The latest monthly "Portfolio Holdings of Taxable Money Market Funds" report released by the Investment Company Institute shows money funds increasing their Repurchase Agreement holdings and reducing their Commercial Paper, Treasury Bills, Certificates of Deposit, and Government Agency Securities. ICI's report also shows Weighted Average Maturities continue to shorten and its "Trends in Mutual Fund Investing April 2010" shows money fund assets declined by $125.9 billion, or 4.2%, in April to $2.858 trillion.
ICI's weekly asset series, though, shows money fund assets rising for the second time in two weeks, and Crane Data's Money Fund Intelligence Daily shows WAMs have continued to get even shorter in May ahead of today's deadline for the SEC's Money Market Fund Reform portfolio and liquidity rule changes. As of today, money funds must begin holding 10 percent in Treasury securities and/or securities maturing in one day and must begin holding 30 percent (this includes the daily 10 percent too) in Treasury, government discount and/or securities maturing in 7 days. Funds must also hold lower "Second Tier" (3 percent total) and illiquid security (5 percent) limits and must adhere to a number of other new rules. (See the SEC s "Money Market Fund Reform: Final Rule" here.)
ICI's Average Maturity figures show taxable AMs (or WAMs) at 44 days in April, down from 46 in March and down from 50 days a year ago. Our Crane 100 Money Fund Index, an average of the 100 largest taxable money funds, shows AMs declining to 39 days -- their lowest level since December 2007. Our broader Crane Money Fund Average, which tracks 868 taxable funds, has declined to 37 days from a peak of 49 days in October 2009. Though the SEC's new WAM and WAL (weighted average life) rules don't go into effect until the end of June, the new liquidity mandates, coupled with higher rates and European troubles, have clearly caused funds to shorten their leashes. (Our MFI XLS product shows the percent of securities maturing in 7 days for funds averaging 42 percent for all taxable funds and 39 for our Crane 100.)
Money funds also continued to add Repo ahead of the dawn of the new 10% daily liquidity and 30% weekly liquidity requirements. ICI's monthly stats (available to subscribers only) show taxable money fund repo holdings rising to $470.0 billion, or 18.8%, of assets. Funds still hold more CDs, though this segment shrunk by $34.4 billion in April to $572.9 billion, or 22.5% of assets. (We've estimated that Europe-affiliated CDs represent about half of this total, though that number has likely decreased of late.) Money funds also reduced CP by $47.2 billion to $410.3 billion (16.4%), reduced Treasuries by $36.7 billion to $345.9 billion (13.8%), and reduced Government Agencies by $29.0 billion to $445.8 billion (17.8%).
Though assets have fallen sharply year-to-date, down by $444 billion, or 13.5% through Wednesday, the European correction appears to have temporarily stauched the outflows from cash. Their latest weekly report says, "Total money market mutual fund assets increased by $4.92 billion to $2.849 trillion for the week ended Wednesday, May 26, the Investment Company Institute reported today. Taxable government funds increased by $4.45 billion, taxable non-government funds increased by $2.84 billion, and tax-exempt funds decreased by $2.37 billion."
Recently, Crane Data LLC Founder and President Peter Crane has given several talks on the state of money funds. Most recently, Crane presented an AFP Webinar entitled, "Money Market Mutual Funds: Reviewing the New Regulations & Discussing the Outlook for Future Changes." We quote some of Crane's recent comments below. (Let us know if you'd like to see Crane's most recent Powerpoint slides, a presentation to the Commercial Paper Issuer's Working Group entitled, "The Money Market Mutual Fund Industry: Reviewing Regulations, Rates & Asset Flows.")
Last week, Crane said, "Paraphrasing Will Rogers, 'Money funds are for investors that want return of capital instead of return on capital.' Of course, in the zero rate environment today, that's never been more true. I also like to call money market mutual funds the FedEx of asset classes, when it absolutely positively has to be there overnight."
On their history, Crane explained, "Throughout the 70's they were really still being born. You had oil price shocks, and rates towards 20% in 1981-82, that really kicked things off. You see spectacular growth in the 80's and in the 90's, then the magnificent spike-up and decline in the '00's. `In the '80's it was the growth of mutual funds over all, the 90's was the dawn of the institutional money fund.... About 15 years ago retail money funds made up 2/3 of assets; today it's the opposite.... You had corporate outsourcing and falling rates driving a lot of the cash into money market mutual funds. The two dominant themes throughout the history of money funds have really been their synergy with mutual funds overall, and the growth of mutual funds and pooled investments, and then also their rivalry with bank deposits."
On asset flows, Crane said, "I often get asked, 'Where is the money going?' When you look at the $1 trillion hole in money funds assets we've seen over the past 14, 15 months, you'll see that bank MMDAs are up over $600 billion. So it almost mirrors the move. Although it's tough tracking dollars, that big bank build up is `partially, or primarily the result of the TAG program, the unlimited non-interest bearing FDIC insurance. We've also seen a lot of brokerage sweep and FDIC insurance amalgamators.... [T]hat explains a lot of that big build up, and of course the FDIC insurance has been a major selling point."
Regarding the Current State of Money Market Funds, Crane commented, "Money funds currently total $2.85 trillion, pushing towards $2.8T.... [J]ust to put money fund asset totals in perspective, $2.85 trillion is the level we were at in September 2007, which is when I, and some others, will date the start of the 'Subprime Liquidity Crisis'.... It's amazing that money funds, throughout 2/3 of the crisis really were gaining assets. Of course, the Fed was cutting rates."
Finally, Crane said funds also have, "Over 30 million share holders, or about 31, 32 million. But those numbers keep ticking down.... It represents a very broad swath of America. There are several million institutional accounts. I like to say, as a well-known proponent of the money fund business, it's a very powerful lobbying group, perhaps the powerful out there -- people with money."
The Securities & Exchange Commission posted a document late yesterday entitled, "Staff Responses to Questions About Money Market Fund Reform," which answers a number of questions related to liquidity, stress testing, NRSROs, and Form N-MFP, among other things. The document says, "The staff of the Division of Investment Management has prepared the following responses to questions related to rule 2a-7, the 'money market fund rule' under the Investment Company Act of 1940, and other rules applicable to money market funds in light of the amendments recently approved by the Securities and Exchange Commission and expects to update this document from time to time to include responses to additional questions."
The intro adds, "These responses represent the views of the staff of the Division of Investment Management. They are not a rule, regulation, or statement of the Commission, and the Commission has neither approved nor disapproved this information. The adopting release for the money market fund reforms (dated February 23, 2010, the 'Adopting Release') can be found at: http://www.sec.gov/rules/final/2010/ic-29132.pdf. Responses to questions on rule 30b1-7 and Form N-MFP will be included in a separate document that will be accessible through a hyperlink when available."
The first question asks, "Is a money market fund required to dispose of securities owned or terminate repurchase agreements entered into as of the time of adoption of the Amendments (February 23, 2010) in order to meet the new maximum WAM and WAL limits by June 30, 2010?" The document answers, "A money market fund must be in compliance with the WAM limit of 60 days and the WAL limit of 120 days by June 30, 2010. Funds may use alternative portfolio strategies in order to comply with these requirements, including the acquisition of securities with shorter maturities to offset securities with longer maturities held at the time the rule was adopted or, if necessary, disposal of those portfolio securities."
It also says about the new Liquidity provisions, "Section II.C.3 of the Adopting Release explains that Daily Liquid Assets and Weekly Liquid Assets include 'only cash and securities that can readily be converted to cash.' The maturity shortening provisions of paragraphs (d)(1) through (d)(8) are not always consistent with this requirement and therefore should not be relied upon in interpreting those definitions. The term 'mature' in these definitions should be understood to mean only the date on which the principal amount must unconditionally be paid, or in the case of a security called for redemption, the date on which the redemption payment must be made."
Regarding "Stress Testing," the SEC says, "We would not object if an investment adviser of a U.S. Treasury money market fund refrained from stress testing for downgrades or defaults if the board makes a determination that these types of stress events are not relevant for the particular fund." They are also asked, "[M]ust a money market fund stress test its portfolio for the risk of breaking the buck on the upside?" The SEC says, "No."
The Q&A adds, "[T]he rule requires the board of directors to receive a report on all periodic testing performed. The Division believes that a single report presenting data from each of the monthly stress tests conducted between meetings would satisfy the rule. We encourage reports to present results (including results previously reported to the directors) in a manner that would facilitate directors' observation of trends in stress testing results."
