Federated Hermes filed its latest "10-K Annual Report" with the SEC last week, and the 112-page document contains discussions on "Distribution Channels and Product Markets," "Regulatory Matters" and "Risk Factors," among other things. The report tells us, "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. Federated Hermes uses its trained sales force of more than 230 representatives and managers backed by an experienced support staff to offer its products and strategies, add new customer relationships and strengthen and expand existing relationships. Federated Hermes' investment products and strategies are offered and distributed in three markets. These markets and the relative percentage of managed assets at December 31, 2021 attributable to such markets are as follows: U.S. financial intermediary (62%); U.S. institutional (26%); and international (12%)."
It continues, "Federated Hermes offers and distributes its products and strategies in this market through a large, diversified group of over 7,500 national, regional and independent broker/dealers, banks and registered investment advisors.... As of December 31, 2021, managed assets in the U.S. financial intermediary market included $301.2 billion in money market assets.... Federated Hermes offers and distributes its products and strategies to a wide variety of domestic institutional customers including, among others, government entities, not-for-profit entities, corporations, corporate and public pension funds, foundations, endowments and non-Federated Hermes investment companies or other funds. As of December 31, 2021, managed assets in the U.S. institutional market included $131.9 billion in money market assets.... As of December 31, 2021, managed assets in the international market included ... $14.8 billion in money market assets."
On the "Current Regulatory Environment," Federated writes, "U.S. and global regulators also continue to focus on the market conditions that existed in March 2020, and their impact on open-end funds, including institutional prime and municipal (or tax-exempt) money market funds.... SEC Chair Gensler indicated that he had asked SEC staff for recommendations to address the challenges to money market funds experienced in the spring of 2020, and stated that he believes 'it is time to reflect upon the reforms of 2014 and 2010 to see if we can further improve resiliency, particularly in times of stress.' ... FSOC indicated that 'the [FSOC] is encouraged by the SEC's engagement on this critical issue' and, ... 'will continue to monitor this initiative in the broader context of efforts by financial regulators to strengthen short-term funding markets and support orderly market functioning, including during periods of heightened market stress.'"
They comment, "Contrary to the focus placed by the PWG Report and regulators on money market funds as a cause of the market turmoil in March 2020, the Investment Company Institute (ICI) had issued a report entitled, 'Experiences of U.S. Money Market Funds During the Covid-19 Crisis' ... that supports the view that the Treasury securities markets, rather than money market funds, triggered the market turmoil. The ICI MMF Report rebuked 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.' ... The ICI MMF Report also noted that, 'press reports do not support the theory that money market funds were at the forefront of the market stress' and that, 'Treasury markets were in the news several days before any real mention of money market funds.'"
The 10-K states, "In response to requests for comments by the SEC's Division of Investment Management regarding aspects of the PWG Report and potential money market fund reforms, Federated Hermes, along with the ICI and other industry participants, submitted comment letters that strongly disagree with the conclusions reached in the PWG Report.... Federated Hermes stressed that the market turmoil in March 2020 was created by the Pandemic and the unprecedented global government response and economic shut-down to stem the spread of the coronavirus.... In a third comment letter, dated September 21, 2021, Federated Hermes expressed its belief that the combination of delinking the potential imposition of redemption gates and liquidity fees with a money market fund's weekly liquid asset requirements, adoption of certain liquidity fee procedures, and enhancements to money market funds' ability to 'know their customer' ..., when combined with consideration of, and improvements in, the short-term markets generally, can address the concerns identified in the PWG Report without adversely impacting the viability of money market funds and their benefits to investors, issuers and capital formation."
It says, "On December 15, 2021, the SEC Commissioners voted to propose new amendments to money market fund rules. In his statement announcing the proposals, SEC Chair Gensler cited the PWG Report, international regulatory concern, the prior FSOC statements, SEC comments and public responses to the SEC's requests for comment, as evidence for the systemic risk posed by money market funds. According to the SEC, the proposed amendments would improve the resilience and transparency of money market funds by: (1) increasing minimum liquidity requirements for daily and weekly liquid assets to 25% and 50%, respectively, to provide a more substantial buffer in the event of rapid redemptions; (2) removing the ability of money market funds to impose liquidity fees and redemption gates when they fall below certain liquidity thresholds, which would eliminate an incentive for preemptive redemptions; (3) requiring certain money market funds (e.g., institutional prime and institutional municipal (or tax-exempt) money market funds) to implement swing pricing, which involves a process of adjusting a fund's current NAV such that the transaction price effectively passes on costs stemming from shareholder redemptions to redeeming shareholders, so that they bear the liquidity costs of their redemptions; (4) enhancing certain reporting requirements (e.g., Form N-MFP and Form N-CR) to improve the SEC's ability to monitor and analyze money market fund data; and (5) requiring stable NAV money market funds to convert to a floating NAV if future market conditions result in negative money market fund yields. The comment period on the SEC's proposed rule will end on April 11, 2022."
