News Archives: May, 2011
When we wrote last week "FDIC Says DDAs w/Interest Ineligible for Unlimited Deposit Insurance," we hadn't been aware of a May 13, 2011, letter written by the Investment Company Institute and its Chief Economist Brian Reid. The "ICI Comment Letter on Federal Reserve Board Proposal to Repeal Regulation Q," says, "The Investment Company Institute appreciates the opportunity to comment on the Federal Reserve Board's proposed rule that would repeal Regulation Q, which prohibits member banks of the Federal Reserve System from paying interest on demand deposits. The proposed rule, which implements Section 627 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), repeals Section 19(i) of the Federal Reserve Act, the statutory authority under which the Board established Regulation Q. In its rule proposal, the Board asked a series of questions about the repeal of Regulation Q, including whether it would have implications for money market funds."
Reid's letter comments, "It is unclear how significant the competitive effect of allowing banks to pay interest on demand deposits will be on investor demand for money market funds, in part because banks already pay implicit interest on certain business demand deposit accounts (DDAs) through 'earnings credits.' We have deep concerns, however, that the elimination of Regulation Q, coupled with the unlimited deposit insurance on noninterest-bearing transaction accounts as required under Section 343 of the Dodd-Frank Act,3 will effectively extend unlimited insurance to interest-bearing accounts. [Note: see Crane Data's prior New story "FDIC Says DDAs w/Interest Ineligible for Unlimited Deposit Insurance" for the latest.] These changes could dramatically alter the competitive landscape between banks and money market funds and potentially create large outflows from money market funds and into banks either immediately or during a future financial crisis, putting severe pressure on the money markets. Furthermore, the combination of these two changes will significantly increase moral hazard for the banking system, and potentially increase the costs of operating the deposit insurance program for the FDIC and ultimately the U.S. taxpayer. Indeed, the adoption of these two provisions likely will create systemic risks that did not previously exist. It is important, therefore, that the unlimited insurance, authorized for two years in Section 343, be allowed to expire as contemplated by the Dodd-Frank Act."
ICI explains, "Regulation Q was put in place by the Glass-Steagall Act of 1933 as part of a Congressional response to banking practices and problems encountered during the Depression. It authorized the Board to set the rates of interest that banks would be allowed to pay their customers, including a rate of zero on DDAs. From the mid-1960s to the mid-1980s, yields on money market instruments generally were significantly higher than the imposed zero rate that banks were allowed to pay on DDAs and also were often higher than the ceiling imposed on passbook savings accounts. Among other things, these developments discriminated against investors with modest balances. When market interest rates were above deposit ceiling rates, wealthy investors, including institutions, were able to shift from deposits to direct investments in money market securities such as repurchase agreements or commercial paper. Smaller investors were forced to continue to hold their liquid balances in deposit accounts paying submarket yields. Money market funds provided a conduit through which smaller investors could, for the first time, gain access to the higher yields available on open market instruments. For institutional investors, through asset pooling, money market funds often provided more efficient cash management and better diversification than direct investments in money market instruments. These funds also provided investors with larger balances with a cash-management tool that reduced their exposure to a single bank."
They says, "With the notable exception of prohibiting the payment of interest on DDAs, Regulation Q restrictions on deposit rates were gradually phased out in the 1980s, allowing depositories to compete more effectively by creating new products. In the retail space, these products included negotiable order of withdrawal accounts and money market deposit accounts, which are not considered DDAs. Banks have used sweep accounts to provide interest to business customers. Under such arrangements, banks allow customers to keep zero balances overnight in DDAs and sweep customer funds into repurchase agreements, money market funds, and offshore deposits daily. Banks also have been able to compete for business deposits by providing 'earnings credits' on DDAs that can be used to offset service charges generated by the business account owner. These earnings credits amount to the implicit payment of interest on DDAs. The earnings credit rate, however, is reportedly sometimes less than that offered by a 'hard' interest-earning account and any unused earnings credits typically do not carry forward from month to month. The repeal of Regulation Q, therefore, may make DDAs a more appealing alternative for business cash management, thereby potentially reducing demand for money market funds, sweeps, or other arrangements."
Reid continues, "The effect of repealing Regulation Q on investor demand for money market funds, however, likely will be tempered by the tremendous benefits and protections money market funds provide to investors. Institutional investors historically have been attracted to money market funds not only for their market-based yields, but also for the unique protections offered by Rule 2a-7 under the Investment Company Act of 1940. Rule 2a-7, which was further strengthened in 2010, contains several conditions designed to limit a money market fund's exposure to certain market risks by specifying strict limits on portfolio credit quality and maturity of portfolio securities, and requiring readily available liquidity for redemptions. In addition, the rule requires that money market funds maintain a diversified portfolio designed to limit a fund's exposure to the credit risk of any single issuer. Indeed, money market funds often invest in hundreds of different underlying securities, providing investors with diversification across a large number of nonfinancial and financial institutions. In contrast, banks depositors are protected against losses by bank capital and through insurance by the FDIC up to $250,000 per account. Institutional investors, however, often manage cash balances totaling millions to hundreds of millions of dollars or more. For such investors, the repeal of Regulation Q may be an insufficient incentive to offset the risks of an undiversified exposure of deposits in a single bank compared to the more diversified investment available through a money market fund."
He adds, "Thus, it is difficult to predict with any degree of precision what effect the repeal of Regulation Q, in and of itself, will have on investor demand for money market funds. As discussed below, however, the balance between the different approaches of money market funds and banks could be dramatically altered, as the risks associated with the lack of diversification in DDAs are mitigated by the availability of unlimited insurance on noninterest-bearing transaction accounts.
ICI's comment letter also says, "The economic role of a carefully designed deposit insurance program is to help promote stability across the entire economy. Deposit insurance reduces the probability of bank runs by guaranteeing that retail depositors are made whole when a bank defaults. Despite its demonstrated benefits, deposit insurance also carries risks for the financial system. For example, deposit insurance reduces the incentives for insured depositors to monitor the creditworthiness of banks, which in turn creates moral hazard that encourages banks to take additional risks, knowing that depositors will not withdraw their deposits if the bank's financial condition deteriorates. In addition, deposit insurance can cause other systemic risks for financial markets by increasing the propensity for investors to sell off assets -- such as stocks, bonds, mutual fund shares, and other securities -- and move the proceeds into insured deposits. As the FDIC itself has previously observed, this behavior can produce or exacerbate broader market dislocations during periods of financial stress."
Finally, Reid writes, "Historically, the risks posed by deposit insurance programs have been mitigated by capping the amount of a depositor's account that is insured (currently $250,000). In the case of the temporary unlimited insurance authorized by Section 343 of the Dodd-Frank Act, even with the statutory limits on the types of accounts covered (noninterest bearing), the moral hazard and systemic risks created by the banking system have increased, particularly with the removal of Regulation Q. For example, we are not aware of any limitation placed on interest-bearing DDA holders that would prohibit them from moving their cash balances to a noninterest-bearing, fully insured transaction account during a period of financial stress at an individual bank or in the financial markets in general. Nor are we aware of any prohibition on banks creating such a linkage that could be executed automatically. Taken together, the removal of Regulation Q and the unlimited insurance on noninterest-bearing transaction accounts required under Section 343 of the Dodd-Frank Act will effectively allow the FDIC to provide unlimited insurance on interest-bearing accounts and will no doubt draw money away from money market funds, other cash pools, and direct investments in the money market, perhaps even to a degree that could raise systemic concerns. It is critical, therefore, that the unlimited insurance on noninterest-bearing transaction accounts, authorized for two years in Section 343, be allowed to expire as contemplated by the Dodd-Frank Act. Indeed, this point is sufficiently important that we recommend the Board express this view to Congress and the FDIC to ensure that the unlimited insurance is not extended by statute or regulation." [Note: This letter was posted before last Thursday's Crane Data News story, "FDIC Says DDAs w/Interest Ineligible for Unlimited Deposit Insurance".)
The Investment Company Institute's latest weekly data show money market mutual fund assets rising. ICI's monthly series, as of April 30, 2011, also show assets inching higher, while the trade association's monthly portfolio holdings aggregates show a continued shift out of near-zero yielding repurchase agreements (repo) and into certificates of deposit (CDs). The weekly "Money Market Mutual Fund Assets" report says, "Total money market mutual fund assets increased by $9.56 billion to $2.748 trillion for the week ended Wednesday, May 25, the Investment Company Institute reported today. Taxable government funds increased by $3.96 billion, taxable non-government funds increased by $7.53 billion, and tax-exempt funds decreased by $1.94 billion."
ICI's weekly continues, "Assets of retail money market funds increased by $90 million to $910.44 billion (33.1% of the total). Taxable government money market fund assets in the retail category decreased by $10 million to $168.31 billion (6.1% of total assets), taxable non-government money market fund assets increased by $660 million to $545.19 billion (19.8%), and tax-exempt fund assets decreased by $560 million to $196.94 billion (7.2%). Assets of institutional money market funds increased by $9.47 billion to $1.837 trillion (66.9%). Among institutional funds, taxable government money market fund assets increased by $3.97 billion to $607.20 billion (22.1%), taxable non-government money market fund assets increased by $6.87 billion to $1.118 trillion (40.7% of all money fund assets), and tax-exempt fund assets decreased by $1.38 billion to $112.08 billion (4.1%)."
ICI's "Trends in Mutual Fund Investing, April 2011" says, "The combined assets of the nation's mutual funds increased by $293.4 billion, or 2.4 percent, to $12.473 trillion in April, according to the Investment Company Institute's official survey of the mutual fund industry. In the survey, mutual fund companies report actual assets, sales, and redemptions to ICI.... Money market funds had an outflow of $3.58 billion in April, compared with an outflow of $14.62 billion in March. Funds offered primarily to institutions had an inflow of $15.02 billion. Funds offered primarily to individuals had an outflow of $18.60 billion." Overall money funds inched up by $0.9 billion in April to $2.728 trillion, representing 21.9% of all mutual fund assets.
The Investment Company Institute also distributes (to subscribers only) a "Month-End Portfolio Holdings of Taxable Money Market Funds," which shows that CDs (including Eurodollar CDs) increased their lead as the largest money fund holding, rising $35.1 billion, or 6.1%, in April to $609.8 billion (25.2% of holdings). CDs have increased by $49.1 billion (8.8%) over 3 months. Repo remained the second largest holding at 18.1% ($437.7 billion), though these totals declined by $10.4 billion (2.3%) in April and have declined by $70.1 billion (13.8%) over the past 3 months.
Commercial Paper (CP) ranked third among taxable money fund holdings with $409.6 billion (16.9%), up $3.4 billion (0.8%) in the latest month and up $19.5 billion (5.0%) over the past 3 months. U.S Government Agency Securities were the 4th largest money fund holding according to ICI's series, with $366.9 billion, or 15.1% of assets. Agency holdings were down $14.1 billion (3.7%) in April and are down $11.1 billion (2.9%) over 3 months. U.S. Treasury Bills and Other Treasury Securities combined totalled $338.8 billion, or 14.0%, down $5.8 billion (1.7%) on the month, while Notes (both Corporate and Bank) holdings totalled $150.4 billion (6.2%). "Other" holdings made up the remaining 4.5%.
