Allspring, the new name for the Wells Fargo Funds, recently hosted a webinar entitled, "On the Horizon: Recent Fed and SEC Updates and What It Means for Investors," which featured Allspring's Jeff Weaver, Laurie White, Brian Jacobsen and Yeng Butler. The description tells us, "All eyes were on Washington as we closed out the year, with several significant proposals and updates announced by the Securities and Exchange Commission (SEC) and Federal Reserve (Fed). Join our panel as they discuss what it means for investors. Topics will include: accelerated Fed tapering and rising rate expectations; recent developments from the SEC's proposed money market reform; and macro developments that prompted market and regulatory changes and the implications on investor's portfolios." We quote from the money fund heavy segments below. (Note: Thanks to those attending and supporting our Money Fund University, which continues this afternoon from 1-3pm. Crane Data Subscribers and MFU Attendees may access conference materials and recordings via our "Money Fund University 2022 Download Center.")
Weaver comments, "Higher rates is great news for money fund investors. You know, we've been at zero rates for ... it seems like forever.... So, higher rates will certainly be welcome.... We expect a rate hike in March. The market has really been adjusting for and expecting higher rates really since the end of September.... We see it in a couple other places too. Fed funds futures currently has about a 90 percent chance of a rate hike in March and [is] pricing in about 3 1/2 rate hikes for 2022."
He explains, "What this provides is opportunities out the curve now for short duration investors, those with separate accounts and those with the ability to buy ultra-short or short-term bond funds. We're starting to see quite a bit of value there. For money funds, you won't actually see the rates go up ... until that first hike, and even more so the second hike. Because of fee waivers in place, we need to get 25, 50 basis points of liftoff before we can really see the effects of that from a yield standpoint.... But the other benefit, too, is, we'll start to see rates higher across the curve."
On the Fed's RRP, Weaver tells us, "One of those tools that has come about in the last few years and has certainly been utilized quite heavily is the reverse repurchase program. That is where money funds and federal banks can take advantage of investing their cash with the Fed and in turn getting a pretty good rate, five basis points, which really helped the Fed manage the Fed funds rate off of that zero floor.... It's been quite popular in that balances at the end of the year were $1.9 trillion in the RRP.... That is one of the tools that is used by the Fed to help manage the Fed funds rate.... Even as the Fed begins to shrink the balance sheet, ... money fund investors will continue to utilize the RRP [though] we could see balances go down. But for now, it still remains an attractive investment for many funds that aim to hold on to a lot of short-term liquidity."
White summarizes the SEC's recent reform proposal, saying, "It comes as no surprise to anybody at this point that the March 2020 market dislocations that we experienced leading up to the pandemic response really highlighted the vulnerabilities in money market funds and short-term funding markets. So, the SEC is proposing amendments to Rule 2a-7, which governs money market funds, to help them be a more resilient in the face of stress and make them more transparent to investors in the future. So, I can summarize the four proposed amendments that would be most visible and impactful to shareholders and money market operations."
She says, "The first proposal that the SEC is making is that they remove the fees and gates from rule 2a-7. Under the current rules, institutional prime and tax-exempt money markets may impose a liquidity fee or temporarily suspend redemptions if weekly liquid assets fall below 30% and the board of directors determines it's in the fund's best interest.... March 2020, however, demonstrated that there were two unintended consequences of this particular rule. The first was that just the mere likelihood that fees and gates could be imposed prompted investors to redeem shares in their funds. And the second was that the linkage between the liquidity requirements and fees and gates curtailed fund managers from actually using their liquidity to fund redemptions. So, in recognition of these shortcomings, the SEC has decided to remove all reference to implementing any fees and gates from the rule. By and large, most organizations were actually advocating for removing the linkage between the two. So, this will be a welcome development for the industry."
White continues, "The second rule change that the SEC is considering is meant to be complementary to removing fees and gates. They would increase the minimum liquidity requirements for money market funds ... to raise those minimums to 25 percent with daily liquid assets and 50 percent on weekly liquid assets. They feel that this would better equip money market funds to manage significant and rapid investor redemptions even under conditions where money markets can't rely on secondary markets for liquidity.... You may think that this is a huge shift, but it's really not. These levels are consistent with liquidity levels that were being managed in money market funds in the four years right before the March 2020 dislocations. So, in combination with the first proposal, what this effectively does is it gives managers access to a larger liquidity bucket for them to work with in times of redemptions from the funds."
She comments, "The third proposal that the SEC is making is to implement swing pricing for institutional prime and tax-exempt money market funds. What this would mean would be it would require institutional funds to adjust their NAVs by what's called a swing factor, and that factor would reflect spread and transition costs if the fund experiences net redemptions during the pricing period. So the swing factor would be applied to the mark to market NAV that would be associated with the redemption cut off after a shareholder places a redemption trade."
White asks, "Why are they doing this?" She answers, "They feel that this provision of swing factors would remove the incentive for shareholders to preemptively redeem their shares in the event of market stresses. Because redeeming shareholders wouldn't necessarily know when or if they swing price from a factor would be implemented. Alternatively, it could also be viewed as a built-in incentive for shareholders to remain in the fund instead of redeeming ultimately. What the SEC feels it would do is that it would ensure redeeming shareholders bear the cost of their liquidity demands and that it will mitigate dilution for shareholders who remain in the fund and what they would experience when liquidity is depleted from the funds."
She adds, "Finally, the fourth important proposal that the SEC is making is that they're proposing to add amendments to address what happens in a potential negative interest rate environment. Since the global financial crisis in 2008, short term funding markets have experienced two periods of prolonged near zero interest rates, and at times this has meant that individual securities are traded at negative rates. Even though the Fed hasn’t implemented a negative interest rate policy."
When asked about challenges, she responds, "Certainly, I think the most complex provision is going to be swing pricing, and it's going to be a challenge to get our arms around that. That's primarily because this would be the first time it's been applied to money funds. It's usually used with other variable NAV funds like stock and bond funds, and really primarily in the EU. So this is relatively new territory for money market funds. There are still many details to be worked out, but conceptually and based on the broad outlines in the proposing release, it would work something like this: fund complexes would have to calculate a swing factor to apply to net redemptions during any given pricing period, and the swing factor would adjust the NAV downward for those shareholders that are redeeming shares. The size of the downward revision depends on the size of the net redemption."
White tells us, "Since many of these costs are non-existent or minimal for these types of securities and for funds that are already pricing on the side of the market, there would be no spread adjustment. However, if redemptions exceed the market cap threshold, in other words, they're relatively large, then you'd have to add an estimate of how much [it costs to] trade a slice of the total portfolio ... if you had to sell it immediately. Now, this would have resulted in a larger factor for larger redemptions, as well as taking into account whether or not markets are stressed."
