The latest monthly numbers from the Investment Company Institute verify that money fund assets were flat in May 2012 and the shift towards repurchase agreements continued. ICI's latest monthly "Trends in Mutual Fund Investing: May 2012" showed that money market mutual fund assets rose by $1.7 billion in May (after falling $24 billion in April and $71 billion in March) to $2.560 trillion. Money fund assets now account for 21.4% of overall mutual fund assets. Bond fund assets continued their dizzying climb. After breaking over $3.0 trillion in March, assets grew $15.2 billion in May to $3.135 trillion, or 26.2% of assets. ICI's "Month-End Portfolio Holdings of Taxable Money Market Funds showed continued growth in Repo holdings (up $14.0 billion); repurchase agreements now account for a full one-quarter of portfolio holdings.
ICI's latest "Trends" says, "The combined assets of the nation's mutual funds decreased by $469.3 billion, or 3.8 percent, to $11.962 trillion in May, 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 inflow of $2.01 billion in May, compared with an outflow of $24.04 billion in April. Funds offered primarily to institutions had an inflow of $3.66 billion. Funds offered primarily to individuals had an outflow of $1.65 billion."
Month-to-date through June 27, however, the outflows have resumed. Crane Data's Money Fund Intelligence Daily shows money fund assets decreasing by $20.5 billion (down 0.8%). YTD, we show asset declines of $144.1 billion, or 5.6%. Our daily series shows `the declines concentrated in Prime Institutional funds in June; they've lost $22.4 billion, or 2.8%, month-to-date.
But ICI's latest weekly "Money Market Mutual Fund Assets" says, "Total money market mutual fund assets increased by $3.43 billion to $2.538 trillion for the week ended Wednesday, June 27, the Investment Company Institute reported today. Taxable government funds increased by $7.07 billion, taxable non-government funds decreased by $2.01 billion, and tax-exempt funds decreased by $1.64 billion."
ICI's Portfolio Holdings series shows Repurchase Agreements increased again in May after jumpinig in April (up $14.0 billion to $568.0 billion after rising $52.3 billion in April and falling $65.2 billion in March). Repos remain the largest portfolio holding among taxable money funds with 24.8% of assets. Treasury Bills & Securities remained the second largest segment at 18.9%, though these fell again by $14.4 billion (after falling $35.3 billion last month) to $432.9 billion. Holdings of Certificates of Deposits, which rank third among portfolio holdings, rebounded by $15.3 billion to $358.5 billion (15.7%).
Commercial Paper declined by $13.2 billion to $351.8 billion, but CP remained the fourth largest composition sector with 15.4% of taxable asset composition. U.S. Government Agency Securities holdings flatlined at $320.1 billion, or 14.0% of assets. Notes (including Corporate and Bank) accounted for 5.4% of assets ($123.5 billion), while Other holdings accounted for 3.9% ($89.6 billion).
The Number of Accounts Outstanding in ICI's Holdings series for taxable money funds decreased to 25.44 million from 25.69 million the month before, while the Number of Funds remained flat at 417. The Average Maturity of Portfolios lengthened to 46 days in May from 45 days in April. 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 May 31, 2012. (We revise these following the monthly publication of our Money Fund Portfolio Holdings data.)
Federated Investors announced its third money fund acquisition of the year, following earlier 2012 deals with the U.K.-based Prime Rate funds and the remainder of Fifth Third's money fund complex. A press release on the latest deal entitled, "Federated Investors' Mutual Funds to Acquire Approximately $903 Million in Assets from Performance Funds Trust," is subtitled, "Assets of eight equity, fixed income and money market funds of Performance Funds Trust to transition into seven Federated funds." It explains, "Federated Investors, Inc., one of the nation's largest investment managers, and Trustmark Corporation announced that a definitive agreement has been reached between Federated, Trustmark Investment Advisors, Inc. and Trustmark National Bank in connection with the proposed reorganization of approximately $903 million in assets, including about $571 million in money market fund assets, of the funds of Performance Funds Trust into Federated funds with similar investment objectives. Under the agreement, Trustmark Investment Advisors, Inc. will sell certain assets relating to its management of the Performance Funds to Federated or certain Federated advisory subsidiaries. The financial terms of the agreement were not disclosed."
The release explains, "The Performance Funds comprise eight mutual fund portfolios of Performance Funds Trust: four equity, two fixed income and two money market funds. Trustmark Investment Advisors, Inc. is a wholly owned subsidiary of Trustmark National Bank and investment adviser to the Performance Funds. The Performance Funds Trust's Board of Trustees has determined to recommend to shareholders of the Performance Funds that they vote to approve the applicable reorganization. The reorganization of each Performance Fund is subject to approval by the shareholders of the applicable Performance Fund and the satisfaction of certain other conditions of closing. It is anticipated that a meeting of shareholders of the Performance Funds to approve the proposed reorganizations will take place in September 2012. Shareholders of the Performance Funds will receive proxy materials describing the proposed reorganizations in greater detail in the near future. Once the proposed reorganizations are completed, Trustmark will no longer serve as investment adviser to the Performance Funds."
Federated Investors President and CEO J. Christopher Donahue comments, "Federated maintains a longstanding tradition of working closely with banks to offer high quality investment products that meet the needs of their customers. That approach, combined with the strength of our intermediary-driven customer service, provides an ideal opportunity for the shareholders of the Performance Funds to transition to Federated. We remain very interested in additional similar transactions."
Doug Ralston, president of Trustmark Wealth Management and Trustmark Investment Advisors, Inc., adds, "Trustmark's goal is to offer our clients best in class money management services. The Performance Funds shareholders will gain a broader, more diverse product offering and the global experience of Federated's investment management team. Federated and Trustmark share the same philosophy that the client is our first priority."
Federated is the third largest manager of money funds in the U.S. with $230.8 billion as of May 31, 2012, according to our Money Fund Intelligence XLS product, and they rank 4th globally with $241.1 billion according to our Money Fund Intelligence International. As we mentioned in the April issue of our Money Fund Intelligence newsletter ("Another Two Bite the Dust: Consolidation Becomes Real"), both Fifth Third's fund complex and KeyBank's Victory funds have announced exits from the money fund business. (Note that Crane Data did not track the Performance Funds due to size and lack of reporting.)
MFI stated then, "In the past two years, we've seen Old Mutual, Paypal, Pacific Capital, Pioneer (partial), Scout (UMB), Ridgeworth (merged into Federated), Eagle (Raymond James), and a handful of others announce liquidations. The number of funds tracked by Crane Data has fallen from 1,310 to 1,209, which also includes lots of mergers and streamlinings." (See our April 6 Crane Data News "Federated To Acquire (The Rest of) Fifth Third Money Market Funds" and our Dec. 22, 2011 News "Federated to Acquire Prime Rate Sterling, Euro, USD Liquidity Funds".)
Late Tuesday, Bloomberg wrote an article entitled, "SEC Money-Market Rule Said to Include Capital, Floating Shares". It says, "The U.S. Securities and Exchange Commission has been presented with a 337-page staff proposal that would require the $2.5 trillion money-market fund industry to float share prices or hold more capital and curb redemptions, according to a person familiar with the proposal. SEC staff delivered the measure to the commissioners yesterday afternoon, two people said. It closely tracks with provisions SEC Chairman Mary Schapiro outlined in testimony last week before the Senate Banking Committee and includes multiple questions for the public, the people said."
The Bloomberg piece continues, "SEC members could meet as soon as next month to vote on sending the proposal for public comment. The agency would have to hold another vote before completing the rule. Schapiro might not have enough support on the commission to advance the measure. The two Republican commissioners, Troy Parades and Daniel Gallagher, are opposed to additional regulation for money-market funds and Luis Aguilar, a Democrat, has expressed concern about the impact on the industry of changes in money-market fund rules."
Reuters also wrote last night, "SEC staff floats draft proposal on money funds". It says, "Top officials at the U.S. Securities and Exchange Commission are reviewing a draft proposal for controversial new reforms for the $2.6 trillion money market fund industry, according to people familiar with the matter. The draft proposal, which was formally circulated among commissioners late on Monday, outlines SEC Chairman Mary Schapiro's vision for adding safeguards to the money market funds, one of those people said. Schapiro contends those funds are still susceptible to runs, despite some reforms already put in place after the 2007-2009 financial crisis."
The article continues, "The new safeguards are strongly opposed by the fund industry and the Chamber of Commerce. Three of the SEC's five commissioners have also publicly expressed skepticism about the need to adopt additional money market reforms beyond the ones enacted in 2010. The draft proposal is largely similar to what has already been publicly discussed by Schapiro in speeches to the industry and in testimony before Congress."
It adds, "The proposal contains two potential plans. One involves the combination of a capital buffer coupled with a holdback on redemption requests by investors. The other, meanwhile, consists of a floating net asset value -- a move that aims to curb investor complacency over the stable $1-per-share value that funds currently quote. The commissioners are being given 30 days to review the draft proposal, those people said, but it is unclear whether Schapiro may call a vote on the plan because she is still trying to gain support for it. She will need three votes from the five-member commission if she hopes to put it out for public comment."
Below, we excerpt from several other statements from last Thursday's panel on "Perspectives on Money Market Mutual Fund Reforms" Senate Banking Committee Chairman Tim Johnson (D-SD) explained, "Today, we are here to review the current state of regulations responsible for providing stability to the money market mutual funds and protecting investors. More than fifty million municipalities, companies, retail investors and others use money market mutual funds. There are $2.6 trillion invested in these funds, which are often viewed as convenient, efficient and predictable for cash management, investment and other purposes. With Americans so heavily invested in these funds this Committee has a responsibility to conduct oversight to see to it that the Securities and Exchange Commission is doing its part and has the resources and authority necessary to effectively regulate this critically important financial market."
Senator Richard Shelby commented, "Today the Committee will hear a range of perspectives on money market fund reform. Since their introduction forty years ago, money market funds have been an important source of short-term financing for businesses, banks, and state and local governments. Money market funds have offered investors a low-cost means to invest in money market instruments and provided them with an efficient cash management vehicle. But, unlike other mutual funds, money market funds are permitted by the SEC to maintain a stable net asset value (NAV). The stable NAV feature of money market funds offers investors the convenience and simplicity of buying and selling shares at a constant one-dollar per share. However, because the market value of the instruments held by the funds can decline, the stable NAV gives the impression that money market funds are without risk and guaranteed to never "break the buck." Indeed, investment management firms have intervened several times with capital contributions and other forms of support to prevent their money market funds from breaking the buck."
The Chamber of Commerce wrote, "On June 21, the Senate Banking Committee held a hearing on the issue of money market fund (MMF) regulation and the potential impact on the U.S. economy if rules such as eliminating the stable $1.00 net asset value (NAV) and restrictions on redemptions are instituted. Among those testifying in opposition to increased regulation was Brad Fox, Vice President and Treasurer of Safeway Inc.... Fox is also Chairman Emeritus of the National Association of Corporate Treasurers (NACT). The scope of his duties handling financing and cash management for an operation the size of Safeway, and his interactions with other treasurers through NACT, give Fox a keen insight into the role of MMFs for businesses."
Fox's testimony said, "There are several important points that I wish to stress to the Committee: Money market mutual funds play a critical role in meeting the short-term investment needs of companies across the country.... Money market funds also represent a significant source of affordable, short term financing for many Main Street companies.... Treasurers are extremely concerned that the changes to money market mutual fund regulation would fundamentally alter the product so that it no longer remains a viable investment option. The significance of such a change cannot be overstated. Should it happen, money market mutual funds would no longer remain a viable buyer of corporate commercial paper, which would drive up borrowing costs significantly and force companies to fund their day to day operations in a less efficient manner. Some corporate treasuers are already making plans to withdraw funds from money market accounts to ensure full access to their funds and avoid the proposed redemption holdback. Also, floating net asset values for money market funds would result in a significant accounting burden for companies across America investing in this product."
Finally, Federated's Chris Donahue said, "We are concerned that, based upon recent speeches by the SEC Chairman and a number of members of the Federal Reserve Board, key regulators have largely disregarded the comments received in response to the PWG Report-not only Federated's comments, but also others who pointed out errors underlying, obstacles to and unintended consequences of possible reforms. More disturbingly, although as of this date neither the SEC nor FSOC have proposed rules or other action specifically targeting MMFs, key members of both agencies have continued to pursue reform proposals heedless of the PWG Report's important warning that "[a]ttempting to prevent any fund from ever breaking the buck would be an impractical goal that might lead ... to draconian and -- from a broad economic perspective -- counterproductive measures...." Their attempt to eliminate risk from MMFs has resulted in draconian proposals that would eliminate MMFs, if not altogether, then as a meaningful component of the U.S. cash markets."
