The Investment Company Institute released its latest monthly "Trends in Mutual Fund Investing: January 2012," which showed money market mutual fund assets declined by $35.6 billion to $2.6558 trillion last month. Money fund assets accounted for 22.0% of overall mutual fund assets, which broke back above the $12.0 trillion level, while bond funds accounted for 24.8% of assets ($2.992 trillion). Separately, ICI's "Month-End Portfolio Holdings of Taxable Money Market Funds showed Taxable MMFs shifting into Repo and out of Agencies and CDs last month. They also extended maturities.
ICI's "Trends" says, "The combined assets of the nation's mutual funds increased by $440.8 billion, or 3.8 percent, to $12.062 trillion in January, 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 $36.35 billion in January, compared with an inflow of $38.43 billion in December. Funds offered primarily to institutions had an outflow of $20.66 billion. Funds offered primarily to individuals had an outflow of $15.69 billion."
Crane Data's Money Fund Intelligence Daily shows money fund assets have declined by $8.0 billion in February month-to-date through 2/27/12. YTD through Monday, we show an overall assets decline of $40.58 billion, or 1.6%. Our daily series shows a shift from Government and Treasury Institutional money funds, which have lost $35.4 billion and $17.5 billion, respectively, and into Prime Institutional funds, which have gained $30.8 billion YTD through 2/27.
ICI's Portfolio Holdings series shows Repurchase Agreements jumped by $35.5 billion in January to $529.6 billion after plunging in December. Repos remain the largest portfolio holding among taxable money funds with 22.4% of assets, followed by Treasury Bills & Securities at 18.8% ($443.9 billion). Holdings of Certificates of Deposits, which rank third among portfolio holdings, fell by $19.4 billion to $412.1 billion (17.4%). U.S. Government Agency Securities saw holdings drop by $34.2 billion to $377.9 billion, or 16.0% of assets, while Commercial Paper rose by $11.2 billion, or 3.1%, to $373.7 billion (15.8% of assets). Notes (including Corporate and Bank) accounted for $5.7% of assets ($134.1 billion), while Other holdings accounted for 4.0% ($94.1 billion).
The Number of Accounts Outstanding in ICI's Holdings series for taxable money funds dropped to 25.81 million from 26.29 million the month before, while the Number of Funds remained steady at 431. The Average Maturity of Portfolios lengthened to 44 days in January from 42 days in December. (Our Crane Money Fund Average currently shows a WAM of 42 days vs. one of 40 days at the start of the year, while our Crane 100 Money Fund Index shows a WAM of 44 days vs. a WAM of 41 days as of Dec. 31, 2011.)
Finally, note that the archived version of our Money Fund Intelligence XLS monthly spreadsheet (see our Content Page to download) now has its Portfolio Composition and Maturity Distribution totals updated as of Jan. 31, 2012. We've begun updated these towards month-end based on our monthly Money Fund Portfolio Holdings information, so will revise these fields late in the month.
The February issue of Crane Data's flagship Money Fund Intelligence newsletter interviewed J.P. Morgan Asset Management Managing Director & Head of Global Liquidity Robert Deutsch. (See too our previous profile in Dec. '09, "Defending the $1 NAV: JPMorgan's Bob Deutsch.") J.P. Morgan ranks as the world's largest money market fund manager with almost $450 billion under management in combined U.S. domestic and "offshore" liquidity funds (see our ranking in MFI), and Deutsch has been one of the money fund industry's most eloquent spokesmen. He discusses flows, regulatory concerns, separate accounts, and the outlook for money funds. We excerpt from the first half of our MFI interview below.
We first asked about assets. Deutsch tells us, "When we looked at global institutional [liquidity flows], we took in $50B in the fourth quarter. The rest of the industry took in $66 billion, so we took in 43% of flows during the quarter. Even for us, that is a pretty dramatic number.... About half of that was U.S. and half was international ... it was fairly divided between credit and government funds in the U.S.... So money is still coming into credit funds. Internationally, it was spread across the Dollar, Euro, and Sterling with additional inflows into RMB. We're well positioned in China, so we have a fairly broad mix across products."
He adds, "Some of this seems to be flight to safety, because the markets were very volatile. [There were] a lot of worries about Europe, sovereigns and banks, but when it came to us almost as much went into the prime as the government funds.... I would say, in terms of what we saw come in, maybe a third was 'flight to safety,' a third was new cash from capital markets activities -- bond issuances and other deals -- and the other third, is at year end, we typically see some cyclical money, particularly from the large retailers."
MFI asked, "Have bank fees been helping?" He answers, "I think we started to see money come back from bank deposits to funds. So it's a reverse of the trend we saw in the first part of 2011.... I think we've seen the bank deposit rates come down. A year ago, some of the banks, and we're probably not one of those, were putting up pretty high yields like, 35 or 40 bps to capture money, and they don't seem to be doing that now.... [T]here was a big wave of [usage of] earnings credit rates and I think less of that is happening."
"The other thing is if your investor is willing to take a zero yield, they still get that FDIC guarantee. That is set to expire at the end of 2012. I don't think it has moved money yet, but I do think some investors are thinking about [that ending]. Some are saying, 'We can't accept the zero yield; we need some return in our money.'"
Regarding, "Separate Accounts, Enhanced Strategies," Deutsch continues, "Another trend we're seeing is the segmentation of cash. We have had a lot of discussions around cash segmentation strategies, and we help clients segment between operating cash, reserve cash, strategic cash, and restricted cash. In some cases, what they did with the money went to funds, like we saw in the fourth quarter. But we also saw our separate account business grow quite a bit. We crossed $50 billion in our separate account cash business and are up a good 10% for the year."
"It's not stuff that happens quickly. These are strategic discussions with clients, and we develop investment policies. They sign on to advisory agreement and all that takes some time. So these tend to be longer lead time, customized deals. A typical client of ours has, maybe $1 billion in cash and they carve out a couple hundred million [for a] strategy that they put out on the curve a bit."
He explains, "A lot of the separate account business is beyond [2a-7].... Most of it is about six-month duration. We use the same credit resources, and technically the same investment platform as our liquidity and 2a-7 products. So it's not the old enhanced cash with lots of derivatives. It's a very constrained strategy both in duration and credit. But in this environment it can pick up 25, 30, or 35 basis points over pure liquidity. So we've got a U.S. fund, we've got an offshore fund, and those two combined are about $1 billion in assets. They are less than a year old. And the separate accounts, most of these are the same Managed Reserves strategy. So this has been a really good product for us, and for the corporate investors it's sort of the right product for them in this environment."
Deutsch also says, "The other product we've done is a product that we model on old rule 2a-7. So it's variable NAV, but it barely varies. It's old 2a-7, so it doesn't have the new 2a-7 guidelines. Now it does not, today, have much of an yield advantage to 2a-7 because of this environment. It's more of a product that we've seeded and we're sort of incubating it and building a track record with it. So most of the client money has either gone to liquidity or managed reserves. But this product ... we think over time there is a place for it and we'll see clients use all three products, all of which are very tightly constrained in the cash space."
He adds, "[W]e've built a product set for this environment, but also for change. So we want to be ready for both market change and regulatory change. Between the product range we've set up in dollars and the size that we've built offshore, even if regulations aren't harmonized between the U.S. and international, we're in a strong place to compete wherever we have to compete." Look for Part II of our "Profile" in coming days, or see MFI for the full interview.
On Friday morning, U.S. Securities and Exchange Commission Chairman Mary L. Schapiro gives "Remarks at the Practising Law Institute's SEC Speaks," which contain a section on "Money Market Funds." The SEC's Schapiro says, "Despite the breadth of Dodd-Frank, there are other gaps in the regulatory system that threaten investors that we are working to address. One high-profile area of interest is money market funds. As you know, when the Reserve Primary Fund broke the buck in 2008, it set off a run so serious that the federal government was forced to step in and guarantee the multi-trillion dollar industry."
She continues, "It was a shock that reverberated across the market and compelled us to take action. And so, two years ago, we adopted regulations making the mix of investments these funds can hold more liquid and less risky. But, at the time, I said we needed to do more. That is because money market funds remain susceptible to runs and to a sudden deterioration in quality of holdings. We need to move forward with some concrete ideas to address these structural risks."
Schapiro explains, "We've spent lots of time and outreach reviewing many possible approaches. There are two serious options we are considering for addressing the core structural weakness: first, float the net asset value; and second, impose capital requirements, combined with limitations or fees on redemptions. It's hard to miss the hue and cry being raised by the industry against either of these approaches. But the fact is investors have been given a false sense of security by money market fund sponsor support and the one-time Treasury guarantee. Funds remain vulnerable to the reality that a single money market fund breaking of the buck could trigger a broad and destabilizing run."
She adds, "Should that happen, the government will not have the tools it had in 2008. Then, Treasury used the Exchange Stabilization Fund to stop the run. But Congress eliminated that option when it passed TARP legislation. Today, the money-market fund industry and, by extension, the short-term credit market, is working without a net."
Finally, Schapiro says, "To the extent that there's a deadline, it's the pressure that we should feel from living on borrowed time. We've been incredibly deliberate about this. The President's Working Group report on reform options was issued in October 2010. We've had extensive public comment. And we held a roundtable with the Financial Stability Oversight Council on money market funds and systemic risk last May."
See other coverage of the speech, including: WSJ's "SEC Chairman Amplifies Call for Money-Market Revamp" and The Washington Post's "Money-market funds 'vulnerable'".
Two more reports analyzing money market mutual funds holdings of European-affilated debt and securities were released yesterday, and both confirmed earlier reports that money funds increased their holdings slightly in January for the first time since May 2011. Investment Company Institute Economists Emily Gallagher and Chris Plantier wrote a piece entitled, "Prime Money Market Funds' Eurozone Holdings Remain Low" while Fitch Ratings continued its recent barrage of money fund related releases with "Fitch U.S. Money Fund Exposure and European Banks: Seeking a New Equilibrium." We excerpt from both updates below.
ICI writes, "Securities of eurozone issuers accounted for 14.0 percent of assets of U.S. prime money market funds in January, up from 11.9 percent in December. This increase was driven by a rise in French assets (up from 3.2 percent to 4.6 percent) and by a rise in asset holdings of other eurozone issuers (up from 8.7 percent to 9.4 percent). The European Central Bank's massive long-term refinancing operation on December 22 provided nearly 500 billion euros in three-year liquidity to the eurozone banking system. Market sentiment has improved since this policy action, leading some commentators to suggest that U.S. prime money market funds' increase in eurozone holdings in January reflects a renewed appetite for risk."
The piece continues, "A closer look, however, undercuts that argument. In particular, the maturity of prime money market fund holdings of French issuers continued to fall in January. At the end of January, 85 percent of these French holdings matured in seven days or less, up from 78 percent at the end of December. These funds' French holdings are considerably more concentrated at the short end of the maturity scale than are their German or British securities. What's more, these funds' French holdings of securities with maturities beyond seven days were little changed in dollar terms, suggesting that prime money market funds remain cautious."