Crane Data's latest Money Fund Portfolio Holdings reports, a part of our Money Fund Wisdom service, also showed Certificates of Deposit as the largest holding among our taxable fund collection with 24.5% of all assets. Our Holdings collection uses the SEC's new categorization breakouts, which differ from ICI's. We show Treasury Debt as the second largest holding with 16.0% of assets, followed by Government Agency Debt with 15.0%. Financial Company Commercial Paper ranks 4th in our new Composition breakout with 10.1%. (Asset Backed Commercial Paper accounts for another 4.7% and Other Commercial Paper adds another 1.6%.)
Government Agency Repurchase Agreements make up 7.4% of our taxable asset totals, Other Repurchase Agreements make up 5.5%, and Treasury Repurchase Agreements make up 5.1%. Other Notes make up 3.7% of taxable assets, while Variable Rate Demand Notes total 2.9% in taxable funds (and total 9.99% of all investments when tax-free funds are included). Other Instruments (Time Deposit) total 1.7%, Other Instruments total 1.4%, Other Municipal Debt total 0.2%, Investment Companies total 0.14%, and Insurance Company Funding Agreements barely register with 0.02%. Unsurprisingly, Structured Investment Company Notes didn't appear in any of the portfolio holdings disclosures.
The FDIC released a Financial Institution Letter (FIL) entitled, "Deposit Insurance Notice Requirement Regarding the Payment of Interest on Demand Deposit Accounts yesterday, and also released its most recent "Quarterly Banking Profile" earlier this week. The FIL says, "Under a provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), insured depository institutions (IDIs) may pay interest on demand deposit accounts (DDAs) starting July 21, 2011. Under another section of the Dodd-Frank Act, the FDIC provides unlimited deposit insurance for noninterest-bearing transaction accounts through December 31, 2012. The purpose of this Financial Institution Letter (FIL) is to remind IDIs that if on or after July 21, 2011, an IDI modifies the terms of a DDA so that the account may pay interest, the IDI must notify affected customers that the account no longer will be eligible for unlimited deposit insurance coverage as a noninterest-bearing transaction account."
The letter's "Highlights" include: "Section 343 of the Dodd-Frank Act provides unlimited insurance coverage for noninterest-bearing transaction accounts at all IDIs from December 31, 2010 through December 31, 2012. Section 627 of the Dodd-Frank Act permits IDIs to pay interest on DDAs starting July 21, 2011. If on or after July 21, 2011, an IDI modifies the terms of a DDA so that the account may pay interest, the IDI must notify affected customers that the account no longer will be eligible for unlimited deposit insurance coverage as a noninterest-bearing transaction account. This notice requirement does not apply to DDAs modified after December 31, 2012. As of January 1, 2013, noninterest bearing transaction accounts are insured subject to the standard maximum deposit insurance amount of $250,000." According to the FDIC's latest statistics (see below), $1.75 trillion is held in noninterest-bearing deposits, over $1.0 trillion of this in noninterest-bearing transaction accounts larger than $250,000.
The FDIC's latest "Quarterly Banking Profile" says, "Deposit Growth Remains Strong. Deposits at FDIC-insured institutions increased by $178.8 billion (1.9 percent), as deposits in foreign offices rose by $61.4 billion (4 percent), and domestic office deposits grew by $117.4 billion (1.5 percent). Noninterest-bearing deposits in domestic offices increased by $58.3 billion (3.5 percent), while interest-bearing deposits were up by $59.1 billion (1 percent). Nondeposit liabilities fell by $101.1 billion (4.2 percent), with Fed funds purchased declining by $44.6 billion (37.5 percent), and FHLB advances falling by $28.6 billion (7.4 percent)."
It explains, "Total assets of the nation's 7,574 FDIC-insured commercial banks and savings institutions increased by 0.7 percent ($94.7 billion) during the first quarter of 2011. Total deposits increased by 1.9 percent ($178.8 billion), domestic office deposits increased by 1.5 percent ($117.4 billion), and foreign office deposits increased by 4.0 percent ($61.4 billion). Domestic noninterest-bearing deposits increased by 3.5 percent ($58.3 billion) and domestic interest-bearing deposits increased by 1.0 percent ($59.1 billion). For the 12 months ending March 31, total domestic deposits grew by 3.9 percent ($298.2 billion), as interest-bearing deposits increased by 1.2 percent ($76.8 billion) and non-interest-bearing deposits rose by 14.5 percent ($221.3 billion)."
The FDIC quarterly continues, "Brokered deposits decreased by 1.7 percent ($9.8 billion) during the first quarter. At the end of the first quarter of 2011, 42 percent (3,215) of FDIC-insured banks and thrifts used brokered deposits and 798 of these institutions had brokered deposits that exceeded 10 percent of their domestic deposits. Reciprocal brokered deposits spread among 1,471 institutions totaled $28.6 billion, representing 5.1 percent of total outstanding brokered deposits. Data newly provided in quarterly financial reports on deposits that institutions obtained through listing services indicate that 1,359 institutions held such deposits, which in aggregate amounted to $40.8 billion."
It adds, "The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), enacted on July 21, 2010, provides temporary unlimited deposit insurance coverage for noninterest-bearing transaction accounts from December 31, 2010, through December 31, 2012, regardless of the balance in the account and the ownership capacity of the funds. The unlimited coverage is available to all depositors, including consumers, businesses and government entities. The coverage is separate from, and in addition to, the insurance coverage provided for a depositor's other accounts held at an FDIC-insured bank."
It says, "Insured commercial banks and savings institutions had $1.75 trillion in domestic noninterest-bearing deposits on March 31, 2011, 60 percent ($1.05 trillion) of which was in noninterest-bearing transaction accounts larger than $250,000. Of this total, $894 billion exceeded the basic coverage limit of $250,000 per account, but was fully insured by the temporary unlimited coverage. Banks with under $10 billion in assets funded 3.3 percent of their assets with deposits receiving the temporary unlimited coverage. Banks with more than $10 billion in assets had deposits receiving temporary coverage equal to 7.6 percent of assets. The following table shows the distribution of accounts receiving unlimited coverage on noninterest-bearing transaction accounts by institution asset size."
Finally, the Quarterly comments, "Total estimated insured deposits increased by 1.4 percent in the quarter ending March 31, 2011, and rose by a total of 16.7 percent over the past four quarters. The large four-quarter increase was primarily attributable to the additional temporary coverage of non-interest bearing transaction accounts authorized by the Dodd-Frank Act. For institutions existing at the start and the end of the most recent quarter, insured deposits increased during the quarter at 5,114 institutions (68 percent), decreased at 2,427 institutions (32 percent), and remained unchanged at 32 institutions. The condition of the Deposit Insurance Fund (DIF) continues to improve. The DIF increased by $6.3 billion during the first quarter of 2011 to negative $1.0 billion (unaudited), the fifth consecutive quarterly increase. Assessment income at $3.5 billion and a $3.1 billion negative provision for insurance losses were the primary contributors to the improvement in the DIF balance. Interest earnings, combined with unrealized gains on available-for-sale securities and other net revenue, increased the fund by another $151 million. Operating expenses reduced the fund balance by $395 million."
The Federal Reserve Bank of New York released a statement entitled, "New York Fed releases expanded reverse repo counterparties list on Monday and one entitled, "New York Fed releases reverse repo counterparties eligibilty criteria for government-sponsored enterprises" on Tuesday. It says of its new "Reverse Repo Counterparties List," "Effective May 23, 2011, the New York Fed has accepted the following money market funds as reverse repurchase transaction counterparties. This is in addition to the primary dealers and previously approved reverse repurchase transaction counterparties."
The "New Reverse Repo Counterparties include: BlackRock Institutional Management Corp's BlackRock Liquidity Funds: T-Fund and TempCash; BofA Advisors LLC's BofA Treasury Reserves; The Dreyfus Corporation's Dreyfus Cash Management Plus and Dreyfus Institutional Reserves Money Fund; Federated Investment Management Company's Federated Capital Reserves Fund and Federated Prime Value Obligations Fund; Fidelity Management & Research Company's Fidelity Fixed Income Trust: Money Market Portfolio; Invesco Advisers, Inc.'s STIT Government and Agency Portfolio; J. P. Morgan Investment Management Inc.'s JPMorgan Liquid Assets Money Market Fund; Morgan Stanley Investment Management, Inc.'s Morgan Stanley Institutional Liquidity Fund Government Portfolio; Northern Trust Investments, Inc.'s Northern Institutional Funds - Diversified Assets Portfolio, Government Portfolio, and Government Select Portfolio; Northern Funds' Money Market Fund; Prudential Investments LLC's Prudential Investment Portfolios 2 - Prudential Core Taxable Money Market Fund; SSgA Funds Management, Inc.'s Institutional Liquid Reserve Portfolio, SSgA Money Market Fund, SSgA Prime Money Market Fund, and State Street Navigator Securities Lending Trust; T. Rowe Price Associates, Inc.'s T. Rowe Price Prime Reserve Fund and T. Rowe Price Summit Cash Reserves Fund; TDAM USA, Inc.'s TDAM Money Market Portfolio; UBS Global Asset Management (Americas) Inc.'s Prime Master Fund, Treasury Master Fund and UBS RMA Money Market Portfolio; U.S. Bancorp Asset Management, Inc.'s First American Treasury Obligations Fund Mount Vernon Securities Lending Prime Portfolio; The Vanguard Group, Inc.'s Vanguard Federal Money Market Fund; Wells Fargo Funds Management's Wells Fargo Advantage Money Market Fund, Prime Investment Money Market Fund, Treasury Plus Money Market Fund."