He added, "The ICI, Federated and other MMF managers, and other organizations have attempted to fill this information gap by sponsoring surveys and preparing studies of the financial and operational impact of various proposals. With the advent of FSOC, the SEC staff no longer appears to give this information the same consideration that they gave to the ICI Working Group report. Certainly the SEC Chairman continues to make public statements that either are contradicted by these studies or fail to acknowledge important issues raised by them. Although I confess to being skeptical of the need for further reforms, Federated is willing to consider and assist the SEC, the ICI and the industry in assessing reform proposals that would enhance the resilience of MMFs. I am asking this Committee to encourage the SEC to do the research necessary to determine what changes, if any, are truly needed, and to express its commitment to the continued vitality and growth of this important investment product."
On Friday, we featured SEC Chairman Mary Schapiro's recent testimony before the Senate Banking Committee last Thursday. Today, we excerpt from ICI President & CEO Paul Schott Stevens' statement, entitled, "An Outcome for Money Market Funds That We Must Avoid". (His full testimony is here, and the archived webcast may be seen here.) Stevens says, "Today, I provided ICI's views on the state of the money market fund industry at a hearing of the Senate Banking Committee, "Perspectives on Money Market Mutual Fund Reforms." My message to legislators was clear: Persistently viewing money market funds through the narrow prism of 2008, regulators are advancing plans for structural changes that would destroy money market funds, at great cost to investors, state and local governments, business, and the economy. We must avoid this outcome."
He continues, "For almost five years, ICI has been deeply engaged in analysis and discussion of events in the money market and the role of money market funds. We take pride in the fact that our engagement helped produce the first comprehensive regulatory reforms for any financial product in the wake of the crisis -- five months before the Dodd-Frank Act was passed. The reforms for money market funds in 2010 benefit investors and the economy by raising credit standards and shortening maturities for funds' portfolios. They remove incentives for investors to redeem rapidly, by increasing transparency of fund holdings and authorizing an orderly liquidation if a fund risks breaking the dollar."
Stevens explains, "And those reforms sharply reduce the spillover effects of money market fund redemptions on the broader markets. As of December 2011, prime money market funds held $660 billion in assets that would be liquid within a week -- more than twice the amount that investors redeemed from prime funds in the week of September 15, 2008. Today, prime funds keep more than 30 percent of their assets in liquidity buffers composed primarily of Treasury and government securities and repurchase agreements -- precisely the instruments investors were seeking in 2008."
He comments, "Unfortunately, the regulatory community doesn't seem to have learned the lessons of 2011. They tell us that money market funds are "susceptible" to runs. They're worried that the government can't "bail out" these funds in a future crisis. Both of these statements are based in myths. Let's look at September 2008. Regulators talk about the "contagion" from the failure of the Reserve Primary Fund on September 16, 2008. But Reserve Primary broke the dollar in the middle of a raging epidemic of bank failures. In the turmoil, banks were refusing to lend to each other, even overnight."
Stevens writes, "Two things stand out. First, Reserve Primary's breaking the dollar did not trigger the tightening of the commercial paper market -- investors of all types began abandoning that market days before Reserve Primary failed. Second, investors did not flee from the money market fund structure. Rather, they fled from securities of financial institutions and sought the refuge of U.S. Treasury securities -- by buying shares in money market funds invested in government securities. Assets of taxable funds -- prime and government -- declined by only 4 percent in the week of September 15."
He continues, "The Treasury and the Federal Reserve stepped in to restore the financial markets. Let me be clear: money market funds received no financial support from the federal government. The Treasury guarantee program never paid a dime in claims -- instead, it collected $1.2 billion for the taxpayers. It's quite a stretch to call that a "bailout." The Federal Reserve's facilities were designed to use money market funds to access the markets and pump in needed liquidity. That's Central Banking 101. Our shareholders realize that money market funds are investments -- and they bear the risk of loss. No one in the investment community believes that these funds carry a government guarantee -- and no one in our industry wants one. Period -- full stop."
Stevens also says, "My testimony permitted me to address the issue of sponsor support for funds. Since the 1970s, advisers to money market funds have on occasion chosen to address credit or valuation issues in their portfolios and support their funds. They did so with private resources -- not taxpayer dollars. And they did so for business interests -- to protect their brand or preserve their fund's rating. The SEC hasn't released any data to back its claims about sponsor support. We can say, however, that we know of only one instance of sponsor support since the 2010 reforms, and that in that case the security in question was in no danger of defaulting. Yet the SEC suggests that every case of sponsor support should be seen as a repeat of September 2008. They suggest that without sponsor support, money market funds would have triggered runs."
Finally, he adds, "Decades of experience with these funds suggest just the opposite. Before the latest financial crisis, there was only one occasion when a money market fund broke a dollar, in 1994. As my colleague Karrie McMillan has discussed, the world yawned. I invite you to read my full testimony, which goes into depth on importance of money market funds, the regulatory progress that has been made for these funds since 2008, and the necessity of preserving their benefits for issuers and investors."
Note: Thanks to everyone who attended our 4th annual Crane's Money Fund Symposium in Pittsburgh! ... Yesterday morning, U.S. Securities and Exchange Commission Chairman Mary Schapiro gave testimony before the Committee on Banking, Housing, and Urban Affairs of the United States Senate on "Perspectives on Money Market Mutual Fund Reforms". She says, "Thank you for the opportunity to testify about the Securities and Exchange Commission's regulation of money market funds. The risks posed by money market funds to the financial system are part of the important unfinished business from the financial crisis of 2008. One of the seminal events of that crisis occurred in September, after Lehman Brothers filed for bankruptcy and the Reserve Primary Fund "broke the buck," triggering a run on money market funds and freezing the short-term credit markets. Although the Commission took steps in 2010 to make money market funds more resilient, they still remain susceptible today to investor runs with potential systemic impacts on the financial system, as occurred during the financial crisis just four years ago. Unless money market fund regulation is reformed, taxpayers and markets will continue to be at risk that a money market fund can "break the buck" and transform a moderate financial shock into a destabilizing run. In such a scenario, policymakers would again be left with two unacceptable choices: a bailout or a crisis. My testimony today will discuss the history of money market funds, the remaining systemic risk they pose to the financial system even after the 2010 reforms, and the need for further reforms to protect investors, taxpayers and the broader financial system."
Schapiro's statement continues, "Despite these risk-limiting provisions, money market funds can -- and do -- lose value. When, despite these risk-limiting provisions, money market fund assets have lost value, fund "sponsors" (the asset managers -- and their corporate parents -- who offer and manage these funds) have used their own capital to absorb losses or protect their funds from breaking the buck. Based on an SEC staff review, sponsors have voluntarily provided support to money market funds on more than 300 occasions since they were first offered in the 1970s. Some of the credit events that led to the need for sponsor support include the default of Integrated Resources commercial paper in 1989, the default of Mortgage & Realty Trust and MNC Financial Corp commercial paper in 1990; the seizure by state insurance regulators of Mutual Benefit Life Insurance (a put provider for some money market fund instruments); the bankruptcy of Orange County in 1994; the downgrade and eventual administrative supervision by state insurance regulators of American General Life Insurance Co in 1999; the default of Pacific Gas & Electric and Southern California Edison Co. commercial paper in 2001; and investments in SIVs, Lehman Brothers, AIG and other financial sector debt securities in 2007-2008. In part because of voluntary sponsor support, until 2008, only one small money market fund ever broke the buck, and in that case only a small number of institutional investors were affected."
She says, "The amount of assets in money market funds has grown substantially, and grew particularly rapidly during recent years from under $100 million in 1990 to almost $4 trillion just before the 2008 financial crisis. This growth was fueled largely by institutional investors, who were attracted to money market funds as apparently riskless investments paying yields above riskless rates. By 2008, more than two-thirds of money market fund assets came from institutional investors, which could wire large amounts of money in and out of their funds on a moment's notice. Some of these institutional assets were what are known in the business as "hot money" -- assets that would be quickly redeemed if a problem arose, or even if a competing fund had higher yields. To compete for that money, some money market fund sponsors invested in new, risker types of securities, such as "structured investment vehicles." The larger amount of assets in money market funds contributed to the likelihood that a credit event would create stresses on one or more funds, and that fund sponsors would not have access to a sufficient amount of capital to support the funds."
Schapiro explains, "Implicit sponsor support as a mechanism to maintain a stable $1.00 share price increasingly came under strain as the size of money market funds grew into a several trillion dollar industry. The Reserve Primary Fund broke the buck after it suffered losses its sponsor could not absorb. The Reserve Primary Fund, a $62 billion money market fund, held $785 million in Lehman Brothers debt on the day of Lehman Brothers' bankruptcy and immediately began experiencing a run -- shareholders requested redemptions of approximately $40 billion in just two days. The Reserve Primary Fund announced that it would re-price its shares below $1.00, or break the buck."
She adds, "Almost immediately, the run on the Reserve Primary Fund spread, first to the Reserve's family of money market funds, and then to other money market funds. Investors withdrew approximately $300 billion (14%) from prime money market funds during the week of September 15, 2008. Money market funds met those redemption demands by selling portfolio securities into markets that were already under stress, depressing the securities' values and thus affecting the ability of funds holding the same securities to maintain a $1.00 share price even if the other funds were not experiencing heavy redemptions. Money market funds began to hoard cash in order to meet redemptions and stopped rolling over existing positions in commercial paper and other debt issued by companies, financial institutions, and some municipalities. In the final two weeks of September 2008, money market funds reduced their holdings of commercial paper by $200.3 billion, or 29%."
Schapiro's comments tell the Senate panel, "More than 100 funds were bailed out by their sponsors during September 2008. But the fund sponsors were unable to stop the run, which ended only when the federal government intervened in an unprecedented manner. In September 2008, the Treasury Department temporarily guaranteed the $1.00 share price of more than $3 trillion in money market fund shares and the Board of Governors of the Federal Reserve System created facilities to support the short-term markets. These actions placed taxpayers directly at risk for losses in money market funds but eased the redemption pressures facing the funds and allowed the short-term markets to resume more normal operations. Because the federal government was forced to intervene we do not know what the full consequences of an unchecked run on money market funds would have been."
She states, "The next run might be even more difficult to stop, however, and the harm will not be limited to a discrete group of investors. The tools that were used to stop the run on money market funds in 2008 are either no longer available or unlikely to be effective in preventing a similar run today. In September 2008, the Treasury Department used the Exchange Stabilization Fund to fund the guarantee program, but in October 2008 Congress specifically prohibited the use of this fund again to guarantee money market fund shares. The Federal Reserve Board's Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility ("AMLF"), through which credit was extended to U.S. banks and bank holding companies to finance purchases of high-quality asset backed commercial paper ("ABCP") from money market funds, expired on February 1, 2010. Given the significant decline in money market investments in ABCP since 2008, reopening the AMLF would provide little benefit to money market funds today. For example, ABCP investments accounted for over 20% of Moody's-rated U.S. prime money market fund assets at the end of August 2008, but accounted for less than 10% of those assets by the end of August 2011."
Schapiro also says, "Shortly after I joined the Commission in 2009, I asked the Commission's staff to prepare rulemaking designed to address concerns about money market funds revealed by the 2007-2008 crisis. The staff, with assistance from a report prepared by the money market fund industry, quickly identified some immediate reforms that would make money market funds more resilient. I am proud of this initial reform effort, but it is important to recognize what it did and did not do. The initial reforms, adopted and implemented in 2010, were designed to reduce the risks of money market funds' portfolios by reducing maturities; improving credit standards; and, for the first time, mandating liquidity requirements so that money market funds could better meet redemption demands. The new reforms also required money market funds to report comprehensive portfolio and "shadow NAV" information to the Commission and the public."
