Moody's Investors Service published an update entitled, "Outlook stable as regulatory uncertainty clouds favorable operating environment." They summarize, "Our global outlook for money market funds (MMF) is stable, unchanged from last year. The industry benefits from record assets under management (AUM), solid revenues on the back of higher yields and conservatively managed portfolios, partly offset by a lack of clarity around upcoming regulatory reform." (Note: Please join us for Crane's Bond Fund Symposium, March 23-24, 2023, in Boston, Mass. Click here for details.)
The report tells us, "Cash is king again. Higher short-term rates and volatility in long-term asset classes have made cash more attractive, supporting MMF revenues. The yield pick-up MMFs offer over bank deposits will help them maintain a competitive advantage. Macroeconomic uncertainty will also mitigate investors' shift towards riskier assets, particularly in H1 2023. Industry AUM will end 2023 at or above current record levels, with growth tempered by corporate investors' need to draw on cash balances as costs rise and earnings growth slows. MMFs will be able to charge full fees, as the end of the near-zero interest rate era has removed the need for waivers to keep clients' returns positive."
Moody's explains, "MMFs have significantly shortened the weighted average maturity (WAM) of their portfolios as interest rates have risen, allowing them to quickly reinvest capital at higher yields. WAMs will rise gradually during the year as MMFs reposition their portfolios for a likely end to the current cycle of rising rates. This will modestly increase their exposure to interest rate risk. They will however maintain ample liquidity buffers in case of unexpected events such as the September 2022 UK gilt crisis."
They tell us, "US prime MMFs have increased their allocation to Aaa rated securities. Their portfolios, which are exposed to bank debt, also benefit from the stable creditworthiness of the banking sector globally. In the US, MMFs are making heavy use of the Federal Reserve's reverse repo facility (RRP). This will likely moderate when an increase in the US debt ceiling increases the supply of Treasury bills. However, uncertainty over the outcome of deadlocked Congressional negotiations to raise the ceiling could trigger market volatility."
On "Regulatory reforms," they write, "Previous regulatory reforms in both the US and Europe drove a structural transformation of the industry. In the US, the requirement for institutional prime funds to convert from constant to variable net asset value and adopt liquidity fees and redemption gates by October 2016 resulted in a $1+ trillion asset rotation in favor of CNAV government funds. In Europe, the new LVNAV category attracted the bulk of the CNAV prime assets as prime CNAV products were phased out."
Moody's says, "The final content and timing of planned changes to MMF regulations in the US and Europe remain unclear. The current proposals, which are designed to limit large-scale preemptive redemptions during times of market stress, would make MMFs more resilient but less appealing to investors. In the US, the Securities and Exchange Commission (SEC) was scheduled to announce a final reform package last year, but changed its priorities because of turmoil in the cryptocurrency market. It might now do so in Q2 2023. The likely implementation period will likely be close to 2 years, as for previous regulatory changes."
They add, "In Europe, the European Commission was due to complete a review of MMF regulation in July last year. However, market dislocation due to COVID-19 has caused delays, and the review may be postponed further as regulators draw lessons from the UK gilt market crisis of September 2022, which showed once again how sensitive MMFs are to market shocks. European parliamentary elections in May 2024 cast further doubt over the timeline for the new rules, which must be approved by the Parliament as well as the European Commission and the Council of the European Union. There is a risk that UK and EU regulators may diverge in implementing Financial Stability Board recommendations. This could threaten the equivalence of fund regulations agreed on post-Brexit, which is valid until the end of 2025. In this scenario, EU fund managers could lose their license to sell to British investors, and new regulatory burdens would emerge."
Fitch Ratings also recently published "U.S. Money Market Funds: January 2023." They tell us, "Taxable MMFs decreased their exposure to all asset types except repo from November to December. Treasury holdings decreased by $77 billion from Nov. 30, 2022 to Dec. 31, 2022, while repo exposure increased by $253 billion over the same period, according to Crane Data. This is the largest shift into repo securities since September 2021. The shift toward repo follows the trend of managers shortening the weighted average maturities (WAMs) and WA lives (WALs) of their portfolios throughout 2022 in anticipation of Federal Reserve (Fed) interest rate increases. Repo remained the largest portfolio segment for the 16th consecutive month."
The piece continues, "As of Dec. 31, 2022, institutional government and prime MMF net yields were 3.95% and 4.22%, respectively, per Crane Data. Yields are up significantly and have continued a steady positive trend since the Fed began increasing interest rates in March, as seen in the charts below."
Finally, another Fitch article, "U.S. ESG Money Market Funds: 4Q22," comments, "On Oct. 14, 2022, Morgan Stanley announced their Institutional Liquidity ESG Money Market Portfolio would convert from an Institutional fund to a Retail fund, as defined in Rule 2a-7 under the Investment Company Act of 1940. The change became effective on Jan. 23, 2023. As a result, shareholders of the fund who were not eligible investors for a retail money market fund (MMF) were involuntarily redeemed from the fund."
It explains, "ESG MMFs had average weighted average maturities (WAMs) of 12 days for 4Q22, while non-ESG MMFs had average WAMs of 11 days; these are down from 14 days for both groups in 3Q22. Gross yields of ESG MMFs averaged 3.85%in 4Q22, the same as non-ESG MMFs. ESG MMFs' net yields averaged 3.62% during the quarter, which was 6 basis points (bps) higher than comparable non-ESG MMFs due to the lower expense ratios."
Finally, Fitch states, "The Fed continued tightening on Nov. 1st and Dec. 13th, raising rates by 75 and 50 bps, respectively. ESG MMFs' gross and net yields were up 165 bps and 136 bps, respectively, between Sept. 30, 2022 and Dec. 30, 2022, while non-ESG MMFs' gross and net yields rose 156 and 139 bps over the same period, respectively. Yields will continue to increase as the Fed's benchmark federal-funds rate is expected to reach 500 bps by the end of 2023."
They add, "Allocations in ESG MMFs remained relatively stable this quarter, but slightly increased allocations to Barclays, Bank of America and Svenska Handelsbanken during this period, a 5% increase in total, while non-ESG reduced exposure by 0.8%. Allocations to Federal Reserve Bank of New York and BNP Paribas increased quarter over quarter in non-ESG MMFs, while staying stable in ESG MMFs. Non-ESG MMF exposure to the Federal Reserve Bank of New York was 20.5% as of 4Q22, to take advantage of the Fed's Reverse Repurchase Program (RRP). This is up from 15.3% during the previous quarter. ESG MMFs continue to be ineligible for Fed RRP due to their smaller size."