ICI explains, "With this in mind, the small increase in prime money market funds' holdings of eurozone issuers should not be viewed as an increase in willingness to take on risk. Instead, the increase probably has more to do with typical year-end effects in December's holdings data. In October and December, we discussed how portfolio managers of U.S. prime money market funds have addressed the ongoing debt crisis in the eurozone. As [a chart] of U.S. prime money market funds' holdings of eurozone issuers from November 2010 to January 2012 shows, January's increase in eurozone securities to 14.0 percent marked a return to the November level (14.2 percent)."
Finally, ICI's update adds, "A December drop in eurozone holdings may well be typical and one month's data certainly does not make a trend.... [W]e would be extremely careful in calling a turning point in prime money market funds' willingness to hold eurozone issuers based solely on January's holdings data. What's probably more significant is that prime money market funds' eurozone holdings remain low and short-dated as fund managers continue to act prudently in the face of the ongoing debt crisis."
The Fitch update tells us, "U.S. prime money market fund (MMF) exposure trends appeared to stabilize, a possible indication of an emerging equilibrium after several months of relatively large reductions in allocations to euro zone banks. MMF exposures to euro zone banks increased by 15% on a dollar basis since end-December, driven by increased exposure to French banks. Exposure to European banks outside the euro zone remained steady at 22% of MMF holdings, while exposure to banks in Australia, Canada, and Japan declined modestly relative to end-December. In other signs of recent stability, MMF holdings of Treasurys and agencies remained elevated despite their low yield, and the top 15 largest bank names were unchanged relative to end-December."
Their report says, "Exposure to euro zone banks is currently about 11% of MMF assets, down from 31% as of end-May. This reduction was largely driven by MMF risk aversion, as the funds in Fitch's sample had historically allocated more than 30% of its assets, on average, to euro zone banks between end-2006 (the beginning of Fitch's period of study) and mid-2011. Recent ECB actions (e.g., the LTRO) may have mitigated some investor concerns and helped to stem the MMF outflows from euro zone banks. It is unclear, however, whether the recent increase in exposure to euro zone banks represents a turning point or the emergence of a new equilibrium."
Finally, Fitch explains, "There are signs that MMFs remain cautious in their posture to European banks, including a historically high 27% of exposure in the form of repurchase agreements (repos). The quality of collateral often varies across repos.... However, roughly 90% of repos with French banks were backed by Treasury and agency collateral, an indication of continuing MMF risk aversion towards these institutions. Even if MMF risk aversion were to soften, euro zone banks might have diminished appetite for MMF funding going forward. First, several banks experienced adjustment challenges in the wake of last year's MMF pullback, resulting in some cases in a search for alternative sources of funding and deleveraging of USD-intensive businesses."
Yesterday, SEC Chairman Mary Schapiro spoke at a reporter's breakfast hosted by the Christian Science Monitor. When asked the question, "What keeps you up at night?" She responded, "Everything keeps me up at night. I do feel a sense of urgency about the structural weaknesses that exist in money market funds, despite the fact that the series of rules we did to improve the credit quality and liquidity were important. [The] tremendous steps that we took in 2010 ... clearly helped these funds weather a lot of the volatility of the European crisis this summer."
Schapiro added, "There is a structural weakness that makes them prone to runs, and I feel that we need further debate and discussion around some concrete ideas there." (See the Christian Science Monitor's story, "What keeps SEC chairwoman up at night? Money market funds (+video)" and the video here.)
Bloomberg's coverage, "SEC's Schapiro Says Money Funds’ Makeup Makes Them Run-Prone ", says, "Money market fund regulations need to be revamped quickly to fix the funds’ inherent vulnerability to runs, said U.S. Securities and Exchange Commission Chairman Mary Schapiro.... The SEC has been working on two possibilities to change aspects of the $2.6 trillion money funds industry that make them 'prone to runs,' she said, with the agency considering either a departure from the traditional $1 share price or mandating capital cushions. Regulators have debated how to make the funds more stable since the 2008 collapse of the $62.5 billion Reserve Primary Fund, which triggered an industrywide run by clients that helped freeze global credit markets."
Their story adds, "The agency enacted changes two years later in an attempt to prevent runs, including new liquidity requirements, shorter maturity limits and enhanced disclosure mandates. Schapiro said in a November speech that the agency would soon propose revamping fund rules. The commission hasn't yet voted on a proposal. Republican Commissioner Daniel M. Gallagher has stated that the agency should hold off on such an overhaul."
In other news, Fitch Ratings put out a release entitled, "Rated US MMF Limit Nongovernment Collateral Backing Repos" late yesterday. It says, "The `Federal Reserve Bank of New York's recently stated that the goal of the triparty repo market reform to reduce the market's dependency on intraday credit provided by clearing banks was not achieved. "The amount of intraday credit provided by clearing banks have not yet been meaningfully reduced, and therefore, the systemic risk associated with this market remains unchanged," the Fed said."
Fitch continues, "The Fed is now expected to increase its direct oversight of the clearing banks and, potentially, introduce restrictions on the types of collateral that can be financed in triparty repo. We believe these additional restrictions would introduce more sound risk management and collateral practices. However, regulatory restrictions on the collateral types and haircuts, if introduced, would most likely negatively affect yield if they reduced the collateral supply and emphasized higher quality, lower risk securities."
They add, "Money market funds rely heavily on the repo market as a means to invest short term and meet daily liquidity requirements. Our analysis of repo transactions in rated money market funds focuses on the credit strength of the counterparty and the quality of the collateral.... For higher risk securities, Fitch ignores the collateral backing the repo and looks solely to the counterparty as if the exposure were unsecured. We note that extremely low interest rates amid constrained supply of MMF-eligible assets have prompted some U.S. prime MMFs to increase their allocations to higher yielding repos backed by nongovernment collateral. At the end of 2011, Fitch-rated U.S. prime MMFs allocated, on average, 6.5% of their total assets to repos backed by nongovernment collateral."
Standard & Poor's published a Q&A on its recent money fund ratings changes entitled, "`A Closer Look At The Revised Principal Stability Fund Ratings Criteria." The update, written primarily by Madeleine Parish and Ruth Shaw, says, "Standard & Poor's Fund Ratings Group released its updated criteria for rating principal stability funds, also known as money market funds, on June 8, 2011 (see "Methodology: Principal Stability Fund Ratings," published on RatingsDirect on the Global Credit Portal). After a five-month implementation period, the criteria went into effect on Nov. 1, 2011, for the principal stability funds we rate. Although our criteria aim to offer a high level of transparency and detail, over the past few months we have received questions from market participants regarding the application of the criteria to areas such as diversification, collateral, cure periods, and the calculation of weighted average maturity to final (WAM[F]), also known as weighted average life."
The "Frequently Asked Questions" include: "Do your criteria only apply at time of purchase? No. Our criteria apply throughout the term of the investment, not only at time of purchase. For example, a fund manager purchases commercial paper that matures in 90 days with an issuer that represents 4% of the fund, and two weeks later, a large redemption pushes that exposure to 6%, causing the fund to breach a quantitative criteria metric. In this scenario, we would apply a 10-business-day cure period for diversification at the time of the criteria breach. Furthermore, if a security is downgraded to 'A-2' from a higher rating category, the cure periods for investments downgraded below 'A-1' would apply, based on the exposure percentage and maturity of the affected investment (see table 1)."
The "Credit FAQ" asks, "Do you consider rounding when determining a breach in criteria? Yes. When determining whether a breach of a quantitative criteria metric has occurred, we apply rounding to the fund holdings provided in weekly surveillance reports. For example, our diversification criteria regarding commercial paper exposure call for a maximum of 5% per issuer. Therefore, we would consider an exposure of less than 5.5% to be within our criteria and exposure of 5.5% or above outside our criteria. In addition, the maximum weighted average maturity to reset, or WAM(R), for 'AAAm' rated funds is 60 days. Therefore, we would consider a WAM(R) of 60.4 days within our criteria and a WAM(R) of 60.5 outside our criteria. However, we do not apply rounding to a money market fund's net asset value (NAV), since we consider the unrounded marked-to-market NAV to at least five decimal places."
S&P continues, "How do you apply your credit quality and diversification criteria for sovereign government-guaranteed programs? We apply our sovereign diversification criteria to securities with a guarantee from a sovereign government--as long as Standard & Poor's has evaluated the sovereign guaranteed program. For example, under our PSFR criteria, we treat securities guaranteed under the U.K. Debt Management Office's 2008 Credit Guarantee Scheme as equivalent to U.K. government securities for the purposes of both our credit quality and diversification criteria. We also treat noninterest-bearing deposits, which the Federal Deposit Insurance Corp. (FDIC) currently guarantees until Dec. 31, 2012, as equivalent to government agencies for the purposes of our credit quality and diversification criteria."
Another question states, "How do you treat securities issued under the FDIC's Temporary Liquidity Guarantee Program (TLGP) for purposes of credit quality and diversification criteria? We consider securities issued under the FDIC's TLGP as FDIC-guaranteed and, therefore, our agency credit quality and diversification criteria would apply. For example, a fund manager could invest up to 5% in General Electric (GE) corporate bonds and then an additional 33.33% in GE's TLGP commercial paper with maturity longer than 30 days and still be consistent with our PSFR criteria."
"How do you treat asset-backed commercial paper (ABCP) programs supported by a sovereign government or government-related entity with respect to your diversification criteria when there isn't an explicit government guarantee? We treat ABCP programs, such as Straight-A Funding LLC and Kells Funding LLC, as separate and distinct issuers. Sovereign government-related entities support these ABCP programs but don't explicitly guarantee the programs' payments. Therefore, our 5% maximum diversification criteria limit applies."
S&P also answers, "Do you treat a bank branch's credit quality as equivalent to the parent company's? How do you apply your diversification criteria to deposits with bank branches? We consider a bank branch's credit quality to be equivalent to its parent company's, unless the branch is located in another jurisdiction. We cap the rating on branches domiciled in foreign jurisdictions at the rating on the "host" sovereign if the sovereign's actions could affect the branch's ability to service its obligations and if the branch's creditors cannot access all of their funds in a timely manner via any other branch located in another jurisdiction. For diversification purposes, we view a branch as the same as the parent company. For example, we consider Deutsche Bank AG (A+/Negative/A-1) and Deutsche Bank AG (Canada Branch) (A+/Negative/A-1) as one entity for diversification purposes."
They address the question, "How do your diversification and credit quality criteria apply to different entities within a bank group? If the entity is legally separate and distinct from its bank holding company and has been assigned a separate credit rating, we would also apply our diversification criteria to that entity. For example, if we rate hypothetical Bank A NV 'A+/A-1' and its hypothetical bank holding company, Bank A Group PLC, 'A/A-1', we would treat these two entities as separate and distinct issuers and apply our issuer diversification criteria to each."
S&P's piece continues, "For diversification purposes, how do you treat municipal securities issued by an issuer on behalf of other obligors? When an issuer issues municipal securities on behalf of a separate obligor, we consider the issuing entity as the "issuer" for diversification purposes. For example, if Illinois Finance Authority (A+/Stable/--) issues debt on behalf of University X, we attribute the exposure to Illinois Finance Authority and not to University X."