She explains, "Given the role money market funds play in providing short-term funding to companies in the short-term markets, a run presents not simply an investment risk to the fund's shareholders, but significant systemic risk. No one can predict what will cause the next crisis, or what will cause the next money market fund to break the buck. But we all know unexpected events will happen in the future. If that stress affects a money market fund whose sponsor is unable or unwilling to bail it out, it could lead to the next destabilizing run. To be clear, I am not suggesting that any fund breaking the buck will cause a destabilizing run on other money market funds -- it is possible that an individual fund could have a credit event that is specific to it and not trigger a broad run -- only that policymakers should recognize that the risk of a destabilizing run remains. Money market funds remain large, and continue to invest in securities subject to interest rate and credit risk. They continue, for example, to have considerable exposure to European banks, with, as of May 31, 2012, approximately 30% of prime fund assets invested in debt issued by banks based in Europe generally and approximately 14% of prime fund assets invested in debt issued by banks located in the Eurozone."
Schapiro continues, "The Commission staff currently is exploring a number of structural reforms, including two in particular that may be promising. The first option would require money market funds, like all other mutual funds, to buy and sell their shares based on the market value of the funds' assets. That is, to use "floating" net assets values. Such a proposal would allow for public comment on whether requiring money market funds to use floating NAVs would cause shareholders to become accustomed to fluctuations in the funds' share prices, and thus less likely to redeem en masse if they fear a loss is imminent, as they do today. It would also treat all investors more fairly in times of stress."
She states, "A second option would allow money market funds to maintain a stable value as they do today, but would require the funds to maintain a capital buffer to support the funds' stable values, possibly combined with limited restrictions or fees on redemptions. The capital buffer would not necessarily be big enough to absorb losses from all credit events. Instead, the buffer would absorb the relatively small mark-to-market losses that occur in a fund's portfolio day to day, including when a fund is under stress. This would increase money market funds' ability to suffer losses without breaking the buck and would permit, for example, money market funds to sell some securities at a loss to meet redemptions during a crisis."
Schapiro tells the Senate panel, "As described above, many money market funds effectively already rely on capital to maintain their stable values: hundreds of funds have required sponsor bailouts over the years to maintain their stable values. Requiring funds to maintain a buffer simply would make explicit the minimum amount of capital available to a fund. Today, in contrast, an investor must wonder whether a sponsor will have the capital to bailout its fund and, even if so, if the sponsor will choose to use it for a fund bailout. Limits on redemptions could further enhance a money market fund's resiliency and better prepare it to handle a credit event. `Restrictions on redemptions could be in several forms designed to require redeeming shareholders to bear the cost of their redemptions when liquidity is tight. Redemption restrictions could be designed to limit any impact on day-to-day transactions."
Finally, she writes, "These ideas and others are the subject of continuing analysis and discussion at the Commission. If the Commission were to propose further reforms, there will, of course, be an opportunity for full public consideration and comment. In addition to a detailed release seeking comment on the likely effectiveness and impacts of the proposed reforms, the proposal will also include a discussion of their benefits, costs, and economic implications. In closing, money market funds as currently structured pose a significant destabilizing risk to the financial system. While the Commission's 2010 reforms made meaningful improvements in the liquidity of money market funds, they remain susceptible to the risk of destabilizing runs. Thank you for the opportunity to testify on this important issue. I am happy to answer any questions that you might have."
The Investment Company Institute published a press release yesterday entitled, "ICI Study: Cost, Operational Complexities of Redemption Restrictions Would Drive Investors, Intermediaries From Money Market Funds," which says, "Redemption restrictions that the Securities and Exchange Commission (SEC) is contemplating for money market funds would impose costly operational and systems changes on fund complexes, financial intermediaries, and their related service providers, according to a new report released today by the Investment Company Institute (ICI). These operational issues would be likely to discourage financial intermediaries from offering money market funds, ICI found, compounding the likely shrinkage in money market fund assets predicted by investor surveys."
It continues, "The ICI study, Operational Impacts of Proposed Redemption Restrictions on Money Market Funds, suggests that redemption restrictions would likely drive users away from money market funds, drive assets into less-regulated, less-transparent alternatives, and disrupt short-term financing for the economy. Under the SEC's redemption restriction concept, a portion of every shareholder's account would be deemed "restricted shares" and would be placed in escrow, denying shareholders full use of their cash. Restricted shares would be used to absorb losses if a fund could not maintain its $1.00 net asset value (NAV) -- an event commonly referred to as "breaking the dollar." Investors who had redeemed shares during the 30 days prior to the fund breaking the dollar would be first to absorb losses."
ICI President and CEO Paul Schott Stevens comments, "These redemption restrictions would fundamentally alter a hallmark investor protection of mutual funds -- the promise that funds always stand ready to buy back shares at their current net asset value. When you combine the operational burdens with the negative investor reaction that ICI and others have documented, it's clear that redemption restrictions would turn money market funds into a product that no one would want to offer and no one would want to buy."
ICI's release adds, "Throughout the 40-year history of money market funds, investors have benefited from the convenience, liquidity, and stability of these funds. To serve investors across a wide range of uses, fund complexes, intermediaries, and service providers have developed intricate and complex systems that allow them, on a daily basis, to communicate and process significant volumes of money market fund transactions on behalf of investors. In order to apply continuous redemption restrictions accurately and consistently across all investors in money market funds, each of these parties, as well as many institutional investors, would need to undertake intricate and expensive programming and other significant, costly system changes."
Kathleen Joaquin, chief industry operations officer at ICI and an author of the report, tells us, "The redemption restriction that regulators are considering would clearly impose major systems and operational changes at a very high cost on fund complexes, intermediaries, and service providers. At the same time, our research with investors shows that a large majority of money market fund investors would be likely to eliminate or cut back their use of these funds if these restrictions are imposed. Fund complexes, intermediaries, and service providers will be hard-pressed to justify undertaking the significant costs of compliance with the restrictions in the face of rapid shrinkage of money market fund assets."
Finally, the release says, "As a result, the ICI report suggests that redemption restrictions will lead many intermediaries to make the business decision to migrate to unregulated or less regulated money market investment vehicles or bank deposit products, rather than implement costly changes to their systems. The total effect would be to force users away from money market funds and increase their usage of less-regulated, less-transparent alternatives, as well as to disrupt short-term financing for the economy."
Note: For those attending our 4th annual Crane's Money Fund Symposium, welcome to Pittsburgh! Our conference starts at 1pm Wednesday and goes through Friday at noon. Watch for coverage in coming days.... Fidelity Investments issued a statement yesterday, saying, "See the attached comment letter that the U.S.-based Fidelity Investments submitted to the European Commission in response to their recent "Green Paper" on shadow banking. In it we argue that money market funds are transparent and adequately disclosed, so they should not be considered part of the "shadow banking" system. Refining the terms of the discussion is critical before policymakers and regulators begin careful consideration of what reforms, if any, are needed."
Fidelity's "Comments on European Commission Green Paper on Shadow Banking," say, "Fidelity Investments appreciates the opportunity to provide comments to the European Commission on its Green Paper on Shadow Banking. Among other businesses, Fidelity serves as the investment adviser to a comprehensive suite of investment products, including mutual funds and institutional accounts, with assets under management of approximately US$1.6 trillion."
It explains, "In connection with its investment advisory business across the globe, including over 75 employees in Europe, Fidelity has a deep understanding of a number of the activities that the Green Paper classifies as part of the shadow banking system. For example, Fidelity is the largest money market mutual fund provider in the United States, with more than US$415 billion in MMF assets under management. In addition, a number of our mutual funds, which are registered with, and subject to a comprehensive body of regulation overseen by, the U.S. Securities and Exchange Commission, invest in repurchase agreements and conduct securities lending activities."
The Fidelity letter continues, "With our broad experience in providing investment advisory services, we offer in this letter our views on the issues presented in the Green Paper. We believe the Green Paper is an important first step in the Commission's efforts to understand more fully certain aspects of the financial system. The stated purpose of the paper is to "take stock of current development, and to present on-going reflections on the subject to allow for a wide-ranging consultation of stakeholders." As a stakeholder in this debate, we think this is a worthwhile purpose and we commend the Commission for engaging in this consultation."
They tell us, "To assist in the Commission’s efforts to advance its general understanding and specific discussions of these issues, we focus our attention in this letter on the following matters, which we encourage the Commission to consider: The term "shadow banking" is confusing and misleading and, thus, should be discontinued in favor of terminology focusing on specific activities. Some of the activities classified by the Commission as part of the shadow banking system are quite transparent and adequately disclosed and do not fit within the proposed definition. Some of the activities contribute positively to the broader financial system and, as such, further regulatory action should occur only after careful consideration. Prudential regulation based on the bank regulatory model may not be applicable or appropriate for mitigating risk in many activities treated in the Green Paper. Further regulation may not be required for some activities, such as MMFs, since existing regulation adequately addresses any risks they may present."
Fidelity adds, "Refining the terms of the discussion and the concepts they represent is critical before policymakers and regulators can begin to consider what reforms, if any, are needed for individual activities, including those described in the Green Paper. In addition, there is a significant amount of variation across different jurisdictions that caution against adopting one single approach to reform. For example, differences in the relative size and maturity of national economies, in activities between jurisdictions, in legislative and regulatory frameworks and in the investor and customer bases of financial services firms all should be considered when evaluating the proper course of reform. Without greater precision, policymakers and regulators run the risk of adopting standards that do not efficiently or effectively solve for the risks at hand and, in turn, miss the desired end-state, in which stable financial markets support sustainable economic growth and "a business environment that allows companies to thrive, innovate and expand their activities.""
Finally, the letter adds, "As we highlighted in our response to question (a), we encourage the Commission to discontinue the use of the term "shadow banking" and instead focus on individual activities. The MMF example illustrates why the term "shadow banking" is inappropriate. For those activities like MMF management to which the term does not apply and for which an appropriate regulatory response has already been established, the Commission should acknowledge that the existing regulatory regimes are sufficient and instead should focus its efforts on activities in greater need of attention."
Today, we excerpt from our latest fund family "profile", "New Queen of Cash: Fidelity's Nancy Prior." The June issue of Money Fund Intelligence interviews Fidelity's Money Market Group President Nancy Prior this month, asking her about ultra-low rates, regulatory reform, and recent challenges. We also touch on the largest money fund provider's venerable history, customer concerns and some other issues in the money market mutual fund space. Our Q&A follows.
Q: Tell us about Fidelity's history, and your history, in the money fund space. Prior: Fidelity has been in the money market fund business for several decades. It is a very important business to us.... Money market funds represent a significant amount of Fidelity's assets under management. We have been at the forefront of innovation in the money market space, whether it be check writing or other features. So Fidelity has a very long and proud history in the money market fund business. I have been with Fidelity just over 10 years now and all of that time has been with the fixed income division. I actually started my career at Fidelity back in 2002, as part of the fixed income legal team. In 2009, I became managing director of research and was responsible for all credit research related to global financial institutions.... [I]n November of 2011, I became the President of our money market group.
Q: What would you consider to be Fidelity's main differentiator in the space? Prior: We have a common set of goals, and a money market fund investment mandate that is crystal clear in all of our minds, which is to give our shareholders a one dollar stable NAV, liquidity and a market-based rate of return. We are very focused on credit research. We have over 80 analysts that are dedicated to working with our traders and portfolio managers constructing appropriate portfolios. We take our obligations under Rule 2a-7 for making minimal credit risk determinations very seriously and have resourced our credit research department accordingly. We monitor every single dollar, every hour. Having people on the ground in the right time zone, and developing relationships with issuers' management teams and local regulators is very important. We have a group of analysts that are responsible for different jurisdictions throughout Europe. They can hop on a plane or a train and be in Germany, Brussels or France in an hour, and that is very valuable.
One other significant differentiator is the incorporation of macro analysis in our process. Historically, looking at financial institutions and other issuers, the key focus of the analysis was always on the fundamental strength of an individual issuer. What are their assets? Who is their management team? What is their funding profile? What is the quality of their assets? It was really focused on an individual issuer and basing minimal credit risk determinations on the fundamental strength of that issuer. Clearly over the last few years, the balance in terms of the weight that macro analysis plays in credit analysis for an individual issuer has changed. With that balance now shifted, a good portion of what we choose to invest in is driven by macro analysis. We always will start with the questions: 'Does an issuer represent minimal credit risk? What is the fundamental strength of an individual issuer?' But the macro overlay today is far "weightier" than it was in the past.