The full list of reverse repo counterparties includes: BlackRock Advisors, LLC Master Institutional Portfolio's Master Money LLC, Master Premier Institutional Portfolio, BlackRock Fund Advisors, LLC Money Market Master Portfolio, Prime Money Market Master Portfolio, BlackRock Institutional Management Corp BlackRock Liquidity Funds: FedFund, T-Fund, TempCash, and TempFund; BofA Advisors, LLC BofA Cash Reserves, BofA Money Market Reserves, BofA Treasury Reserves; Charles Schwab Investment Management, Inc. Schwab Advisor Cash Reserves, Schwab Cash Reserves, Schwab Government Money Fund, Schwab Money Market Fund, Schwab Value Advantage Money Fund; Deutsche Investment Mangement Americas, Inc. Deutsche Cash Management Master Portfolio; The Dreyfus Corporation Dreyfus Cash Management, Dreyfus Cash Management Plus, Dreyfus Government Cash Management, Dreyfus Institutional Cash Advantage Fund, Dreyfus Institutional Preferred Money Market Fund, Dreyfus Institutional Reserves Money Fund, Dreyfus Treasury & Agency Cash Management, General Money Market Fund, Federated Investment Management Company Federated Capital Reserves Fund, Federated Government Obligations Fund, Federated Government Reserves Fund, Federated Prime Cash Obligations Fund, Federated Prime Obligations Fund, Federated Prime Value Obligations Fund, Federated Treasury Obligations Fund; Fidelity Investments Money Management, Inc. Fidelity Revere Street Trust: Fidelity Cash Central Fund, Fidelity Revere Street Trust: Fidelity Securities Lending Cash Central Fund, Fidelity Management & Research Company Fidelity Phillips Street Trust: Fidelity Cash Reserves, Fidelity Colchester Street Trust: Government Portfolio, Fidelity Colchester Street Trust: Money Market Portfolio, Fidelity Fixed Income Trust: Money Market Portfolio, Fidelity Newbury Street Trust: Prime Fund, Fidelity Colchester Street Trust: Prime Money Market Portfolio, Fidelity Money Market Trust: Retirement Money Market Portfolio, Fidelity Colchester Street Trust: Treasury Portfolio; Goldman Sachs Asset Management Goldman Sachs Financial Square Government Fund, Goldman Sachs Financial Square Money Market Fund, Goldman Sachs Financial Square Prime Obligations Fund, Goldman Sachs Financial Square Treasury Obligations Fund; Invesco Advisers, Inc. STIT Government and Agency Portfolio, STIT Liquid Assets Portfolio, STIT Treasury Portfolio; J. P. Morgan Investment Management Inc., JPMorgan Liquid Assets Money Market Fund, JPMorgan Prime Money Market Fund, JPMorgan U.S. Government Money Market Fund, JPMorgan U.S. Treasury Plus Money Market Fund; Legg Mason Partners Fund Advisor, LLC Western Asset/Institutional Cash Reserves Portfolio, Western Asset/Institutional Government Reserves Portfolio, Western Asset/Liquid Reserves Portfolio; Morgan Stanley Investment Management, Inc. Morgan Stanley Institutional Liquidity Fund Government Portfolio, Morgan Stanley Institutional Liquidity Fund Prime Portfolio; Northern Trust Investments, Inc. Northern Institutional Funds - Diversified Assets Portfolio, Northern Institutional Funds - Government Portfolio, Northern Institutional Funds - Government Select Portfolio, Northern Funds - Money Market Fund; Prudential Investments LLC Prudential Investment Portfolios 2 - Prudential Core Taxable Money Market Fund; Passport Research, Ltd. Edward Jones Money Market Fund, RBC Global Asset Management (U.S.) Inc. RBC Prime Money Market Fund; SSgA Funds Management, Inc. Institutional Liquid Reserve Portfolio, SSgA Money Market Fund, SSgA Prime Money Market Fund, State Street Navigator Securities Lending Trust; T. Rowe Price Associates, Inc. T. Rowe Price Prime Reserve Fund, T. Rowe Price Reserve Investment Fund, T. Rowe Price Summit Cash Reserves Fund; TDAM USA Inc. TDAM Money Market Portfolio; UBS Global Asset Management (Americas) Inc. Prime Master Fund, Treasury Master Fund, UBS RMA Money Market Portfolio; U.S. Bancorp Asset Management, Inc. First American Government Obligations Fund, First American Prime Obligations Fund, First American Treasury Obligations Fund; Mount Vernon Securities Lending Prime Portfolio; The Vanguard Group, Inc. Vanguard Federal Money Market Fund, Vanguard Market Liquidity Fund, Vanguard Prime Money Market Fund; Wells Fargo Funds Management Wells Fargo Advantage Cash Investment Money Market Fund, Wells Fargo Advantage Government Money Market Fund, Wells Fargo Advantage Heritage Money Market Fund Wells Fargo Advantage Money Market Fund, Wells Fargo Advantage Prime Investment Money Market Fund, and Wells Fargo Advantage Treasury Plus Money Market Fund"
The update adds, "Inclusion on this list simply means that, should the New York Fed conduct reverse repurchase agreements, those listed would be eligible to participate. It does not mean that any listed eligible reverse repurchase transaction (RRP) counterparty is eligible for any other program or transactional relationship with the New York Fed. Further, it does not in any way constitute a public endorsement of any listed eligible RRP counterparty by the New York Fed, nor should inclusion on the list be viewed as a replacement for prudent counterparty risk management and due diligence. Each listed fund applied to be an eligible RRP counterparty under the criteria and application published by the New York Fed."
Under its "Reverse Repo Counterparties: Documents and Forms" the New York Fed explains its previously posted "RRP Eligibility Criteria for Money Funds III." It says, "This document sets forth the criteria for acceptance as a counterparty eligible to participate in reverse repurchase transactions (RRP) with the Federal Reserve Bank of New York (FRBNY). FRBNY may engage in RRP, if at all, at the direction of the Federal Open Market Committee (FOMC) in order to drain reserves."
It explains, "In any such RRP, FRBNY will sell securities held in the System Open Market Account (SOMA) to counterparties subject to an agreement to repurchase them at some future date. FRBNY will use the existing industry tri-party infrastructure to undertake any such RRP. In addition, as with current operations, FRBNY intends to use an auction format for awarding transactions to counterparties. Upon submission of an application and acceptance of that application by FRBNY, an applicant will be added to a public list, maintained on FRBNY's website, of RRP counterparties.... Details of transactions undertaken with RRP counterparties will be disclosed in accordance with the requirements of Section 1103 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. That legislation requires the disclosure of certain information regarding open market transactions between a Federal Reserve Bank and nongovernmental entity that have been authorized under specified provisions of Section 14 of the Federal Reserve Act, which would include RRP."
The criteria say, "To be accepted as a RRP counterparty, an applicant must: A. be an open-end management investment company that is organized under the laws of a State of the United States, registered under the Investment Company Act of 1940, holds itself out as a money market fund, and is in compliance with the requirements of Rule 2a-7 under such Act; B. have net assets of no less than $5 billion for the most recent six consecutive months (measured at each month-end) prior to the submission of the application; C. have been in existence for at least one year prior to the submission of the application; D. be a consistent investor in the tri-party repo market (in particular, in transactions collateralized by U.S. government debt, agency debt, and agency MBS securities), E. be able to confirm and arrange settlement of a significant volume of transactions with FRBNY, and F. be able to satisfy the following transaction requirements: (a) execute RRP with securities margined at 100% (i.e. the value of the securities provided by FRBNY will equal the funds provided by the counterparty), (b) execute term RRPs, with tenors of one-week or longer, (c) submit minimum bids of $500 million or greater, (d) execute RRP for next day settlement, and (e) execute the requisite RRP documentation including FRBNY's Master Repurchase Agreement, triparty custody documentation and other documentation, as applicable."
The first comment letter directly in response to the SEC's recent "Roundtable Discussion on Money Market Funds and Systemic Risk" (see archived webcast here) has been submitted. The post (which is not available on the SEC website yet) from Vice Chairman John McGonigle says, "Federated Investors, Inc. would like to thank the Securities and Exchange Commission for allowing John Hawke to present our views on money market fund reform to the SEC Roundtable on Money Market Funds and Systemic Risk. We would also like to take this opportunity to (1) address squarely the public policy concerns raised by various regulators during the Roundtable, (2) respond to some of the agenda items that the Roundtable did not have time to address, and (3) substantiate certain claims made during the Roundtable."
Federated writes under "Public Policy Considerations," "The central policy question is whether tax dollars should be used to prevent a run on money market funds. There was really no disagreement on this point -- the answer is no and the real question is how best to prevent this from happening. We hope that the SEC noted that none of the representatives of money market fund investors, managers or industry associations assumed that any form of federal guarantee would ever be provided to money markets. Only the current and former representatives of regulatory agencies alluded to an 'implicit government guarantee' of the funds' stable net asset values. Given that there is no such government guarantee (implicit or explicit) and that the authority for the temporary guarantee provided to shareholders in 2008 was rescinded by the Dodd-Frank Act, there is no basis for these assertions. Statements by public officials that presume some form of government guarantee for money market funds can only foster expectations of support, which is contrary to our shared policy objective."
They continue, "Given that we all seek to avoid any need for a government guarantee of money market funds, there is no reason to suppose that money market funds create any moral hazards for the financial system. We have already explained how the temporary guarantee program did not create any moral hazard on the part of managers or shareholders. The Roundtable participants representing investors confirmed that they do not view funds as guaranteed by the government and do not encourage funds to take undue risks to generate yield. No one who claims a moral hazard has provided evidence to substantiate the claim, or even provided a plausible explanation of how the hazard might have been created."
McGonigle's letter explains, "A wholesale run on money market funds need not present a systemic risk to the broader financial markets or the U.S. economy so long as borrowers can obtain alternative short-term funding from other sources. Many money market instruments are already structured to include an alternative funding source, such as stand-by liquidity facilities for commercial paper and municipal demand obligations. Other instruments have collateral that can be used to secure alternative funding. Establishing a liquidity facility bank will provide an additional funding source during periods of financial crisis. The liquidity facility bank will help to shield the rest of the credit market from the effects of a large scale run on the funds, and will do so at the expense of the funds and their managers -- not the taxpayer."
He says, "Most of the other reforms discussed at the Roundtable seek to avoid a run on the funds. Some reforms, such as floating the NAV, have already proven to be ineffective in preventing runs. Other reforms, such as capital requirements, cannot provide sufficient protection on a cost-effective basis to prevent a run. More fundamentally, raising investor expectations of safety is antithetical to the objective of avoiding a government guarantee. If investors who regard money market funds as 'riskless' are part of the problem, reducing the perceived risk of the funds cannot be part of the solution."
McGonigle comments, "Federated also thinks that the policy questions regarding the liquidity facility bank were exaggerated. Although a central bank is only required to provide liquidity to the banking system, the 'social contract' requires banks to use that liquidity for the benefit of the financial system, including providing liquidity to the market. Money market funds would not consider a special purpose bank if they could rely on other banks to provide liquidity in times of stress. A severe financial crisis is apt to affect banks first, however, and to a greater extent than other sectors of the financial markets. Indeed, if the Dodd-Frank Act reforms work as intended, during the next financial crisis money market funds can expect one or more major financial institutions to undergo a rapid 'resolution,' with a corresponding reduction in market liquidity."
The letter explains, "Federated does not agree that the creation of a liquidity facility bank raises any far-reaching policy implications for the Fed. As Mr. Hawke noted at the Roundtable, the liquidity facility bank would be subject to regulatory oversight by the Fed and would use the discount window on the same basis as other banks. The demand for loans at the discount window is always a consequence of the lending and other business activities of the banks requesting the funds. The Fed has never viewed this as a justification for regulating the panoply of companies that rely on these banks to finance and conduct their businesses. A liquidity facility bank would be uniquely transparent: funds obtained at the discount window could be traced to specific transactions, rather than disappearing into a welter of activities. We do not see why this transparency would justify Fed regulation of money market funds, insofar as the Fed has never asserted jurisdiction over any other ultimate beneficiary of borrowings at the discount window."
Finally, Federated's letter concludes, "We continue to be surprised by the double-standard being applied to money market fund reforms. Banks required more extensive and costly government support than money market funds during the financial crisis of 2008. While extensive regulatory reforms have been proposed for banks, these reforms would not require fundamental structural changes comparable to requiring money market funds to float their NAVs or start to maintain capital. Although banks continue to pose greater systemic risks than money market funds ever could, no one is conducting roundtables to discuss whether banks should be forced to change their essential nature so as to eliminate these risks. We do not understand why federal regulators feel compelled to hold money market funds to higher standards than other financial institutions."
