and communities. My goal is to work with Ranking Member Brown and other Senators on this Committee to identify and move legislative proposals that achieve these aims. Many of the bills we will discuss in today's hearing have been considered in the House of Representatives earlier this Congress."
He continues, "Of those that the House has considered to date, all have passed the House Financial Services Committee with bipartisan support and some have passed the full House, including one with a vote of 419 to 0. “Many of my colleagues on this Committee are also interested in these issues and have introduced Senate companions to many of these bills as well as taking the lead in introducing bipartisan bills in the Senate.... Senators Toomey, Rounds and Menendez, among others, introduced a bill that would provide more financing options for state and local governments seeking to raise money.... I look forward to hearing from our witnesses on these legislative proposals."
The GFOA, or Government Finance Officer's Association, previously submitted a letter of support entitled, "Maintaining the Stable Net Asset Value Feature of Money Market Funds," which says, "The stable net asset value (NAV) is the predominant safety feature of money market funds. A stable NAV means that the chance of the fund losing principal or breaking a buck is minimized because it always maintains a $1.00 value (investors will receive $1.00 back for every $1.00 invested). The fund is managed towards that goal."
They explain, "State and local governments are a major purchaser of money market funds, holding $92 billion in stable NAV money market funds in 2009. Many governments choose to use - or are required to use as directed by state statutes, federal restrictions, and policies - money market funds as a cash management tool, as they carry little credit risk. Additionally, money market funds hold 65% of outstanding short-term municipal debt, making them the largest holder of short-term tax-exempt debt."
GFOA's "Policy Statement" said, "The Government Finance Officers Association (GFOA) strongly opposes changes to SEC Rule 2a-7 that would require or allow funds to use a floating NAV rather than the current stable NAV. Governments depend on the safety and liquidity of money market funds for their constantly flowing operating funds and as part of their cash management strategy. Without being able to invest in these funds, governments would have to look to other investment vehicles that would be less attractive, less liquid and may carry greater risks. Furthermore, if this major purchasing power of municipal bond were to exit the market, state and local governments would suffer higher borrowing costs on their short-term debt.
It added, "The GFOA also strongly believes that the SEC should consult with state and local governments regarding any changes to this market, and allow the opportunity for GFOA and others in our community to comment and provide analysis on any SEC changes to Rule 2a-7 that will have an effect on the public sector."