They add, "How do you apply your diversification criteria to tender option bonds (TOBs)? If a TOB is issued from its own separate and distinct trust (that is, a separate legal entity) we would consider each trust as a separate issuer when applying our PSFR diversification criteria. Therefore, our diversification of 5% per issuer would apply. However, if the TOB is issued through a "series trust," we would consider that series trust as a single issuer based on our criteria. For example, the Deutsche Bank SPEARs/LIFERs Trust TOB Program Series 1000 bonds are issued from a single legal entity and, thus, under our PSFR criteria, all series issued under this structure will be combined and capped at a maximum exposure of 5% for the investment-grade PSFRs."
Finally, the Q&A asks, "How do you factor variable-rate demand notes (VRDNs) in the WAM(F) calculation? We consider VRDNs to be nonsovereign government floating-rate instruments that should be included in the calculation of a fund's WAM(F) using the unconditional put date. When the VRDNs aren't included in the calculation, the resulting maximum WAM(F) is higher."
Earlier this month, the U.S. Chamber of Commerce held an event on "Money Market Fund Reform" which included a speech by Senator Pat Toomey (R-PA). We listened in on the event, but hadn't gotten a transcription until this weekend, when the organization PreserveMoneyMarketFunds.org sent one out. Below, we excerpt from the Senator's comments. Toomey said on Feb. 8, "I was asked to talk a little bit about the regulatory atmosphere, that which is -- appears to be coming. Of course the article yesterday on the front page of the Journal certainly does make this very timely.... Look, my own view -- I like to disclose my biases upfront -- I happen to think that money market funds are a very, very important part of today's financial marketplace. I think that money market funds are under attack. I think there is a concerted effort to impose very, very, very troublesome regulations that, in some cases, I think do threaten the viability of the product itself. I think that is not by accident. And I think we should push back very aggressively, because in the absence of this product, our financial markets will be less liquid. I think they will have fewer choices. And I think we will all pay a price, both investors and borrowers, for that."
He continued, "First thing that I think we ought to remind folks ... I hope you will take the occasion to remind my colleagues about just how well money market funds have functioned for the 40 years that they've been around. It's really a very impressive history, it seems to me, of safe, steady and predictable mechanism by which millions of investors have been connected to thousands of borrowers. It's a huge scale that you know very well -- 30 million investors, I'm told something on the order of $2.6 trillion dollars in assets. And it's very diverse. I'm not sure all my colleagues appreciate the range of instruments, from ordinary commercial paper to asset-backed paper to treasurers to munis. The full range of short-term debt instruments that money market funds participate in is important."
Toomey explained, "I think the business model, the very mechanism by which the managers of money market funds -- by which they operate, by which they make the connection between the investor and the borrower and not through a banking type of intermediation but rather through direct purchases is part of the reason that you just have a business model that enables greater efficiency. You've got lower overhead, and so borrowers have a lower cost of funds and investors get a better return on their investment. And so therein lies the obvious appeal of the – of the instrument. As far as the safety goes, my understanding is, over the 40 years during which money market funds have been in existence, there have been over 2,800 bank failures at a cost of something approaching $200 billion to the federal government. And during that time, I'm aware of only two money market funds that were unable to redeem their investors' money at 100 cents on the dollar. One was done at 96 cents on the dollar, and the other at 99 cents -- a little over 99 cents on the dollar -- no cost to the government and really extremely modest loss in very, very few cases to the shareholders. And that's part of why I was a little disappointed at the way The Wall Street Journal article yesterday characterized some of these reforms."
He said, "I saw very early on in the article, the writer -- the reporter described these proposed regulations as necessary to shore up the industry. It was not obvious to me that the industry was sort of listing to the side and badly needed to be shored up. The other -- like the next paragraph, it said that this set of regulations comprises of a two-part plan meant to stabilize -- and that's the word they used -- to stabilize the industry. Maybe you're aware of something that I'm not, but it is not clear to me that this is all that unstable an industry. The exception, of course, that everybody will point to and that justifies -- in the minds of many of the regulators, that justifies this action really, I think, centers around the Reserve Primary Fund, you know, a very well-known case that was a very exceptional case."
Toomey added, "But nevertheless, as we all know, in 2010, there was a new wave of regulations that were imposed which, whether you agree with them or not, I understand the logic behind the idea of addressing liquidity as a way to minimize the risk of a run and maximize the ability of a fund to withstand, you know, heavy redemption pressure. And so you've got the ... 10 percent of holdings that are required to have daily liquidity and the 30 percent within 5 days. And it's interesting to note -- and again, I would urge you to remind my colleagues -- that under these regulations, money market funds have already weathered some pretty tough additional storms. Right? The emergence of the European debt crisis last summer was very, very disruptive. And there's no question, money market funds had a -- significant investments with European banks. And despite that, they got through that storm really remarkably well."
He continued, "By the way, that was also around about the time that the debt of the United States government was downgraded, right -- a completely unprecedented, shocking event in many ways. And, as it happens, during July and -- June and July of last year, there was a very significant level of redemptions. As I understand it, over 10 percent of the prime money market fund investments were redeemed, over $167 billion -- in some cases, as much as 20 (percent) to 40 percent of individual funds. And yet not a single money market fund broke the buck. None faltered; there were none that were unable to meet the redemption requests. The reforms that were imposed in 2010 evidently worked reasonably well. It seems to me, this is evidence that this is a pretty safe product, even during times of considerable stress."
Toomey told the Chamber, "So now we discover --- and obviously we've been concerned about this for some time now -- that there is yet a new wave of regulations that is being very, very seriously considered. And I think -- well, I think it's -- there's several regulatory bodies that are very supportive and pushing this. I think the Fed is one of them, let's just be clear. It's the SEC that may oppose it, but the Fed is -- has, I think, long sought to change the way money market funds operate, to say the least. Senior Fed officials have described money market funds as part of the shadow banking system, which I think is meant to be a pejorative term that suggests that they're unregulated. That will come as news to the SEC and to many of you, that this is an unregulated industry; but that's how they view it."
He explained, "So I think a lot of the pressure is coming from that direction. I think Fed Governor Tarullo has even said that, in the absence of new regulations, money market funds could get the SIFI designation, which I think would be -- is inappropriate. But this gives you a sense of where the mindset is. And Secretary Geithner cited as a success the fact that money market funds had shrunk since their 2008 peak. So again, it's not clear to me why that ought to be perceived as a success. But it speaks to his mindset on this."
Toomey continued, "So I just want to touch briefly on some of the specific ideas that appear to be about to be visited upon us, and share with you my concerns about them. The first is one of the -- it's been kicking around for a long time, I suppose, which is floating the NAV. And it seems to me that this idea is one that strikes at the very heart of this product. At the very heart of this product is the convenience and the predictability and the stability of a fixed NAV. I think that's a big part of what attracts investors, a big part of the source of liquidity and attractiveness as a cash-management tool. And I think there are some big problems if we depart from that."
He said, "First, I -- my understanding is, there are many institutional investors that are prohibited from investing in vehicles that have a floating NAV. So they'll be forced to withdraw. I wonder to what extent the regulators have considered the exodus from the funds that they could cause if they proceed down this road. The second point is, it's not clear to me that floating the NAV reduces the risk of runs on money market funds. It's not clear that that would mitigate the liquidity crunch that we had in 2008. And my understanding is that there are instruments that have had a floating NAV in Europe that did experience runs, despite the floating NAV. So it's not clear that that's a great solution. It is clear that there's a big problem with the tax treatment. That is -- you know, the fact that every sale could become a taxable event and has to be recorded and accounted for -- clearly that would be a huge detraction for many, many investors, and diminishes the appeal of this. So I think this regulation would be very, very problematic for the product. And it seems -- it -- well, let's just say it's not clear to me how it deals with improving systemic risk. And so it's not clear that it's a good idea."
Toomey also said, "The redemption restrictions and the holdback provisions that are also being discussed -- my understanding is, some suggestions are that we could force investors to leave as much as 5 percent in the fund for 30 days after a redemption. Again, this just changes the fundamental nature of the product. The purpose of the product is for people to feel they've got their cash there to be withdrawn at any moment when they need it. And if they can only get a certain percentage of it back, I think it dramatically undermines that appeal."
He added, "And then the last one is this idea of capital buffer requirements. What -- I just haven't seen how the math works. In a basically zero-percent interest rate environment, where the yield for ordinary investors is so low, how many basis points are available to use to create the higher return you need for a capital cushion? Now if the fed funds rate were 8 percent ... well, then maybe there's a way that that works.... [I]t's not clear to me that the math works. And it's not clear to me that it's necessary."
Toomey explained, "So, you know, my concern is that if these regulations are actually enacted, this -- if most or much of this comes to pass, it really threatens to wipe out this product. I mean, I think it really goes to an existential threat over this product.... And because we would be taking one whole business model out of the equation and asking -- you know, forcing our financial markets to rely just on the bank intermediary activity, I think it's very likely to drive up costs for borrowers, drive down returns for investors, provide less liquidity, fewer options. There'd be a huge transition problem, because obviously the money market funds plays such a big role in the commercial paper market itself."
He told the group, "So I think this is very problematic. It comes at a bad time, given the stresses that are still evident across our banking system, and in particular with interest rates as low as they are. So given this threat -- you know, given the totality of this -- my own view is that whatever risks are inherent in money market funds -- and any kind of investment activity has some level of risk -- but given the risks as they exist today, it's just not clear to me that they justify this regulatory regime that's been described in the press and that I'm -- I fear is heading our way. So, in anticipation of some of this, my -- some of my colleagues and I have been active in trying to push back; trying to slow this down; trying to force a rational, considered judgment about these regulations before they're imposed. We sent a letter to the SEC last November asking them not to rush ahead with adoption of these regulations. I've personally met with regulators, many of them, to discuss this and to express my concern. I've asked specific questions at the Banking Committee hearings. But all of this does not seem to have appreciably slowed the process, and it looks like it's still coming. So I think we need to stay very, very engaged in this. It's important to me that our investors and borrowers continue to have access to this very important tool."
He added, "So if we do see a new wave of regulations -- some combination of those that I've just described -- there's a few things that I think we can and should do. One is, as a member of the Banking Committee, I would intend to insist that we have some hearings to give as much public scrutiny as possible to this; make sure that my colleagues understand that this isn't just a problem for the people who are in the business of running a mutual fund. This is a problem for the investors and the borrowers who use this mechanism. I will continue to meet with folks over at the SEC to press my case. I want to see what kind of cost-benefit analysis has led them to the conclusion that the costs -- which seem to me quite substantial -- are justified by the benefit. And I want -- I want to see how they've done that and challenge their methodology. And if necessary, I wouldn't rule out introducing legislation that would push back and ensure that we can continue to function."
Finally, Toomey commented, "I'm a big believer that a dynamic economy is one in which the market gets to sort out and gets to pursue many different ways of providing goods and services. And having the government come in and, through an extremely onerous regulation, just basically foreclose some options and force the market to behave in the way that certain regulators approve of -- I generally take a very skeptical view to that. This is no exception. I appreciate -- many of you I've had a chance to work with on this issue and others, and I appreciate that working relationship. And I look forward to continuing it. So thanks for having me this morning."