Money Fund Intelligence and Crane Data celebrate their fifth birthday this month. As we wrote in our most recent issue, little did we know when we launched in May 2006 that the next five years would be the most tumultuous in the 40-year history of money market mutual funds. During our first two years, we saw assets increase by over $1.5 trillion and yields drop from almost 5 percent to under 1.0 percent. The past three years, we've seen assets decrease by over $1 trillion and we've suffered through the lowest yields in history. Money funds have survived, though, and Crane Data has prospered, thanks to you. We appreciate your continued support!
Our company has grown into a 10-person firm with hundreds of customers and thousands of readers and web visitors. Crane now offer conferences, database products and international coverage, and, with the addition last year of our Money Fund Portfolio Holdings collections, we now track tens of thousands of money market securities. Our website, www.cranedata.com is easily the most comprehensive money fund resource available. (CraneData.com has been averaging over 2,200 visitors a day in May 2011 so far, up almost 100 percent from a year ago.)
As we say in the MFI masthead, "Crane Data LLC measures money ... and provides competitive intelligence on money market mutual funds & cash investments. The publisher of Money Fund Intelligence and producer of Money Fund Symposium was founded in 2006 by money fund expert Peter Crane and by computer guru Shaun Cutts. Our mission is to provide faster, cheaper & cleaner money market & fund information.
Subscriptions to Money Fund Intelligence are $500 a year and include web access to archived issues and fund "profiles." Additional users are $250; "site licenses" for unlimited redistribution are $5,000. Visit www.cranedata.com or call 1-508-439-4419 to subscribe or add users. Crane Data's other products include: Money Fund Intelligence XLS ($1K/yr), MFI Daily ($2K/yr), Money Fund Wisdom ($5K/yr; includes Money Fund Portfolio Holdings and other products), MFI International ($2K/yr), and Brokerage Sweep Intelligence ($2K/yr). We are liberal with our samples and support, so don't be afraid to call or write.
In sum, Crane Data aims to deliver low-cost and high quality money fund information. Please let us know if we can improve MFI (or www.cranedata.com) or assist in any way. We're happy to discuss where to find information if we don't have it, or to tell you that it doesn't exist. We continue to pursue our goal of faster, cheaper and cleaner money fund information, and we thank you again for your backing! Sincerely, Peter G. Crane
As we wrote in our March 11 Crane Data News story "Moody's Finalizes Money Fund Rating Methodology, Leaves Aaa Alone," Moody's new money fund rating methodology goes live today, May 20. (Moody's now says the "migration process will be completed on Monday," May 23.) The change has been accompanied by a flurry of press releases announcing a number of withdrawn ratings. The previous press release entitled, "Moody's finalizes new methodology for money market funds," sent out in March says, Moody's Investors Service has published its new global methodology for rating money market funds.... The new rating methodology reflects experience gained from the tumultuous period in late 2008 when disruptions in short-term funding markets caused market value declines and record outflows from prime money market funds." The final ratings changes reflect an about-face after a firestorm of criticism over Moody's initial proposals, which included abandoning the triple-A scale and heavily weighting parental support in fund ratings. (See also our Sept. 8, 2010, Crane Data News news article, "Moody's Proposes New Money Market Fund Rating Methodology, Symbols," and our Jan. 19, 2011, piece, "Moodys Backs Down From MMF Ratings Change Proposals, Keeps AAA.")
The full paper, "Moody's Revised Money Market Fund Rating Methodology and Symbols," says, "In this report, we present our revised rating methodology for rating money market funds. The analytical framework uses a set of objective measures to assess portfolio credit quality as well as market and liquidity risks in stress scenarios in order to differentiate among funds. In addition, we are introducing a new set of rating symbols and definitions that better address the unique risks of money market funds and distinguish our money market fund ratings from our credit ratings. This new rating methodology is scheduled to become effective on 20 May 2011, and all existing money market ratings will be migrated then to the new rating symbols based on the new methodology."
It explains, "Our revised money market fund rating methodology incorporates market feedback that we received after publishing our Request for Comment on the same subject in September 2010. Once effective, the new methodology will supersede the following principal methodologies as they apply to money market funds: "Moody's Managed Funds Credit Quality Ratings Methodology" and "Moody's Money Market and Bond Fund Market Risk Ratings", both published in 2004."
Moody's new Rating Methodology continues, "The introduction of Moody's revised money market fund methodology reflects experience gained from the tumultuous period in late 2008 when disruptions in short-term funding markets caused market value declines and record outflows from prime money market funds. During this period, a large money market fund -- The Reserve Primary Fund -- 'broke the buck' and suspended redemptions together with funds managed by the same fund family. Many other funds experienced stress within their portfolios and elevated redemptions at the same time, heightening systemic risk. Ultimately, support from the US Treasury, via the introduction of a guaranty fund for money market fund investors, served to stem investor outflows and prevent a disorderly unwind of money market funds."
Over the past several days, Moody's has withdrawn the ratings on a host of money funds. Press releases were sent out entitled, "Moody's withdraws rating of Williams Capital Government Money Market Fund," "Moody's withdraws ratings of two Milestone Money Market Funds," "Moody's withdraws rating of Federated Short-Term Euro Money Market Fund," "Moody's withdraws rating of [Invesco] Short-Term Investment Trust, Tax-Free Cash Reserve Portfolio," "Moody's withdraws ratings of two BlackRock tax-exempt money market funds [BlackRock Liquidity Funds MuniFund and FFI Institutional Tax-Exempt Fund]," and "Moody's withdraws rating of COLOTRUST PLUS + Local Government Investment Pool," were sent out ahead of the ratings changes.
Most of these continue to have AAA ratings from S&P or Fitch, and Fitch just newly rated the Milestone fund AAA. One representative release explains, "Moody's Investors Service has withdrawn the Aaa rating assigned to the Williams Capital Government Money Market Fund. Moody's has withdrawn the rating for business reasons. For further information on Moody's ratings withdrawal policy, please refer to Moody's Withdrawal Policy on moodys.com."
Today, we continue our excerpts from the May issue of our Money Fund Intelligence article, "BNY Mellon's Spirgel on Portals and Transparency." MFI: What makes your portal different? Spirgel: The difference is critical mass and our connection to the platform of one of the best known and most technologically advanced asset servicers in the world. Making our money market fund portal available to clients is not ultimately our goal; our goal is to be able to provide a total liquidity solution for our clients. We're doing things today that are unique and different compared to what we were doing just a few years ago in pursuit of our goal of delivering a total liquidity solution. If our clients want to buy direct securities, we can help them with that. We can provide a custodial solution that puts their money funds in the same account. We can provide consolidated reporting. They can use their Liquidity DIRECT account as the hub of their liquidity transaction processing.
MFI: Where do you see the portal and the money fund industry headed? Spirgel: I think we've come a very long way over the past two years, with the various reforms to Rule 2a-7 funds. They've been successful in the sense that things have quieted down. I think people have confidence in these fund structures, which is terrific. But there's still some work to be done.
Our client feedback plainly indicates that the constant NAV is still very important to them. It makes it easy to transact and it makes it easy for them to do business on a day-in day-out basis. But hopefully people will focus on the ultimate goal of these products, which is to facilitate business across many different types of entities and many different types of transactions on a daily basis.
Our client base is predominantly large institutions -- corporations, insurance companies, hedge funds, not-for-profits. They rely on our service as a resource that enables them to do their business on a day-in day-out basis, to move money to appropriate locations, and invest their money at the end of the day with the expectation that it will be available tomorrow morning. So I caution people within the industry that meeting their liquidity needs is our ultimate goal.
MFI: What has changed since 2008? Spirgel: People are doing a lot more due diligence. They're also using a number of different funds. Situations where investors rely on only one or two fund families have definitely changed. We've developed monitoring tools here specific to those types of clients. They can now filter on asset size; they can select if they don't want to be larger than a certain percent of the fund.... A lot more people are using that type of compliance monitoring tool. So it's a whole new world.
MFI: How are the low yields impacting fund revenues? Spirgel: When you look at specific funds, like certain Treasury funds, yields certainly pose a rub. We're very happy working with our fund company partners. We do recognize that this is a very long-term business and we want success for them and for ourselves. So we try to take out the short-term nature of fee waivers, although they have been around for a little longer than any of us would like. We recognize that waivers will not be here forever and that interest rates will go up.... But everyone needs to realize that the service we provide in partnership with the fund companies has to be sustainable, and that one part can't outweigh the other one. We want everyone to be fairly compensated -- ourselves and the fund companies -- for the services that we all provide.
MFI: Any thoughts about the future growth of portals? Spirgel: I think there is a lot of room to continue to grow in the U.S. But I also think globally there is a much bigger opportunity. It's a big world, and we're just scratching the surface with our abilities. The money funds business is globally almost $5 trillion in assets.... I think there is a lot more room to be able to work within just the liquidity space and educate some of those entities that maybe aren't using money funds today. I think there is a lot more opportunity globally to be able to service clients and their liquidity wherever they may be.
The May issue of Crane Data's flagship newsletter Money Fund Intelligence (monthly, $500/yr) recently discussed online money market trading developments with Jonathan Spirgel, Executive Vice President & Head of Liquidity Services for BNY Mellon. The company's Liquidity DIRECT platform was the first and is the largest player in the approximately $600 billion 'portal' marketplace. The following discussion is reprinted from the latest issue.
MFI: Tell us about the history of Liquidity DIRECT. Spirgel: Back in 1997, as we were sharpening our strategic focus on custodial safekeeping, we asked ourselves if helping clients invest their cash might be a new and different way to service their needs. We asked, 'How do we make it easy, simple, cost effective, and secure?' We'd always had a platform of money market funds and had relationships with all the name-brand money market providers at the time, so we came up with the idea of offering just the money market fund portfolio capabilities to large institutional clients around the world. Given our relationships with money fund providers, it became readily apparent to us at that time that we could come up with a product that would make their funds accessible to our client base in a very streamlined and efficient manner.
The merger of BNY and Mellon brought together Mellon's Liquidity Management Service and BNY's Money Funds DIRECT. We put the two of them together soon after the merger and came up with our Liquidity DIRECT portal.... Now our goal is much broader than just [being] a money fund portal, our goal is to be a short-term liquidity solution across many different currencies and many different locations. We're a global company, and the emergence of our product as a global offering has been especially helpful to our clients of late.
MFI: How big is the portal? Spirgel: The way we view it here is that we are one part of a one very large platform. Depending on the nature of their relationship with BNY Mellon -- e.g. asset servicing, corporate trust, treasury services, etc. -- clients have multiple points of connection with our platform. BNY Mellon is the largest custodian in the world with $25 plus trillion in assets under custody. The cash that we look after is quite large. We typically don't talk about portal assets in detail, but the platform assets are a multiple of hundreds of billions of dollars. We use multiple currencies as we handle diverse and different types of clients around the world. If there is a product out there that we feel is appropriate for our client's needs, we are happy to add it to our systems. That allows clients to invest their cash in that particular product via a transaction carried out in their time zone, through a local web-based product.
We have about 32 different funds families. It's driven by the client base and what they desire and what they are looking for in a product. Of course, we have prime funds. We have the government funds and Treasury funds with or without repo. Today, we are more focused on funds that have [things like] the QII distinction and the NAIC distinction for insurance companies. We now have more than 800 clients using the portal -- but that said, we still maintain personal relationships with many clients based upon their desire to interact with a live person vs. an electronic platform.