The report also tells us, "Federated Hermes is currently reviewing the proposed rule to assess any potential impact to Federated Hermes' business, and intends to participate in the comment process. Federated Hermes believes that swing pricing is not a workable alternative for institutional prime and municipal (or tax-exempt) money market funds because it creates uncertainty around redemption proceeds and requires significant system changes for money market funds.... Federated Hermes also opposes increasing the liquidity requirements for daily and weekly assets because of the negative effect such increased requirements will have on money market fund yields. Federated Hermes also opposes the elimination of liquidity fees and redemption gates, and believes money market funds should have a choice between imposing liquidity fees and redemption gates and implementing swing pricing. Finally, Federated Hermes disagrees with the SEC's refusal to permit money market funds to use reverse distribution mechanisms or share cancellation methodologies to maintain a stable NAV in a negative rate environment."
It continues, "Federated Hermes has expended, and will continue to expend, significant internal and external resources to engage with regulators on potential money market fund reforms, including through additional comment letters and meetings with U.S. and global regulators and legislators, the ICI and other industry participants. Management believes money market funds provide a more attractive investment opportunity than other competing products, such as insured deposit account alternatives. Management also believes that money market funds are resilient investment products that have proven their resiliency during the Pandemic. 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.... Legislation has been re-introduced in the Senate and in 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."
Discussing "International Regulations," Federated tells us, "The post-Brexit regulatory environment ... also creates a level of uncertainty regarding the ability and requirements to distribute products and provide investment management services between the UK and EU, increasing regulatory burdens and compliance.... Regarding the regulatory environment for money market funds post-Brexit, UK-domiciled money market funds remain on par with current EU regulatory requirements; however, it is possible that the UK may deviate from - or simply not adopt - any new or amended EU money market fund laws, rules or regulations that may be adopted in the future."
They explain, "On February 16, 2022, ESMA published a final report, 'ESMA Opinion on the review of Money Market Fund Regulation,' which makes recommendations to improve the resiliency of money market funds. Among other recommendations, it recommends: (1) addressing the threshold effects for constant NAV money market funds by removing the possibility to use amortized cost for low volatility NAV money market funds and decoupling regulatory thresholds from suspensions, gates and redemption fees for low volatility NAV and constant NAV money market funds; (2) addressing liquidity concerns by ensuring mandatory availability of at least one liquidity management tool for all money market funds; (3) amending daily liquid asset and weekly liquid asset ratios; (4) adjusting the pool of eligible assets to require money market funds to hold public debt assets, which could be used to satisfy the daily and weekly asset liquidity ratios; (5) reinforcing the possibility of temporarily using liquidity buffers in times of stress; and (6) enhancing reporting and disclosure requirements and the stress testing framework for money market funds."
The report then states, "Federated Hermes does not believe money market funds are shadow banking entities. As discussed above, Federated Hermes believes that money market funds are resilient investment products that have proven their resiliency during the Pandemic. Federated Hermes intends to continue to engage with UK and EU (as well as U.S.) regulators in 2022, 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 provide."
Among the "Risk Factors" cited is the "Risk of Federated Hermes' Money Market Products' Ability to Maintain a Stable Net Asset Value." They state, "Approximately 19% of Federated Hermes' total revenue for 2021 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. Federated Hermes' retail and government/public debt money market funds, and its private and collective money market funds, seek to maintain a stable or constant NAV.... Federated Hermes devotes substantial resources, such as significant credit analysis, consideration of ESG factors and attention to security valuation, in connection with the management of its products and strategies. However, the NAV of an institutional prime or municipal (or tax-exempt) money market fund, or variable NAV fund or, if the above described conditions are met, a low-volatility NAV fund, can fluctuate, and there is no guarantee that a government/public debt or retail (i.e., stable or constant NAV) money market fund, or a low-volatility money market fund, will be able to preserve a stable or constant NAV in the future.... 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' Financial Condition."
On low rates, they write, "For the year ended December 31, 2021, Voluntary Yield-related Fee Waivers totaled $420.3 million. These fee waivers were partially offset by related reductions in distribution expenses of $277.1 million, such that the net negative pre-tax impact to Federated Hermes was $143.2 million in 2021. For the year ended December 31, 2020, Voluntary Yield-related Fee Waivers totaled $113.0 million. These fee waivers were partially offset by related reductions in distribution expenses of $98.4 million, such that the net negative pre-tax impact to Federated Hermes was $14.6 million in 2020."
Finally, the 10-K adds, "Short-term interest rates remained near historic lows during the fourth quarter of 2021 as technical factors at the front end of the yield curve kept yields on short-term government securities -- including repurchase agreements and Treasury bills -- just above zero. Market expectations are that the FOMC will raise interest rates multiple times in 2022, starting in March. Higher yields in 2022 will lower the impact of Voluntary Yield-related Fee Waivers.... Assuming an increase in interest rates of 25 basis points by the FOMC in March 2022, the first quarter 2022 estimated $22 million of net negative impact on pre-tax income from Voluntary Yield-related Fee Waivers is expected to be reduced by approximately 90% for the second quarter 2022. The actual amount of future Voluntary Yield-related Fee Waivers and the resulting negative impact of these fee waivers could vary, including in a material way, from management's estimates as they are contingent on a number of variables including, but not limited to, changes in assets within the money market funds, changes in yields on instruments available for purchase by the money market funds, ... changes in fees and expenses of the money market funds, changes in the mix of money market customer assets, changes in customer relationships, changes in money market product structures and offerings, demand for competing products, changes in distribution models, changes in the distribution fee arrangements with third parties, Federated Hermes' willingness to continue the Voluntary Yield-related Fee Waivers and changes in the extent to which the impact of these fee waivers is shared by any one or more third parties."