Q: What is your biggest challenge now? Prior: I think it has been dealing with the markets. We continue to be in a low rate environment with lots of volatility and uncertainty. As money market fund investors, that situation dictates that we continue to invest very conservatively. The rate environment and volatility are what we focus in on every day, making sure that we carefully review and consider everything we own. One of our mantras here is 'Know what we own it and why we own it.' We focus everyday on how events might impact those decisions. We are also looking at some of the bank ratings issues that are approaching. You've got Moody's looking at global banks and how potential ratings changes may affect some of largest financial institutions in the world. Between uncertainty and potential downgrades in Europe and here in the States, our investable universe continues to become smaller. We have partially responded to that trend by increasing our allocations to U.S. government securities and overnight repos.
Q: What are the funds buying and what aren't they buying now? Prior: We generally don't comment on specific securities, but I can tell you that we have a process that includes an "approved" list. For each issuer there is a dedicated analyst, because we believe in front line accountability. We invest only in banks and other corporations that we believe represent minimal credit risk. Our maturity limits for many of those institutions have been shortened, primarily in response to larger macro issues. We are investing quite conservatively and defensively.
Q: What are customers concerned about? Prior: There are still concerns over Europe, though certainly not to the extent that we saw last summer. We tend to be very proactve in our shareholder relationships. We have a great client relationship team that reaches out to clients to learn what is on their minds and to make sure that they understand our philosophy and current thinking. I think the new holdings disclosures that are available to clients, combined with our proactive client outreach have done quite a bit to ease customers' concerns. We know that our customers are focused on many of the same things we are focused on, which includes the low rate environment, and credit market volatility, particularly in Europe. We have been proactive in communicating to our clients that we are not invested in Greece, Portugal, Ireland, Spain or Italy.
Deutsche Bank's William Prophet wrote in a commentary last week entitled, "This Won't Hurt a Bit," that "There are two distinct observations worth making about the May month-end holdings of the U.S. money fund industry. First, unsecured lending to Europe didn't really change all that much last month.... [A]mong this sample anyway, we would say that lending patterns have been remarkably stable so far this year (all things considered). And there can be no doubt that this is the main reason why the LIBOR setting has been stable as well."
He continues, "And lending to Europe appears to be even more stable when we take secured funding into account.... When both secured and unsecured loans are accounted for, lending to Europe fell for the first time in eight months during May, and even then it was a relatively small change. And we're sure that geographic dynamics are largely responsible for this stability.... [N]otice how not much has happened since then. The numbers have indeed fallen a bit further for a few of these countries. But it's pretty clear that the U.S. money fund industry has decided that no matter what happens to the EUR, the banks of certain countries will remain safe (or necessary?) places to invest."
Prophet explains, "And this brings us to our second observation. Perhaps an even more relevant topic at this point is how all these dynamics change in the event of a broad Moody's downgrade of U.S. banks.... [W]hereas [retail deposits] represented only about 55% of total bank liabilities back in 2008, they now represent over 75%. And at the same time there has been an equally sharp decline in what we would call "institutional" funding.... [T]he main takeaway here is that lending to U.S. banks represents a very small component of U.S. money fund balance sheets these days, with unsecured lending representing just 2% of total assets. And by the way, the levels here haven't really changed in over 2 years."
He writes, "In other words, given that U.S. banks are borrowing less within the "institutional" market, no one should be surprised to see data consistent with this among the U.S. money funds themselves. The overall numbers are a bit higher for the secured market (we estimate that 7% of money fund balance sheets are repo's with U.S. bank counter-parties) but it's entirely fair to say that U.S. banks are not doing a lot of business with U.S. money funds these days, which explains why the latter is lending to Europe."
Prophet tells us, "The broader point here is that we think a broad Moody's downgrade of the U.S. banking system would actually have a somewhat limited impact on short rates. There will of course be the knee-jerk reaction within euro-dollars which will depend upon how many banks actually see their ratings go down. But we just don't see the leverage among U.S. banks whereby a broad downgrade would be a truly critical event for funding markets."
He adds, "And there are a couple of other dynamics to keep in mind as well, although these are much broader in scale. First, there has been a radial decline in the overall demand for short-term funding within the U.S.... This has been offset by a decline in assets among money funds, but it's instructive to compare the total amount of funding supply to the level of demand.... In short, the gap between the supply of cash assets and the demand for short-term funding is wider than it's ever been. And so the bottom line is that credit ratings do matter, but it's hard to draw up a scenario where there is material, sustained upward pressure on funding rates as there appears to be some serious supply/demand imbalances here."
Finally, Prophet comments, "As a very final thought on this topic, it is indeed strange how high funding rates are given the low level of longer-maturity yields. Indeed judging from the front end of the U.S. curve, you would never guess that global financial markets are anywhere near a crisis. And this would seem to suggest that there is indeed a lack of funding supply. But we think the level of short-term rates is being kept high by some temporary factors and on a structural basis, there is plenty of downward pressure on short rates."
Crane Data's latest Money Fund Portfolio Holdings collection, with taxable money fund data as of May 31, 2012, was released to our Money Fund Wisdom subscribers on Tuesday. Our most recent statistics show Repurchase Agreement (Repo) holdings increased by $8.5 billion in May to $564.8 billion, a record 25.0% of holdings. There was a pronounced shift away from Other Repo (down $35.6 billion to $90.0 billion, or 3.98% of all holdings) and a jump in Treasury Repo (up $26.6 billion to $184.4 billion, or 8.2% of holdings) and in Government Agency Repo (up $17.5 billion to $290.4 billion, or 12.8% of holdings). Treasury Debt plunged again by $38.4 billion, or 1.5%, to $429.8 billion, or 19.0% of holdings, the second largest segment after Repo. CDs remained the third largest holding segment with $406.0 billion, or 18.0% of taxable money fund assets.
Government Agency Debt rose slightly to $312.2 billion (13.8%). CP inched lower to $353.3 billion (15.6%). CP was comprised of $182.9 billion (8.1% of all holdings) in Financial Company CP, $110.8 billion (4.9%) in Asset Backed Commercial Paper, and $59.6 billion (2.6%) in Other CP. Other securities increased to $121.2 billion (5.4%) with Other Notes (the largest subcategory of this segment) falling to $81.7 billion (3.6%). VRDNs accounted for $74.5 billion (3.3%) of the total securities held by taxable money funds as of May 31, 2012.
Among all Taxable money funds, the U.S. Treasury remains by far the largest issuer with 19.0% of all investments ($429.8 billion). (Treasuries are the largest segment of Prime money funds too at 9.4%, or $117.8 billion of the total.) Federal Home Loan Bank again ranked second among money market issuers with $140.0 billion (6.2%) of the money held in taxable money funds tracked by Crane Data's MF Portfolio Holdings collection. Barclays Bank remained in third place with $96.6 billion (4.3%) of Taxable holdings. Deutsche Bank remained in fourth place with $90.2 billion (4.0%), while Federal Home Loan Mortgage Co. ranked fifth with $71.1 billion (3.1%) of outstandings among taxable money fund holdings.
The rest of the top 10 issuers include: Bank of America ($66.1B, 2.9%), Federal National Mortgage Assoc. ($63.7B, 2.8%), Credit Suisse ($63.0B, 2.8%), Bank of Nova Scotia ($50.2B, 2.2%), and Citi ($46.8B, 2.1%). Numbers 11-20 include: JPMorgan ($45.8B). Bank of Tokyo-Mitsubishi UFJ Ltd ($45.4B), RBC ($44.9B), Sumitomo Mitsui Banking Co ($42.6B), Societe Generale ($42.5B), National Australia Bank Ltd ($41.5B), Goldman Sachs ($40.5B), Rabobank ($37.6B), RBS ($36.6B), and UBS ($33.1B).
J.P. Morgan Securities' latest "Short-Term Market Research Note: Update on prime money fund holdings for May 2012 comments, "Total bank exposures remained about flat at about $1tn but prime MMFs shifted some of their bank holdings away from European banks to non-European banks as Eurozone headlines intensified in May. Concerns surrounding the Eurozone and its banks has had limited impact on prime MMF portfolios this year as exposures to Eurozone banks were trimmed significantly last year. The larger concern for prime MMFs currently is the ongoing Moody's bank ratings review, particularly those of firms with global capital market operations (GCMIs).... This concern has been most visible in the repo markets, where fund managers have reallocated away from non-traditional repo driven by the impending downgrades. Most of this money has been reallocated to Treasury and agency repo, which are less impacted by the downgrades."
JPM's Alex Roever adds, "We estimate that GCMIs borrowed $220bn from prime MMFs in repo and another $290bn from government MMFs as of May month-end. Together ($510bn), this represents about 89% of all repo held by taxable MMFs. In anticipation of GCMI downgrades, MMFs (prime and government) decreased their exposures to repo collateralized by non-government securities (-$45bn) in favor of repo collateralized by Treasury or agency repo (+$68bn), much of which are overnight in maturity. Prime MMFs accounted for about $15bn of the decline in non-government repo and $20bn of the increase in government repo."
Note that Crane Data just added an online query tool to its Money Fund Portfolio Holdings spreadsheets and reports entitled, Money Fund Portfolio Laboratory. Our new "Laboratory," available to Money Fund Wisdom subscribers under the Wisdom option on our main menu or at: http://cranedata.com/lab/, allows users to "X-ray" portfolios of money funds and examine their holdings, country exposure, maturity distributions, composition, and Issuer concentrations. (E-mail Pete to request trial access or a demo, and to see our entire suite of "transparency" and portfolio holdings products.)
Federal Reserve Board Governor Daniel Tarullo spoke Tuesday on "Shadow Banking After the Financial Crisis." He said, "The three decades preceding the financial crisis were characterized in the United States by the progressive integration of traditional lending and capital markets activities. This trend diminished the importance of deposits as a source of funding for credit extension in favor of capital market instruments sold to institutional investors. It also altered the structure of the financial services industry, both transforming the activities of broker-dealers and fostering the emergence of large financial conglomerates. Although the structure of foreign banking systems was less noticeably changed, many foreign banks drew increasingly on the resulting wholesale funding markets and made significant investments in the mortgage-backed securities that had proliferated in the first decade of this century."
Tarullo continued, "The financial crisis underscored the failure of the American regulatory system to keep pace with these developments and revealed the need for two reform agendas. One must be aimed specifically at the problem of too-big-to-fail institutions. The other must be directed at the so-called shadow banking system, which refers to credit intermediation involving leverage and maturity transformation that is partly or wholly outside the traditional banking system. As I have noted on other occasions, most reforms to date have concentrated on too-big-to-fail institutions, though many of these reforms have yet to be fully implemented. The shadow banking system, on the other hand, has been only obliquely addressed, despite the fact that the most acute phase of the crisis was precipitated by a run on that system. Indeed, as the oversight of regulated institutions is strengthened, opportunities for arbitrage in the shadow banking system may increase."
He explained, "The growing demand for safe and liquid assets was met largely by the shadow banking system's creation of assets that were seemingly safe and seemingly liquid. New varieties of shadow-banking activities were created, some pre-existing types grew larger, and the shadow banking system became much more internationalized. For example, the volume of asset-backed commercial paper, or ABCP, grew enormously. Many ABCP vehicles issued short-term, highly rated liabilities and bought longer-term, highly rated securities, often mortgage-backed securities. Many of the vehicles were sponsored abroad, especially by European banks, which issued dollar-denominated ABCP in the U.S. market and bought dollar-denominated assets in the U.S. market. The overall volume of this activity was very large, although the net flows between the U.S. and Europe were not, leaving European bank sponsors of such ABCP vehicles with a huge exposure when market participants stopped believing that ABCP was risk-free."
Tarullo told a San Francisco audience, "It now seems clear that the tail risk associated with many shadow-banking instruments was not understood by many market actors, including both sellers and buyers. An important contributing factor on the buyers' side that helped set the stage for the 2007-2008 financial crisis was the widespread acceptance that risk-free assets could be created by augmenting what was already thought to be a low-risk asset with a promise from a large financial institution to provide liquidity or bear credit losses in the unlikely event that such support might be needed. When, in stressed conditions, the credibility of the promise came into question, the susceptibility to runs increased dramatically."