MFI: What's new in the money fund portal marketplace? Spirgel: We started looking at transparency a few years back. What it really comes down to is asking our clients the questions: 'What can we do to help you? What would make your life easier? What would answer the questions that you're getting from your treasurer, CFO or board of directors?' Back in 2008, clients were getting a lot of questions. We didn't want to provide investors with reams of paper that they would have to cull through.
Last summer, we started getting files from some of our providers and started building reports. But just getting the information wasn't good enough. We needed to be able to ask and filter information based upon some set of criteria that our client would need to respond to it internally. We look at transparency as not just providing a monthly list of holdings in a PDF, but being able to provide the clients with a variety of tools -- e.g. a reporting tool, a search tool, a filtering tool, and an analytical tool.
We are going to continue moving forward with transparency. We feel that our reporting has already reached a fairly sophisticated level and our clients have been happy with the information and analytical tools that we provide to them. But we're not resting on our laurels.... Clients want the ability to analyze the data in a coherent and a thoughtful matter, and that is what we are committed to delivering. Offshore is the next logical step for us. We are going to continue to build that out.... Transparency is a goal, and offshore is a goal -- we intend to keep rolling on both fronts as we find ways to provide more and more detailed analytical and helpful tools to our clients.
Look for more excerpts in coming days, or e-mail Kaio Barbosa to request the full article in the latest issue of Money Fund Intelligence.
In his "Welcoming Remarks" at the "2011 Money Market Funds Summit," Edward C. Bernard, Chairman of the Investment Company Institute and Vice Chairman, T. Rowe Price Group Inc said, "Just about two weeks ago, the Institute hosted another meeting -- its annual General Membership Meeting -- where we had the honor of hearing from Treasury Secretary Timothy Geithner. When he was asked about money market funds, Secretary Geithner gave a pretty good description of what we're trying to do here today. As he said, the challenge we face is 'to figure out how to bring a little bit more resilience into that system -- without depriving the economy of the broader benefits that those funds provide.' Secretary Geithner went on to say: 'I think it's hard.' Boy, don't we know it."
Bernard continued, "It's been 32 months -- to the day -- since the Reserve Primary Fund broke the dollar, and we've been working nearly every day since toward finding the balance that Secretary Geithner described. Our industry and our financial regulators have devoted enormous resources to the hunt for solutions. We've considered a wide range of ideas, but there's still no consensus on any proposal that will give us all comfort that we can take the next step, without undermining the significant economic and investor benefits that money market funds provide. That's true even after the President's Working Group Report and the Securities and Exchange Commission's Roundtable last week."
He added, "[M]oney market funds don't exist in a vacuum. The landscape in which they operate is very different today. The crisis has changed how other players in the money markets behave. And to the degree that financial regulatory reform has made banks and other financial institutions more secure, money market funds will be less susceptible to systemic problems, like the liquidity freeze in September 2008.... [W]e have solid evidence that investors still value and prize the core features of money market funds -- stability, simplicity, and convenience. How else can we explain the fact that institutional and individual shareholders still have a combined $2.7 trillion in money market funds -- after months of yields near zero, and when those investors could get significantly higher returns in short-term bond funds with the click of a mouse?"
The Keynote speech, given by Vanguard Group Chairman F. William McNabb III, was entitled, "A World Without Money Market Funds?" It says, "I want to start by thanking ICI for facilitating this forum, and really, for leading the conversation on money market fund reform for the past several years.... [T]he dialogue has been, by turns, both encouraging and frustrating. We were greatly encouraged last year, for example, when the SEC adopted improvements to Rule 2a-7, which strengthened money market fund standards for liquidity, credit quality, maturity, and transparency. But we've been frustrated more recently by some of the rhetoric calling for money market funds to essentially be turned into short-term bond funds -- or banks."
McNabb told the approximately 150 attendees, "I'm going to talk about why these funds have been so important, and then, what the world might look like without money market funds ... because, make no mistake, that is the conversation we are having. Whether we are talking about floating NAVs or bank-like regulation or some of the other proposals we've heard, the issue in front of us is a choice. A choice between a world with money market funds ... and a world without money market funds.... [M]oney market funds are one of the most important financial innovations of the past century."
He added, "If the structure of these funds is significantly changed -- say, by mandating excessive capital requirements or by floating the $1 share price -- money market funds as we know them would disappear. And I don't believe the ramifications of 'a world without money market funds' has been fully considered or understood. We take threats to the interests of our investors very seriously. I think it's better to have a pre-mortem analysis of the importance of money market funds rather than post-mortem regrets."
Finally, McNabb said, "I don't mean to sound dramatic. But this is a serious topic, and I'd ask participants on all sides of this debate to bear in mind: The great improvements that have been made to money market fund regulations over the years; and the law of unintended consequences that could be realized with significant changes to the structural integrity of these funds. Remember, at the end of the day, many of us in this room are stewards of other people's money. What's at stake is incredibly important to millions of investors, businesses, and the health of the overall economy."
In today's Wall Street Journal, Fidelity Investments Chairman & CEO Edward Johnson and Vanguard Group William McNabb write "Your Money Market Funds Are Safe." They say, "For 40 years, money market mutual funds have worked exceedingly well, providing substantial benefits to investors. Crucially, they've done so without receiving a dime of taxpayer funds. Money market funds offer a convenient way for millions of individuals and institutions to invest their short-term cash. They offer stability, liquidity and income at a very reasonable cost. They give small investors the same access to competitive investments that previously were available only to large investors."
The piece continues, "Money market funds are also a linchpin of the U.S. economy, providing an important source of funding to states and municipalities for building schools, roads and bridges. In fact, 65% of all short-term debt of states and municipalities is owned by money market funds. They also fund banks and other lenders, making it possible for Americans to buy homes, purchase cars, and send their children to college. Additionally, major companies enjoy attractive short-term funding from money market funds that purchase short-term debt issued by businesses, nonprofits and governments."
Johnson and McNabb explain, "Yet the many benefits of money market funds are at risk of disappearing. Why? Because one fund at one firm, the Reserve Primary Fund, during the worst economic crisis since the Great Depression, dipped below the stable $1 per share price that money market funds strive to maintain. Ultimately, that fund's shareholders were given 99 cents per share. Although this was only the second instance in the 40-year history of money market funds in which a fund dipped below the $1 per share value, some critics are now suggesting that funds comply with draconian measures. They argue that money market funds should be required to submit to banking regulations with bank-like capital requirements, or abandon their stable $1 share price. Either move would seriously undermine money market funds, while creating a more monopolistic position for banks. This would have terrible effects on investors and our economy."
The pair ask, "Why would we regulate money market funds with rules that were intended for banks when the banking industry has experienced unprecedented difficulties? More than 350 banks have collapsed since the start of the financial crisis, including 40 so far this year. Those that survived required hundreds of billions of dollars of taxpayer money during the economic downturn, which was brought on in part by poor practices of many in their own industry. In contrast, money market fund shareholders received temporary support during the crisis from the federal government through a fee-based insurance program, which cost the government nothing as no money market funds needed these resources. Indeed, this temporary support earned the U.S. Treasury (and, thus, taxpayers) approximately $1.2 billion."
The Journal article says, "Others are advocating that money market funds abandon the fixed $1 share price, instead allowing share value to float each day. They contend that under this model, shareholders might be less inclined to redeem shares during market turmoil. But recent history shows just the opposite. During the downturn, ultra-short-term funds with floating share prices experienced significant outflows and lost a much greater proportion of their assets than money market funds."
They comment, "If a floating share price is adopted, some predict -- and we agree -- that investors would shift their savings to banks, which currently hold more than $8 trillion in deposits, compared to $2.7 trillion in assets for money market funds. It's important to remember that the banking system is significantly larger today than it was prior to the start of the financial crisis in 2007. Funneling trillions of dollars into this one sector will only narrow the landscape of choices for investors and increase risks to our economy. The pressure on the Federal Deposit Insurance Corporation, which is already dealing with the collapse of so many banks, would dramatically increase, raising serious questions about whether there is sufficient capital in the banking system to avoid a government bailout in a market environment similar to 2008."
Johnson and McNabb continue, "Critics also argue that investors may be unaware of the investment risks in money market funds because of their perceived similarity to bank savings accounts. But our millions of interactions with our customers over the years show us that shareholders do understand these risks. In fact, by U.S. Securities and Exchange Commission (SEC) mandate, money market literature states that a money market fund 'is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.'"
The pair comment, "In the aftermath of financial meltdown, money market funds have been considerably strengthened. The SEC adopted a comprehensive set of amendments to Rule 2a-7 of the Investment Company Act of 1940, which regulates the maturity, quality, liquidity and diversity of the assets in which funds can invest. Although the existing rule had worked extremely well, the SEC decided to make money market funds even 'more resilient to short-term market risks,' as the commission put it in February 2010. These changes have created more than $800 billion of new liquidity in the system, which will enable money market funds to navigate market volatility without government support."
Finally, they add, "The industry has suggested several ways to further increase the resiliency of money market funds during extreme market stress, and they should be explored. But we shouldn't adopt rules that will jeopardize the viability of funds for investors and issuers and put undue strain on an already weakened banking system."
In what is starting to seem like an infinite loop, comment letters continue to trickle in regarding the President's Working Group Report on Money Market Fund Reform. Two more postings have appeared on the SEC's website recently -- a critique of the NAV buffer proposal and defense of the Liquidity Facility written by Federated Investors' John McGonigle and a new proposal for a redemption fee plan written by HSBC Global Asset Management's CEO John Flint. No doubt there will be more comments and even more proposals in the coming weeks. (Monday's ICI Money Market Funds Summit should be another interesting affair.)
McGonigle says, "We are writing to address recent industry proposals that seek to further reform money market funds managed in accordance with Rule 2a-7 by adding a net asset value buffer to Money Market Funds, by requiring some other form of capital requirement, or by regulating Money Market Funds as special purpose banks. Although Federated Investors, Inc. previously commented on the proposals made in the President's Working Group Report, we consider it extremely important to highlight, in advance of the May 10, 2011 roundtable discussion, some strong reservations we have on such reforms, and to reiterate our support for the Investment Company Institute's proposed liquidity exchange facility. We believe that the Liquidity Facility is the leading concept to provide enhanced liquidity, resiliency and shareholder protections for Money Market Funds."
The letter continues, "Federated acknowledges that the Buffer Proposal would permit a Money Market Fund to incur small trading losses without having to disclose a shadow NAV significantly below a dollar and that it is possible that small trading losses could help to avoid later and more significant credit losses. Federated also acknowledges that the Buffer Proposal would provide limited protection against credit and liquidity events (except in the event the markets freeze up as in the Fall of 2008) and could be implemented relatively easily (notwithstanding the obvious tax inefficiencies and providing interest rates increase to a level at which it would be possible to retain sufficient income to create the buffer). We believe, however, caution is called for when considering any proposal that so fundamentally alters the character of what has been an important and highly successful part of the capital markets."
