Federated Hermes filed its latest "10-K Annual Report" with the SEC Friday, and CEO Chris Donahue also spoke last week to an investor conference. Both the filing and the presentation contained a number of statements involving money market mutual funds, and we excerpt from both the 10-K and Donahue's speech below. The annual report says about "Distribution Channels and Product Markets," "Federated Hermes' distribution strategy is to provide investment management products and services to more than 11,000 institutions and intermediaries, including, among others, banks, broker/dealers, registered investment advisors, government entities, corporations, insurance companies, foundations and endowments.... These markets and the relative percentage of managed assets at December 31, 2020 attributable to such markets are as follows: U.S. financial intermediary (63%); U.S. institutional (25%); and international (12%).... As of December 31, 2020, managed assets in the U.S. financial intermediary market included $286.2 billion in money market assets ... managed assets in the U.S. institutional market included $117.6 billion in money market assets [and] ... managed assets in the international market included ... $16.6 billion in money market assets."
On "Regulatory" matters, they write, "U.S. and global regulators are focusing on the market conditions that existed in March 2020, and their impact on open-end funds, including institutional prime and municipal money market funds. The President's Working Group on Financial Markets (PWG) published a report on December 22, 2020 providing an "Overview of Recent Events and Potential Reform Options for Money Market Funds." The PWG Report reviews the effects of Covid-19 on the short-term funding markets, including institutional prime and municipal (or tax-exempt) money market funds which participate in those markets, and outlines ten possible reforms."
Federated continues, "On December 23, 2020, the SEC's Division of Investment Management released a statement on the PWG Report requesting comments to assist the Staff in providing recommendations to the SEC. The Staff requested comment in regard to three specific areas: (1) potential stress points for funds and short-term funding markets; (2) measures that can enhance the resilience and function of short-term funding markets; and (3) measures that can reduce the likelihood of future official sector interventions."
They explain, "Contrary to the focus placed by the PWG Report on money market funds as a cause of the market turmoil in March 2020, the ICI MMF Report supports the view that the Treasury securities markets, rather than money market funds, triggered the market turmoil. The ICI MMF Report rebukes suggestions that money market funds, particularly institutional prime money market funds, were a primary, if not the sole, cause of market distress in March 2020, noting that '[t]hese suggestions are inconsistent with the data and early press reports.'"
Federated adds, "As discussed above, one of the proposed reforms included in the PWG Report is to eliminate the requirement for a fund's board to consider imposing redemption gates and liquidity fees if weekly liquid assets drop below 30% of the fund's total assets.... Management believes money market funds provide a more attractive investment opportunity than other products, such as insured deposit account alternatives. Management also believes that money market funds are resilient investment products that have proven their resiliency during Covid-19. While Federated Hermes believes that some regulations could be improved, such improvements should be measured and appropriate, preserving investors' ability to invest in all types of money market funds. Federated Hermes believes that regulators should look closely at the redemption gates and liquidity fee requirement from the 2014 Money Fund Rules and Guidance and supports efforts to reduce regulation, including the PWG's recommendation to eliminate the redemption gates and liquidity fee requirement. Federated Hermes also continues to support efforts to permit the use of amortized cost valuation by, and override the floating NAV and certain other requirements imposed under the 2014 Money Fund Rules and Guidance for, institutional and municipal (or tax-exempt) money market funds. Legislation has been introduced in both the Senate and the House of Representatives in a continuing effort to get these revisions to money market fund reform regarding the use of amortized cost passed and signed into law."