Yesterday, Investment Company Institute President and CEO Paul Schott Stevens gave a speech at Bloomberg's "Portfolio Manager Mash-Up" conference entitled, "Do Money Markets Pose a Systemic Risk?," which says, "In recent weeks, several media outlets have reported stories that put investors and their advisers on alert. One headline said, 'U.S. Sets Money-Market Plan.' The reporting detailed the Securities and Exchange Commission's upcoming proposal to tighten the regulation of money market funds -- a core product that 56 million individual investors and their financial advisers all depend upon. In the fund industry's response to the reported proposals, I noted that these changes will 'harm investors, damage financing for business and state and local government, and jeopardize a still-fragile economic recovery.' Quite a hat trick for the SEC -- except that they're scoring against the interests of investors and the economy."
He continues, "Now, those are strong words for a financial industry to level against its regulator -- especially for the mutual fund industry. We recognize that our business is built on investor confidence and a strong foundation of investor-focused regulation. But the SEC's plans for money market funds will not help investors. Instead, they will undermine the core features of money market funds that investors seek -- stability, liquidity, and convenience. They will drive retail investors back to the fixed, low rates paid by banks ... institutional investors to less regulated, higher-risk alternatives…and fund companies out of the business. For you, that means fewer competitors vying for your business -- and a product that few investors will want to buy and few brokers or advisers will want to offer."
Stevens explains, "What does the SEC plan to propose? This spring, we expect the Commission to come forward with a proposed rule that gives money market fund sponsors a choice of two options. The first choice will be to abandon the stable $1.00 net asset value that has been a hallmark of money market funds since their inception in the inflationary 1970s. The second choice will keep the $1.00 NAV, but will require money market funds to build a capital reserve and to put a freeze on part of each investors' assets. When an investor with cash in a money market fund sees an investment opportunity in stocks, the SEC reportedly will require that fund to hold back 3 to 5 percent of the investors' cash for 30 days -- limiting investors' freedom to act. Basically, for the money market fund industry and the investors and issuers who rely upon it, this is like a game of 'Clue' -- death by rope, or death by candlestick?"
He tells the Bloomberg audience, "Let's look at each of these ideas and what they'll do to investors and the economy. Forcing money market funds to float their NAV would drive millions of investors away from these funds. Individual investors who write checks on their money market funds want to know that their shares are worth $1.00. If their share values floated, they'd lose that benefit -- and they would have to treat every money market fund transaction as a taxable event, a huge accounting and tax headache. Institutional investors would face the same problems. Moreover, many institutional investors are required to put their cash in stable-value accounts. As one institutional money manager told us: "If your money market fund isn't dollar-in, dollar-out, then you won't get my dollar.""
Stevens asks, "What would regulators gain by forcing money market funds to float their value? They won't reduce the chances of runs -- after all, floating-value funds lost 60 percent of their assets in 2007 and 2008. And they won't reduce systemic risk. Businesses and institutions that require or demand stable-value products will find them -- in less-regulated, riskier cash products, often offered offshore. That's not going to make our financial system safer."
He adds, "The second choice the SEC could offer would require money market funds to build capital buffers and to freeze a portion of investors' assets in what are called 'redemption holdbacks.' The cost of building or paying for capital buffers would come from investors' yields -- yields that have been near zero for more than 30 months. The redemption freeze would strike directly at the convenience and liquidity that money market fund investors want. We estimate that implementing this freeze will cost investors, funds, and financial intermediaries hundreds of millions of dollars -- and may wipe out the ability to offer check-writing or to use money market funds in a wide range of common investment programs, including sweep accounts, retirement plans, and securities lending."
Stevens continues, "The impact of driving investors away from money market funds will be felt throughout the economy. Is any of this necessary? Regulators will argue that the financial crisis of 2008 exposed a fundamental weakness in money market funds, and that these changes are needed to prevent investor runs, systemic risks, and government bailouts. That ignores the 40-year history of money market funds and the stability that they maintained through a wide range of market conditions and financial upsets. The fact is, it took the worst banking crisis in 70 years to call money market funds into question. Think of it -- at least 13 major institutions -- including Citigroup, Countrywide, Fannie Mae and Freddie Mac, and, of course, Lehman Brothers -- failed or needed substantial government assistance before the one money market fund 'broke the dollar.'"
He adds, "What's more, the SEC has already succeeded in addressing the problems that emerged in 2008. In 2010, the SEC gave money fund boards the power to unwind a fund and treat all investors equally if a fund is hit by heavy redemption pressure -- without taxpayer dollars or government intervention. And Congress has closed the taps that regulators used to pump aid into commercial paper through money market funds. In short -- the SEC has already succeeded in making money market funds stronger. Those reforms have been tested, and they've worked. The further changes that the Commission reportedly plans to propose won't reduce risks or help investors. Instead, they will harm investors, business and state and local government, and the economy."
Finally, Stevens says, "As I noted at the outset, investors and their advisers should find this alarming -- and they should speak out. So let me leave you with two web addresses -- www.ici.org/mmfs and www.preservemoneymarketfunds.org -- where you can find more information on money market funds and statements from scores of organizations opposing the SEC's changes. I'd invite you to add your voice to the effort to preserve money market funds."
Crane Data's latest batch of Money Fund Portfolio Holdings, which were released to subscribers of our Money Fund Wisdom database and product "suite" on Monday, verify recent reports about money funds returning to Europe and France in January. (See Crane Data's Feb. 10 News "Eurozone Holdings Increase in Jan. Says JPM; BarCap on Supply Relief" and Feb. 2 "DB's Prophet on MMFs Return to Europe; ICI's December Composition".) A huge jump in Repurchase Agreement (Repo) holdings in January (up $69.4 billion, or 2.7%) was notable while Commercial Paper also rose strongly (up $19.8 billion, or 0.7%). Government Agencies, VRDNs and Other (which includes Time Deposits) showed drops in January. We review some of the trends and largest issuers below.
Among all Taxable money funds, the U.S. Treasury remains by far the largest issuer with 21.9% of all investments ($478.8 billion). (Treasuries are the largest segment of Prime money funds too at 7.1%, or $89.5 billion of the total.) Federal Home Loan Bank again ranked second among money market issuers with $153.8 billion (7.0%) of the money held in taxable money funds tracked by Crane Data's MF Portfolio Holdings collection ($50.8 billion of this was held in Prime funds). Barclays Capital jumped into third place with $107.2 billion (4.9%) of Taxable holdings and $59.9 billion (4.7%) of Prime holdings. BarCap, Bank of America and RBS all had big jumps in January, riding the repo rebound.
Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Co) ranked 4th and 5th among issuers, with $86.0 billion (3.9%) and $85.4 billion (3.9%) of taxable money fund holdings, respectively. The rest of the top 10 issuers include: Deutsche Bank ($77.7B, 3.6%), Credit Suisse ($62.1B, 2.8%), Bank of America ($62.0B, 2.8%), Citi ($52.8B, 2.4%), and RBS ($52.6B, 2.4%). French banks reappeared among the top 25 issuers this month. Numbers 11-25 include: RBC ($48.8B), UBS AG ($45.7B), JP Morgan ($41.2B), Goldman Sachs ($40.3B), Rabobank ($40.1B), Westpac Banking Co ($38.6B), Bank of Tokyo-Mitsubishi UFJ Ltd ($38.3B), Bank of Nova Scotia ($38.0B), BNP Paribas ($37.5B), National Australia Bank Ltd ($36.5B), Societe Generale ($33.6B), Sumitomo Mitsui Banking Co ($33.3B), HSBC ($32.8B), Svenska Handelsbanken ($29.7B), and Credit Agricole ($27.8B).
Repos accounted for 23.4% of taxable money fund holdings ($545.7 billion) in January, which was comprised of $254.7 billion in Government Agency Repurchase Agreements (10.9%), $166.3 billion in Treasury Repo (7.1%) and $124.7 billion in Other Repo (5.3%). Treasury securities totalled $479.8 billion (20.6%), CDs totalled $399.8 billion (17.1%), and Agencies totalled $368.2 billion (15.8%). Commercial Paper (CP) accounted for $362.8 billion (15.5%) of taxable money fund holdings; $202.3 billion of this (8.7% of the total) was `Financial Company CP, $114.9 billion (4.9%) was Asset Backed Commercial Paper, and just $45.6 billion (2.0%) was Other CP. Other securities totalled $115.9 billion (5.0%) with Other Note being the largest subcategory of this segment with $73.4 billion (3.1%). VRDNs accounted for $62.9 billion (2.7%) of the total securities held by taxable money funds as of Jan. 31, 2012.
The Maturity Distribution of funds remained relatively static in January with Overnight assets accounting for 25.7% vs. 26.3% a month earlier. Securities maturing in 2-7 days accounted for 12.1% of assets, holdings maturiing in 8-30 days accounted for 24.8% of assets, holdings maturing in 31-90 days accounted for 22.7%, holdings maturing in 91-180 days accounted for 8.9%, holdings maturing in 181-365 days accounted for 5.4% and just 0.4% matures in 366 or more days.
European related holdings accounted for 30.8% of taxable money fund assets in January, or $718.1 billion, up from 28.5% in December. The U.K. surpassed Canada as the second largest domicile of parent companies with 9.6% ($223.6 billion) vs. 6.9% ($161.2 billion). (The U.S. ranks first with $1.216 trillion, or 52,1% of assets.) The rest of the top 10 include: Australia ($120.4 billion, or 5.2%), Japan ($115.3 billion, or 4.9%), France ($112.8 billion, or 4.8%), Switzerland ($111.9 billion, or 4.8%), Germany ($99.1 billion, or 4.2%), Netherlands ($75.3 billion, or 3.2%), and Sweden ($53.5 billion, or 2.3%). Note that all securities purchased by money funds are U.S. dollar-denominated and that country refers to domicile of the issuer's parent company (even in the case of repo).
Crane Data has been collecting Money Fund Portfolio Holdings for over a year now, since the SEC mandated the monthly disclosure of portfolios starting in November 2010. We publish our month-end Taxable money fund portfolio information on the 9th business day of the following month, and we publish our Tax Exempt and Offshore money fund portfolio holdings on the 13th business day. (Look for these latter series later today or tomorrow, respectively.) Contact Pete to request the latest dataset or for more information.
We mentioned SunGard's recent "Cash Management Study" in a "Link of the Day" last week. Today, we excerpt more extensively from the survey. SunGard's Study explains, "Since the financial crisis of September 2008, treasurers have increasingly recognized the importance of defining and delivering on the right investment policies. Treasurers need to find appropriate repositories for their cash and maintain access to liquidity in an environment where borrowing continues to be expensive and difficult to source. To help understand investment trends and corporate treasurers' priorities, SunGard conducted an online survey, which attracted responses from 215 corporations globally. This included respondents from all regions and industries, with over 50% of companies headquartered in the United States and significant responses from other regions such as Europe and Asia. The survey aimed to understand corporates' cash investment policies, their attitude to risk and return and consequently, their preferred cash investment instruments, both now and in the future. It also sought to explore how companies transact their investments in practice, such as using web-based portals."
