Federated Hermes President and CEO J. Christopher Donahue and President Ray Hanley presented earlier this week at Morgan Stanley's "Virtual US Financials Conference," where they discussed recent money fund flows, fee waivers and implication of recent Fed support programs. Donahue comments, "The money market growth so far in 2020 is $80 billion, which is about 20 percent. As you know, money markets tend to shine when things are unsettled, but we notice that money markets do well in higher rates too. Our whole history is a history of higher highs and higher lows." We quote from the Federated session below, and we also review recent comments from Bank of England's Jon Cunliffe on money funds.
Host Mike Cyprys comments, "We saw during the recent crisis over a trillion dollars of inflows across the industry into money funds, most of it into institutional 'govie' funds. Is that mostly pension fund clients? Just curious what types of clients [were] driving these inflows?" Donahue answers, "We would say about 90 percent of our growth came from institutional clients, and that includes wealth management, bank trust, corporations. The other 10 percent would be retail, broker dealers, sweeps, things like that.... There's a bunch of that money that's CARES money, that's PPP money, and that money was designed to come in and go out and get forgiven. So, you would expect some of it to have that kind of a character."
He continues, "Not all the money was a pure flight to safety type money, and that's an important thing to consider. Now, when you say, 'Well, gee wiz what would it take to have all this flow out?' Well, I already told you about some of the money that's being used, that's what happens with cash. We think that if rates are at all higher that sure helps the money funds. In past cycles with rates going up, ... the money funds will get there sooner than the bank deposit rates.... Our house view is that the Fed isn't going to do anything to rates anyway and we're going to be living in this type of environment. But we have seen things like Repo rates go up a basis point or so over the last day or two, little things like that."
On fee waivers, Donahue comments, "Well, we are not going to change what we said at the other conference and at the quarter end, which was: We estimate $3 million of reduction in Q2 operating income from what we call money market fund minimum yield waivers. So, we're staying with that. That's based on our investment team's outlook on the asset level and the mix at the time."
Hanley comments, "In terms of the reinvestment rates, you're right. We've seen Libor come in and concur with the actions that the Fed took in that market. You can see the rates that are out there. We can go out in a money fund out beyond one year, 397 days, but of course much of the portfolio is very short. So we're just under 20 basis points in terms of 1-month Libor, and a bit more going up to three. On the government side, where we've seen the bill rates jump a bit, as Chris mentioned, we're up into the teens on 3- and 6-months, the mid to upper teen levels. On the repo rates, which is where a lot of the portfolios need to be to provide liquidity, we've seen a couple basis point improvement there over the last week or two. So, we're seeing six to 11 basis points on different types of Repo, Treasury and MBS and weekly Muni."
When asked how waivers this time might be different from 2009-2015, Donahue explains, "It's always a multifaceted calculation. It's a function of both the rates and the volume and what kind of funds. In our case ... a big factor is the distribution expenses. So today our assets are higher than they were in '08, and we are more concentrated in Government money funds compared to Prime and Munis than before. Government funds ... have lower yields and so they could run into minimum yield waivers faster. But, we also have much more assets at lower fee levels, which means they run into waivers later than the last cycle. And there were a lot of funds that we had before that were in sweep vehicles which are now in bank deposits, and those ran into waivers earlier in the cycle. It's just very, very difficult to try and build a model to take care of all of these factors, to come up with an estimate. So there are a lot of differences, but the money fund remains very, very solid cash management vehicle."
Earlier this week, the Bank of England's Jon Cunliffe gave a speech entitled, "Financial System Resilience: Lessons from a real stress," which discussed money funds and short-term funding issues. He states, "Within the investment fund universe, we need to look at the related question of whether actual or prospective redemption requests generated additional pressures for funds invested in illiquid assets, how well liquidity management tools operated under stress and whether we saw any emergence of first mover advantages that could have created 'run' dynamics. One important element in the amplification of liquidity pressure appears to have been the unwinding of large positions in interest rate markets, particularly US Treasuries, by very highly leveraged hedge funds."
Cunliffe explains, "As the search for liquidity intensified, money market funds (MMFs) came under pressure. Post crisis reforms in the US and in other jurisdictions had sought to make MMFs stable under stress, to reduce 'first mover' advantages and incentives for investors to 'run'. However, under the recent stress, MMFs appear again to have been a source of vulnerability in the system. As the demand for liquidity grew and market participants drew down their investments in money markets, MMFs saw substantial withdrawals. However, as many funds tried to liquidate their assets (largely commercial paper) to meet redemptions, they found the markets effectively closed."
He tells us, "Some MMFs came very close to regulatory liquidity thresholds and to the point at which they would have to suspend or 'gate' withdrawals, which could in turn have triggered contagion to other MMFs and severely exacerbated the overall stress in the financial system. Various direct and indirect central bank actions helped to avoid this outcome. We need to look at whether, despite the post crisis reforms, investors conceive of MMFs as equivalent to deposit accounts and whether MMFs have the resilience to meet the meet the consequent liquidity demands in a severe stress. We should also explore the liquidity characteristics under stress of some of the underlying assets, like bank commercial paper, on which MMFs depend for liquidity."
Cunliffe also says, "As well as looking at what drove and amplified the search for liquidity, we will I think need to examine why the core funding markets were overwhelmed by the demand, amplifying further the pressures in the system. There have been warning signs that these markets might prove unable to transmit liquidity under stressed conditions. It is not clear whether this is due to the role of regulation such as the leverage ratio as has been claimed or to the increasing risks to dealers as government bond prices fell or some combination of the two. But as with CCP margin, it is important that we remember the reasons for the regulatory reforms in this area."
Finally, he adds, "As I have noted, one of the key differences between this crisis and the financial crisis has been the ability of the core banks to absorb a very severe financial market shock. We should not put that at risk by weakening the regulation of banks. If we want to increase the overall resilience of the system we cannot simply lower resilience in one area in order to strengthen it in another. Rather we need to look at other ways to reduce surges in the demand for liquidity and improve the supply of liquidity under stress."
Bloomberg Law first wrote about the news in its piece, "Money Fund Industry Draws BOE Scrutiny After March Market Strain." They tell us, "The multi trillion-dollar money market fund industry was a source of 'vulnerability' in the financial system at the height of the coronavirus crisis and demands closer scrutiny, said Jon Cunliffe, a Bank of England deputy governor. Cunliffe told a web conference on Tuesday that regulators must look at whether the funds are invested in liquid assets that can be easily sold to meet redemptions during times of stress."