It also says, "The Adopting Release states that a money market fund should incorporate 'know your customer' evaluations in its stress testing procedures. How could money market funds incorporate these evaluations in their stress tests? It answers, "A money market fund should incorporate an evaluation of the liquidity needs of its shareholder base into its stress testing procedures. For example, testing of the fund's ability to maintain a stable net asset value per share based upon specified hypothetical events should account for the fund's anticipated redemption activity for the relevant period. In addition, the investment adviser's assessment of the fund's ability to withstand the events (and concurrent occurrences of those events) that are reasonably likely to occur within the following year should be based, in part, on the redemption activity that the investment adviser believes is reasonably likely to occur in the following year."
The Q&A says funds do not need to designate NRSROs (ratings agencies) if it only invests in government securities, and says, "The board of directors of a money market fund does not have to designate four NRSROs for every type of security held by the fund (or one NRSRO for every type of security held by the fund, given that a fund may hold Unrated Securities). As long as a Designated NRSRO rates at least one type or class of securities in which the fund invests, the Designated NRSRO will count toward the required four."
Finally, the document says, "Form N-MFP filings must first be made no later than December 7, 2010 for the period ending November 30, 2010, and will first be made publicly available on the SEC website on January 31, 2011. How should funds comply with the requirement to provide the required link during the initial start-up period? A: Funds should provide the link beginning with the monthly website posting for the month ending November 30, 2010, which will be available on the SEC website on January 31, 2011."
As we mentioned last week, Robert Plaze, Associate Director for Regulation of the Division of Investment Management of the U.S. Securities and Exchange Commission recently presented to the SEC's Investor Advisory Committee on the history and current state of money market funds, regulations, and the concept of the floating NAV. (See the full Webcast here, click "Afternoon" and see our previous Crane Data News piece, "Floating NAV Won't Solve Problems Says SEC's Plaze to Committee".) The archived webcast should be required viewing for students of money market funds, but we excerpt more of Plaze's comments below. (Email Crane Data to request our transcript.)
Plaze told the Committee, "I thought I might get some basics first of why this is an issue, of why this is important issue. A money market fund is just another form of mutual fund, subject to all the regulations and laws of mutual funds are plus some. That plus is called Rule 2a-7 which is alluded to, I see, in a resolution which you might have heard, or read about in articles on front pages of papers where you would never have seen those words [a couple of] years ago. Money market funds invest in short term, dollar denominated securities and typically purchase them at discount. They accrue income each day typically in small amounts."
He continued, "The Investment Company Act requires funds to calculate their net asset value daily by taking the value of all of the securities they hold, subtracting the liabilities, and dividing by the number of securities share outstanding. The question is what is the value of those securities? IN most cases, a mutual fund's net asset value will change daily with the value of the underlying securities, just like a stock.... A money market funds' portfolio will change in value on a day to day basis principally based upon changes in interest rates, and if there are any credit events that affect the value of the securities held by the money market funds."
Plaze explained, "Because the funds hold securities with very high quality and short term, that change in value is much smaller than, let's say, a longer term bond fund. But nonetheless, without Rule 2a-7, there would be small changes, maybe not daily but periodically, in a money market fund portfolio.... In order to avoid that from happening, Rule 2a-7 allows money market funds to use something called the amortized cost value evaluation, which means a fund can indulge in the presumption that the portion of the discount that accrues daily throughout the life of the fund accrues on a straight line basis. In other words, it allows the fund to maintain its stable net asset value at essentially par at a dollar at all times."
He added, "To prevent the amortized cost value of the share, of the dollar, from getting out of 'whack' with the true value of the portfolio securities, money market fund managers are required to do something called 'shadow price' the portfolio. This means they actually go into the market to get 'bids' on the portfolio securities and compare them to the amortized cost. If the deviation, when you add up all of the securities of the portfolio, is less than 1/2 of 1 percent, which is half a penny on a dollar money market fund, the fund managers are obligated to re-price the portfolio's securities, which in commerce parlance is called 'breaking a buck'. That is what happened in September 2008 with the Reserve Fund, not so much because of the change interest rates, but because they had a valuation event."
Plaze explained, "The fund held a 785 million dollar position in Lehman Brothers, which went bankrupt the previous day and essentially became nearly worthless.... Only about a dozen funds actually held Lehman Brothers at the time, most of the money market funds had stopped, rolled off Lehman Brother years before. The idea of a money market fund is, because you have short term positions, if a particular credit is weakening then a money market fund can roll out of that credit in an orderly way. That is the way for 30 and more years money market funds have remained fairly stable. Most high quality commercial paper issuers don't go 'belly up' every night."
Finally, he said, "The other way money market fund have been able to maintain a dollar for over thirty years ago is when an event did occur, most of them that occurred were isolated credit events.... Funds were able to maintain a stable net asset value by drawing on capital of sponsor of the money market funds. When you had, in Orange County for example, when it lost the ability to repay, went essentially bankrupt. It had issued paper that was held by a number of municipal funds that was unable to pay on a timely way. Those funds would've broken the dollar but for the fact that ... they had affiliates that went in and bought out the paper from the money market fund at par.... In most cases, the affiliates recouped those losses over time because Orange County did end up paying on that money."
Late last week, Standard & Poor's published "Default, Transition, and Recovery: Global Short-Term Ratings Performance And Default Analysis (1981-2009)," a study of defaults in the commercial paper and other short-term money markets. Unsurprisingly, it says, "Consistent with all of our long-term default studies, our short-term corporate ratings performance analysis confirms that higher ratings generally correlate with greater stability and a lower likelihood of default, and vice versa. Defaults are rarer among short-term corporate ratings than they are among long-term corporate ratings. During the full sample period (1981-2009), global 'A-1+' rated entities had an average default rate of 0.0007% over a 30-day horizon, whereas global 'A-1', 'A-2', and 'A-3' issuers had average default rates of 0.005%, 0.004%, and 0.041%, respectively."
S&P explains, "The purpose of our study was to gauge short-term corporate ratings performance through the analysis of ratings changes as well as to provide a useful summary of the short-term default experience. Our study covers 4,466 financial and nonfinancial corporate obligors from 100 countries that had short-term local currency ratings from January 1981 through Dec. 31, 2009.... [T]he methodology does not differentiate between issuers that had commercial paper (CP) and other short-term securities outstanding at the time of default. The default and transition rates we refer to in this article are not instrument specific but rather are indicators of aggregated issuer behavior."
Among the main conclusions of the study are: "The difference in the cumulative default experience between Tier-1 ratings (generally defined as 'A-1+' or 'A-1') and Tier-2 ratings (generally defined as 'A-2' or lower) is clear as the time horizon grows longer.... [W]e observed the following default rates: 'A-1+' (0.002%), 'A-1' (0.016%), 'A-2' (0.023%), and 'A-3' (0.109%). At 12 months, cumulative average default rates were 'A-1+' (0.018%), 'A-1' (0.062%), 'A-2' (0.184%), and 'A-3' (0.633%). The short-term corporate market is generally regarded as a bastion of stability, with a low incidence of defaults. Between 1981 and 2009, only 118 issuers with short-term ratings (though not necessarily CP issuers) defaulted, in contrast with 1,933 defaults observed among companies with long-term ratings.... The annual short-term corporate default rate peaked in 2009 at 0.93%, exceeding the previous high of 0.73% in 2002."
The report says, "Defaults by companies with short-term ratings are fairly rare. In the 29 years we covered in our analysis, a total of 118 issuers with short-term ratings defaulted, which includes 35 companies that Standard & Poor's no longer rated at the time of default. Defaults have been sparse in most years, with only six years having more than three defaults and nine years having zero defaults. The median annual default count is two. Often, defaults (i.e., Standard & Poor's revising its ratings to 'D') occur long after a company's credit quality has declined past the point of where it could issue CP. Thus, defaults by companies with short-term ratings that also have outstanding CP are even rarer than the general default statistics in the study show."
It continues, "The paucity of defaults is not surprising because short-term paper typically provides a liquidity channel only for companies with superior creditworthiness. The credit standards for companies that tap this market are higher because investors in the short-term debt market are typically not looking for exposure to credit risk when they buy CP or other short-term debt. Moreover, the tight rollover schedule forces issuers to maintain greater discipline and results in an orderly exit mechanism, so only the most creditworthy borrowers are able to tap the market regularly."
They say, "Not surprisingly, defaults tend to be sparse in an average year and high in times of stress. Indeed, we see defaults clustered in just a few years. For example, 34 issuers defaulted from 2001-2002. The severe credit crisis and recession that began in 2008 spurred the worst two-year period in short-term corporate defaults in the 29-year history of our study. Between 2008 and 2009, 40 issuers defaulted, compared with just four defaults in the prior four years. In fact, the four years with the largest number of defaults (2001, 2002, 2008, 2009) accounted for approximately 63% of the 118 defaults that occurred in the 1981-2009 period."