The Executive Summary explains, "The current economic and regulatory challenges have resulted in a complex cash management environment for corporations globally. One element of this is the need to define and deliver on the right investment policies. Counterparty risk has become a particular priority but with a number of credit rating downgrades, and a growing awareness that no organization is 'too big to fail', companies that have developed large cash balances often struggle to find a sufficient number of counterparty banks and issuers that meet their credit requirements. The problem of finding appropriate repositories for cash is compounded by the need to maintain access to liquidity in an environment where borrowing is more difficult and expensive. Furthermore, with interest rates remaining at a historic low, treasurers and cash managers are tasked to generate a return on cash to prevent value erosion through inflation and rising prices."
SunGard continues, "This report outlines the findings from the Corporate Cash Investment Survey commissioned by SunGard in 2011. The survey explores the trends in investment strategy and policies, and how corporate treasurers fulfill their policies in practice, including their choice of cash investment instruments, how these may change in the future, and how they conduct transactions. The key findings of this report include the following: The most popular investment type among respondents are bank deposits, representing 67.9% of respondents, followed by money market funds (MMFs) used by 48.37%. Corporate investment policies remain conservative, with a significant focus on security and liquidity. Yield is a major consideration for 17% of respondents, suggesting that there is an obligation in many companies to seek the highest yield so long as investment decisions are within the company's risk and liquidity policies. Bank deposits are likely to continue to form the mainstay of corporate investment policy, with more than half (61.69%) of respondents indicating that deposits would be extremely important in the future; however this represents a drop of 6.22% from today."
The key findings also say, "Forty-eight percent (48.37%) currently use MMFs and over half (55.1%) identify them as an extremely important part of their future investment strategy, an increase of 6.73% <b:>`_. Just above 50% reported that they do not currently use MMFs , citing reasons as credit quality, access to liquidity and yield, although these factors are typically considered to be the factors in favor of using MMFs. A large proportion of respondents who use MMFs already access these via an on-line portal (37% of respondents), compared with 48.37% who use MMFs. Those who do not use a portal indicated that the lack of integration with treasury management systems and the inability to access the full range of funds through a single portal are also issues."
The report states, "Money Market Funds (MMs) are growing in importance as an investment instrument as both familiarity and availability increase. However, there are some differences in the relative degree of importance of MMFs in different regions. MMFs have the most strategic importance in the UK, followed by the United States, both of which have the longest history of MMF investment. MMFs were first introduced in the United States, and quickly taken on by investors in the UK, so there is typically greater familiarity with these instruments than in other regions. In addition, investors in the United States have long appreciated the value of a standardized investment product that 2a-7 funds offer."
It adds, "In Europe and Asia, MMFs have been introduced more recently, accounting for their lower significance historically, and in some cases, less familiarity. Furthermore, there has been some ambiguity in the definition of MMFs in the past: various types of funds with quite different risk profiles have been described as MMFs. This has now changed with standardized definitions of MMFs and short-term MMFs. This standardization is encouraging greater adoption."
SunGard explains, "Although MMFs are set to grow in importance among the corporate investment community, there are still a sizeable proportion of companies (just above 50% of respondents in this survey) that do not currently use them. However, this seems likely to change as volatile and fragile economic conditions continue to illustrate the need for a robust, diversified cash investment policy. Respondents who do not currently use MMFs were asked for their reasons. A roughly equivalent proportion of respondents expressed their concerns regarding credit quality, liquidity and yield. Among those that indicated other factors, these include lack of familiarity with MMFs. While these concerns are consistent with many companies' overall investment considerations, security (including credit quality) and liquidity are typically the benefits of using MMFs as they comprise a diversified range of high quality assets, rigorous investment policies and credit research, and same-day access to liquidity. Consequently, it seems likely that many respondents who have these concerns are largely unfamiliar with MMFs."
The study also says, "As familiarity and confidence with MMFs gradually increase, more companies are likely to take advantage of the visibility, automation and audit ability that MMF portals offer, particularly when integrated with a treasury management system for straight-through-processing. The capabilities of online MMF portals have developed considerably in recent years. Leading portals, for example, provide not only transaction capabilities, but also full visibility over fund metrics and asset allocation, and risk analysis tools for analyzing and managing both interest rate and counterparty risk. With integration opportunities increasing rapidly, and the number of funds available through some portals also growing, these concerns are likely to become less prevalent in the future."
Finally, SunGard adds, "37% of respondents indicated that they use a MMF portal: when compared to the total percentage of 48.37% respondents who use MMFs, this represents a very high proportion. Lack of familiarity with MMF portals accounts for the largest proportion of responses, while the lack of integration with treasury management systems and the inability to access the full range of funds through a single portal are also considered issues by 45%."
The Investment Company Institute, the trade group representing the mutual fund industry, recently submitted an extensive comment letter to an international group of securities regulators. The document, listed under "ICI Submits Information to IOSCO on Money Market Fund Reform" is titled, "Submission by the Investment Company Institute Working Group on Money Market Fund Reform Standing Committee on Investment Management International Organization of Securities Commissions." It says, "In connection with the International Organization of Securities Commissions' Standing Committee on Investment Management's review of money market funds, the Investment Company Institute is pleased to offer the following submission. Our submission focuses on U.S. money market funds and explains why in light of the effectiveness of the U.S. Securities and Exchange Commission's recent amendments to the regulatory program for money market funds under the Investment Company Act of 1940, no further reforms are necessary."
ICI writes, "Since ICI's inception in 1940, we have been active participants in the development of laws and regulations that have been instrumental in the growth of fund investing in the United States and worldwide. Most recently, we have been deeply engaged in the development of laws and regulations responsive to the recent financial crisis, including mechanisms to counter systemic risk and to make money market funds more resilient in the face of adverse market conditions, such as those caused by the widespread bank failures in 2008. Indeed, in recognition of the importance of money market funds to the global economy and to investors, we share the goals of regulators and other policymakers -- strengthening the regulation of these funds and making them more robust under adverse market conditions. We have devoted significant time and resources to this end."
The letter explains, "Since the worst of the 2008 banking crisis, the SEC and the fund industry have made a great deal of progress toward their shared goals of bolstering money market funds. In March 2009, ICI issued the Report of the Money Market Working Group, an industry study of the money market, of money market funds and other similar participants in the money market, and of recent market circumstances. The MMWG Report included wide-ranging proposals for the SEC to enhance money market fund regulation."
ICI continues, "Incorporating a number of the MMWG Report's suggestions, the SEC, in 2010, approved far reaching rule amendments that enhance an already-strict regime of money market fund regulation. The new rules make money market funds more resilient by, among other things, imposing new credit quality, maturity, and liquidity standards and increasing the transparency of these funds. The SEC indicated that the amendments are designed to strengthen money market funds against certain short term market risks, and to provide greater protections for investors in a money market fund that is unable to maintain a stable net asset value per share. In fact, these reforms were tested this past summer when money market funds met, without incident, large volumes of shareholder redemptions during periods of significant market turmoil, including a credit event involving the historic downgrade of U.S. government debt."
They add, "This experience reinforces our belief that the SEC's current program for regulating and supervising money market funds is sufficient to meet the challenge of even adverse market conditions. The 2010 regulatory reforms are working, and further changes are not necessary. In particular, replacing this program of money market fund regulation with a model that would fundamentally alter the product and/or impose inappropriate bank-like regulation on money market funds would not enhance the stability of these funds -- or of our global financial system -- and, in fact, could have the opposite effect of increasing risk worldwide."
ICI's letter to IOSCO continues, "It also is important to consider the SEC's 2010 amendments to money market fund regulation within the context of other reform efforts to strengthen the resilience of the international financial system. Since the onset of the global financial crisis, the G20 has established core elements of a new global financial regulatory framework that are intended to make the financial system more resilient and better able to serve the needs of the global economy. Through the efforts of the FSB, which is responsible for coordinating, monitoring, and reporting to the G20 regarding its reform efforts, the national authorities and international bodies have further advanced the G20/FSB financial reform program through various policy reforms. These include reforms designed to, among other things, improve the soundness of the banking system, address the risks posed by systemically important financial institutions, strengthen the regulation and oversight of the "shadow banking" system, improve the over-the-counter and commodity derivatives markets, develop "macroprudential" frameworks and tools to identify and monitor systemic risk, strengthen and converge global accounting standards, strengthen adherence to international financial standards, and reduce reliance on credit rating agency ratings."
It also says, "In the United States, the Dodd-Frank Wall Street Reform and Consumer Protection Act provides regulators with an array of new tools to address abuses and excessive risk taking by financial market participants, and to detect new buildups of risk in the financial system. Through these coordinated efforts, the FSB has found that "a comprehensive standard for reform has now been established that, when fully implemented, will enable authorities to resolve failing financial institutions quickly without destabilizing the financial system or exposing taxpayers to the risk of loss."
ICI adds, "Notwithstanding these global reform efforts, including the proven success of the SEC's 2010 amendments, the calls for more money market fund reform continue. Unlike the 2010 amendments, however, the reforms now being considered would drive funds out of business, reducing competition and choice, and alter the fundamental characteristics of money market funds, thereby destroying their value to investors and the economy. Rather than making our economies and financial systems stronger, such reforms have the potential to increase systemic risk."
Finally, they say, "It is therefore imperative that before any further regulatory action is taken, all market participants better understand the singular benefits money market funds provide to investors and the economy. With this in mind, our comments below begin with an overview of the U.S. money market to provide context (Section I). Next, we describe the regulation of U.S. money market funds, including the SEC's recent reforms (Section II). We then examine each of the reform options currently under serious consideration in the United States and describe how they would undermine money market funds' value to investors, effectively destroying these funds and disrupting the supply of credit to businesses, state and local governments, and consumers (Section III)."
Saturday's Wall Street Journal featured an article titled, "Time to Leave Your Money Market Fund", which says, "Short-term savings yields won't make anyone rich these days. But investors can pick up some extra cash -- and get a little added safety -- by switching from money-market funds offered by investment companies to money-market accounts held at banks. There are some trade-offs, however, and the maneuver won't make sense for everyone. "Money market" can refer to two entirely different financial products. One is a mutual fund that invests in safe, short-term securities and passes the income along to investors. The other is a bank account where the rate is set by the lender. Both offer safety and easy access. The average money-market fund yields just 0.06% as of Wednesday, according to Peter Crane, president of Crane Data, which tracks the funds."
The Journal piece, by Jack Hough, continues, "Why is the difference between money funds and money-market accounts so vast? New restrictions on what money funds can buy have "put managers in a smaller box and made yields more similar," says Deborah Cunningham, chief investment officer at Federated Funds, one of the largest money-fund companies. A big money fund called Reserve Primary "broke the buck" after the 2008 collapse of Lehman Brothers, meaning its share price slipped below the $1 a share that such funds seek to maintain. A judge ordered the fund to liquidate and investors got back about 99% of their money."
It explains, "Such losses have been rare, and new rules that took effect in 2010 have made money funds as safe as they have ever been, say Peter Rizzo, director of the fund research group at Standard & Poor's, and Roger Merritt, head of the fund group at Fitch Ratings. The Securities and Exchange Commission announced a plan this week that could make funds even safer, but fund-industry executives say it could squeeze yields even more."