McGonigle explains, "In light of the success of the Commission's first round of changes to Money Market Fund regulation, any subsequent round of change should be focused on addressing the core issues that caused the liquidity crisis in the first instance, rather than altering the product so fundamentally. More specifically, while the Buffer Proposal purports to allow Money Market Funds to sell portfolio securities at a loss without "breaking the buck," the crisis in 2008-2009 would not have been alleviated by a Money Market Fund maintaining a 40 basis point buffer. In the days following the Lehman bankruptcy there were no bids available or the spreads were much wider than 40 basis points (as was the case during the crisis). The crisis was alleviated to a large measure by the Boston Fed's AMLF program. This program provided needed liquidity to a system that had ceased to function because of issues wholly unrelated to Reserve Primary Fund's breaking the buck."
Finally, he says, "The Liquidity Facility provides greater protection against systemic risk than the Buffer Proposal. After ten years, the Liquidity Facility is projected to provide nearly $54 billion in available funds to help respond to a liquidity crisis. In contrast, using the same assumptions, a 40 basis point cushion would never provide more than $6.6 billion. The buffer is designed to allow funds to absorb modest losses created by an illiquid market, while the Liquidity Facility is designed to avoid such losses. Importantly, the Liquidity Facility, as proposed, would be a member bank of the Federal Reserve System with access to the Fed discount window. The marginal utility of the Buffer Proposal does not come close to justifying the unintended consequences which would negatively impact shareholders and financial markets."
The HSBC letter comments, "After the recent market events, we continue to affirm our commitment to the money market fund business. We believe MMFs are an important investment product to continue to offer our clients and have an important role to play in the financial system. However, it must be clear that the risks of investing in MMFs reside with the investors. Over the years, due to a number of fund sponsors stepping in to support their MMFs, and the most recent U.S. governmental action in support of MMFs, we believe there continues to be ambiguity about who owns the risk of investing in MMFs. As long as ambiguity about risks continues to exist, we believe there will be an unacceptable mispricing of these risks, and a misallocation of resources. As disclosed to investors in prospectuses, money market funds are an investment product and, as such, investors' capital in MMFs is at risk. We believe that by not addressing this issue at this time that the investment industry will, so to speak, be kicking the can down the road until the next financial crisis."
Flint explains, "We do not believe that there is a single reform that addresses the issue of MMFs susceptibility to runs by investors. As we can never presage future market events, experience shows that MMF investment advisors and Boards need appropriate tools at their disposal to act in the best interest of their shareholders. HSBC Global Asset Management is responding now ... because in addition to the eight possible reforms put forth in the Report, we believe there is another reform worthy of further consideration. We believe the most effective way of mitigating systemic risk is to discourage shareholder runs; and the most effective way of discouraging shareholder runs is to apply a charge on redemption that accurately reflects the cost of raising liquidity to meet redemptions and ... the realisable value of the shares being redeemed."
Finally, HSBC adds, "In summary, we are supportive of the PWG's efforts to enhance the stability of the money market fund industry and we believe now is an opportune time to make the changes necessary to achieve that goal. Any reform enacted must look to remove the ambiguity that exists as to who owns the risk in a money market fund. We believe the use of redemption charges would help achieve both these objectives."
While we're still digesting and transcribing the SEC's 3-hour marathon Roundtable Discussion on Money Market Funds and Systemic Risk (see web video here), we've managed to select some of the standout quotes from the first half of the event below. Overall, the event was an interesting exercise, but its focus on the more radical "long-shot" options listed in the President's Working Group report and short duration made it unlikely to have advanced the debate much. Nonetheless, the forum did serve to highlight many of the major issues and to refine some of the arguments for reform. It appears that the debates are still just getting started though. (We hope to have a full transcript by early next week.)
After SEC Chairman Mary Shapiro's remarks (see yesterday's "News"), SEC Division of Investment Director Eileen Rominger said, "The PWG report concluded that MMFs are susceptible to runs. Do panelists agree with this assessment? Arnold & Porter LLP John D. Hawke, Jr. responded, "It's important to note that runs on money market funds are vastly different than runs on commercial banks ... The investments are very short-term. Their assets are 'money good'. I think it paints a misleading picture to say that money market funds are susceptible to runs."
Fidelity's Bob Brown commented, "I think the run developed because there was no transparency." He noted that Fidelity Cash Reserves "experienced a 2 percent decline in net assets" during Sept. 2008 while they saw a "40 percent reduction in their institutional prime fund". Plaze added later in this discussion, "In some ways, transparency cuts both ways."
While CVS Caremark Senior Vice President and Treasurer Carol A. DeNale said, "I do not look to the money market funds for yield." Capital Advisors added, "Investors were voting with their feet." Pan explained, "Because of their own success [money funds] attracted the attention of some of the shadow banking products.... When we experienced problems with ABCP, we saw the pickup in European banks.... That's another way of saying that we also need to address the correlation risk of the money funds ... to reduce the systematic risk."
As expected, Paul Volcker blasted away at money funds, "Are they prone to a run? The answer is obviously yes.... You had a structural problem with an organization that had no backstop, no ... support.... MMF were pure regulatory arbitrage.... It is a shadow bank. Do you need shadow banks or do you make them real banks?"
Hawke countered, "A lot of people out there think money market funds are very good for them. They find them enormously useful for cash management, for liquidity, retail investors put a high value on the transaction account features of those funds. I think there's a great danger in looking at all sources of mechanisms for reinventing the money market funds. The danger is there will be unintended consequences.... The basic problem that The Reserve Fund caused is how you deal with emergency liquidity needs. And I think that ought to be the focus. How do you deal with those extraordinary situations where there's tremendous market disruption, not caused by money market funds, as to which they are the victims. How do you deal with the demand for liquidity that comes when investors wanting to cash in?"
Erik Sirri, one of the professors on the panel, proceeded to confuse listeners with talk of guarantees. He said, "The idea of a guarantee ... is a trait of all financial intermediaries. It seems to me ... 2008 wasn't the first time. What we really need to figure out is how you pay for it, and who's the guarantor." The Bank of England's Paul Tucker added, "Once the State steps in ... then the State is also entitled to [its] say.... Either take away or make explicit the guarantee."
Brown asked, "What would bank-like regulations provide the money fund industry? We've studied our market value NAVs back over the past 20 years and we would consider a significant deviation from the amortized cost NAV to a market value NAV of 10 basis points. I think the integrity of the rule 2a-7 speaks loudly with those numbers."
The FDIC's Sheila Bair commented, "They will run.... And that's why we have deposit insurance. So we got into this situation where money market mutual funds have had the stable NAV. I believe a fiction.... Just because your term is short, doesn't mean that the investment is risk free.... It was a model that was broken. Now it seems we have a moral hazard issue.... I understand from a business perspective maybe the status quo is just fine.... But regulators should be worried about moral hazards.... It seems to me your customers want money market like bank accounts.... They are not risk-free investments."
IMMFA's Travis Barker responded, "They're there to provide institutional investors with diversification.... It's not clear to me that a world without money market funds would be better.... Fundamentally the product exists for legitimate risk mitigation reasons." Pann added, "Institutional investors would like to have some substitute for bank deposits.... They have to worry about their counterparty risk."
GFOA's Kathryn Hewitt commented, "It's very important to us to be able to put a dollar in and to get a dollar out. We're trying to balance investments ... that we are going to get par back for.... If we don't have it, if we have a fluctuating one, we won't be in it.... With our daily operating cash that we need to pay our bills with, that, we need to have stability for.... If interest rates are 5%, we shouldn't be earning 1%. We need the safety, stability of the $1 NAV."
CVS's DeNale added on the floating NAV, "We will not do it. We will pull out of money market funds.... This is not a product that corporate America can back.... We do not just invest in money markets. We invest in CP. The money market is just an avenue for diversification. I do not expect to be picking up different yield for my money market. We're looking for diversification for my portfolio.... Corporate accounts were not guaranteed dollar for dollar. There was a run from banks too. So I think to say the money markets had a run on it and to say other products didn't, that's not true.... How did S&P and Moody's rate Lehman as an A-1, P-1? I think we're all forgetting ... this wasn't just the Reserve fund that created the run.... Goldman Sachs and MS were about to fail. AIG had to be bailed out.... To say that the Reserve fund caused the run is very naive."
Finally, Barker commented, "The purpose of the floating NAV is to change the psychology. [But] I don't see any evidence to that in practice. If you look, for example, at the German money funds, they had a run.... The floating NAV doesn't address the issue.... This changing the pricing structure doesn't change the outcome, which is making investors less likely to run in the event of a crisis."
On Tuesday, the U.S. Securities & Exchange Commission hosted its Money Market Funds and Systematic Risk Roundtable, which featured a number of alternative opinions on future changes to money fund regulations. While the core of the roundtable debated a bank regulatory regime vs. changes to the existing fund system, panelists also discussed the possibility of a floating NAV, a liquidity facility and an NAV buffer. In her "Remarks Before the Money Market Funds and Systemic Risk Roundtable," SEC Chairman Mary Schapiro said, "I am pleased to open today's roundtable discussion on Money Market Funds and Systemic Risk. And I am particularly pleased to be joined by representatives from the Financial Stability Oversight Counsel, as well as my fellow SEC Commissioners. This multi-regulator presence reflects the broad level of focus and attention that money market funds garner -- and highlights their importance in the overall financial landscape."
She explained, "Money market funds catapulted into the public consciousness in September of 2008 -- in the midst of the market crisis. It was then that the Reserve Primary Fund broke the buck, and we subsequently witnessed a run on institutional prime money market funds. Regulators and investors alike, were once again reminded of the tremendous significance of the role of money market funds in the financial system. During the week of September 15, 2008, investors withdrew approximately $310 billion from prime money market funds, with the heaviest redemptions coming from institutional funds. This represented 15 percent of those funds' assets. The run was halted by the announcement of the Treasury Money Market Fund Guarantee Program, which temporarily guaranteed money market fund account balances as of Sept. 19, 2008. In addition, government facilities were put in place to provide liquidity to the commercial paper market in which prime money market funds invest."
Shapiro continued, "The SEC and other federal financial regulators worked closely and collaboratively on these programs. And we have worked closely and collaboratively since, in order to wind down the programs and focus on regulatory reforms to mitigate the systemic risk posed by money market funds. The most significant of those regulatory changes to date include the SEC's reforms to our money market fund regulations. Through this effort, we tightened credit quality standards, shortened weighted average maturities, and for the first time imposed a liquidity requirement on money market funds. Those reforms, which we adopted in February 2010, have been in effect for nearly a year."
She added, "In addition, we adopted new reporting requirements that provide for a comprehensive and searchable database of money market fund portfolio information. This database enables us to monitor trends in money market funds' holdings and risk profiles. Complementing these developments, we have provided investors access to money market funds' shadow NAV information. This information is publicly reported on a monthly basis, with a 60 day lag. The public shadow NAV information is expected, in part, to help sensitize investors to the fact that money market fund shares are interests in pools of investments that fluctuate in value, although those fluctuations generally are small."
Shapiro told the Roundtable, "Despite all of this, more needs to be done to better protect money market funds -- and the broader financial system -- from the destabilizing risk that can result from a broad money market fund run. I think everyone agrees that our country should never again be in the position of having to choose between providing support to private market participants, including money market funds, or risking a breakdown of the broader financial system. To further the public dialogue on this important issue, the President's Working Group on Financial Markets issued a Report on Money Market Fund Reform Options. The SEC requested public comment on the options identified in the report, and received approximately 80 letters. The letters, which were thoughtful and substantive, reflected a variety of views."