Finally, S&P's default study says, "The short-term debt markets, which historically have been characterized by significant stability, have undergone a substantial transformation in light of the very high strain experienced in the past couple of years. This trend is especially noticeable in the U.S., where short-term markets -- among the world's deepest and most developed -- have retrenched, despite the overall stabilization in the financial markets. In the aftermath of the Lehman bankruptcy, the Federal Reserve played a substantial role in bolstering liquidity and available credit to the short-term funding market through the launch of special programs, such as the Commercial Paper Funding Facility (CPFF), the Money Market Investor Funding Facility (MMIFF), and the Asset-Backed Commercial Paper Money Market Fund Liquidity Facility (AMLF). The government is gradually ending these extraordinary measures."
It adds, "Nevertheless, note that the dollar amount of financial and nonfinancial outstanding CP has declined by one-third since its most recent peak in August 2008. The share of financials in total CP outstanding has increased to 52% from 46% because of larger declines in ABCP and nonfinancial CP. On a dollar basis, ABCP has led the decline, falling to $395 billion in April 2010 from $725 billion in September 2008 and $1,214 billion in July 2007."
Recently, some have expressed concerns about issues with "shadow NAVs" once money funds begin reporting these statistics early next year. (See Crane Data's May 6 News "CFOs, Treasurers Should Prepare for Big Changes in MMFs Says AFP" and Peter Crane's AFP Webinar, "Money Market Mutual Funds: New Regulations and Outlook for Change".) While we dismiss fears about any "shadow" NAVs of $0.9999 being interpreted as "breaking the buck," we wanted to discuss the issue in a little more detail and cite some other recent comments on the matter below.
The SEC's New Money Market Reforms explains the current regime, "In addition, the rule includes certain procedural requirements overseen by the fund's board of directors. One of the most important is the requirement that the fund periodically 'shadow price' the amortized cost net asset value of the fund's portfolio against the mark-to-market net asset value of the portfolio. If there is a difference of more than one-half of one percent (or $0.005 per share), the fund's board of directors must consider promptly what action, if any, should be taken, including whether the fund should discontinue the use of the amortized cost method of valuation and re-price the securities of the fund below (or above) $1.00 per share, an event colloquially known as 'breaking the buck.'"
The new Rule 2a-7 changes say, "Money market funds also must report on Form N-MFP the market-based values of each portfolio security and the fund's market-based net asset value per share, with separate entries for values that do and do not take into account any capital support agreements into which the fund may have entered." The new reported shadow NAVs will begin appearing (in a format that only a computer will love) in early February 2011, 60-plus days after month-end November 2010. Expect to see values ranging from 1.0003 to 0.9991.
The Commission explains, "We anticipate that, during the 60 days between the end of the reporting period and public availability of the information, funds will take steps to resolve issues that may raise concerns with investors and analysts. In addition, because money market fund portfolios have a limited maturity, many of the portfolio securities will have matured by the time the information is released to the public. Thus we expect that the 60-day delay will ameliorate many of the risks associated with public disclosure. We also expect that, over time, investors and analysts will become more accustomed to the information disclosed about fund portfolios, and thus there may be less need in the future to require a 60-day delay between the end of the reporting period and the public availability of the information. We therefore may revisit in a subsequent release whether to retain the same (or any) delay in public availability of this information."
Recently, Federated Investors Debbie Cunningham wrote in a piece entitled, "Market Memo: 'Shadow pricing' will lift the veil off benefits of $1 NAV," "[W]hen it comes to money market mutual funds, 'shadow pricing' in many ways is just the opposite -- it is a very precise calculation of money fund asset's net asset value (NAV). Simply put, it's the mark-to-market price of the money market fund."
She explains, "It sounds dramatic, but it really isn't. Because money fund assets are of short duration -- under the amended rules, the weighted average maturity of a fund's portfolio of securities can't be more than 60 days, down from 90 days previously -- the amortized cost price and the mark-to-market price (the shadow price) are identical to the penny. The shadow price simply is a case of carrying the stable $1 NAV out more than two decimal places, to four, as required by the SEC starting in November. This shadow price might be $1.0001, for example, or $0.9999."
Cunningham continues, "Although the value of the money fund will end up being rounded to a dollar, we believe investors and the SEC should benefit from seeing the shadow price because it will provide statistical confirmation of the stability of a $1 NAV and -- as had been discussed but ultimately rejected by the SEC as part of the changes to Rule 2a-7 industry standards -- disprove the need for a floating NAV. For record-keeping, accounting and valuation purposes, $1 NAV pricing is critical to the nearly $3 trillion-asset money market industry, which is a key source of short-term funding for business and industry."
Finally, she says, "Moreover, shadow pricing of money market funds really isn't new. The industry currently has been providing shadow pricing of each fund to the SEC twice a year, but not in a way that was operationally identical from fund to fund. Now it will be reported in a standardized format. As such, the SEC -- and investors who care to do so -- will be able to collect the fund data over a period of time so that perhaps they can discern patterns among types of funds and groups over a period of time. And we think that will prove, on a quantitative basis, what we have been suggesting all along -- that when you look at the statistical evidence, there is no need to consider a fluctuating NAV."
In what is likely to cause continued confusion in the money markets, the Committee for European Securities Regulators (CESR) announced yesterday that it will stick with its proposal of a two-tiered system of "money market funds," with "Short-Term Money Market Funds" being the new term for U.S.-style, or IMMFA money market funds, and "Money Market Funds" being the new term for longer-term, European-style ultra-short bond funds. Europe previously has not had any restrictions on the use of the term "money market fund." (See Crane Data's previous News briefs on the topic: "European Regulators Consult on Definition(s) of Money Market Fund" on Oct. 22, 2009, and "JPM, Crane Oppose Two-Tiered Definition for European Money Funds" on Jan. 13, 2010.)
A press release entitled "CESR sets out harmonised definition of European money market funds" says, "CESR publishes today its guidelines on a common definition of European money market funds (Ref. CESR/10-049). The guidelines aim to improve investor protection by setting out criteria to be applied by any fund that wishes to market itself as a money market fund. The criteria reflect the fact that investors in money market funds expect the capital value of their investment to be maintained while retaining the ability to withdraw their capital on a daily basis. A common definition will also help provide a more detailed understanding of the distinction between funds which operate in a very restricted fashion and those which follow a more 'enhanced' approach."
Lamberto Cardia, Chair of the Italian Commissione Nazionale per la Societa e la Borsa (CONSOB) and Chair of CESR's Investment Management Standing Committee, which prepared the advice, states, "The publication of these guidelines is a significant step in improving investor protection and will help stakeholders -- competent authorities, management companies and investors -- to draw a clearer distinction between funds according to their investment strategies. It was clear from the difficulties that arose in the markets in 2007 and 2008, that the term 'money market fund' covered a very broad range of investment funds. This created risks for investors who may not have fully understood the types of asset in which these funds were able to invest. In particular, the strategies of some funds may not always have been consistent with the generally accepted concept of money market funds as being relatively liquid, short-term investments. I am confident that CESR's guidelines will provide greater clarity and in so doing, better equip investors to be able to make informed investment decisions."
The release continues, "CESR's guidelines set out two categories of money market fund: Short-Term Money Market Funds and Money Market Funds. This approach recognises the distinction between short-term money market funds, which operate a very short weighted average maturity and weighted average life; and money market funds which operate with a longer weighted average maturity and weighted average life. For both categories of fund, CESR expects that there should be specific disclosure to explain clearly the implications of investing in the type of money market fund involved. For Money Market Funds, for example, this means taking account of the longer weighted average maturity and weighted average life of such funds. For both types of money market fund, this should reflect any investment in new asset classes, financial instruments or investment strategies with unusual risk and reward profiles."
"The guidelines will enter into force in line with the transposition deadline for the revised UCITS Directive (1 July 2011). However, money market funds that existed before that date will be granted an additional six months to comply with the guidelines as a whole," says CESR. See the full publication here: "CESR's Guidelines on a common definition of European money market funds." See the feedback statement here.
While we're still transcribing Monday's SEC Investor Advisory Committee Webcast and awaiting the posting of the archived video and audio, we have managed to excerpt several interesting comments from Robert Plaze, the SEC's Associate Director for Regulation of the Division of Investment Management, who presented on "Money Market Funds and Net Asset Value." We also found some additional tidbits in a May 3 Memorandum from the IAC's Investor as Purchaser Subcommittee, which we quote below.