The Journal adds, "Bank money-market accounts have some big advantages. While money funds pay a market rate based on securities yields, banks can pay "artificial rates based on funding needs and competitive factors," says Robert Deutsch, managing director at JP Morgan Asset Management, the largest U.S. money-fund manager. In the past, some banks have offered significantly higher yields because they were in trouble and needed to attract deposits."
This week's Barron's also writes "Regulation Worries Roil Money-Market Industry". It says, "As we explained in our Jan. 9 cover story, "Broken Forever?" the Securities and Exchange Commission has floated some fairly significant -- and, to most in the industry, highly alarming -- proposals for money-fund regulation. On the table, in brief: Ditching the steady $1-per-share convention in favor of a floating net asset value, mandating a capital reserve for each fund, and creating a "hold-back" that would mean you'd have to wait 30 days to receive a portion of your withdrawal."
This article adds, "The SEC hasn't announced anything publicly, but in informal talks with the Investment Company Institute and others, the agency has indicated that its timeline for releasing these new rules has moved up from "sometime in the first half of the year" to "could be March." This, of course, could change again. But the behind-the-scenes discussions we reported on a month ago are now much more public."
While the broader markets have focused on the major problems that money markets face this week -- regulatory uncertainty and ultra-low yields -- there has been some good news. J.P. Morgan Securities reports that money fund holdings in the Eurozone did indeed hit bottom in December and have begun to rebound in January, and Barclays Capital writes about the surprising supply and yield relief that has recently appeared in the money markets. Below, we excerpt from Alex Roever's latest Portfolio Holdings Update, as well as a recent piece from Joe Abate.
JPM's latest "Short-Term Fixed Income Markets Research Note: Update on prime money fund holdings for January 2012" says, "The New Year rally has not been lost on the short-term credit markets and has enabled some investors to return to credits they've shunned over the second half of last year. Eurozone bank exposures in prime money funds across all credit products (CP, ABCP, CD, repo, time deposits, and other notes) increased in January (+$27bn) for the first time since April 2011. Although most of this increase was driven by increased exposures to repo (+$21bn), unsecured CP/CD and ABCP exposures also increased by $7bn and $5bn, respectively. Some of this increase was offset by decreases in other credit products (-$6bn), almost all of which are time deposits."
The update from Roever, Teresa Ho and Chong Sin continues, "Non-Eurozone European bank exposures in prime funds decreased slightly by $1bn, driven by declines in ABCP (-$2bn) and other credit exposures (-$6bn), offset by increases in unsecured CP/CD (+$2bn) and repo exposures (+$4bn). Non-European bank exposures also decreased slightly by $3bn, driven by declines in unsecured CP/CD (-$9bn) and other credit exposures (-$21bn), offset by increases in ABCP (+$1bn) and repo (+$26bn). January's month-over-month increase in total bank exposures (+$23bn) was driven, in part, by investors returning to Eurozone credits but more so by increases in repo as some dealers are growing their balance sheets after year-end. Indeed, repo outstandings have quickly risen after year-end."
They explain, "Some large prime funds returned to the long-shunned French banks, modestly increasing their total exposures by $23bn to $55bn. The largest increase was to repo (+$13bn) but January's month-end balance of $28bn isn't much higher than the average balance of $23bn from May to November 2011. Confirming anecdotes we've gathered in January about increased buying of French bank unsecured CP/CD and ABCP by liquidity investors, January prime fund holdings data show increased exposures to French bank unsecured CP/CD and ABCP by $5bn and $2bn, respectively. Although these increases illustrate the improved tone in short-term credit markets as of late, maturities still remain very short."
Finally, the J.P. Morgan Securities note adds, "Repo holdings rebounded in January by $51bn to $252bn from the prior month due to seasonal factors that have led repo rates to rise while time deposit holdings declined by $34bn. Time deposit holdings have generally been elevated since August 2011 as repo holdings have trended downwards. We think, at least partially, prime funds have used time deposits as substitutes for repo for overnight liquidity." (Note: Crane Data's Money Fund Portfolio Holdings dataset with Jan. 31, 2012 information will be sent out on Monday.)
Another recent feel good piece, Barclays Capital's "Money markets: Feast or famine", tells us, "To the relief of money market investors, front-end supply has swung from dearth to excess since the start of the year. However, the supply-driven dynamics behind the back-up in repo bill and repo rates might not extend much past March."
Strategist Joseph Abate says, "The Treasury's projected increase in Q1 net new bill supply is roughly $60bn higher than market estimates for the end of last year. A pile up of Twist collateral on dealer balance sheets seems to be pushing repo rates higher. At the same time, still-high Libor rates coupled with a steady improvement in market sentiment could entice front-end investors back to the deposit and CP markets. We expect bill and repo rates to remain biased toward higher yields through the April 15 tax date. Three-month bill yields could rise to 8-9bp by late February. Overnight Treasury repo could settle in around 11bp. Further ahead, we expect bill and repo supply to decline."
He adds, "Rising risk aversion and a dearth of government-guaranteed supply caused bill yields to head toward 0bp late last year. This was widely expected to abate somewhat in the first quarter -- at least based on normal seasonal tax flows into the Treasury's coffers. Excluding the retirement of the $200bn Supplemental Financing Bill program, net new bill supply rose by $126bn in Q1 2011 after declining by a net $16bn in Q4 2010. Late last year, the Treasury Borrowing Advisory Committee (TBAC) projected net new bill supply in the first quarter this year of nearly the same amount. Under these assumptions, the Treasury could keep the weekly 3m and 6m bill auctions at close to their late Q4 levels (that is, $29 and $27bn respectively)."
Abate writes, "Last week, the Treasury unexpectedly bumped up the size of both of these auctions by $2bn each. Short bill yields immediately began to back up as the market started to sense that additional auction increases lay ahead. Between the beginning of January and last Friday, 1 and 3m yields rose by 4bp each and 6m yields rose by 2bp. The market's 'extra supply perception' proved correct: the Treasury's borrowing announcement on Monday pointed to a $190bn net bill borrowing assumption. This is roughly $60bn more than the TBAC had projected in November.... We think auction sizes over the remaining two months of the quarter will need to raise substantially more money the previously assumed -- even with $50bn of cash management bills penciled in for the end of February and early March."
Finally, he adds, "The back-up in bill yields coincides with a surprising heaviness in overnight collateral rates since mid-January. Overnight Treasury collateral cheapened from an average of 6bp in December to 9bp in January, although 3m term GC was largely unchanged. Since there is little evidence of a shift in demand or a change in asset allocations by money fund managers, we suspect the heaviness has been driven more by the supply-side of the market. Given the timing we also think the Fed's Operation Twist-related sales of short dated paper are pushing collateral rates up, though some aspects of the effect are puzzling."
Fidelity Management & Research Company Senior Vice President & General Counsel Scott Goebel is the latest to submit a Comment Letter to the SEC on the President's Working Group Report on Money Market Fund Reform. The letter says, "Fidelity Investments would like to provide the Commission with the results of some of our recent research into the views of money market mutual fund investors. Currently, money market mutual funds are subject to a comprehensive regulatory framework overseen by the Commission. This existing structure includes the recent enhancements to Rule 2a-7, which were designed to strengthen further money market mutual funds. Fidelity has been working with regulators, including Commission staff, to evaluate the need for additional money market fund reforms. To inforn our view, we have conducted extensive research with retail and institutional investors to gain insight into which money market mutual fund features are most important to investors and how investors might react to potential reforms. We urge the Commission to consider these materials as it evaluates whether any additional regulation for money market mutual funds is appropriate."
Fidelity's research study, entitled, "The Investor's Perspective: How individual and institutional investors view money market mutual funds and current regulatory proposals designed to change money funds," explains, "In 2010, regulations governing money market mutual funds (Rule 2a-7) were strengthened by requiring funds to hold more liquid and shorter duration investments in their portfolios. Since then, Fidelity Investments, along with other money market mutual fund managers, has been working with regulators to evaluate whether additional money market reform proposals are needed. To inform our viewpoint on these proposals, Fidelity, the largest money market mutual fund manager with $433 billion in assets under management and 10.9 million money market mutual fund accounts as of December 31, 2011, has conducted extensive research with both individual investors, often called "retail" investors, and "institutional" investors, including corporate treasurers, bank and broker/dealer intermediaries. Among other things, we hope this research will provide further insights into which money market mutual fund features are most important to investors and feedback about how investors might react to certain reform proposals now being considered by regulators."
It continues, "While Fidelity has serious questions about the need for more regulation, especially since there is compelling evidence to suggest that the 2010 reforms have significantly improved the overall soundness of money market mutual funds and made them more resilient to market stress, we continue to keep an open mind to new ideas that might further improve money market mutual funds. We believe that the costs and benefits of any new rule proposal should be carefully weighed to understand the potential impact on the millions of retail and institutional investors who have come to rely upon money market mutual funds to manage their cash balances. The following research results suggest that adopting rules requiring money market mutual funds to float their net asset values (NAV) or impose liquidity restrictions on shareholders -- two ideas that are currently under consideration -- could spark retail and institutional investors to pull significant amounts of assets out of money market mutual funds, leading to unintended consequences for the financial markets and the U.S. economy."
The Fidelity Research Survey's "Key Takeaways" include: "Retail and institutional investors overwhelmingly indicate that they first and foremost invest in money market mutual funds for safety of principal and liquidity, while yield is a secondary consideration; Retail investors use money market mutual funds as a complement to bank products, such as checking and savings accounts, not as a replacement for these FDIC-insured vehicles; A vast majority of retail money market mutual fund investors understand that these funds are not FDIC-insured and the prices of securities held by these funds fluctuate up and down daily; and, Money market mutual fund reform measures that would reduce liquidity or require the NAV to float could cause a significant number of retail and institutional investors to shift assets out of money market funds into banks and other short-term investment vehicles."
The survey says, "Safety of Principal and Liquidity are What Investors Value Most in Money Market Mutual Funds. Fidelity retail and institutional investors overwhelmingly viewed protecting the principal of, and maintaining ready access to, their investments as the most important characteristics of money market mutual funds. A Large Percentage of Fidelity Customers Have a Good Understanding of Money Market Mutual Fund Risks.... [T]hree out of four (75%) Fidelity retail money market mutual fund investors understand that there is not any sort of government guarantee standing behind money market mutual funds. When we probed further on the topic of risks associated with money market mutual funds, 81% of those surveyed understood that the securities held by money market mutual funds had some small daily price fluctuations (11% thought money market mutual fund securities didn't fluctuate while 8% were unsure). Further, only 10% of Fidelity retail money market mutual fund investors believe the government will step in if a money market mutual fund is in danger of breaking $1."
It adds under [the] "Vast Majority of Institutional and Retail Investors Favor Keeping a Stable $1 NAV" that "89% of institutional investors indicated a preference for keeping the stable $1 NAV and only 4% of those surveyed indicated a preference to change to a fluctuating NAV. A large percentage of retail money market mutual fund investors (74%) also favor keeping the stable $1 NAV and just 3% indicated a preference to change to a fluctuating NAV."