He commented, "In some cases, there were explicit contractual provisions for liquidity support or credit enhancements, such as were provided to ABCP vehicles by their sponsoring banks. In other cases, the support was more implicit, and was conveyed in the marketing of the assets or through an historical pattern of providing support. Forms of implicit credit support were present in a variety of important funding channels and, to a considerable degree, persist today. Three examples are money market funds, the triparty repo market, and securities lending."
Tarullo said, "Money market funds aim to maintain a stable net asset value of one dollar per share and to meet redemption requests upon demand. As such they are the very model of a nonbank "deposit" or cash equivalent. Unlike other mutual funds, money market funds are allowed to round their net asset values to one dollar per share so long as the underlying value of each share remains within one-half cent of a dollar. But a drop in the unrounded net asset value of more than one-half of one percent causes a money fund to "break the buck," a scenario in which losses, at least in theory, would be passed along to the fund's investors."
He explained, "However, fund sponsors historically have absorbed losses whenever necessary to prevent funds from breaking the buck, with only two exceptions. Even though they had no legal obligation to do so, sponsors voluntarily supported their funds more than 100 times between 1989 and 2003, presumably because allowing a fund to break the buck would have damaged the sponsor's reputation and franchise. This tendency was well understood by investors. Indeed, a standard reference book on money markets states that a "money fund run by an entity with deep pockets, while it may not have federal insurance, certainly has something akin to private insurance ... likely to prove adequate to cover any losses sustained by the fund."
Tarullo told the "shadow banking" event crowd, "Many money funds sustained significant capital losses when the market for asset-backed commercial paper collapsed in the summer and fall of 2007. As in previous decades, losses at money funds were absorbed by the funds' sponsors. Indeed, money funds were seen as highly safe in 2007 and received large net inflows as concerns about other portions of the financial system increased."
He explained, "But when, in 2008, the Reserve Primary Fund did not provide support for the relatively small losses at its money market fund, the illusion that money funds were effectively as safe as insured bank accounts was shattered. A general run on money funds ensued. Within two days, investors withdrew nearly $200 billion from prime money market funds, about 10 percent of their assets. This contributed to severe funding pressures for issuers of commercial paper. The run ultimately prompted--and was stopped by--unprecedented interventions by the Treasury and the Federal Reserve to provide insurance and liquidity support to the industry."
Later, he commented, "Although the experiences of money market funds, triparty repos, and securities lending vary in the details, they all share a common underlying pathology: Offering documents with stern warnings notwithstanding, explicit and implicit commitments combined with a history of discretionary support to create an assumption, even among sophisticated investors, that low-risk assets were free of credit and liquidity risk -- effectively cash, but with a slightly higher return. This risk illusion led to pervasive underpricing of the risks embedded in these money-like instruments and made them an artificially cheap source of funding. The consequent oversupply of these instruments contributed importantly to systemic risk."
Tarullo said, "Let me then suggest three more-or-less immediate steps that regulators here and abroad should take, as well as a medium-term reform undertaking. First, we should create greater transparency with respect to the various transactions and markets that comprise the shadow banking system. For example, large segments of the repo market remain opaque today. In fact, at present there is no way that regulators or market participants can precisely determine even the overall volume of bilateral repo transactions--that is, transactions not settled using the triparty mechanism. It is encouraging that the Treasury Department's new Office of Financial Research is working to improve information about this market, while the Securities and Exchange Commission is considering approaches to enhanced transparency in the closely related securities lending market."
He continued, "Second, the risk of runs on money market mutual funds should be further reduced through additional measures to address the structural vulnerabilities that have persisted even after the measures taken by the SEC in 2010 to improve the resilience of those funds. The SEC is currently considering several possible reforms, including a floating net asset value, capital requirements, and restrictions on redemption. Clearly, as suggested by Chairman Schapiro, action by the SEC to address the vulnerabilities that were so evident in 2008, while also preserving the economic role of money market funds, is the preferable route. But in the absence of such action, there are several second-best alternatives, including the recent suggestion by Deputy Governor Tucker of the Bank of England that supervisors consider setting new limits on banks' reliance on funding provided by money market funds."
Finally, Tarullo said, "The shadow banking system today is considerably smaller than at the height of the housing bubble six or seven years ago. And it is very likely that some forms of shadow banking most closely associated with that bubble have disappeared forever. But as the economy recovers, it is nearly as likely that, without policy changes, existing channels for shadow banking will grow, and new forms creating new vulnerabilities will arise. That is why I suggest what is, in essence, a two-pronged agenda: first, near-term action to address current channels where mispricing, run risk, and potential moral hazard are evident; and, second, continuation of the academic and policy debate on more fundamental measures to address these issues more broadly and proactively."
The Investment Company Institute's Paul Schott Stevens responded to Monday's Wall Street Journal Editorial with a brief entitled, "Forcing Money Market Funds to "Float": Hurting Investors, Increasing Risk." Stevens writes, "It's rare to see the Wall Street Journal editorializing in favor of regulation for regulation's sake. But in repeatedly endorsing the Securities and Exchange Commission's campaign to force money market funds to "float" their per-share price ("`Republicans Against Reform," Review & Outlook, June 11), the Journal supports new rules that will harm investors without helping taxpayers or the financial system. The stable $1.00 net asset value (NAV) of money market funds reflects market reality, not accounting fiction. In fact, investors already know that money market fund portfolios can change in value. But money market funds consistently deliver a $1.00 share price by carefully managing their portfolios of short-term, high-quality assets."
He explains, "As a result, fluctuations in money market fund portfolios are miniscule: During the worst of the eurozone crisis in 2011, the prime money market funds with the greatest exposure to the eurozone saw their NAVs drop by 0.00009 percent -- less than one one-hundredth of a penny. Neither the SEC, the Federal Reserve, nor the Wall Street Journal has made an empirical case that forcing funds to "float" in such tiny increments would have any effect on investor behavior. Instead, what the floating NAV would do is force millions of individual and institutional investors to give up the convenience, stability, and liquidity of money market funds. It would force hundreds of billions of dollars into too-big-to-fail banks and into alternative funds that operate without the risk-limiting rules and transparency applied to money market funds. Rather than making the financial system safer, the floating NAV would increase risk in hidden pockets."
Stevens continues, "The Temporary Guarantee Program for money market funds, imposed by the Treasury Department in September 2008, earned taxpayers $1.2 billion in fees paid by funds, and didn't pay any claims. The program was small and temporary because the fund industry insisted on limits to prevent a destabilizing run from bank deposits to money market funds -- as the Journal's editors know from our conversations."
Finally, he adds, "Calls for structural changes to money market funds ignore the very real costs of this fruitless regulation -- damage to investors, damage to financing for business and state and local governments, and damage to the financial system through increased risk. Legislators who want the SEC to make its case before imposing those costs should be praised, not scolded."
In other news, the ICI also recently wrote a comment letter to the Office of the Comptroller of the Currency. (See Crane Data's April 11 News, "OCC Proposes Rules on 112 Billion Short-Term Investment Fund Market".) The ICI comment says, "The Investment Company Institute ("ICI") appreciates the opportunity to comment on the notice of proposed rulemaking that the Office of the Comptroller of the Currency ("OCC") has issued to revise the requirements imposed on banks pursuant to 12 CFR 9.18(b)(4)(ii)(B), the short-term investment fund ("STIF") rule ("STIF Rule"). We support the efforts of the OCC to improve investor protection by strengthening the resilience of STIFs and increasing the transparency of these products. ICI and its members have invested substantial time and resources in similar efforts to ensure the continued success of money market funds, another type of fund that also seeks to maintain a stable net asset value ("NAV")."
ICI General Counsel Karrie McMillan explains, "Since 1983, money market funds have been governed very effectively by the Securities and Exchange Commission ("SEC"), pursuant to Rule 2a-7, a carefully crafted rule under the Investment Company Act of 1940 that strictly limits the risks these funds can take. The framework of Rule 2a-7, combined with all the regulatory protections applicable to mutual funds in general, has made these funds, for more than 25 years, uniquely valuable to investors and an indispensable source of short-term financing in the U.S. economy."
She tells the OCC, "In 2010, the SEC approved far-reaching amendments to Rule 2a-7 that enhanced an already strict regime of money market fund regulation by imposing new credit quality, maturity, and minimum liquidity standards and increasing the transparency of these funds. These reforms proved their value last summer when money market funds -- without incident -- met large volumes of shareholder redemptions during periods of significant market turmoil, including a credit event involving the historic downgrade of the U.S. government debt."
The letter continues, "We are pleased that the OCC (also a member of the FSOC) in its proposal has recognized the significance of the SEC's 2010 amendments to Rule 2a-7. The Release suggests that the changes to the STIF Rule were "informed by" the SEC's actions. We urge the OCC to take full account of the reforms already implemented for money market funds as it changes its STIF Rule. Indeed, so far-reaching were these reforms that today's money market funds are dramatically different and more resilient to economic and financial shocks -- a fact that has largely been ignored by some in the regulatory community whose commentary seems predicated on the notion that the industry is unchanged since 2008. We therefore support efforts by the OCC to carefully study the money market fund regulatory regime, including the 2010 amendments, as part of its analysis of ways to improve investor protection by strengthening the STIF product."
We learned from a Reuters story that the Federal Reserve Bank of New York posted a piece yesterday entitled, "Money Market Funds and Systemic Risk." Written by Marco Cipriani, Michael Holscher, Antoine Martin, and the Fed Board of Governors' Patrick McCabe, it says, "On September 16, 2008, Reserve Primary Fund, a money market fund (MMF) with $65 billion in assets under management, announced that losses in its portfolio had caused the value of shares in the fund to drop from $1.00 to $0.97. The news that an MMF had "broken the buck" spread panic quickly to other MMFs. In the two days following Reserve's announcement, investors withdrew approximately $200 billion (10 percent of assets) from so-called "prime" MMFs, which, like Reserve, mainly invest in privately issued short-term securities. The massive redemptions and resulting strains on MMFs contributed to a freezing of the markets that provide short-term credit to businesses and financial institutions and a sudden spike in short-term interest rates. Responding to these severe disruptions, the Treasury Department intervened on September 19 with a government guarantee of the value of MMF shares, and the Federal Reserve announced on the same day a facility designed to provide liquidity to MMFs. These unprecedented actions stopped the run on MMFs (for more analysis of the run in 2008, see McCabe, 2010). In this post, we discuss why MMFs are a source of financial fragility and the need for reforms to mitigate the risks they pose to the financial system and the economy."
The NY Fed's Liberty Street Economics blog post explains, "Since 2008, policy makers, MMF industry participants, investors, and academics have considered options for reducing the vulnerability of MMFs to runs and limiting their contribution to systemic risk. Developments since the crisis have heightened the importance of these objectives. For example, Treasury's authority to provide a guarantee to MMF shareholders -- which was critical to stopping the run in 2008 -- was eliminated by legislation later that year. The European fiscal crisis has highlighted the need to mitigate MMFs' vulnerabilities, as European holdings made up more than half of prime MMFs' assets at times in early 2011. Meanwhile, institutional investors' heightened responsiveness to MMF risks since 2008 probably has exacerbated the susceptibility of MMFs to runs."
The paper continues, "Both the popularity of MMFs and their vulnerability to runs traces back, in large part, to their defining feature: MMFs usually maintain stable net asset values (NAVs), typically at $1 per share. Like other mutual funds, MMFs are regulated under the Investment Company Act of 1940. But MMFs also must follow SEC rule 2a-7, which imposes strict guidelines on their assets, while allowing them to employ pricing methods that help hold NAVs steady even when there are small changes in the values of MMFs' underlying assets."
It says, "The resulting stability of MMF share prices, combined with the liquidity investors enjoy in a product that allows redemptions (at least) daily, has made U.S. MMFs a very popular financial product for institutional and retail investors alike. Investors use MMFs for cash management, and with $2.7 trillion in assets under management at the end of 2011, MMFs represent about a quarter of all U.S. mutual fund assets. MMFs deploy investors' cash to provide short-term funding for financial institutions, other businesses, and governments, and the funds play key roles in short-term credit markets. For example, MMFs owned over 40 percent of U.S. dollar-denominated financial commercial paper outstanding at the end of 2011 and about one-third of dollar-denominated negotiable certificates of deposit."