The May 3 Memorandum says, "The Subcommittee is placing the issue of the floating net asset value (NAV) for money market funds (MMFs) on the Commission's agenda for the May 17 meeting. The issue would be only for discussion at this time.... The SEC adopted certain MMF reforms on Feb. 23, 2010, but did not adopt the floating NAV proposal.... The President's Working Group, of which Chairman Schapiro is a member but which is predominantly comprised of banking regulators, has been asked to opine on the floating NAV issue and is expected to release its analysis soon."
It continues, "Industry and consumer groups have been virtually unanimous in their opposition [to] the floating NAV proposal, as illustrated by the attached Appendix.... In view of the dramatic consequences that a floating NAV requirement could have for America's retail investors and its short-term debt markets, the Subcommittee believes that it may ultimately be appropriate to make a recommendation to the full Committee on this issue, but not before obtaining the full Committee's initial views. One form of resolution that the Subcommittee would like the Committee to evaluate, but not vote on at this time, is as follows:"
"RESOLVED: Money market funds should not be required to use a floating NAV. Money market funds play a vital role as cash management vehicles for millions of Americans and as liquidity facilities for short-term borrowers. They have an extraordinary history of stability, with only two instances of failure in three decades of regulation under Rule 2a-7. If the Commission believes that the stability of money market funds can be improved, then it should consider appropriate prudential measures. Mandating a floating NAV, however, would put the continued viability of money market funds at risk and be detrimental to the interests of America's retail investors."
The SEC's Plaze gave a detailed history of money funds and events, saying, "What you had starting in 2007 was the first time where you had permanent losses as a result of investments in money market funds. First the SIVs, the structure investment vehicles, issued highly rated commercial paper as a way of gaining leverage managing a larger portfolio of securities. Most SIVs did not have a Sub-A mortgages, some did. They were buried and very small portions of the portfolios. But nonetheless what happened in 2007 is the market essentially rejected asset-backed vehicles because of the lack of understanding of what was in the portfolio and the lack of trust in that market place. Those SIVs had to unwind and not all of them could unwind fast enough to pay off the commercial paper. Therefore, you had your first money market fund crisis, ultimately leading to September 2008 when Lehman Brothers went down."
He added, "When you have a stable net asset value and you go to a floating NAV, which is something we have talked about and we are continuing to talk about as an option, it is not going to solve the essential problem of maturity transformation and the mismatch between assets and liabilities of a money market fund.... It's not a solution. People who think that moving to a floating NAV is THE solution and that it will all go away are just simply wrong."
Finally, Plaze says, "Going away from a stable net asset value presents a number of problems too.... We don't know to what extent of the $3 trillion dollars, how many people are going to walk away? Who will fund the short term needs of corporate America and commercial paper? Where will investors go? They are not going to get as good a yield as they are getting from money market funds. Who is going to buy the commercial paper? The commercial paper market will shrink. There is no solution. Second, how do you transition away from the stable net asset value?"
He continues, "Third, what about the institutional funds, why wouldn't they just reorganize an unregistered 3c-7 vehicles? If they did that, wouldn't you simply restructure the systemic risk in an unregulated, less transparent world? Maybe they wouldn't and maybe they would.... If you did go to a floating NAV, investors that [have been] conditioned to expect a stable NAV for 30 years now, how do they respond to the daily fluctuations?"
A statement entitled, "New York Fed Releases White Paper on Tri-Party Repurchase Agreement (Repo) Reform," says, "The Federal Reserve Bank of New York today announced the publication of a white paper on the work of the Tri-Party Repurchase Agreement (Repo) Infrastructure Reform Task Force. The white paper highlights policy concerns over weaknesses in the infrastructure of the tri-party repo market and seeks public comment on the task force's recommendations to address these concerns."
It says, "The recommendations set forth by the task force in its final report, when implemented, should: dampen the potential for problems at one firm to spill over to others, clarify the credit and liquidity risks borne by market participants, and better equip them to manage these risks appropriately. Feedback on this paper received during the 30-day public comment period will help New York Fed staff, and others with regulatory and supervisory responsibilities, to assess the task force proposals and identify any additional or alternative measures that should be considered."
William C. Dudley, president and chief executive officer of the Federal Reserve Bank of New York, "We are grateful for the work of the task force and encourage all stakeholders to provide comments. The Federal Reserve is committed to initiating actions, as necessary, to promote strong risk management practices by all market participants and the stability and resilience of financial markets more broadly. The work of the task force represents an important step in this direction."
The statement continues, "The tri-party repo market and short-term funding markets will continue to evolve as broader regulatory reforms take shape, and enhancements to infrastructure, such as those proposed by the task force, are implemented. Going forward, it will be imperative to monitor the evolution of these markets closely. The New York Fed tasked the Payments Risk Committee (PRC), a private-sector group of senior U.S. bank officials sponsored by the New York Fed, to form a group of industry stakeholders to address tri-party repo market infrastructure weaknesses exposed during the financial crisis of 2008 and 2009. The PRC created the Tri-Party Repo Infrastructure Reform Task Force in 2009, and included tri-party repo market participants, service providers and representatives from industry groups. The task force met regularly since its creation to discuss enhancements to the policies, procedures and systems supporting the tri-party repo market. The final report of the task force was also issued today."
The 68-page "Tri-Party Repo Infrastructure Reform" white paper says, "A key focus of the recommendations is to reduce reliance by market participants on intraday credit provided by tri-party repo agents. Other complementary recommendations are designed to foster improvements to credit and liquidity risk management practices of market participants, enhance market transparency, and decrease the likelihood and mitigate the negative effect of default by a large cash borrower."
The paper explains, "Tri-party repos are the most prevalent form of repo contract in the United States. Broker dealers obtain a significant portion of financing for their own and their clients' securities inventories through the market. During first-quarter 2010, the value of securities financed by tri-party repos averaged $1.7 trillion. Federal Reserve Bank of New York calculations, based on data from The Bank of New York Mellon and JPMorgan Chase. The size of the market has declined notably since the peak of about $2.8 trillion in early 2008.... Activity in the tri-party repo market is highly concentrated: the top ten cash borrowers account for approximately 85 percent of the value of tri-party repo securities being financed, and the top ten cash investors provide about 65 percent of the funds invested."
To see the New York Fed white paper and task force report, visit: http://www.newyorkfed.org/banking/tpr_infr_reform.html. For the Tri-Party Repo Infrastructure Reform Task Force final report, visit: http://www.newyorkfed.org/prc.
A press release subtitled, "New Research to Help Treasurers Evaluate Money Market Fund Investments," says, "Capital Advisors Group (CAG), a leading institutional investment advisor focused on short-term cash investing, today announced the launch of FundIQ -- the industry's first money market fund research product designed to help treasury professionals pursue investment performance by applying the firm's new fundamental risk analysis process and an independent credit opinion to institutional prime money market funds."
It continues, "Over the past 19 years, Capital Advisors Group has worked to select the most appropriate money market funds as part of its clients' comprehensive separate account investment strategies. In the course of this selection process, the firm developed a detailed due diligence process that has helped to identify risks that may be associated with specific funds. While some money market fund tools provide treasurers with basic fund characteristics and metrics, FundIQ looks beyond the numbers to provide real analysis and a new fund risk rating system to help investors pursue yield while monitoring specific risk factors."
Ben Campbell, Capital Advisors Group's President and CEO, notes, "The most interesting part of this research is that all of the funds we evaluate today are rated triple-A by nationally recognized ratings agencies, yet we still find notable variances in the inherent risk in the funds based on the research method we use. This deeper level of risk assessment is meant to help treasurers who simply don't have the time or resources to conduct the level of due diligence required to support their money market fund investment decisions. FundIQ was developed in response to these treasurers' concerns and we hope that they can now invest more confidently knowing that a research team has invested a great deal of time and effort in assessing some very specific risk factors within these funds."
The release adds, "Capital Advisors Group's FundIQ research seeks to answer some difficult questions in carrying out its methodical money market fund due diligence process. Portfolio Risk: How is liquidity affected by WAM, Spread WAM, diversification and other key characteristics? Sponsor Risk: Are the funds backed by institutions with support mechanisms that can withstand crises? Advisor/Management Risk: Do the management teams have a favorable track record, in good times and bad? Shareholder Risk: Can the funds retain assets and reduce outflows when perceived risk increases? Systemic Risk: Are the funds prepared to withstand geopolitical, regulatory, market and other non-fund specific risk factors?"