The comment letter explains that "Changing to a Fluctuating NAV Could Prompt Institutional and Retail Investors to Flee from Money Market Mutual Funds," saying that "57% of institutional investors we surveyed said they would move all or some of their assets out of money market mutual funds if the NAV of these funds were allowed to fluctuate." It adds, "Likewise, 47% of retail investors said they would move all, or some of their assets, out of money market mutual funds. It also appears that banks would capture the lion's share of the assets moving out of money market mutual funds. For instance, when we asked institutional investors to indicate the primary investment vehicle into which they would move, 42% said they would move to money market deposit accounts at banks and 14% said they would move to CDs/Time Deposits. 19% said they would transfer assets primarily into Treasury securities and 13% said into commercial paper. Separately managed cash accounts, offshore funds, non-2a-7 funds with maturities under 1 year, and cash were mentioned by only 1%. (Note: 8% did not indicate a primary vehicle.)"
Finally, Fidelity says, "Instituting Liquidity Restrictions on Money Market Mutual Funds Could Be Received as Negatively as a Floating NAV." It explains, "Regulators are also considering whether to institute liquidity restrictions on money market mutual funds as a way to make them less susceptible to runs during periods of market stress. One approach that has been talked about is holding back a portion of redemption proceeds for a period of time to provide a safety cushion should a money market fund run into trouble. Fidelity has tested two versions of a holdback feature. In the first version, a portion of proceeds (either 1% or 3%) was held back for 30 days on all redemptions. In the second version, a portion of proceeds (either 1% or 3%) was held back for 30 days only during periods of severe market stress that resulted in the NAV of a money market mutual fund to falling below a certain "trigger level" ($.9975 was used as the example) and was in danger of breaking the $1 stable share price.... [W]e learned that this potential reform could be as destabilizing as a floating NAV.... Given the importance retail investors place on the liquidity feature of money market mutual funds, it is not surprising that investors reacted so negatively to a potential rule that would restrict access to principal."
Investment Company Institute President & CEO Paul Schott Stevens posted a response to yesterday's Wall Street Journal article "U.S. Sets Money-Market Plan". Stevens piece, entitled, "The SEC's Money Market Fund Plans -- Scoring a Hat Trick Against Investors and the Economy," explains, "The Wall Street Journal reports today that the Securities and Exchange Commission (SEC) continues to pursue regulatory changes for money market funds that will harm investors, damage financing for businesses and state and local governments, and jeopardize a still-fragile economic recovery. Quite a regulatory hat trick."
He continues, "The reported changes are not necessary, particularly in light of the SEC's own success in reforming money market funds. In January 2010 -- six months before the passage of the Dodd-Frank Act -- the Commission enacted U.S. regulators' first substantive response to the financial crisis with new amendments to the rules governing money market funds. The changes to Rule 2a-7 made money market funds stronger by raising standards for credit quality, liquidity, and transparency, while reducing risks by shortening the maturity of these funds' portfolios. The fund industry strongly supported these changes."
Stevens writes, "The first test for these newly strengthened funds came swiftly -- and they weathered it well. In the summer of 2011, money market funds faced three challenges: the ongoing European debt calamity, the showdown over the U.S. debt ceiling and subsequent downgrade of government securities, and the long-running punishment of near-zero interest rates, compounded by unlimited insurance for non-interest-bearing checking deposits and payment of interest on business checking for the first time in 80 years."
He adds, "Under this pressure, some investors took cash out of prime money market funds. About 10 percent of prime funds' assets were redeemed from June to August -- some $170 billion -- with nary a hiccup in the money market. U.S. money market funds met the redemptions, maintained liquidity well in excess of the new standards put into place in 2010, and saw no change in the mark-to-market value of their portfolios. Even more remarkably, investors still maintain $2.6 trillion in money market fund assets -- the same level as mid-2007, before the start of the financial crisis -- despite yields hovering near zero for the more than 30 months."
Stevens says, "In light of the success of the 2010 reforms, we see no need for further regulatory changes. And we are especially concerned that the ideas reported in the Journal's story -- forcing money market funds to float their value, imposing bank-like capital requirements, and freezing investors' funds when they try to redeem -- present the worst of all worlds. These proposals will both drive fund sponsors out the industry, reducing competition and choice for investors, and leave the remaining sponsors with a product that few investors or their financial advisers will use."
He tells us, "The harm to investors and the economy of such changes could be enormous. Scores of organizations representing businesses, state and local governments, nonprofit institutions, and individual investors have told the SEC in no uncertain terms that they prize the stability and liquidity of money market funds. Forcing these funds to abandon their $1.00 net asset value (NAV) or denying investors full access to their assets will undermine the core features that make money market funds a valued cash-management tool for individuals and institutions alike."
"The combination of capital requirements and redemption restrictions may well be the one idea that's worse than forcing funds to float. Compliance with redemption freezes will impose hundreds of millions of dollars in added costs on investors, funds, and financial intermediaries and impair features -- like check writing, debit-card access, and sweep accounts -- that investors demand," says Stevens.
He writes, "We have no doubt that these changes will drive investors away money market funds -- because investors have said so. As hundreds of billions of dollars flow out of these funds, the economy will take a hit due to the disruption of vital financing. After all, money market funds buy more than one-third of commercial paper, which businesses rely upon to fund payrolls and operations; more than one-half of short-term municipal debt, which state and local governments issue to fund public projects such as roads, bridges, airports, and hospitals; and almost one-sixth of short-term Treasury bills. There is no ready source of financing to replace money market funds."
Finally, Stevens adds, "The mutual fund industry is committed to ensuring that money market funds are strong enough to withstand adverse market conditions. Since the summer of 2007, we have worked alongside regulators to propose and examine constructive changes to make these funds more resilient. ICI has marshaled its members' expertise to respond to regulators' requests with extensive analysis and insights into a wide range of reform proposals. But the changes reportedly under consideration are neither constructive nor likely to make financial markets more resilient. The SEC has already made money market funds stronger. It should recognize its own success."
(Note: ICI's Paul Stevens will also be speaking this morning at the Chamber of Commerce's webinar on "Money Market Fund Reform".)
The February issue of Crane Data's flagship Money Fund Intelligence is scheduled to be e-mailed to subscribers this morning, along with our performance and rankings for the month ended Jan. 31, 2012. The latest edition of MFI features articles titled, "Changes Continue, Still More Cosmetic than Consolidation," which reviews recent changes and liquidations among money funds; "MMFs Going to Be Fine Says JPM's Bob Deutsch," which interviews J.P. Morgan Asset Management's Managing Director & Head of Global Liquidity; and "Heavy Hitters Comment on Pending Regulations," which excerpts from recent comments by regulators and CEOs. Crane Data will also be sending out its latest Money Fund Intelligence XLS monthly spreadsheet and rankings shortly, and we've updated our Money Fund Wisdom database with 1/31/12 data. (Note: We also quote from today's front page Wall Street Journal story on money funds, "U.S. Sets Money-Market Plan". See our 'Link of the Day' at right.)
In other news, Charles Schwab wrote an editorial to the Wall Street Journal yesterday entitled, "The Fed Votes No Confidence", and subtitled, "The prolonged -- 'emergency' -- near-zero interest rate policy is harming the economy." Schwab commented, "We're now in the 37th month of central government manipulation of the free-market system through the Federal Reserve's near-zero interest rate policy. Is it working? Business and consumer loan demand remains modest in part because there's no hurry to borrow at today's super-low rates when the Fed says rates will stay low for years to come. Why take the risk of borrowing today when low-cost money will be there tomorrow? Federal Reserve Chairman Ben Bernanke told lawmakers last week that fiscal policy should first "do no harm." The same can be said of monetary policy. The Fed's prolonged, "emergency" near-zero interest rate policy is now harming our economy."
He explained, "Average American savers and investors in or near retirement are being forced by the Fed's zero-rate policy to take greater investment risks. To get even modest interest or earnings on their savings, they move out of safer assets such as money markets, short-term bonds or CDs and into riskier assets such as stocks. Either that or they tie up their assets in longer-term bonds that will backfire on them if inflation returns. They're also dramatically scaling back their consumer spending and living more modestly, thus taking money out of the economy that would otherwise support growth."
Schwab commented, "In short, the Fed's actions, rather than helping, are having the perverse effect of destroying the confidence of businesses and individuals to invest and the willingness of banks to loan to anyone but those whose credit is so strong they don't need loans. The Fed's Jan. 25 statement that it would keep short-term interest rates near zero until at least late 2014 is sending a signal of crisis, not confidence. To any potential borrower, the Fed's policy is saying, in effect, the economy is still in critical condition, if not on its deathbed. You can't keep a patient on life support and expect people to believe he's gotten better."
Money market mutual funds were mentioned in both Federal Reserve Chairman Ben Bernanke's Economic Update before the House Committee on the Budget and in Treasury Secretary Timothy Geithner's Financial Reform speech on Thursday of last week. Bernanke was asked about the European debt situation and its possible impact on money market funds, and he was questioned by a member over the penalties that low rates are inflicting on savers. We excerpt from these exchanges below.
During Fed Chairman Bernanke's testimony on "The Economic Outlook and the Federal Budget Situation Before the Committee on the Budget, U.S. House of Representatives, Representative Todd Young (R-Indiana) asked, "I'd also like you to speak to the money market mutual fund market. Right after Lehman, there was a bailout of the money market mutual funds because of a panic over so-called 'breaking the buck'.... There was an intervention by the U.S.... Could that also be something that people begin demanding ... [that] we bail out the money markets as a result of a disorderly default in Europe?" (See the C-Span Video here. This discussion starts around 2:02.)
Bernanke responded, "The Federal Reserve has been ... working ... to understand the exposures of banks to European nations, banks and economies, and trying to help them manage the risks and reduce the risks whereever possible.... We pay close attention to money market mutual funds. Of course, the SEC is the primary regulator there. They too, like our banks, have been working to reduce their exposure to Europe. They have substantially reduced their exposure to the Eurozone countries, and all that's to the good."
Young interrupted and asked, "Is there a reason why the Financial Stability Oversight Council (FSOC) ... has not characterized the money market mutual funds as a systematic risk?" Bernanke answered, "It did point to MMMFs as an area that needed more work.... The things that were done in 2008, such as the Treasury using the Exchange Stabilization Fund to guarantee MMMF deposits [sic] were outlawed by Dodd-Frank.... So it's very important that the MMMFs take the necessary actions to be safe."
Bernanke added, "The SEC, which has already imposed some improvements in these funds, is considering additional steps and consulting with the Federal Reserve. We are quite sympathetic to the idea that more might need to be done in order to ensure that we don't see another run like we did in 2008."
In another exchange, Representative Diane Black (R-Tennessee) asked, "Does a zero interest rate encourage savers to save?" Bernanke responded, "It may, because there's both what economists call substitution effects and income effects, because you may need to save more to get the same return, but...." Black interrupted, "I'm not sure that putting my money into accounts where I'm going to get a zero return is probably what I would want to do especially in an economy that's so uncertain."
Bernanke says, "Let's think this through. Suppose in order to solve savers problems, suppose the Fed raised interest rates sharply. That would almost certainly throw the economy back into recession. It would mean the stock market would decline. It would mean returns on other investments would go down. And it might mean increase deficits might lead to more concerns about our federal government. So, again, we understand the concern that savers have, but we are trying to deal with a bad situation, and this is one of the tools we have to try to get the economy back to full employment."