Finally, Shapiro's introduction said, "The issues surrounding money market funds are significant. And the variety of perspectives that exist regarding how best to moderate their run risk requires the kind of in-depth dialogue that can only occur by getting some of the best minds in one room to engage in a free exchange of ideas. That is why I am so thankful that our esteemed panelists have given of their time and been willing to travel across the country and even across the Atlantic to join us this afternoon. I look forward to a robust dialogue, and a healthy exchange of ideas -- and the perspectives of a broad range of current regulators. Also, former regulators Paul Volcker and John Hawke represent a respected long-term perspective, and Paul Tucker, Bank of England Deputy Governor, provides an important international focus. Thank you to the current and former regulators and all of our panelists for your participation today."
Click here to watch the SEC's 2pm EDT Webcast "Money Market Funds and Systemic Risk" Roundtable here.... The Investment Company Institute's President & CEO Paul Schott Stevens wrote a response to yesterday's Wall Street Journal editorial, "Taxpayers and Money Market Funds," which appeared to support a floating NAV for money market funds. (See yesterday's "Link of the Day".) Stevens response to the WSJ says, "Your editorial 'Taxpayers and Money Market Funds' (Review & Outlook, May 9) ignores the substantial progress that has already made money market funds more resilient in a financial crisis, while blithely dismissing the economic disruption and proliferation of risks created by a long-discredited 'solution.' The risks of money market funds have always been clearly disclosed, and investors are told in every advertisement, prospectus, and statement that their shares in these funds are not insured. No one can miss the fact that money market funds are not guaranteed."
Stevens explains, "For almost 40 years, money market funds have had an unmatched record of stability. When cascading bank failures shook the money markets in 2008, our industry tackled the vulnerabilities for money market funds exposed by that episode head-on. Our funds voluntarily raised standards for credit quality, shortened portfolio maturities, and increased disclosure. We endorsed new liquidity standards that now require prime money market funds to have 30 percent of their assets liquid within five business days. At current asset levels, that's $490 billion in liquidity."
His letter continues, "We took these steps before the Securities and Exchange Commission acted -- knowing that reforms would raise costs and constrain yields -- because we understand that investors prize the stability, simplicity, and convenience that money market fund provide. How else to explain the fact that stable-value money market funds have 7.5 times the assets of short-term bond funds, which are paying sharply higher yields? The strong demand for money market funds, even with near-zero yields, should give clear warning that fundamental changes to this product will cause severe market disruptions."
The ICI President writes, "We continue to work on sound ideas to reduce risks and make these funds stronger. But the notion your editorial endorses -- floating the value of money market funds -- does nothing to reduce risks. We saw how that experiment played out with floating-value ultra-short bond funds in 2008. Those funds' investors pulled out 60 percent of their assets when the funds' values dropped. It's clear that experiencing routine fluctuations of a few basis points does not 'condition' investors to sit tight when they're hit by a black-swan market."
Stevens adds, "While there's little to gain from floating funds' value, the costs are enormous. Key economic players from across the private and public sector have roundly rejected such proposals. Issuers of commercial paper and municipal securities count on money market funds to finance their payrolls, inventories, and public projects from bridges to hospitals. They've clearly said they don't want to see this crucial financing -- the lifeblood of the economy -- disrupted. Yes, markets will eventually adapt: markets have a way of finding prices that will accommodate even the most harmful policies. But why pile another costly and disruptive regulatory burden on a still-fragile economy, for such illusory gains?"
He also says, "Floating the value of money market funds will drive away legions of investors, including businesses and institutions that are required by law or policy to hold cash in stable-value accounts. Retail investors will also flee, because they want same-day access to their assets that floating-value funds can't provide -- and don't want to turn every transaction with their fund into a taxable event."
Finally, Stevens comments, "During the brief federal guarantee program for money market funds, taxpayers collected $1.2 billion in fees from these funds without paying a dime in claims. We're committed to ensuring that taxpayers are never on the hook for money market funds. But the 'solution' you advocate is all cost with no benefit. We need to preserve the value and key characteristics of money market funds."
The SEC's press release says, "The Securities and Exchange Commission today announced the panelists and final agenda for the Money Market Funds and Systemic Risk Roundtable to be held May 10. The roundtable will address: The potential for money market funds to pose a systemic risk to broader financial markets – what makes money market funds vulnerable to runs and how should the role of money market funds be viewed through the prism of systemic risk analysis. Possible options for further regulatory reform and their implications, including floating NAV, bank regulation, and options that reflect a hybrid of these regulatory approaches: a private liquidity bank; mandatory reserve or capital requirements; and liquidity fees."
The List of Participants and Moderators for SEC Roundtable on Money Market Funds and Systemic Risk, May 10, 2011 include: Participants and Moderators - SEC Hosts Chairman Mary L. Schapiro, Commissioner Kathleen L. Casey, Commissioner Elisse B. Walter, Commissioner Luis A. Aguilar, Commissioner Troy A. Paredes; Representatives of the Financial Stability Oversight Council Chairman Sheila C. Bair of the Federal Deposit Insurance Corporation, Chairman Gary Gensler of the Commodity Futures Trading Commission, Chairman Deborah Matz of the National Credit Union Administration, Governor Daniel K. Tarullo, Member, Board of Governors of the Federal Reserve System, Under Secretary Jeffrey A. Goldstein, of the United States Treasury, Domestic Finance, Mario L. Ugoletti of the Office of the Director Federal Housing Finance Agency. SEC Moderators include: Director Eileen P. Rominger, Division of Investment Management, and Associate Director Robert E. Plaze of the Division of Investment Management.
The SEC says "Additional Participants include: Travis Barker, Chair, Institutional Money Market Funds Association, Global Business Manager, Front Office, HSBC Global Asset Management; Seth P. Bernstein, Managing Director, Global Head of Fixed Income, J.P. Morgan Asset Management; Robert P. Brown, President Money Market Group, Fidelity Management & Research Company; David Certner, Legislative Counsel and Director of Legislative Policy for Government Relations and Advocacy, AARP; Carol A. DeNale, Senior Vice President and Treasurer, CVS Caremark; John D. Hawke, Jr., Partner, Arnold & Porter LLP; Kathryn L. Hewitt, Treasurer, Harford County, MD, Government Finance Officers Association; Lance Pan, Director Investment Research and Strategy, Capital Advisors Group; Brian Reid, Chief Economist, Investment Company Institute; Erik R. Sirri, Professor of Finance, Babson College; Bill Stouten, Senior Portfolio Manager, Thrivent Financial; Rene M. Stulz, Everett D. Reese Chair of Banking and Monetary Economics, The Ohio State University; Paul Tucker, Deputy Governor, Financial Stability, Bank of England; Paul A. Volcker, Former Chairman, Board of Governors of the Federal Reserve System.
The Agenda for Roundtable on Money Market Funds and Systemic Risk, May 10, 2011 includes: 2:00-2:10 p.m. Opening Remarks -- Chairman Mary L. Schapiro; 2:10-2:20 p.m. Introductions -- Participants and Moderators; 2:20-3:05 p.m. Discussion -- Potential for Money Market Funds to Pose a Systemic Risk to Broader Markets What makes money market funds vulnerable to runs? How should the role of money market funds in the short-term funding market be viewed through the prism of systemic risk analysis?; 3:05-3:20 p.m. Break; 3:20-5:00 p.m. Discussion -- Regulatory Options and their Implications Floating NAV vs. Bank regulation, Hybrid approaches to regulation: Private liquidity bank, Hybrid approaches to regulation: Mandatory reserve/capital requirements, Hybrid approaches to regulation: Liquidity fees."
The release adds, "The roundtable discussion will begin at 2 p.m. and be available by webcast on the SEC website. The webcast also will be archived for later viewing. Public seating to view the webcast will be available in the auditorium at the SEC's headquarters at 100 F Street NE in Washington, D.C. Members of the public who wish to provide their views on the matters to be considered at the roundtable discussion may submit comments to the comment file for the President's Working Group Report on Money Market Fund Reform, as noted below. Comments to the Commission may be submitted by ... send[ing] an e-mail to rule-comments@sec.gov and include File Number 4-619 on the subject line.... All submissions should refer to File Number 4-619."
Yet another comment letter on the President's Working Group Report on Money Market Fund Reform in anticipation of the SEC's Money Market Fund Roundtable next week was posted yesterday by Scott Goebel of Fidelity Management & Research Company, Carrie Dwyer of The Charles Schwab Corporation and David Messman of Wells Fargo Funds Management. They write under "File No. 4-619; Release No. IC-29497 President's Working Group Report on Money Market Fund Reform," "We are writing to express our support for the idea of adding a net asset value or NAV buffer to money market mutual funds. To the extent the Commission or other federal financial regulators believe that more regulation of money market mutual funds is necessary, we think that an NAV buffer is the leading concept to provide enhanced resiliency and shareholder protections for money market mutual funds. We urge the Commission to give full consideration to this proposal at the roundtable discussion scheduled for May 10, 2011."
The letter explains, "The NAV buffer would be funded over time by withholding a small portion of the income paid to shareholders. This buffer would be an asset of each money market mutual fund and therefore belong to shareholders, not the management company. Disclosure would ensure that fund shareholders understood exactly how much income was held back to fund the buffer and what impact the holdback had on the net yield of the fund. The buffer would grow over a period of years to minimize disruption to short-term markets that could result if money market mutual funds were required to fund the buffer all at one time. Current and prospective fund shareholders would be able to evaluate the yield impact over time and decide whether to invest in a particular money market fund, or some other investment option. The buffer could apply to prime funds only or all money market mutual funds."
It continues, "The NAV buffer would address both liquidity and credit concerns that federal financial regulators have raised. First, in terms of liquidity, money market mutual funds would have the ability to sell securities at a loss in times of market stress in order to meet redemptions. This flexibility to sell some securities at prices below par could be a key tool for money market mutual funds and one that did not exist during the financial crisis in 2008. Attachment I illustrates how a fully-funded NAV buffer creates significant resiliency for money market funds by showing the large percentage of a fund that is able to be liquidated over a short period of time before even approaching a market NAV of $0.9950. Moreover, trades in money market securities transacted at market prices -- rather than trades executed at par with government supported facilities -- should have the effect of allowing turbulent markets to reset more quickly in times of stress."
The three say, "Second, the NAV buffer would allow money market funds to withstand price volatility of securities held in the portfolios caused by credit concerns in the market. Because money market mutual funds would operate at a net asset value higher than today, funds would be able to tolerate greater realized and unrealized losses due to credit issues."
They continue, "Third, a key feature of the NAV buffer is that a fund's market value per share would typically increase as shareholders redeem. This greatly reduces any incentive for shareholders to run on the fund. If the NAV buffer were in place, each fund would typically operate at a per share market value of greater than $1.00, but all purchases and redemptions of shares would take place at $1.00. Thus, as shareholders redeem at $1.00, the per share market value for the remaining shareholders increases because the buffer amount above $1.00 is shared across a smaller shareholder base. This increase in market value greatly reduces the incentive to redeem shares a of money market mutual fund, as the likelihood of not receiving $1.00 per share is significantly reduced -- and each shareholder that exits the fund actually improves the position of the shareholders who remain in the fund. Of course, if a fund incurs losses selling securities while raising cash to meet large redemptions, this feature is diminished."