Lance Pan, Director of Investment Research and Strategy, adds, "Most institutional treasurers today are facing an uphill battle. Between the lack of information, a lack of time and a lack of resources, the job has grown exponentially more difficult on a number of fronts since the implosion of the auction rate securities market in early 2008." He continues, "That was really the end of an era -- when the perception was that most short term investments were safe and liquid and money market funds were as good as cash in a vault. Today is a much different story -- any liquidity investment, including money funds, should undergo a considerable amount of due diligence before a treasurer moves forward. FundIQ was developed specifically to fill this growing information gap."
Finally, the release says, "Past money market fund issues and recent regulatory changes have highlighted the need for institutional money market fund investors to possess a much deeper understanding of the funds in which they invest. After the Reserve Primary Fund famously 'broke the buck' in 2008, treasurers scrambled to find a safe haven for the most liquid portion of their cash portfolios -- some are still hesitant to return to the institutional prime fund market. What had previously been considered among the most risk free of investment vehicles, the prime institutional (or cash management) money market fund had lost favor as treasurers rushed into government and agency funds. FDIC-insured bank deposit accounts also found favor with corporate treasurers. With signs of improvement in the economy, treasurers are once again seeking yield but are unsure about where and how to begin. Capital Advisors Group's FundIQ has been developed to shed new light on money funds to help treasurers confidently pursue return while responsibly assessing risk."
FundIQ covers "15 of the largest AAA-rated institutional prime money market funds representing more than $540B in fund assets," conducts a "deep analysis in 5 major risk categories including: management, portfolio, fund sponsor, systemic, and shareholder" and "monitors more than 40 individual risk variables in each fund." (Note that Crane Data also provides a Due Diligence service, providing analysis and "safety grades" to some institutional investor clients.)
A press release entitled, "SEC Investor Advisory Committee Announces Meeting Agenda, List of Participants, was sent out late yesterday. It says, "The Securities and Exchange Commission's Investor Advisory Committee today announced the agenda for its public meeting to be held on May 17, 2010. The Committee was formed by the SEC in 2009 to advise the Commission as to its regulatory priorities." One of the issues to be discussed is "money market fund 'net asset value' calculation, which is scheduled for 2:00-2:45 p.m. on Monday. The entry says, "Discussion with Staff: Money Market Funds and Net Asset Value" with Staff Presenter: Robert Plaze, Associate Director of the SEC's Division of Investment Management. The meeting will be webcast.
A 6-page Statement of the Investment Company Institute has been posted on the SEC's website. It says, "The Investment Company Institute, the national association of U.S. mutual funds and other investment companies, appreciates the opportunity to offer its views to the Investor Advisory Committee of the Securities and Exchange Commission on money market funds and the issue of net asset value, an agenda item for the May 17 Committee meeting.... [T]he money market fund industry understood the need to make money market funds more resilient under extreme market conditions. Indeed, the SEC and the fund industry already have made significant and important progress toward making money market funds more secure."
It says, "Earlier this year, the SEC approved final amendments to Rule 2a-7 that will raise credit standards and shorten the maturity of money market funds' portfolios -- reducing credit and interest rate risk. They require more frequent disclosure of money market funds' holdings, so both regulators and investors will better understand funds' portfolios. The SEC amendments also directly address the liquidity challenge. They impose for the first time explicit liquidity requirements that will require taxable money market funds to maintain daily liquidity of 10 percent of their assets, and all money market funds to maintain weekly liquidity of 30 percent of their assets. Funds also must adopt 'know your investor' procedures to help them anticipate the potential for heavy redemptions and adjust their liquidity accordingly."
The comment also says, "The search for ways to make money market funds even more secure under the most adverse market conditions, however, has not stopped. Indeed, the fund industry remains open to a wide range of ideas on reform of money market funds. As discussed below, however, we strongly oppose the notion of forcing money market funds to abandon their objective of maintaining a stable per-share value. The steady NAV -- typically $1.00 per share -- is a fundamental feature of money market funds. A somewhat related idea to a floating NAV that we also oppose is the suggestion that money market funds be required to publicly disclose market-value based information on a real-time basis. We believe that such disclosure would not be helpful to fund shareholders and very well could, in fact, increase systemic risks."
Under "The Case for Stable NAV Money Market Funds," the statement says, "Some observers believe that a simple solution to the challenges faced by money market funds during the financial crisis is to force these funds to float their per-share value. By their account, the amortized cost accounting that allows a money market fund to seek to maintain a stable NAV makes these funds more vulnerable to runs. They argue that investors are prone to sell stable-value shares when there are small drops in the value of the funds' underlying securities below the fixed $1.00, but wouldn't sell if the shares' value floated routinely. After a careful review of this proposition, however, we have concluded that, in light of market data and investor behavior, the notion of forcing money market funds to float their value would wreak havoc on our markets -- without any offsetting benefits."
The statement continues, "Indeed, we have concluded that: (1) a floating NAV could lead to substantial and far-reaching negative consequences for the money market; (2) a floating NAV is unlikely to reduce systemic risk; and (3) a $1.00 stable NAV provides far more benefits to money market fund investors than a floating NAV. If money market funds were required to float their NAVs, this very likely would lead to many investors -- both retail and institutional alike -- ceasing to use these funds in favor of alternative products that offer a stable NAV, albeit without the market-based returns (bank products) or regulatory protections (private or offshore pools) that money market funds provide. Significantly decreasing the value of this product would have negative consequences to the economy as well, by increasing systemic risk, reducing the supply of short-term credit to corporations, or severely restricting the supply of credit to municipalities."
It adds, "Another solution that some observers have suggested to help reduce systemic risk is to force money market funds to publicly disclose their market-based NAV per share ('shadow price') and/or the market-based prices of their portfolio securities on a real-time basis. These observers believe that this information would enable money market fund investors to understand the fund's exposure to distressed securities and the risk that the fund may be unable to maintain a $1.00 stable NAV. On the other hand, we believe that such disclosure would not be helpful to fund shareholders and could, in fact, introduce greater market instability. Indeed, there is little evidence that requiring funds to disclose either shadow prices or market-based prices of portfolio securities would be informative. For example, a sample of shadow prices provided on a confidential basis to ICI by a number of the largest institutional money market funds indicates that shadow prices deviated very little from $1.00 in the run-up to September 2008."
Finally, the letter says, "ICI appreciates the Committee's attention to this important issue for money market funds, their shareholders, and our economy. We urge the Committee to carefully consider the implications of forcing money market funds to float their NAVs or requiring such funds to publicly disclose market-value based information on a real-time basis. Instead, we urge the Committee to consider other efforts to further strengthen money market funds. For example, ICI and its members have responded to an idea advanced by the Treasury Department's June 2009 white paper on financial regulatory reform, which called for exploring measures to require money market funds 'to obtain access to reliable emergency liquidity facilities from private sources.' Indeed, ICI is moving forward rapidly to complete a blueprint for such a liquidity facility."
Money market mutual fund managers continue the post-crisis trend of producing frequent communications with shareholders. Two of the most recent are publications from Invesco, which recently jettisoned the AIM moniker, and Wells Fargo, which continues to produce its monthly "Overview, Strategy, and Outlook. Invesco's May 3 "Global Cash Management" publication is entitled, "Ongoing financial reform could lead to unintended consequences on short-term markets," while the Wells piece says, "After an extended period of relative calm, credit concerns once again leapt to the forefront, this time in the form of concerns about the viability of certain sovereign credits."
Invesco's update says, "While the implied government support has lifted the long-term credit ratings of these [large U.S. financial] institutions during the crisis, a long-term credit rating downgrade will likely, at a minimum, increase their cost of obtaining capital. What is much less clear and potentially more harmful is the effect on these firms' short-term credit ratings." It discusses the "Impact of new regulations on large U.S. financial institutions," saying, "With the recent amendments that the Securities and Exchange Commission (SEC) has implemented to Rule 2a-7, which govern U.S.-registered money market funds, a downgrade could be detrimental to these banks due to the estimated $800 billion in funding they obtain from the short-term debt market."
It continues, "If these institutions did experience a downgrade to Tier 2, this does not align well with the new Rule 2a-7 which are now further reducing money market funds' exposure to Tier 2 credits in both dollar and term limits, and in addition, removing the look through provisions of repurchase agreements (repo) counterparties. Previously, a fund's advisor could look through the repo counterparty to the collateral underlying the repo transaction for credit and diversification purposes. However, the amendment to Rule 2a-7 now mandates a credit analysis of the counterparty, which makes their short-term ratings even more important. Before too dire a picture is painted, if a downgrade did occur, it may not lead to another credit crisis. These institutions have substantial cash balances and any ratings action would lead these firms to seek some combination of funding outside of the money markets, increase deposits and/or capital raises while potentially resizing their respective balance sheets."