They also tell us, "The activities of the Financial Stability Oversight Council (FSOC) also continue to be monitored by the investment management industry, including Federated Hermes.... FSOC has focused on potential risks in the asset management industry, including money market funds, and other types of cash management vehicles (such as local government investment pools) that continue to use amortized cost or have a stable NAV but are not subject to the 2014 Money Fund Rules and Guidance. The FSOC also has recommended that the SEC and other financial regulators monitor developments concerning such short-term cash management vehicles for any financial stability risk implications (such as liquidity, redemption risks and leverage). As discussed above, the market volatility and liquidity stress on money market funds experienced as a result of Covid-19 in March 2020 has drawn the attention of U.S. and global regulators, including FSOC. In its 2020 Annual Report, FSOC noted that "[s]tresses on prime and tax-exempt [money market funds] revealed continued structural vulnerabilities that led to increased redemptions and, in turn, contributed to and increased the stress in short-term funding markets."
Federated writes, "Management also is monitoring and assessing the potential impact of Covid-19 generally, and the impact of current low interest rate environment on money market fund and other fund asset flows, and related asset mixes, as well as the degree to which these factors impact Federated Hermes' prime and municipal (or tax-exempt) money market business and Federated Hermes' business, results of operations, financial condition and/or cash flows generally. Management is also monitoring the potential for additional regulatory scrutiny of money market funds, including prime and municipal (or tax-exempt) money market funds."
Regarding "International" regulatory issues, they comment, "Despite negative deposit interest rates, euro-denominated European money market funds have successfully operated and provided investors with high quality diversified investments which continue to provide same day liquidity, first through the use of an approved share cancellation methodology and more recently through the use of accumulating share classes. Federated Hermes continues to work with the FCA and the Central Bank of Ireland (CBI) on appropriate permissions to operate in each jurisdiction, in a manner similar to euro-denominated money market funds, should official rates in U.S. dollars or British pound sterling become negative. Additionally, Federated Hermes continues to work with the CBI on appropriate permissions to operate its U.S. dollar money market funds in a manner similar to euro-denominated money market funds, should official rates in U.S. dollars become negative."
The 10-K says, "The activities of the International Organization of Securities Commissions (IOSCO) and FSB also continue to be monitored by the investment management industry, including Federated Hermes.... On November 20, 2020, IOSCO published its final report providing a thematic review of the consistency in implementation of money market reforms across the nine largest money market fund jurisdictions. In this report, IOSCO concludes that these jurisdictions generally implemented money market fund reforms in line with 2012 IOSCO policy recommendations for money market funds, but that market conditions in March 2020 highlighted continuing vulnerabilities in certain types of money market funds and the need for further reform. Similar to the PWG in the U.S., IOSCO issued a paper on "Money Market Funds during the March-April Episode" ... in November 2020. The IOSCO Paper calls for further consideration of the functioning of money market funds, investor behavior and elements of the existing regulatory framework for money market funds which could have played a role in accelerating the outflow of assets from non-government money market funds in March 2020."
It also tells us, "In its 2020 Annual Report regarding the 'Implementation and Effects of the G20 Financial Regulatory Reforms', among other topics, the FSB reviewed the status of money market fund reforms across G20 jurisdictions, ongoing vulnerabilities from liquidity and leverage in asset management, and measures taken by financial regulators relating to funds (including money market funds) in response to Covid-19. The FSB also issued a report on its "Holistic Review of the March Market Turmoil" ... on November 17, 2020, in which it specifically reviewed the impact of the markets in March 2021 on open-end funds, including money market funds."
Federated adds, "As a result of these IOSCO and FSB reports, similar to the SEC in the U.S., UK and EU regulators are expected to re-examine existing money market fund regulation in 2021. As discussed above, Federated Hermes believes that money market funds are resilient investment products that have proven their resiliency during Covid-19. Federated Hermes intends to engage with UK and EU (as well as U.S.) regulators in 2021, both individually and through industry groups, to shape any further money market fund reforms to avoid overly burdensome requirements or the erosion of benefits that money market funds can provide."
They also state, "On December 16, 2020, ESMA published its 2020 update of the guidelines for money market fund stress tests under the Money Market Fund Regulation (MMFR). The updated guidelines provide specifications on the type of stress tests and their calibration to allow money market fund managers to have the information needed for reporting under the MMFR. The update takes into account the experience of money market funds in March 2020, particularly in relation to redemption scenarios. The updated 2020 guidelines will be required to be used for the first reporting period that is two months after publication of the translations of the updated guidelines. Federated Hermes has reviewed the updated guidelines and is taking steps to timely comply."