The Fed piece adds, "But MMFs' stable NAVs and the methods used to keep them steady in normal times also make the funds susceptible to runs in unusual times, and these runs pose broad systemic risks. In part, these risks arise because the historical record of MMFs keeping NAVs steady (only two money funds have "broken the buck" since 1983, when the SEC adopted rule 2a-7) has attracted a large, highly risk-averse shareholder base that includes many institutional investors. These shareholders reportedly place great value on principal stability and are prone to fleeing money funds quickly at any sign of trouble. Importantly, because of the sheer size of the money fund industry and its importance in providing short-term funding to financial institutions, MMFs' vulnerability to runs not only puts their investors at risk, but also poses considerable systemic risk to the U.S. financial system, as was observed in the fall of 2008."
It states, "Although the stable NAV is critical for many MMF investors, no capital buffer protects a money fund's $1 share value. Instead, MMFs usually have relied on the SEC's risk-limiting rules for portfolio holdings and on rounding of their NAVs to the nearest cent, as permitted under those rules. But NAV rounding can create dangerous dynamics when a fund is in trouble: If a MMF has incurred a small loss (less than 0.5 percent of assets), it can continue to redeem shares at $1 apiece. However, by doing so, the fund concentrates the loss over a shrinking number of shares. Redeeming shareholders get $1 per share, while those who stay invested see their potential losses grow. Clearly, under such circumstances, shareholders have strong incentives to run."
The New York Fed blog tells us, "In addition, MMFs' liquidity management practices, while they contribute to principal stability, also increase investors' incentives to run from the funds. MMFs meet redemptions by selling their most liquid assets, rather than selling a cross-section of all of their holdings. This practice allows an MMF to avoid realizing losses from sales of less liquid securities and, as long as all investors do not redeem at once, effectively provides shareholders with more liquidity than they would have individually. But during periods of market strain, when less-liquid assets may sell at deep discounts, redeemers who receive $1 per share bear none of the implicit liquidity costs of their redemptions. Rather, remaining investors are left with claims on a less-liquid portfolio. For this reason, shareholders have an incentive to run from troubled money funds as they leave behind risks and costs to be borne by those who remain invested in the fund."
It adds, "Historically, when all else has failed, MMF sponsors (asset management firms and their affiliates) have voluntarily provided support -- when they have had the wherewithal to do so -- to prevent shareholder losses. Indeed, sponsor support has been crucial for MMFs' apparent price stability. For example, the SEC documented 100 cases in which MMFs received support from sponsors during the 2008 crisis alone (see "Money Market Fund Reform: Proposed Rule"). Notwithstanding language in MMF prospectuses stating that the funds' shares are risky, sponsor support probably has led many investors to view MMFs as safer than their underlying assets and thus has attracted highly risk-averse investors. Yet, sponsors are not required to demonstrate an ability to support MMFs, and no capital requirements or other rules ensure that money will be available during crises to hold NAVs at $1. So, if investors doubt the ability of a sponsor to prevent losses, they have strong incentives to redeem shares before others do. In September, 2008, Reserve's announcement that its MMF had broken the buck evidently undermined investor confidence that sponsors would provide support and sent MMF shareholders running for the exits."
Finally, the piece says, "How to mitigate the vulnerability of MMFs to runs? In January 2010, the SEC strengthened rule 2a-7 by requiring that MMFs hold substantial amounts of highly liquid assets, shortening the maximum average maturities of MMF portfolios, limiting holdings of certain risky assets, and mandating monthly disclosure of portfolio holdings. The new rules made MMFs more resilient to strains, including heavy redemptions and changes in interest rates. But SEC Chair Mary Schapiro made clear in a speech, even as the new rules were announced, that more was needed. In particular, MMFs can still take risks similar to those that destroyed the Reserve Primary Fund and triggered the damaging run in 2008: MMFs still use the same set of tools, including rounded NAVs, to maintain principal stability; and investors still have incentives to run at the first sign of trouble. Thus, the SEC's current efforts to modify the structure of MMFs to reduce incentives to run may be essential not only for protecting MMF investors -- especially retail investors -- but also for protecting the stability of the U.S. financial system and maintaining the access of businesses, consumers, and governments to credit. In a future post, we intend to describe a proposal for improving the stability of MMFs by making them less vulnerable to runs."
Friday's "Short-Term Fixed Income" update from J.P. Morgan Securities discusses Moody's bank ratings reviews and pending downgrades, and their impact on money market fund portfolio holdings, among other things. The piece says, "Since mid-February, when Moody's first announced its review of both Global Capital Market's Institutions (GCMIs) and global banks, the credit markets have not-so eagerly anticipated the results. Following a short delay -- understandable given the scale of its task -- Moody's has been adjusting ratings lower, generally following the order it previously announced. This past week, the agency adjusted its ratings on Austrian and German banks, and the GCMIs are now next on the list. For the GCMIs, the moment is here."
JP Morgan's weekly writes, "We have previously noted that even if all the GCMIs' ratings are cut to the lowest level originally suggested by Moody's, it should not trigger a funding crisis in short term debt because both issuers and investors have had months to prepare. Later in this note, we present data on the degree to which MMFs have prepared. It is also worth noting that some of the investors most sensitive to Moody's ratings -- the Moody's rated MMFs -- have some latitude under fund rating guidelines to continue to hold downgraded debt, even bank debt downgraded to P-2. So, fund guidelines should not precipitate liquidations upon a Moody's downgrade."
It explains, "As of this writing, Moody's has yet to conclude its ratings review of GCMIs and to many money market participants, this is the main event as these institutions are often the largest borrowers in the money markets, particularly through the repo market. According to our estimates using MMF holdings data (including government MMFs), GCMI counterparties represented about $510bn or 89% of total repo held by MMFs."
The piece continues, "Our initial May month-end estimates reveal that MMFs significantly reduced exposures month-over-month to "other repo", which consist of repo collateralized by nongovernment securities, shifting exposures to repo collateralized by treasuries, agency debt, and agency MBS. This shift was likely driven mostly by funds that carry fund ratings from Moody's. From a Moody's fund ratings perspective, "other repo" would fall under non-traditional repo which count as exposure to the counterparty, whereas overnight repo collateralized by Aaa-rated government or government-related securities receive look-through treatment. As the ratings conclusions became more imminent, MMFs rolled their nongovernment repo to government repo, much of which are overnight in maturity."
JP Morgan adds, "We also remind our readers that from a money fund ratings perspective, for entities not rated by Moody's, the agency looks to the parents' ratings (many who are also facing downgrades) of the unrated entities to assess ultimate credit quality. This applies to many primary dealers that are not rated by Moody's but have parents who are rated. This may sound very onerous for Moody's rated funds but Moody's fund ratings criteria, in some ways, are less restrictive than those of S&P and Fitch."
Finally, the weekly tell us, "Moody's matrix approach considers the maturities of the securities along with their credit quality, which allows a bit more flexibility in managing the overall credit quality of the portfolio than S&P or Fitch's fund ratings methodologies, which bar the holding of any Tier-2 (A-2/F2) rated security. Even with potential downgrades of active repo counterparties looming, we don't expect MMFs in aggregate to trim repo exposures significantly in the coming weeks. With repo levels still elevated, which we expect will continue to be the case at least until the end of Operation Twist, and levels cheap versus repo substitutes like T-bills and agency discos, we expect demand for repo to remain fairly stable in the near term."
The Securities and Exchange Commission recently announced "that it is re-opening the public comment period for proposed amendments to its net capital, customer protection, books and records, and notification rules for broker-dealers." This proposal includes possible changes to Rule 15c3-3, which governs the use of collateral on broker reserve funds and the possible use of money funds for this purpose. (See the release, "SEC Reopens Comment Period for Proposed Amendments to Its Net Capital, Customer Protection, Books and Records, and Notification Rules for Broker-Dealers and the posting under the SEC's Proposed Rules website area.) The SEC explains, "The proposed rule amendments are designed to update the financial responsibility rules for broker-dealers and make certain technical amendments. The Commission issued the proposed amendments on March 9, 2007, and the public comment period on the proposal closed on June 18, 2007. The Commission did not act on the rule amendments it proposed in 2007. Given economic events, regulatory developments, and passage of time since then, as well as the continuing public interest in this area, the Commission believes that it would be appropriate to seek additional public comment on the proposed rule amendments. Accordingly, the Commission is reopening the public comment period for 30 days."
A number of money funds commented last time around, including Federated Investors, which has now posted a new comment, this one by Lee A. Pickard, Pickard and Djinis LLP, on behalf of Federated Investors, Inc.. (See Comments on Amendments to Financial Responsibility Rules for Broker-Dealers.) Pickard writes on the "Proposed Rulemaking Regarding Amendments to Financial Responsibility Rules for Broker-Dealers," "This letter presents comments on behalf of Federated Investors, Inc. ("Federated") on the Commission's reconsideration of the proposed amendments to the customer protection rule (Rule 15c3-3) initially proposed by the Commission in "Amendments to Financial Responsibility Rules for Broker-Dealers, Proposed Rule," 72 Fed. Reg. 12861 (Mar. 19, 2007)(the "2007 Rule Proposal")."
He says, "In the 2007 Rule Proposal, the SEC proposed, among others, to expand Rule 15c3-3(a)(6) to include money market funds that only invest in securities meeting the definition of "qualified securities" in Rule 15c3-3. As Federated stated then -- and which continues to be true today -- there is a demand in the broker-dealer industry for greater options to place undeployed customer funds. Broker-dealers, who are customers of Federated, maintain significant funds in their Special Reserve Accounts to meet their Rule 15c3-3 deposit requirements. It is estimated that aggregate requirements for deposits in Rule 15c3-3 segregated accounts at times have exceed 180 billion dollars. The proposed amendment, if adopted, will provide a much needed additional option; improve broker-dealers' operational flexibility in meeting their obligations under Rule 15c3-3; avoid the burdens of actively managing a portfolio of U.S. Treasuries; and will allow broker-dealers to obtain more competitive yields on such assets while, at the same time, not compromise the Rule 15c3-3's Congressional purpose of safeguarding customers' deposits or credit balances."
Pickard and Federated continue, "Indeed, U.S. government money market funds are closely related to U.S. Treasury securities and cash. Investing customer funds segregated in a Rule 15c3-3 account in U.S. government money market funds, U.S. Treasuries, or interest-bearing checking accounts serves the same purpose -- to protect the value of a customer's funds with little risk to the customer due to the non-speculative, liquid nature of these types of holdings. The financial markets as well as the Commission recognize money market funds as cash items. The Financial Accounting Standards Board ("FASB"), the highest authority in establishing generally accepted accounting principles for public and private companies, identifies money market funds as cash equivalents, and the Commission has acknowledged that "money market fund shares generally are equivalent to cash items. Accordingly, U.S. government money market funds should be included under the definition of "qualified securities."
They tell the Commission, "Since the 2007 Rule Proposal release, the financial industry has experienced the 2008 financial crisis, bringing into question the credit and liquidity risks attendant to a number of business practices. Here, however, given the very restrictive composition of the portfolio which would be allowed for a U.S. government money market fund (i.e., only securities issued or guaranteed by the United States Government or cash), the issue of credit worthiness and liquidity is satisfactorily addressed. The portfolio of a U.S. government money market fund would not be subject to default. Nor would a U.S. government money market fund portfolio be without ready buyers or sellers if the need arose, as the U.S. government securities market is extremely liquid. The safety record of U.S. government money market funds further supports the acceptability of this financial instrument for Rule 15c3-3 deposit requirements. There have been no defaults in the type of U.S. government money market fund proposed in the 2007 Rule Proposal. Indeed, during the most volatile period of the credit crisis (September 2, 2008 through October 28,2008), institutional U.S. government money market assets grew $403 billion."
Pickard adds, "In further support of the use of U.S. government money market funds as an appropriate investment vehicle for customer segregated funds, we note that since the 2007 Rule Proposal release and the 2008 financial crisis, the Commodity Futures Trading Commission has adopted amendments to CFTC Rules 1.25 and 30.7 decisively affirming the use of U.S. government money market mutual funds as a permitted investment for customer funds held by Futures Commission Merchants under the CFTC's customer segregation rules. In determining to permit with virtually no limits the use of U.S. government money market funds, the CFTC analyzed the safety provided by enhanced SEC Rule 2a-7 and the equivalency of a U.S. government money market fund to a self-managed U.S. Treasury portfolio, as well as the operational and administrative efficiencies of U.S. government money market mutual funds. The Commission's fellow agency concluded that the permissible use of U.S. government money market funds for customer segregated funds is consistent with the prudential standards of preserving principal and maintain liquidity."