Wells' most recent commentary says, "For money market funds, Greece itself does not pose a problem, as it does not appear that any U.S. money funds have direct exposure to Greek sovereign debt, but as in every credit event since 2007, the fear of contagion looms large. There are questions about which banks may have direct exposure to Greece and whether a similar problem could confront other European nations. Fuel was added to this fire when Standard & Poor's downgraded Spain from AA+ to AA on April 28. Now, AA is still a mighty strong rating, but the direction of the change and the fact that there was an actual downgrade caused concern that other countries might be in the ratings agencies' sights."
It continues, "Bank exposure to Greece sovereign debt appears to be manageable, especially by those banks in which we invest. We would view bank exposure to actually be a positive in a macro sense, as it is yet another reason for the European Union to step up and assist Greece in a significant way. Still, we would prefer to see the matter resolved sooner rather than later in order to stem the uncertainty."
On rates, Wells writes, "But away from any overt action by the Fed, rates have begun to creep higher. We think several factors have been at work here: First, the settlements of new U.S. Treasury debt have been large, and the need to finance those securities in the repo market has been putting upward pressure on those rates. As overnight repo rates move higher, longer-term money market rates must also move higher in order to induce investors to extend the term of their investments. Second, we've seen a slow but steady increase in the effective federal funds rate."
Finally, they say, "The amendments to Rule 2a-7, the section of the Investment Company Act that governs money market funds, that were adopted at the SEC's January 27 meeting start to take effect May 5, 2010; however, required compliance dates are staggered throughout 2010 and into 2011. The SEC had proposed certain amendments last June, asking for public comment. After receiving over 150 comments from the public, the final amendments largely mirrored the initial proposals. We have been supportive of regulatory reform in this area. The SEC states that the rule changes will 'increase the resilience of these funds to economic stresses and reduce the risks of runs on the funds,' and 'improve liquidity, increase credit quality and shorten maturity limits ...' and 'also enhance disclosures.' Having long emphasized high credit quality and liquidity in our funds, the new rules required few changes on our part, and the portfolios of the Wells Fargo Advantage Money Market Funds are currently positioned in a manner that is in compliance with the rule changes."
The May edition of Crane Data's Money Fund Intelligence XLS, our monthly spreadsheet that tracks money fund statistics and performance, shows that money fund yields inched higher for the second month in a row in April. MFI XLS also showed that assets fell by over $100 billion for the second month in a row. It also showed that repo holdings declined and the the percent of holdings maturing in 7 days jumped during the month.
The Crane 100 Money Fund Index, a simple average of the largest taxable money funds, 7-Day Yield increased to 0.06% as of April 30 from 0.05% at the end of March and a record low 0.04% at the end of February. The Crane 100 30-Day Yield (annualized) also rose to 0.06%. Its 1-month return (unannualized) was 0.00%; its 3-month return was 0.01%; its YTD return was 0.02%; its 1-year return was 0.13%; its 3-year annualized return was 2.02%; its 5-year return was 2.93%; and its 10-year return was 2.71%.
Our broaded Crane Money Fund Average yielded 0.03% as of April 30, while our Crane Institutional MF Index yielded 0.05% and our Crane Retail MF Index yielded 0.01%. The Crane Tax-Exempt MF Index yielded 0.05%, up from 0.04% a month earlier. (For more Crane Money Fund Indexes, ask to see our Money Fund Intelligence, MFI XLS or Crane Index products, or type 'ALLX CRNI' on a Bloomberg terminal.)
MFI shows money fund assets declined by $113.1 billion, or 4.0%, in April to $2.703 trillion. This follows a decline of $159.2 billion in March, and marks the 14th month out of the past 15 that assets have declined. Year-to-date, money funds assets have decreased by $481.8 billion, or 15.1%, and over 12 months, money fund assets have decreased by $872.1 billion, or 24.4%. Government and Treasury funds continue to lead the declines -- Government (including Treasury) assets declined by 8.0% in April and have declined by 40.9% over 12 months to $476.7 billion.
Crane's MFI XLS Portfolio Composition averages show Repo holdings fell from 25% to 22% in April, while Government securities holdings increased to 20% from 19%, Treasury holdings increased from 16% to 18%, and CP holdings increased from 12 to 13%. CDs remained at 15%, ABCP fell to 4%, FRNs rose to 4%, Corp holdings remained at 2%, MTNs were at 1%, and "Other" was at 2%. Crane Data's % Maturing in 7 Days statistics show the average fund's weekly liquidity rising to 42% from 39% a month earlier.
ICI's separate Portfolio Holdings series, which covers data through March, showed that CDs (at 19.2%, or $502.7 billion) regained the largest money fund holding spot from Repo (which fell from 19.9% to 17.2%, or $449.3 billion). Government Agency securities became the 2nd largest holding with 18.1% (up from 17.4%), or $474.9 billion, while Commercial Paper took the No. 3 spot, rising to 17.5% from 17.2% in March ($457.4 billion). Treasury securities held by taxable money funds totalled $382.5 billion, or 14.6%.
Adam Dean, President of SVB Asset Management writes about "The Trouble with CDs (2010 edition)" in the latest edition of the firm's "Observation Deck newsletter. Dean asks, "What's a securities broker to do? The boards and CFOs that have employed them to manage corporate cash have largely and perhaps permanently lost all appetite for the products that were once so lucrative for brokers to sell. Auction rate securities, self-underwritten debt, investments with low liquidity and high underlying risk; because of the pain these investments caused their corporate clients and boards, the broker business isn't nearly what it used to be."
He continues, "Corporations now demand extremely liquid and ultra-safe investments such as money funds, agencies and treasuries, and frankly, those don't pay brokers much. Enter the non-negotiable Certificate of Deposit and CD placement programs. For corporations looking for safety and yet hungry for yield, CDs sounded like the best of both worlds. Today that yield benefit is largely gone."
Dean explains, "Central to the selling of non-negotiable CDs (meaning they cannot be liquidated prior to maturity without penalty) and CD placement programs is the considerable payout brokers get relative to other standard money market options they could offer their clients. In other words, if you are interested only in government-backed investments, there is at least one reason you may be hearing about a CD-only investment strategy instead of a diversified treasury, agency and money fund strategy that leverages a credit research team and fiduciary oversight."
He says, "The other reason you may have heard of them was yield. What CDs and CD placement programs used to have relative to more liquid investments was yield. This despite the fact that the unrated regional and community banks that typically use broker sales channels like CD placement programs comprise the majority of the 220 bank failures observed since 2008 and the 57 that have occurred so far in 2010."
But now, the Observation Deck piece explains, "There are two reasons for lower CD rates. One is that the FDIC has moved to cap the yields that banks can offer on FDIC-guaranteed CDs. A number of banks were essentially staying in business by offering CD rates well above market.... The second reason is driven by better-capitalized banks. Yields are down across the board because government-guaranteed safety is not something that most banks need to offer much yield on to attract depositors. Their market-setting rate pushes down the yield that deposit-hungry banks can offer."
It continues, "With the yield benefit largely gone, very little else about non-negotiable CDs meets the liquidity, transparency and credit standards required of every other investment typically allowed in a conservative cash investment policy. For corporations allowing investment in CDs, make sure your investment policy clarifies the terms on which you are willing to buy them. If you are making exceptions to the liquidity, transparency and credit standards you require of each your other investments, make sure you are stating this in your investment policy."
Finally, Dean warns, "The higher-yield CD offerings are almost exclusively non-negotiable. Every security type permitted in your corporate investment policy should include the ability to easily sell back into an open market on demand and without incurring an early withdrawal penalty prior to maturity. Non-negotiable CDs don't meet this standard.... Knowing the condition of the bank you are making the loan to should be mandatory for a corporation. With CD placement programs, individually brokered CDs, or even direct investment in CDs from regional banks, an ability to accurately assess their health requires a considerable investment in time that the selling broker has almost certainly not done for you.... If a certain CD is yielding well above market, ignore the FDIC insurance for a moment and look at the bank's actual credit rating."
Our May 2010 issue of Money Fund Intelligence features the articles: "Money Fund Intelligence Celebrates 4th Birthday," which reviews the history of Crane Data's flagship newsletter; "Capital Preservation Still In at American Century," which interviews Portfolio Managers Denise Latchford, Todd Pardula, and Lynn Paschen; and "ICI Fact Book Says Outflows From Low Rates," which excerpts from the Investment Company Institute's annual fund analysis and statistics. Look for excerpts in the coming days or let us know if you'd like to see the latest issue.