It adds, "Finally, the NAV buffer has the advantage of simple implementation. The Commission could mandate an NAV buffer with some minor changes to Rule 2a-7. No other legislative or regulatory actions are required, but we remain open to discussion of any implementation challenges or questions that may arise. The buffer would be an asset of the fund, subject to board oversight The investment advisor would invest the buffer as directed by the board just like every other asset of the fund."
The comment explains, "The Commission has already made significant changes to Rule 2a-7 that have strengthened money market funds by creating massive pools of liquidity in the funds, along with reducing the maturity of portfolios and providing greater transparency to shareholders. Those changes alone have done much to improve the resiliency of money market mutual funds. Nonetheless, as the Commission, along with other federal financial regulators, considers additional regulation of money market mutual funds, we believe that many of the proposals in the PWG Report, such as floating the NAV or imposing bank-like capital requirements, could have damaging effects on money market mutual funds and the short-term markets. Moreover, combining any of these proposals with an NAV buffer would have the same harmful effects to the short-term funding markets. The NAV buffer addresses both liquidity and capital. Thus, no additional liquidity facility or onerous capital requirements are needed."
Finally, the letter adds, "The NAV buffer would have positive effects on the capital markets by ensuring that money market mutual funds remain an attractive option for short-term investors and a key source of funding for the federal government, state and local governments, non-profit institutions, corporations and financial companies. We urge the Commission to give the NAV buffer strong consideration as it reviews whether any additional regulation for money market mutual funds is appropriate."
Yet another entry has appeared on the SEC's website commenting on the President's Working Group Report on Money Market Fund Reform. This latest, written by Cachematrix CEO & Founder George Hagerman, discusses the "portal" marketplace and is the first entry responding to the SEC's request for comments on its upcoming "Roundtable on Money Funds and Systematic Risk," which will take place next Tuesday, May 10 at 2pm EDT. Hagerman writes, "Cachematrix Holdings LLC appreciates the opportunity to submit comments in connection with the Roundtable Discussion Regarding Money Market Funds and Systemic Risk to be hosted by the Securities and Exchange Commission on May 10, 2011."
It continues, "We understand that the roundtable is intended to provide a forum for exchanging views on the potential effectiveness of certain options in mitigating systemic risks of money market funds, including, but not limited to, those contained in the Report of the President's Working Group on Financial Markets. The role of omnibus accounts and electronic portals and the purported lack of transparency through such channels has been an area of focus in the analysis of the financial crisis of 2008 and its aftermath. We believe that a comprehensive understanding of the potential strengths and benefits of portals, and the technology and other capabilities of portal providers, is critical to an evaluation of systemic risk in the money market arena and any related reform efforts."
Hagerman says, "Short term investing is a critical function of most corporate treasury departments. Historically, treasury and other short term investors have viewed money market mutual funds as safe havens in which to invest their excess cash. Over the past decade, particularly after 2006, many treasury and other short term investors have turned to webbased investment portals to manage their investments in money market funds and other short term instruments such as commercial paper. From the perspective of banks and financial institutions seeking to meet the needs of corporate treasury departments and other clients who are short term investors, portals provide a powerful tool. Portals can offer investors time savings, electronic compliance monitoring, investment diversification, and the ability to facilitate reporting and mutual fund analysis within one consolidated platform. Following the liquidity crisis in 2008, investment portals facilitated investors' research by posting recent fund holdings, subprime/SIV statements, fund fact sheets, prospectuses and other information."
He explains, "During challenging or turbulent market conditions, portals allow investors with a myriad of choices. These include not only a menu of institutional money market funds, but also other money market instruments such as commercial paper and discount notes. In addition, by offering precise information on the destination of wire transactions, the name of the authorizer and time stamps, portals can help financial institution customers comply with Sarbanes Oxley, which requires tighter audit controls on cash management."
Hagerman's letter also says, "Portals can also offer participating money market funds many benefits including efficiencies in processing, compliance and risk management tools, customized reporting and realtime transparency. Many portals use omnibus settlement in which trades are consolidated and settled through a single wire. Accordingly, participating funds or their transfer agents do not need to process the voluminous amount of trading that can occur in institutional money market funds that are geared toward providing daily liquidity to corporate treasurers and other financial institutions. In addition, portals provide extensive audit trails and checks and balances, which not only increase efficiency but also reduce the likelihood of errors."
He tells the SEC, "Currently, there are approximately 17 portals operating in the institutional money market space, including 9 portals powered by Cachematrix technology, and assets of approximately $500 billion traded through such portals. In addition, we estimate that there are over 100,000 small to Fortune 500 companies that use portals. Accordingly, portals are an integral participant in the institutional money market space and provide critical interfaces between short term investors including bank and financial institution customers, and money market funds. With their heavy emphasis on online technology and innovation, portals and technology providers to portals have played and can continue to play an integral role in developing private market based solutions to managing systemic risk. Accordingly, we strongly believe that portals should be viewed as a part of the solution to systemic risk management, rather than part of the problem."
Hagerman says, "Electronic portals were criticized during the liquidity 'run' that occurred in the fall of 2008 following the Lehman Brothers bankruptcy. Following the events of 2008, some providers of money market portal technology developed significant enhancements that have helped industry participants evaluate and manage liquidity risk by creating a range of transparency solutions, compliance tools and customized reporting."
Finally, he writes, "Cachematrix believes that both portals and omnibus accounts serve an important function to all key constituencies in the money market space including money market funds, financial intermediaries and end investors such as corporate treasurers. Cachematrix supports reform initiatives that are aimed at mitigating risk through increased transparency with respect to transactions placed through portals or other omnibus arrangements. Various measures have ranged from increased reporting to more significant measures, such as extending Rule 22c-2 to money markets funds. As discussed above, certain private industry participants and service providers have already developed technology enhancements to achieve the goal of greater transparency. We believe that the staff of the Commission should seek to fully understand the technology capabilities of private market participants in formulating further reform efforts with respect to money market funds."
The Investment Company Institute just released its "2011 Investment Company Fact Book," the organization's annual compilation of mutual fund statistics and information. The fact-filled 51st edition says on the "Demand for Money Market Funds," "Money market funds continued to experience substantial outflows in 2010. This trend likely reflects the search by investors for higher yields in an environment of low short-term interest rates accompanied by a steep yield curve and a continued unwinding of the flight to safety in response to the financial crisis of 2007 and 2008."
ICI's "Fact Book" comments, "Retail money market funds, which are principally sold to individual investors, saw a total outflow of $125 billion in 2010, following an outflow of $309 billion in 2009. Money market fund yields continued to follow the pattern of short-term interest rates in 2010, hovering between 0 and 25 basis points. In addition, yields on money market funds remained consistently below those on bank deposits for the past two years -- an unprecedented occurrence since the inception of money market funds in the early 1970s. In general, retail investors tend to withdraw cash from money market funds when the difference in interest rates between bank deposits and money market funds narrows. The sizable outflows from retail money market funds in 2009 and 2010 do not appear to be atypical considering the negative interest rate spread."
It continues, "Institutional money market funds -- used by businesses, pension funds, state and local governments, and other large-account investors -- had outflows of $399 billion in 2010, following outflows of $230 billion during the previous year. Outflows from institutional money market funds likely reflected the low interest rate environment and the continued unwinding of the flight to quality by these investors in 2007 and 2008."
ICI explains, "The tumult in financial markets around the world that started in August 2007 and continued through early 2009 led many institutional investors to seek the liquidity and safety of money market funds that invest primarily in U.S. government securities. These funds, which can invest in U.S. Treasury debt solely or a combination of U.S. Treasury debt and obligations of U.S. government agencies, received $881 billion in net new cash flow from institutional investors in 2007 and 2008. As financial markets stabilized in 2009 and 2010, institutional investors shifted away from U.S. government money market funds, withdrawing $537 billion, on net, from these funds over the past two years. Nevertheless, U.S. government money market funds comprised nearly 39 percent of institutional taxable money market assets at year-end 2010, up from only 24 percent at year-end 2006, prior to the start of the financial crisis."
Finally, the new "Fact Book" adds, "U.S. nonfinancial businesses continued to reduce their holdings of money market funds in 2010. During the financial crisis, corporate treasurers made extensive use of institutional money market funds; at year-end 2008, 36 percent of their short-term assets were in money market funds. By year-end 2010, nonfinancial businesses held 25 percent of their short-term assets in money market funds, back to approximately the same proportion measured at year-end 2006, prior to the start of the financial crisis."
On Friday, Federated Investors hosted its most recent quarterly earnings conference call. President & CEO Chris Donahue told analysts and listeners, "Looking at cash management, money market average assets increased from the prior quarter for both our funds and our separate accounts. As mentioned last call, expected outflows early in Q1, mainly from flows that came in late in the year, led to lower period end fund assets. Growth in average money fund assets was mainly from wealth management and trust channel, while money market separate account growth reflected tax seasonality. While market conditions remain challenging, our cash management business is strong and stable with our market share steady at around 8.8%."
He continues, "On the regulatory front, money funds continue to be an active topic of discussion. Federated and others support the liquidity bank proposal advanced by the industry through the ICI. This enhancement would complement the new liquidity provisions of 2a-7 and would not socialize credit risk. We do not agree with suggestions that favor bank-like regulation, or bank-like capital requirements, which in our view are far off the point and are more likely to do significant harm than enhance the resiliency of money funds, an important stated objective. In terms of the potential for systemic risk designation, we don't believe that we will nor should be designated, and have submitted commentary and support for our opinions to the regulators."
Donahue added, "Money market mutual fund assets stand at about $237 billion. So far in April, our money fund assets have ranged between, 235 and 245 billion, and the average has been about 239 billion.... We also recently launched a redesigned website, to showcase the insights of our investment professionals and better deliver product and market information and tools to our clients.... We're also actively seeking consolidation deals.... Obviously, we cannot predict the probability and timing of any other deals."
CFO Tom Donahue said, "Money fund yield waivers reduced pre-tax income by $13.1 million for the quarter compared to $12.1 million in the prior quarter.... Based on current market conditions and asset levels, these waivers would reduce income by approximately $17.5 million in the 2nd quarter. Lower short term interest rates, in particular, for repurchase agreements impacted these waivers so far in April. Looking forward, we estimate that gaining 10 basis points in gross yields will likely reduce the impact of these waivers by about one-third from the current level and a 25 base point increase would reduce the impact by about two-thirds."
Money Market CIO Debbie Cunningham commented, "Our interest rate outlook has actually not changed too much from the past two quarters, but it has been impacted in the short term ... by some of the regulatory changes.... From the beginning of April, what we've seen based on the FDIC assessment change is lower overnight Fed funds rates which are the driver for lower overnight repo rates. What was essentially an average repo rate in the low to mid 20's ... became in the neighborhood of the mid to high teens ... and going forward it will [now] likely be in the high single digit area.... That will impact how portfolios are aligned." Cunningham predicts rates will rise by "the end of 2011."