He writes, "The CFTC's findings are particularly relevant here as the SEC and the CFTC each have well-established programs for the segregation of customer funds held by a broker-dealer or FCM, and both permit the broker-dealer or FCM to place customer funds into specific investment options. These regimes are fundamentally the same. SEC Rule 15c3-3 requires broker-dealers to account for all customer funds held by the broker-dealer and permits customer funds to be invested in securities which enable their prompt return in the event of insolvency. Similarly, CFTC Regulation 1.20 requires FCMs to treat customer funds separately, permitting customer funds to be invested in securities which preserve principal and maintain liquidity. Attach hereto is a letter to Mr. Robert W. Cook, Director of the Division of Trading and Markets, of January 5, 2012 which highlights the CFTC's approval process for the use of U.S. government money market funds for customer segregated funds and recommends that the Commission similarly permit such use."
Finally, Pickard and Federated conclude, "U.S. government money market funds did not exist in 1972 when the Commission adopted Rule 15c3-3 and permitted broker-dealers to deposit only cash or Treasury securities in the Reserve Account. The addition of U.S. government money market funds provides an appropriate alternative for the investment of Rule 15c3-3 customer funds and would facilitate the placement of this large pool of customer cash among a greater number of financial institutions. Federated strongly endorses the Commission's 2007 Rule Proposal to amend Rule 15c3-3(a)(6) to include U.S. government money market funds."
The June issue of Crane Data's Money Fund Intelligence was e-mailed to subscribers Thursday morning, along with our May 31, 2012 monthly performance data and rankings, our Money Fund Intelligence XLS monthly spreadsheet, our Money Fund Wisdom database query website and our Crane Index money fund averages series. (Our monthly Money Fund Portfolio Holdings with 5/31/12 data will be distributed on the 8th business day, June 12.) The new edition of MFI features the articles: "State of the Money Fund Industry: Facts and Figures," which reviews recent statistics and previews Peter Crane's "State" speech for Money Fund Symposium; "New Queen of Cash: Fidelity's Nancy Prior," our monthly fund "profile" which interviews the new Fidelity Money Market Group President; and, "MFs Not Shadow Banks, Fund Industry Tells IOSCO," which excerpts recent comment letters to the SEC and International Organization of Securities Commissioners.
Our lead piece says, "As our Peter Crane prepare to give another "State of the Money Fund Industry" talk at our annual Crane's Money Fund Symposium conference in two weeks (Pittsburgh, June 20-22), we thought we'd give readers a brief preview and show several charts included in the presentation. In addition to Crane Data's asset, expense and trend data, we also excerpt some of the ICI's latest graphics published in their annual "Fact Book.... The state of money funds, while far from strong, is not that bad considering the ridiculous amount of pressures on the business."
Our latest Profile, which we'll excerpt later this month, tell us, "MFI interviews Fidelity's Money Market Group President Nancy Prior this month, asking her about recent challenges, ultra-low rates, and regulatory reform. We also touch on the company's history, customer concerns and a number of other issues in the money market mutual fund space. Our Q&A follows."
The third feature piece in our monthly says, "We're probably not the only ones who had no idea who IOSCO, or the International Organization of Securities Commissioners, was just a couple of months ago. Though the organization doesn't seem to have any jurisdiction in the United States, you wouldn't know it from the comment letters piling up on the SEC's President's Working Group Request for Comment web page. Mutual fund companies have taken this opportunity to yet again lambast the series of radical changes to money fund regulations that have been floated by U.S. and European regulators to date, and they've also used it to refine their arguments against regulators claims that funds are susceptible to runs and are "shadow" banks."
The June MFI also contains monthly News, Indexes, top rankings and extensive performance tables. E-mail firstname.lastname@example.org to request the latest issue. Subscriptions to Money Fund Intelligence are $500 a year and include web access to archived issues and fund "profiles". Additional users are $250 and bulk pricing and "site licenses" are available. Crane Data's other products include: Money Fund Intelligence XLS ($1K/yr), MFI Daily ($2K/yr), Money Fund Wisdom ($4K/yr), MFI International ($2K/yr), and Brokerage Sweep Intelligence ($1K/yr).
Two articles posted late Tuesday brought a rare dose of good cheer to money market mutual fund managers and investors. The Wall Street Journal, in a piece entitled, "House Republicans Seek to Delay Money-Fund Reforms," writes, "House Republicans are seeking to delay a new regulatory plan for the $2.6 trillion money-market mutual-fund industry, signaling in a bill introduced Tuesday they want the Securities and Exchange Commission to study prior changes to its rules before moving forward with any new reforms. Under a provision tucked into a GOP-backed appropriations bill for the fiscal year beginning Oct. 1, the SEC would have to analyze the 2010 reforms designed to improve the resilience of the industry." Also, a Reuters story, "Money funds rates ultra low but "no place to go"," tells us, "The miniscule interest rates being paid by money market mutual funds are making many investors restless, but wealth advisers are urging most to stay the course."
The Journal article explains, "SEC Chairman Mary Schapiro, joined by Federal Reserve and Treasury Department officials, see money-market funds as one of the weakest links in the financial system, despite the 2010 changes that included tighter standards on the kinds of securities funds could hold and a new requirement that funds keep enough cash on hand to meet "reasonably foreseeable redemption requests." Ms. Schapiro has said she is concerned funds remain susceptible to sudden drops in the value of securities they own. She also warns regulators no longer have access to the tools they used to buttress the industry during the financial crisis in 2008."
It adds, "A House Republican aide said the SEC hasn't done the diligence to show the effectiveness of the 2010 reforms or show any additional reforms are needed. An SEC spokesman declined to comment on the proposed study, which the SEC would have 90 days to complete after the passage of the fiscal 2013 budget, assuming the House language becomes law. Though the SEC would not be required to complete the study before it proposes any new money-market-fund reforms, doing so would likely anger its appropriators who set SEC funding levels, regulators and Capitol Hill aides said."
The Reuters piece comments, "Already historically low U.S. short-term interest rates have dipped even lower in recent weeks as investors fleeing financial turmoil in Europe have sought safe havens. But investors have little to fear that rates could turn negative on money market funds, and alternatives like bank savings or checking accounts are no more appealing, advisers said."
They quote Douglas Conoway, managing principal of Wealth Management Group LLC, "Everything that is stable is crummy.... There's no place to go." Reuters adds, "Conoway's firm invests about 5 percent of its $40 million in client assets in money funds, the same level as a year ago."
The story explains, "Low interest rates have already forced fund sponsors to waive billions of dollars in fees to prevent yields from going negative. Fund companies have the resources to keep waiving fees and maintain yields above zero, said Peter Crane, publisher of Cranedata.com, a website that tracks the industry." They quote Crane, "If they haven't gone negative by now, guess what, they're not going negative."
Finally, Reuters also says, "By some measures, the pressures on fund companies are easing despite the safe-haven flood into short-term U.S. government securities. While rates on Treasury bills declined, rates on other investments the funds buy such as repurchase agreements have ticked up. Big fund sponsors like Fidelity, Federated Investors Inc and JPMorgan Chase & Co on average waive 45 percent of fund fees, down from 50 percent several months ago, Crane said."
While IOSCO, or the International Organization of Securities Commissioners, doesn't have any jurisdiction in the United States, you wouldn't know it from the comment letters piling up on the SEC's President's Working Group Request for Comment web page, as mutual fund companies have taken this opportunity to yet again lambast the series of radical changes to money fund regulations that have been floated by U.S. and European regulators to date. The latest addition comes from John Hawke, Jr. of Arnold and Porter on behalf of Federated Investors. Hawke writes, "Enclosed is a copy of comments submitted by Federated Investors to the International Organization of Securities Commissions ('IOSCO') on its consultation report on Money Market Fund Systemic Risk Analysis and Reform Options. As Federated has outlined in these comments, money funds should not be labeled as any type of "shadow bank" and should not be subjected to banking-style regulations. Instead, money funds should continue to be treated as what they actually are -- highly liquid investment funds by which investor cash is pooled and invested in money market assets -- and regulated by securities regulators in a manner consistent with their actual structure and purpose. The Commission has had a highly successful record with respect to the supervision and oversight of money funds. In fact, the 2010 amendments to SEC rules governing money funds have made them even more liquid, transparent and stable than ever before. Accordingly, the enclosed comments to IOSCO urge consideration of those reforms as a model for any new standards that may be adopted for global money funds. I appreciate the opportunity to provide you with Federated's comments to IOSCO, and hope they will be helpful to the Commission."
Federated's IOSCO comment says, "Federated appreciates the effort made in the IOSCO Report to provide an assessment of the proposed reforms and Federated continues to support prudent regulation that strengthens and enhances MMFs. Federated participated in developing industry recommendations as part of the rulemaking process followed by the United States Securities and Exchange Commission (SEC) in its 2010 amendments to Rule 2a (2010 Amendments) and Federated is ready to play an equally active role in supporting additional MMF reform measures globally. In order to permit preparation of more complete and thoughtful comments on these important issues from broad cross-section of market participants and the public, we respectfully suggest a longer period be provided for public comment on the IOSCO Report."
The letter continues, "Federated, as a participant in the money markets and a sponsor of the Federated MMFs, is interested in the policy discussions in Europe, the United States and elsewhere around the globe on the status and regulation of MMFs. Adoption in 2009 of the revised "Undertakings for Collective Investment in Transferrable Securities" (UCITS), which put in place a more comprehensive framework for the regulation of investment companies within Europe, has been a significant development. The continuing work of the European Securities andnd Markets Authority (ESMA) and its predecessor, the Committee of European Securities Regulators (CESR)), to develop and implement common definitions, standards and requirements for MMFs in Europe has been a major step forward in the regulation of MMFs. Federated supports those efforts to further improve the global framework for regulation of MMFs."
Hawke explains, "In considering any further reforms, IOSCO should evaluate the effectiveness of: (1) the value of the many changes which have occurred in the global MMF industry since the liquidity crisis, including (i) the 2009 revisions to the UCITS Directive; (ii) the requirements placed upon MMFs and Short-Term MMFs by the May 2010 CESR (now ESMA) guidelines on a "Common Definition of European Money Funds" (ref. CESR/10-049) that went into effect in 2011 (CESR/ESMA Guidelines) that established a common definition of MMFs; (iii) enhanced portfolio requirements required by the Institutional Money Market Fund Association (IMMFA); and (iv) the global impact of the SEC's 2010 Amendments which are followed voluntarily by many MMFs around the world as a "best practice," (2) existing structural mandates requiring distressed constant net asset value (C-NAV) MMFs to float their NAV, and (3) existing disclosures to investors and investors' knowledge of the risks associated with investing in MMFs."
He tells IOSCO, "The implementation of reforms addressing liquidity coupled with the changes previously implemented in the global MMF industry since the 2007-2009 financial crisis, address the key risks that regulators are looking to mitigate. Federated also believes that investors are aware, probably now more than ever, that MMFs are in fact "investments" that have risk. Finally, it should be emphasized that C-NAV MMFs in the United States and UCITS C-NAV MMFs are prohibited from using amortized cost when such use fails to fairly reflect the market-based net asset value per share, and have a regulatory mandate to cease the use of amortized cost in such instances and convert to a variable net asset value (V-NAV)."
Hawke adds, "Given all of the above, IOSCO should not recommend any other radical untested reforms that would fundamentally alter and undermine the global MMF industry. In particular, imposing the "reforms" being advocated for MMFs by bank regulators, such as bank-like capital structures and regulatory frameworks, mandatory use of V-NAV, liquidity fees, and hold-back requirements on redemptions of MMF shares, would be particularly damaging to MMFs globally and all who rely upon them. To do so could risk tremendous disruption in short term markets globally, increase assets held in already "too big to fail" banks, increase borrowing costs of businesses and governments and further slow economic recovery, cause movements of liquidity balances to separately managed accounts, repurchase agreements, unregulated fund products, and trigger a host of other unintended consequences."
He states, "We note that the issues associated with further changes to MMF regulation are sufficiently complex and in need of detailed economic analysis as to both the efficacy of existing and potential further reforms and the direct and indirect effects on the economy of further changes that a majority of the Commissioners of the SEC recently have gone on record to withdraw SEC support of publication of the IOSCO report in its current form."