Money Fund Intelligence, Crane Data's flagship newsletter, celebrates its fourth birthday this month. The money fund information company was founded in May 2006 by Peter G. Crane and Shaun Cutts. As we wrote in this issue, "MFI is written for both money market investment professionals and investors. Our core mission is to deliver low-cost and high quality money fund information, performance statistics, and indexes. We hope we have succeeded to date."
In other news, the SEC's Buddy Donohue spoke Friday to close the Investment Company Institute's annual conference in place of Chairman Mary Shapiro. The prepared remarks say, "As you know, the SEC has a strong commitment to working with stakeholders from every facet of the financial markets, including industry groups like ICI. In fact, shortly after I returned to the SEC last year, ICI provided very constructive input into proposed rules designed to improve the resiliency of money market funds. The money market rules that emerged were, I believe, better as a result of your input, and are already helping to bolster protections for investors without imposing undue burdens on the funds themselves."
The SEC speech continues, "Now, I'm sure that there are some here who may disagree with that assessment. That is to be expected. We do after all play different roles in the financial markets -- we are never going to see eye-to-eye on every issue. But I'd like to believe we both have very similar goals: Honest markets that efficiently allocate capital and reward investors, and, a financial system that gives investors and their advisors the tools they need to make rational decisions. I am committed to working with you and with other industry representatives to achieve that goal."
The ICI transcript says, "Following his prepared remarks, Donohue indicated that the Commission may be waiting for the President's Working Group on Financial Markets to release its long-awaited report on money market funds prior to proceeding on further regulations: 'We think [the report] will help initiate dialogue around some of the issues.' In January, when the SEC adopted amendments to Rule 2a-7 governing money funds, Schapiro said staff had begun to consider several additional changes for a potential second round of reforms, including considering moving from the standard of a stable $1 NAV to a floating NAV for money market funds. The industry strongly opposes such a change, arguing that it would eliminate money market funds."
U.S. Treasury Secretary Timothy Geithner gave Testimony before the Financial Crisis Inquiry Commission yesterday on "Causes of the Financial Crisis and the Case for Reform" and briefly mentioned money market funds and the pending President's Working Group report. Money funds and regulations were also a brief topic at the ICI's General Membership Meeting in Washington. We excerpt the money fund-related highlights below.
Geithner said of the "parallel banking system," "A large parallel financial system emerged outside of the framework of protections established for traditional banks.... This parallel system came in many shapes and sizes. Independent investment banks like Lehman Brothers and Bear Stearns grew in size and financed themselves in the overnight repurchase agreement, or 'repo' markets, which rely on assets or securities as collateral. Asset-backed commercial paper (ABCP) conduits and structured investment vehicles (SIVs) were used by banks and a broad range of other financial institutions as funding vehicles for different types of assets.... These institutions and funds were financed by institutional investors and by money market mutual funds, which purchased their short term commercial paper, or lent to them overnight in the repo markets secured by various forms of collateral."
He then said about "These reforms will give the Federal Reserve the authority to build a more stable funding system, take action to address the unstable aspects of the short-term repo markets, and ensure that these markets are used much more conservatively in the future. These steps will give clear authority to set risk management requirements for these markets, including capital standards, set standards for collateral requirements, and to help ensure that settlement procedures are robust. They will also create enforcement authority to compel corrective actions as risks build up, or when risk-management is inadequate. These authorities will also reinforce stability and liquidity even in times of market stress such as a terrorist attack or acute financial crisis."
Finally, Geithner mentioned "Higher Standards for Money Market Mutual Funds," saying, "The SEC recently enacted new rules to strengthen liquidity, credit standards and disclosure in the money fund industry. More work remains to be done in this area, and the President's Working Group on Financial Markets is preparing a report setting forth options to reduce the susceptibility of money funds to runs."
Members of the mutual fund industry were also discussing money market funds yesterday at the Investment Company Institute's 2010 General Membership Meeting. The ICI's "Highlights" page says, "In a wide-ranging conversation at ICI's GMM, a leadership panel discussed the way forward for the fund industry and investors. Among the topics covered were key lessons of the recent financial crisis, the stable net asset value (NAV) for money market funds, and creating a fiduciary standard for brokers.... [Greg] Johnson [of Franklin Resources] mentioned that in the larger financial reform debate, the stable net asset value (NAV) had been questioned. McNabb, Johnson, and Walters stressed that the stable NAV must be retained. A stable NAV provides investors with the stability they crave and funds short-term lending for corporate America."
The ICI highlights page also said, "In a panel discussion moderated by ICI's General Counsel Karrie McMillan, panelists James F. Febeo Jr., Vice President of Government Relations, Fidelity, and Richard Y. Roberts, Principal, Roberts, Raheb & Gradler, LLC discussed upcoming and past federal legislation, along with other related matters.... In reference to the numerous delays in the release of the President's Working Group (PWG) report on money market funds, Febeo said that because of recent reforms announced by the SEC to Rule 2a-7, the PWG report may no longer be essential in some ways. Plus, he noted, the current climate of debate surrounding financial regulatory reform makes it unlikely that the report will be released soon, lest it 'muddy the waters'."
See also MarketWatch's "Fund company leaders voice regulation fears", which says, "Money-market muddle At a panel on Thursday, fund executives also voiced concerns about proposals to regulate the money-market fund sector, in particular suggestions that funds' share price should be allowed to float." They quote Bill McNabb, CEO of Vanguard Group, "Our investors really value that $1 a share NAV. We think it's very important that ... continue."
The Association for Financial Professionals put out a press release late yesterday entitled, "CFOs, Treasurers Should Prepare for Big Changes in Money Market Funds." The piece is subtitled, "Shadow NAV Could Fall Below $1. Does this fit in your investment policy guidelines?" and announces the launch of AFP's "information resource for corporate investors who need to know what today's changes in money fund regulations might mean for their companies." It says, "The AFP Money Market Resource Center (www.afponline.org/moneyfunds) supports finance professionals who invest their cash balances in money market mutual funds."
The AFP release explains, "U.S. organizations continue to hold significant cash balances, and AFP research has shown that about 32 percent of short-term corporate investment balances reside in money market mutual funds. Those money market funds are now under increased scrutiny from the Securities and Exchange Commission (SEC). Effective today, fundamental changes have occurred to the guidelines under which 2a-7 money market funds (MMFs) operate."
It explains, "The SEC has instituted new rules about maturities of fund holdings, types of holdings, amount of liquidity, and the way in which funds report the value of their holdings to the public: The weighted-average-maturity (WAM) of a fund must now be 60 days or less, down from 90 days, mitigating the risk of a fund 'breaking the buck.' A shorter WAM might decrease the weighted-average-yield, however. To provide investors with greater protection in the event of a market disruption, a fund must have 10 percent of its assets maturing in one day, and 30 percent of its assets maturing within seven days.... The SEC is now requiring money market funds to disclose their 'shadow NAV' -- the mark-to-market valuation that a money market fund is required to calculate for each security it owns -- with a 60-day delay, beginning February 7, 2011."
Brian Kalish of AFP says, "Corporate treasurers need to be prepared for potentially having to explain to their senior management and board why they own or owned a money market fund with a shadow NAV that broke the buck. Now that the shadow NAV will be publically disclosed, albeit on a delayed basis, will investors be willing to invest in a money market fund that was or could be reported as worth less than one dollar? This is the question that investment managers at organizations must be asking themselves now so they aren't caught unprepared when this rule goes into effect."
The release says, "The AFP Money Market Resource Center includes articles, fact sheets, research and a complimentary webinar for finance professionals. (Note: Crane Data's Peter Crane will present the AFP webinar, "Money Market Mutual Funds: Reviewing the New Regulations & Discussing the Outlook for Future Changes" on May 19 at 3:30pm.) AFP will continue to take a leadership role in this subject in its upcoming liquidity survey. Results will be published in June."
In other news, Secretary Geithner testified before the Financial Crisis Inquiry Commission on 'The Shadow Banking System' this morning. His comments discuss the emergence of parallel banking system and how its collapse has made the need for comprehensive financial reform undeniable."
Two separate banks put out press releases Tuesday announcing the launch of online money market trading "portals". The first, entitled, "Bank of America Merrill Lynch to Offer CashPro Invest," is subtitled, "Investment Banking Affiliates Will Collaborate with Cachematrix on Enhanced Online Investment Application." The second is headlined, "Comerica Securities Introduces New Online Money Market Trading System." Online money fund trading portals, which allow web access to offerings from multiple fund families, control approximately $380 billion, or 20% of institutional money fund assets, according to Crane Data estimates.