Congressman Black added, "I know my time is out, but I'm not advocating a sharp increase. I'm just saying that there's not an incentive right now if there's zero percent interest. Thank you." Then Chairman Ryan added, "There's a case for normalizing policy."
Also on Thursday, U.S. Treasury Secretary Tim Geithner, on The State of Financial Reform, commented, "[W]e are putting in place a carefully designed new set of safeguards against risk outside the banking system and enhanced protections for the basic 'infrastructure' or plumbing of the financial markets. Money market funds will face new requirements designed to limit their vulnerability to 'runs' like the one that took place in 2008, with the SEC planning to propose significant reforms this year. Important funding markets like the tri-party repo market are now more conservatively structured.... Designated financial market utilities will be subject to comprehensive oversight and required to hold stronger financial cushions against risk."
Geithner also said, "I want to conclude by emphasizing that the U.S. financial system is getting stronger, and is now significantly stronger than it was before the crisis.... We have shut down or restructured the weakest parts of our system that played a central role in the crisis. Banks and other financial institutions with more than $5 trillion in assets at the end of 2007 have been shut down, acquired, or restructured. The asset-backed commercial paper market has shrunk by 70 percent since its peak in 2007, and the tri-party repo market and prime money market funds have shrunk by 40 percent and 33 percent respectively since their 2008 peaks. Finally, we have been able to dramatically reduce the expected costs of the financial rescue to levels that were unthinkable in early 2009. The financial assistance we provided to banks through TARP, for example, will result in taxpayer gains of approximately $20 billion."
The January issue of the DTCC's Corporate Newsletter features an article entitled, "DTCC Announces Plans to Reduce MMI Settlement Processing Risk," which says, "DTCC has announced plans to enhance the settlement processing of money market instruments (MMI) in ways that will help mitigate credit and systemic risks in this $363 billion-a-day market. DTCC is developing the initial round of enhancements, scheduled to take effect in May 2012 subject to Securities and Exchange Commission approval, as part of an industry-wide effort to reduce risks associated with the settlement of these instruments."
Susan Cosgrove, DTCC managing director and general manager, Settlement and Asset Services, comments in the newsletter, "After robust and thorough consultation with market participants, we are now poised to implement the first round of changes to The Depository Trust Company (DTC) MMI processing system. The goal is to strengthen and reduce risk associated with issuance and maturity settlement processing in the MMI market, a market that plays such a vital funding role in the U.S. economy."
DTCC writes, "In addition, discussions with the industry on longer-term and more structural enhancements to the MMI settlement process are under way and will continue in 2012. The daily MMI market accounts for approximately 55% of the gross value of settlement activity at DTCC's depository and includes a daily average of $122 billion in issuances, $125 billion in maturities and $116 billion in deliveries."
The issue explains, "The MMI initiative is being spearheaded by an MMI Blue Sky task force organized by DTCC and the Securities Industry and Financial Markets Association (SIFMA). The task force released a report in March 2011 proposing a series of short-term changes to the MMI processing system, along with ideas for long-term structural change. In response to feedback from a broad spectrum of MMI market participants, the task force revised the short-term recommendations, and DTCC now expects to implement them in May 2012. The task force will further discuss and prioritize the report's ideas for longer term enhancements with the goal of finalizing recommended proposals and implementation timelines by the end of 2012."
DTCC continues, "The short-term changes include the implementation of new cutoff times intended to give MMI Issuing and Paying Agents (IPAs) sufficient time to calculate their exposure to issuer credit risks and, if a funding shortfall exists, time to resolve the shortfall by 3 p.m., the time by which an IPA must determine whether it will issue a Refusal to Pay (RTP). An RTP reverses all transactions for that day in a given issuer's MMI and can trigger market concerns about the issuer's financial health. The planned short-term changes have garnered broad industry support, thanks to the task force's collaborative efforts and its active pursuit of industry input."
Christopher Buechner, executive director for commercial paper IPA services at JPMorgan Chase, says, "This is part of what we see as a necessary evolution of the money market process in the U.S." The piece tells us, "Buechner, a task force member who played a key role in the drafting of its report, said the overall proposed changes to the MMI process would help increase transparency and create more settlement finality in the MMI marketplace." He adds, "We see the revised cutoff times as a necessary first step." (For more information on the MMI Blue Sky Task force, write to firstname.lastname@example.org.)
Last week, Deutsche Bank Economist Bill Prophet gave a rare intra-month update on portfolio holdings of the largest money funds. His piece, "Throwing Out the First Pitch," says, "Although the mid-month data (as opposed to end-of-month) is generally wanting, we are seeing clear evidence that money funds are beginning to lend to Europe again. Having said that, it looks like French banks aren't participating just yet." We excerpt his recent comments below. We also briefly discuss the ICI's latest "Portfolio Holdings of Taxable Money Funds" dataset, which shows a plunge in Repo holdings and a jump in Treasuries, Agencies and Cash in December.
Prophet's "The Latest on Money Funds" comment explains, "We don't normally do this, but we have received so many questions over the past few days about money fund lending to Europe -- with some even asking if French banks are back in the game -- that we decided to update our monthly series on this dynamic (or at least to the extent that we can using mid-month releases). Be aware however that since we are trying to do this before month-end, our data is pretty spotty.... [T]hese are indeed mid-month numbers so we are not able to see what has happened over the last couple of weeks of the month. But anyway, the six funds in our universe have $260bn in assets which accounts for about 20% of the entire prime fund industry."
He continues, "[H]ere is what the data is telling us: In short, money fund lending to European banks is definitely stabilizing, and in some cases it's even increasing. For the record, we do not yet see any evidence of increased lending to French banks (we're not saying it's not happening; it's just not showing up in our sample), but we are seeing improvements elsewhere. We show the geographic breakdown of the changes in money fund holdings of European bank CDs for the past few months in Chart 1.... Notice how unsecured funding markets have recently improved for British, Swedish, and (ahem) German banks. What's even better news however is that the term of these unsecured loans is starting to pick up as well."
Finally, Prophet comments, "[T]here was a pretty dramatic decline in these "long-maturity" loans between May & December, but then there has been a meaningful rebound in this series during January.... What's noteworthy however is that while unsecured lending is still largely within a stabilization phase, we're beginning to see broad and unambiguous increases in secured lending to European banks. This is what we show in Chart 3; notice how things actually stabilized back in Sep and have been improving ever since. We interpret this as a leading indicator of unsecured lending. After all; increased risk tolerance has to start somewhere."
The Investment Company Institute's latest portfolio composition statistics show that Repurchase Agreements remained the largest holding among money funds in December at 20.6% of assets ($495.2 billion), though Repo declined by $44.4 billion, or 8.2% during the month. `Treasury Securities remained the second largest segment at $452.6 billion, or 18.9%; they increased by $21.3 billion in December. The third-largest slice, Certificates of Deposit, increased slightly (up $8.4 billion) to $431.5 billion (18.0%).
Government Agency securities, which represent $17.2% of assets ($412.1 billion) also saw a jump in holdings; they increased by $27.8 billion, or 7.2%. Commercial Paper declined slightly in December. CP accounts for 15.1%, or $362.4 billion of taxable money fund holdings. Notes represent 5.5% of assets ($131.3 billion), Other holdings represent 4.0% ($95.2 billion), and Cash Reserves represent 0.8% ($19.4 billion). (Note: Crane Data's January 31 Money Fund Portfolio Holdings are scheduled for release on Feb. 13.)
The latest comment letter posted on the SEC's website for the President's Working Group Report on Money Market Fund Reform (Request for Comment) is from Thomas Horgan, President and CEO of the New Hampshire College & University Council. His letter says, "I write to offer comments on behalf of the board of the New Hampshire College & University Council (NHCUC) and our eighteen member public and private higher education institutions regarding money market mutual funds and proposals to further amend Rule 2a-7. Specifically, the NHCUC has serious concerns relating to any proposal that would require a floating NAV for these funds rather than a stable $1.00 per share NAV. A floating NAV for money market mutual funds would require significant and expensive changes to operational and recordkeeping systems for our member institutions."
Horgan continues, "Many of our member colleges and universities regularly use money market mutual funds for their cash management needs. These funds have consistently proven to be a safe, efficient, and effective cash management tool. Requiring a floating NAV would have negative implications for the utilization of money market mutual funds, as investors would be forced to seek alternative products that are less regulated and provide less diversification. To that end, we are concerned a floating NAV would effectively eliminate money market mutual funds as a viable investment tool for public and private higher education institutions."
Finally, he adds, "While we are aware of the money market fund liquidity issues revealed during the 2008 economic crisis, it appears that recent reforms have already significantly addressed the need for increased fund liquidity and the capacity to satisfy large redemption requests in times of market stress. The proposal to create a floating NAV would do nothing to make money market funds more secure for investors should adverse liquidity conditions occur in the future. A floating NAV would make the management of money market mutual funds too onerous, expensive and complicated for most institutional investors, including those of us in higher education. We appreciate the opportunity to comment on this important topic and your careful consideration of our concerns."
In other news SunAmerica filed to liquidate its Municipal Money Market Fund. The filing says, "On January 17, 2012, the Board of Directors of the Company approved a Plan of Liquidation for the SunAmerica Municipal Money Market Fund, a series of the Company, pursuant to which the Fund will be liquidated on or about March 2, 2012, subject to shareholder approval. If shareholders approve the Plan, the distribution of Liquidation proceeds to shareholders of record as of the close of business on the day prior to the Liquidation Date will occur on the Liquidation Date."
It adds, "As previously announced in a supplement to the Fund's prospectus dated December 5, 2011, the Fund closed to new investments on January 13, 2012, and no longer accepts orders to buy Fund shares from new investors or existing shareholders (although reinvestments of any dividends and capital gain distributions from existing shareholders continue to be permitted). As anticipated, the closing of the Fund to new investments resulted in a significant redemption of Fund shares by shareholders who hold Fund shares through brokerage accounts that utilized the Fund as a cash 'sweep' vehicle. Due to the size of the remaining assets in the Fund, the Fund has had to depart from its stated investment strategies and techniques, although the Fund continues to seek to maintain a stable share price of $1.00 and to follow the rules of the Securities and Exchange Commission applicable to money market funds relating to the credit quality, liquidity, diversification and maturity of investments. If the Liquidation is approved by shareholders, the Fund will cease to engage in any investment activities, except for the purpose of winding up its business and affairs, preserving the value of its assets, discharging or making reasonable provision for the payment of all of its liabilities and distributing its remaining assets to shareholders in accordance with the Plan."
The filing adds, "The closing of the Fund to new investments (and Liquidation, if approved by shareholders) does not restrict shareholders from selling shares of the Fund and shareholders may redeem their shares at any time (up until the Liquidation Date, if the Liquidation is approved by shareholders), in accordance with the terms set forth in the Fund's prospectus. On or about February 23, 2012, the Fund expects to convene a special meeting of shareholders to vote on the Plan. Shareholders of record of the Fund as of the close of business on January 19, 2012 are entitled to notice of and to vote at the special meeting, and will receive proxy materials describing the Liquidation and Plan in greater detail."