The letters concluding paragraphs say, "MMFs are important participants the financial markets because they efficiently intermediate investor's shareholdings with short-term funding of governments, businesses and financial institutions. MMFs have been successful by using a very simple, common sense approach, which permits investment only in short term, high quality money market instruments, and maintaining a very liquid investment portfolio sufficient to meet investor redemption requests out of normal cash flows from maturing portfolio investments."
Hawke continues, "MMFs should not be labeled as a type of "shadow bank," and should not be subjected to a banking-style capital structure and regulatory program. Instead, MMFs should continue to be treated as what they actually are -- highly liquid investment funds by which investor cash is pooled and invested in money market assets -- and regulated by securities regulators in a manner consistent with their actual structure and purpose. Rather than imposing dramatic and potentially dislocative changes on the regulation of MMFs by imposing bank-like capital structures and regulations, it would be more prudent to continue the careful fine-tuning of regulatory programs for MMFs developed by securities regulators that have included the revised UCITS Directive in 2009 and the CSER/ESMA Guidelines in 2010, as well as SEC Rule 2a-7. There remain areas for further improvement in the regulation and supervision of MMFs globally that are appropriate for consideration."
Finally, he adds, "These further enhancements to MMF regulation were adopted by the SEC in 2010 after the financial crisis, and have shown the capacity to further stabilize share values, increase investor awareness, and stave off "runs" by shareholders of MMFs. Serious consideration should be given to adopting additional standards for global MMFs similar to those adopted in 2010 for U.S. MMFs. We remain committed to avoiding any recurrence of liquidity events similar to those experienced in September 2008. We are equally committed to the continuation of MMFs as an important sector of the global financial markets. We will be happy to continue to work with the IOSCO and its member nations regulators on reforms that are consistent with both of these objectives."
The web page hosting Comment Letters for the President's Working Group Report on Money Market Fund Reform is seeing another burst of activity recently with the initial May 31 deadline (since extended, see our "Link of the Day") to post comments to the International Organization of Securities Commissioners passing. We covered ICI's and Fidelity's lengthy responses last week, but additional letters from Schwab and Invesco have since been added. (U.S. companies are filing these dually with IOSCO and the SEC's PWG site.) Charles Schwab's Marie Chandoha writes, "Attached is a copy of a comment letter recently filed by Charles Schwab Investment Management, Inc., to the International Organization of Securities Commissions in response to its Consultation Report of April 27, 2012, "Money Market Fund Systemic Risk Analysis and Reform Options." In our letter, we provide our perspective on the Consultation Report. We discuss several concerns with the Report, and in particular challenge three of its basic premises: 1) that money market funds are dangerously susceptible to runs; 2) that money market funds are somehow more systemically risky than the global banking system; and 3) that there is a presumption that more regulation is needed, despite the lack of empirical evidence. We point to the SEC's 2010 reforms to Rule 2a-7 as having strengthened considerably money market funds and urge that a comprehensive analysis of the effectiveness of those reforms be undertaken prior to consideration of any further regulation. We ask the Commission to give full consideration to our comments on the IOSCO Consultation Report as it continues to consider whether additional reforms to the regulatory regime for money market funds are necessary."
Chandoha writes to IOSCO's Mohamed Ben Salem, "Schwab appreciates the work that went into the preparation of the Consultation Report, particularly in the discussion of the different regulatory schemes governing money market funds (and their equivalents) in different jurisdictions across the globe and in its Appendix B, which analyzes what happened during the 2008 financial crisis and the steps various jurisdictions have taken in response. The Report is also comprehensive in its exploration of more than 20 possible reforms, and is, for the most part, balanced in its assessment of the pros and cons of those options."
She continues, "Nevertheless, Schwab finds numerous aspects of the Report troubling. Perhaps most troubling are three of its basic premises: 1) that money market funds are dangerously susceptible to runs; 2) that they are somehow more systemically risky than the global banking system; and 3) that there is a presumption that more regulation is needed, despite the lack of empirical evidence. We believe strongly that money market funds are one of, if not the, safest investment options in the market today, with an incomparable track record of safety, security, convenience and investor satisfaction. As an investment product, they carry some risk, but the risks are clearly and simply disclosed, of short duration and managed through high-quality investments. If the regulatory goal is to eliminate all risk from the product, then the bar is set impossibly high. Rather, the focus should be on ensuring that money market funds retain sufficient liquidity to handle surges in redemption requests and maintain rigorous scrutiny over the quality of their investment portfolio. As we discuss, we believe that reforms put in place by US regulators in 2010 have accomplished that -- and the volatile markets of the summer of 2011 served as a test for those new requirements, a test that US money market funds passed with flying colors."
Chandoha adds, "Finally, we discuss in this comment letter our concerns that there are limited alternatives to money market funds, particularly for individual investors, and that the result of many of the reform ideas posed in the Consultation Report will be a rapid flight from money market funds either to banks or to unregulated or less regulated alternative products. Either way, the potential systemic risks of those outcomes are several orders of magnitude greater than any minimal risk currently posed to the global financial system by money market funds."
Invesco's Lyman Missimer writes in his comment, "We are writing to provide our views with respect to certain aspects of the Money Market Fund Systemic Risk Analysis and Reform Options Consultation Report dated 27 April 2012 (the "IOSCO Report") published by the International Organization of Securities Commissions ("IOSCO"). The IOSCO Report discusses potential reform options intended to reduce systemic risk generally and to enhance the stability of money market funds in particular. As a major sponsor of money market funds, Invesco strongly supports efforts to bolster the resiliency of these products, which for over four decades have provided a solid foundation for the preservation of capital, daily liquidity and market-based yield that investors have come to expect while also offering global portfolio credit diversification, ease of administration, efficiency in accounting and simplicity of tax reporting."
He explains, "Our interest in commenting is driven by our fiduciary responsibility to our money market fund shareholders and our concern that several of the policy options discussed in the IOSCO Report could have unintended and highly adverse consequences including: harming the orderly functioning or efficiency of credit markets by substantially reducing availability of credit to consumers, corporations, financial institutions and government borrowers; triggering a sudden, widespread shift of assets to less regulated vehicles that do not offer the protections afforded by regulated money market funds; and reducing the number of investment options available to investors."
Missimer adds, "We recognize that the goal of policymakers is to reduce further the vulnerability of the financial system, including money market funds, to systemic risk. We share this aim and have worked actively with both policymakers and our industry peers in the U.S. and Europe in recent years to enhance industry standards and practices in numerous areas, including the tri-party repurchase agreement market. Given the central importance of money market funds to short term credit markets, however, we believe it is critical for policymakers to recognize that disruption of these funds or a significant reduction in their asset base could have a severe destabilizing impact on issuers (including government issuers) and on the markets generally."
Finally, Invesco writes, "While we would support an extension to non-U.S. money market funds of the changes to Rule 2a-7 adopted in 2010, we believe that prior to proposing any additional money market regulations it is critical for policymakers to conduct a thoughtful and comprehensive analysis of the impact of the significant reforms made to date affecting money market funds and global financial system generally. Taking action prior to such an analysis would be premature and could seriously jeopardize the fragile global economic recovery. The analysis must therefore include a rigorous cost-benefit analysis balancing this and other risks against the incremental benefits that might be achieved by further reforms. We appreciate the opportunity that we have been given to comment on this important matter and look forward to continuing to work with policymakers and others in the industry to ensure that money market funds remain a useful and important investment alternative for investors seeking a product that offers safety, liquidity and yield."
The largest U.S. money fund manager, Fidelity Investments, added its two cents to the European front of the regulatory debate with a comment letter to IOSCO, the International Organization of Securities Commissioners, which was also posted to the SEC's President's Working Group Report on Money Market Fund Reform (Request for Comment) page. Fidelity Senior VP and General Counsel Scott Goebel writes in his cover letter to the SEC, "Enclosed is a copy of comments that Fidelity Investments ('Fidelity') submitted to the International Organization of Securities Commissions ('IOSCO') on its consultation report on Money Market Fund Systemic Risk Analysis and Reform Options (the 'Report'). The Report sought comment on a variety of possible reforms to money market funds, much like the President's Working Group Report on Money Market Fund Reform, but on a global level. As we have outlined in the attached letter, U.S. money market mutual funds currently are subject to a comprehensive regulatory framework and to oversight by the Commission. We believe that the Commission's robust regulation and oversight of money funds has been very successful and the Commission's 2010 amendments to its rules governing money funds have made them even more liquid, transparent and stable than ever before."
He explains, "We believe that some minimum international standard must exist for consistent treatment and management of money market funds under a global regulatory framework. However, we realize that money market fund regulation has developed in different markets based on differences in relative size and maturity of national economies. It is important for regulators to recognize these differences within their jurisdictions, which may necessitate varying regulation. Accordingly, our recommendation to IOSCO, the Financial Stability Board, and other regulators globally is to consider certain key features and principles that offer the greatest protections to investors while enabling money market funds to play an important role in the capital markets."
Goebel continues, "These practices include constraints on the liquidity, maturity, diversification, and credit quality of money market funds, as well as transparency and clear governance requirements, all of which have proven effective in increasing the resilience of money market mutual funds in the U.S. In addition, we encourage regulators to expand their focus beyond money market funds to examine investment products that remain unregulated and non-transparent in the money markets. We recommend that international regulators concentrate on introducing regulation to the various pools, structured vehicles, and other funds that offer cash investment without the strict rules under which money market funds operate. We urge the Commission to give full consideration to these materials as it evaluates whether any additional regulation for money market mutual funds is appropriate."
Fidelity's letter to IOSCO states, "Fidelity Investments ('Fidelity') appreciates the opportunity to provide comments to the International Organization of Securities Commissions ('IOSCO') on its consultation report on Money Market Fund Systemic Risk Analysis and Reform Options. Fidelity is the largest money market mutual fund ('MMF') provider in the United States, with more than US$415 billion in MMF assets under management. Funds we manage represent more than 16% of MMF assets in the United States (as of March 31, 2012) and more than 9% of MMF assets worldwide (as of December 31, 2011). More than nine million customers, who include retirees, parents saving for college and active investors, use Fidelity's MMFs as a core brokerage account or cash investment vehicle. Continued viability of MMFs is important to investors, issuers and financial markets, and it is important to us."
It explains, "MMFs are subject to extensive oversight and regulation in the United States under the Investment Company Act of 1940, together with the rules promulgated thereunder. These comprehensive regulations and rules encompass portfolio construction, investor protections, extensive disclosure requirements, and broad financial reporting and recordkeeping requirements. In addition, mutual fund investors are afforded protections under state law and other federal statutes, such as the Investment Advisers Act of 1940, the Securities Act of 1933 and the Securities Exchange Act of 1934."
Goebel writes, "We note that the Report seems to presume that MMFs present risks to the financial system and that additional reform is needed. We do not agree with those presumptions, which are asserted, but unsubstantiated, in the Report. Importantly, we believe that all costs and benefits should be enumerated and evaluated before regulators seek to make further structural changes to a well-functioning investment vehicle that serves the needs of short-term investors and borrowers. Additional reforms should be carefully considered prior to implementation to ensure that they are consistent with creating a stronger, more resilient product, without imposing harmful, unintended consequences on financial markets or on the global economy."
Finally, Fidelity's 21-page response urges that IOSCO and the FSB adopt a stricter, U.S.-style, definition of the term "money fund" and comment, "We think investors will benefit from having a common definition of MMFs that is well understood and clearly regulated. That said, as daily participants in the broader money markets, we remain concerned with the narrow regulatory focus on MMFs. First, the Report does not critically examine the Financial Stability Board's (FSB) assertion that MMFs are part of "shadow banking." In fact, MMFs are the antithesis of shadow banking because portfolio characteristics and holdings are transparent to investors -- certainly much more so than actual banks…. We recognize that the FSB asked IOSCO to "examine regulatory action related to MMFs", but believe that regulators would do much more to reduce the possibility of systemic risk in the money markets in particular (and capital markets more generally) by focusing first on these unregulated areas before trying to force structural changes onto MMFs. Thus, we think more focus should be placed on the FSB's third workstream that "will examine shadow banking entities other than MMFs" as those unregulated vehicles merit more attention."