The BofA release says, "Bank of America Merrill Lynch today announced an agreement that will create a world-class investment application to be integrated with the bank's next-generation treasury management portal, CashPro Online. CashPro Invest will be developed through an agreement with Cachematrix, a leading provider of custom trading solutions for global financial institutions. When available later this year, the new order entry, research and reporting application will provide more efficiency and give clients a higher level of service in investment activities."
Fred Berretta, Global Liquidity Solutions executive, comments, "By leveraging the latest technology and best practices, CashPro Invest will deliver the investment capabilities that our clients expect from an industry-leading financial services firm. This new application will offer clients improved navigation, faster speed and other benefits, and serves as another example of Bank of America Merrill Lynch's ongoing investment in innovation and commitment to global expansion."
The release adds, "CashPro Invest will be integrated with CashPro Online, the new treasury management portal that Bank of America Merrill Lynch launched in 2009. CashPro Invest will be provided through the Bank of America's investment banking affiliates -- Banc of America Securities LLC and/or Merrill Lynch, Pierce, Fenner & Smith Incorporated. CashPro Online also will be enhanced over the next year with new payments and information reporting applications. Cachematrix currently hosts a separate investment account management application within Bank of America Merrill Lynch called MoneyMarkets Express. Clients now using that platform, as well as those using another existing investment application, will migrate to CashPro Invest starting later this year."
George Hagerman, CEO of Cachematrix, says, "We're pleased to build on our existing relationship with Bank of America Merrill Lynch and welcome the opportunity to help create a leading investment application in CashPro Invest. The release also says, "Bank of America Merrill Lynch embarked on a multi-year investment in new technology as part of the bank's expansion of treasury management, corporate banking and other businesses in key global markets."
Comerica's release says, "Comerica Securities has introduced Maestro, a new online money market trading system designed especially for institutional customers of Comerica Securities. Comerica Securities' Maestro system can be accessed 24 hours a day, seven days a week through Comerica's home page www.comerica.com. Through the Maestro system, Comerica Securities' institutional customers can place and cancel trades, check daily activity reports, and review their money market and 'sweep' account balances."
"With the constant need for information in today's business environment, Maestro is a tool that can be a great asset for our institutional customers -- saving time and enabling them to work more effectively," explained Ross Rogers, senior vice president and chief executive officer of Comerica Securities.
On Monday, Bank of America completed the sale of Columbia Management's long-term asset management business to Ameriprise Financial. The company has also rebranded its money funds as the BofA Funds and rebranded its money fund manager as BofA Global Capital Management. A statement sent to Crane Data says, "As previously announced, Bank of America has retained Columbia Management's cash business on the strength of its investment professionals, the quality of its product offering and the depth of its client relationships. The cash business is now called BofA Global Capital Management. The money market fund family is now called BofA Funds."
The statement says, "As of March 31, 2010 the BofA Global Capital Management business had more than $114 billion in assets under management and approximately 150 professionals, including 25 experienced portfolio managers, credit analysts and traders. This business serves both retail and institutional investors through taxable and tax-exempt money market funds; multi-currency offshore funds and customized separate account strategies.... BofA Global Capital Management resides within Bank of America's Global Wealth & Investment Management division [and] continues to be headquartered in Boston."
A letter from new BofA Global Capital Management President Michael Pelzar says, "Today is an important day for us, as it marks the launch of BofA Global Capital Management. While our name is new, you are likely already familiar with our experienced cash professionals and our high-quality investment solutions from your relationship with Columbia Management."
Pelzar continues, "Over the past year, we at BofA Global Capital Management have been working diligently to build on the already considerable strengths of Columbia Management's cash business. We have enhanced our management team; we are making substantial investments in technology to help us better manage risk; and we have refined our product set, which includes taxable and tax-exempt money market funds, offshore funds, customized separate accounts and subadvisory services. These enhancements, combined with our strong emphasis on client service and satisfaction, will help us deliver three important objectives: preserving our clients' principal; ensuring their assets are readily accessible; and delivering solid performance. In short, we are geared toward meeting your liquidity needs with a business dedicated exclusively to short-term investment strategies."
Finally, he says, "The global financial crisis has reconfigured the investment landscape, particularly with respect to short-term investing. Supported by the full resources of Bank of America, BofA Global Capital Management is well positioned to help investors navigate the challenges presented by these changes. I speak for all of my teammates in saying that I am extremely excited by the opportunity to leverage our expertise, our technology and our diverse mix of liquidity solutions on behalf of those of you who have chosen to invest with BofA Global Capital Management. We very much look forward to working with you and to meeting your needs for liquidity-oriented asset management solutions."
Look for more details in coming weeks and a more in-depth discussion in the June issue of Money Fund Intelligence
The Federal Reserve Bank of Boston just published a study on its AMLF money market support program, which was perhaps the single most important backstop for money market funds during September 2008 and which may serve as a model for the recently proposed Liquidity Exchange Bank (LEB). The new Boston Fed paper is entitled, "How Effective Were the Federal Reserve Emergency Liquidity Facilities? Evidence from the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility."
In the introduction for "QAU Working Paper No. QAU10-3, authors Burcu Duygan-Bump, Patrick M. Parkinson, Eric S. Rosengren, Gustavo A. Suarez, and Paul S. Willen, write, "Following the failure of Lehman Brothers in September 2008, short-term credit markets were severely disrupted. In response, the Federal Reserve implemented new and unconventional facilities to help restore liquidity. Many existing analyses of these interventions are confounded by identification problems because they rely on aggregate data. Two unique micro datasets allow us to exploit both time series and cross-sectional variation to evaluate one of the most unusual of these facilities -- the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF)."
It continues, "The AMLF extended collateralized loans to depository institutions that purchased asset-backed commercial paper (ABCP) from money market funds, helping these funds meet the heavy redemptions that followed Lehman's bankruptcy. The program, which lent $150 billion in its first 10 days of operation, was wound down with no credit losses to the Federal Reserve. Our findings indicate that the facility was effective as measured against its dual objectives: it helped stabilize asset outflows from money market mutual funds, and it improved liquidity in the ABCP market. Using a differences-in-differences approach we show that after the facility was implemented, money market fund outflows decreased more for those funds that held more eligible collateral. Similarly, we show that yields on AMLF-eligible ABCP decreased significantly relative to those on otherwise comparable AMLF-ineligible commercial paper."
The full 44-page study's introduction says, "Short-term credit markets experienced unprecedented stresses after the failure of Lehman Brothers in September 2008. In interbank markets, Libor spreads over overnight index swap rates reached over 350 basis points, as many of the largest financial institutions became unwilling to lend to each other. Similarly, in the commercial paper market, outstanding volumes dropped, maturities shortened, and interest rates climbed to record highs relative to overnight index swap rates. The severe strains in short term credit markets played a pivotal role in the financial crisis by compounding other funding pressures at financial institutions, with the potential of disrupting credit flows to firms and households. To help restore liquidity to short-term credit markets, the Federal Reserve used its authority to lend to nonbanks in 'unusual and exigent circumstances' under Section 13(3) of the Federal Reserve Act, and implemented new and unconventional emergency lending facilities. As a result of these emergency facilities, the purchase of Treasury and agency securities, and other interventions in credit markets, the balance sheet of the Federal Reserve doubled in the fall of 2008. Given their novelty and size, it is important to understand whether these facilities were effective in stabilizing financial markets."
It continues, "The AMLF is especially interesting, as it was one of the most unusual facilities when viewed against traditional uses of the discount window. The facility was unconventional in two ways. First, in a substantial departure from 'traditional' -- recourse and over-collateralized -- discount window loans, the Federal Reserve accepted a modest amount of credit risk under the AMLF by issuing non-recourse loans to banks that purchased ABCP directly from money funds. The ABCP purchased by the bank was pledged as collateral for the loan, but the Federal Reserve did not impose a haircut on the collateral. Second, the facility was created to foster liquidity in secondary markets for ABCP, an asset not typically held by depository institutions."
Finally, the paper says, "Our results show that the AMLF was quickly accepted as a means of meeting redemptions by providing an important source of liquidity to money funds. It also helped stabilize asset outflows from these funds. Our analysis of the drivers of the facility's use also confirms that the facility provided a much needed liquidity back-stop. Especially during the first two months of operation, when the majority of the AMLF loans were originated, funds that experienced substantial redemptions were the most active users of the facility. Once redemption pressures subsided and market conditions improved, the use of the facility wound down, consistent with the design of an emergency facility.... We also show that the AMLF helped to restore liquidity to the ABCP market and drive down ABCP spreads."