Finally, on the "Risk of Federated Hermes' Money Market Products' Ability to Maintain a Stable Net Asset Value," they warn, "Approximately 40% of Federated Hermes' total revenue for 2020 was attributable to money market assets. An investment in money market funds is neither insured nor guaranteed by the FDIC or any other government agency.... If the NAV of a Federated Hermes stable or constant NAV money market fund were to decline to less than $1.00 per share, such Federated Hermes money market fund would likely experience significant redemptions, resulting in reductions in AUM, loss of shareholder confidence and reputational harm, all of which could cause material adverse effects on Federated Hermes' business, results of operations, financial condition and/or cash flows."
At last week's "Credit Suisse Virtual Financial Services Forum," Federated Hermes CEO Chris Donahue, commenting on low rates and fee waivers, says, "We try to structure this whole enterprise so that what happens with rates, what happens with pandemics, what happens in the world, we can still do a great job for our clients. Now, specifically on the low rates ... we had gone from an announcement of $9 million a quarter, for the fourth quarter, of waivers, to $14 million for Q1 of '21. We're not changing that. In terms of the rates, in having recently spoken with our people about this, post-House testimony, our belief is that this stimulus is going to roll out by mid-March or so, and that will lead to more T-bill issuance and supply. So, we'd expect one or two basis points of increase in rates to come from that. Moreover, we also believe that they're going to start moving the repo rates, and the interest on excess reserve rates ... by five basis points each. The reverse repo from zero to five, and the IOER from 10 to 15. The reason is they like to have a base of about five in the short-term money market."
He comments, "The low rates are here, and we don't think that they're going to change that or blink this year. We're well aware of all the discussions of inflationary pressures and all of that. But ... 'What happens when they start to raise rates again?' Our experience is that the AUM goes up because you get more return on your cash. Obviously, the rates go up, waivers go down. But don't forget, the cash is always looking for a warm and loving home. And we always have a warm and loving home for all the cash. So to us, you look at things like increases in ... money supply, stimulus, all of this is more money flopping around in the system that will want to find at least a temporary home with money funds."
Donahue responds, "We're also bringing out 'Micro-Short' funds.... These are between ultra-shorts and money markets; the yields so far are right in between them, and we have very strong interest from clients in these products. I think they're going to do quite well. So, when you look at our positioning, growth, value, across the spectrum on fixed income, and across the spectrum on money markets, I think we are extraordinarily positioned as asset manager." (See our Feb. 4 Crane Data News, "Federated Hermes Enters Conservative Ultra-Short BF Market; ICD; CAG.")
When asked about consolidation, Donahue remarks, "The way that this business has changed over the last ten years is that there used to be well over 200 competitors in this business. Now if you look at the list there's about 50, and only 10 of them compete for money. It has in fact 'oligopolized'. Another big change that occurred was those amendments that were adopted in '14 and then implemented in '16, which basically eliminated the dollar-in-dollar-out $1 net asset value in prime funds for institutions. So, you had a trillion and a half dollars move out of prime and basically move into govies, a giant crowding out, and the muni funds weren't able to get to their previous peaks of about $500 billion. So that changed a lot."
Lastly, he comments, "The President's Working Group came up with a report recently, which basically was 'The Night of the Living Dead.' They brought up all the zombies which we had dispatched before and pretended as if they had never been dispatched. So, we will have to run through that again. One thing that they recognized was a problem with linking the 30% weekly liquidity with decisions about fees and gates on money funds, and that that triggered more problems than it ever solved. I think there's a real good shot that that gets changed, because that would basically enhance the whole effort. I do expect more regulation ... but what's really going on underneath is that the clients and issuers in the capital markets have great standing."
