News Archives: May, 2013

Fidelity Investments released a "Update on Money Market Mutual Fund Regulatory Developments," yesterday, which says, "On May 29, 2013, the Securities and Exchange Commission (SEC) announced that the SEC Commissioners plan to vote on June 5, 2013, on whether to issue a proposal for further regulation of money market mutual funds. Should a majority of the five commissioners vote to issue a proposal, it is important to bear in mind that this will still be just a proposal and it will be many months, if not years, before new rules -- if any -- come into effect. There is not yet a formal proposal to change money market mutual fund regulation."

Fidelity writes, "Rule 2a-7 of the Investment Company Act of 1940, which has been in place for decades and which was significantly strengthened in 2010, continues to regulate how all U.S. money market mutual funds are managed. There is no change in money market mutual fund regulation at this time."

They explain, "Should the SEC Commissioners decide to make an initial regulatory proposal, a comment period -- typically lasting at least a few months -- will open, during which industry participants, investors and others are invited to provide regulators their perspective on the proposed reforms. During the comment period, the existing rules remain in place. After the comment period ends, regulators generally spend several more months reviewing comments received and refining any proposed regulation. At the end of the review period, a final rule may or may not be voted upon by the SEC commissioners. To be approved, the rule would need a majority of the Commissioners' votes. Should the vote result in the adoption of the regulation, it is typically some extended period of time before new rules become effective."

Fidelity adds, "In the wake of market events in 2008, the SEC introduced reforms in early 2010 designed to make money market mutual funds more resilient to major market disruptions and to reduce their susceptibility to large and sudden shareholder redemptions. By setting further specific limits on money market mutual fund holdings, including establishing minimum levels of liquidity, reducing the average maturity of the funds' holdings, and further improving their overall credit quality, the SEC 2010 changes, which Fidelity supported, have made money market mutual funds less sensitive to both market events and shareholder activity.

Finally, they state, "We have provided the SEC with additional analysis and feedback that may prove helpful in their decision making. Fidelity believes that a consensus has emerged across the various constituencies that have been actively involved in this debate -- including, most importantly, the regulators. The consensus recognizes that market data shows how Treasury, government, municipal and retail general purpose/prime money market mutual funds have not demonstrated any need for further reform."

Fidelity ultimately shares the same goal as regulators and policymakers: to ensure the strength and stability of money market mutual funds and our financial system, while preserving the benefits that these funds provide investors, issuers and our economy. We will continue to advocate on behalf of all of our money market mutual fund shareholders and work with all policymakers as these important regulatory discussions continue.

We can state unequivocally that Fidelity’s money market mutual funds and accounts continue to provide security and safety for our customers’ cash investments. Our funds invest in money market securities of high quality, and our customers have full access to their investments anytime they wish. Most importantly, we continue to be vigilant in keeping our money market mutual funds safe and in protecting the $1.00 net asset value (NAV), which has always been our #1 objective in managing these funds."

The Securities & Exchange Commission announced the scheduling of a June 5 meeting to vote on the release of a set of long-awaited money market funds reforms. The "Sunshine Act Meeting posting says, "Notice is hereby given, pursuant to the provisions of the Government in the Sunshine Act, Pub. L. 94-409, that the Securities and Exchange Commission will hold an Open Meeting on Wednesday, June 5, 2013 at 10:00 a.m., in the Auditorium, Room L-002. The subject matters of the Open Meeting will be: The Commission will consider a recommendation to propose amendments to certain rules under the Investment Company Act that govern the operation of money market funds and related amendments to Form PF under the Investment Advisers Act. At times, changes in Commission priorities require alterations in the scheduling of meeting items. For further information and to ascertain what, if any, matters have been added, deleted or postponed, please contact: The Office of the Secretary at (202) 551-5400. Elizabeth M. Murphy, Secretary."

Bloomberg explains in "SEC to Vote June 5 on Floating Share for Riskier Money Funds," "The U.S. Securities and Exchange Commission will vote next week on a proposal that would require a floating-share value for the riskiest type of money-market mutual funds, two people briefed on the matter said. The floating-share proposal would apply only to funds that buy corporate debt and cater to institutional clients, said the people, who asked not to be named because details of the proposal haven't been made public. The commission announced in a notice posted on its website today that it would meet on June 5 to consider rules governing money-market funds."

The Wall Street Journal writes in "SEC to Vote Next Week on Money-Market Fund Rules," "U.S. securities regulators plan to vote next week on new rules for a $2.6 trillion corner of the mutual-fund industry that would target money-market funds catering to large institutional investors, who bolted out of such funds during the financial crisis. The Securities and Exchange Commission plans to vote next Wednesday on a draft proposal that would require certain types of money funds whose shares are held by corporations and other institutional investors to abandon their fixed $1 share price and allow the price to float as it does with other mutual funds, according to people familiar with the draft. The rule would apply to prime money funds, which invest in short-term corporate debt. SEC officials expect the measure to sail through the five-member commission, but it faces a long path to implementation, including a lengthy comment period and a second SEC vote before its provisions can go into effect."

The Investment Company Institute commented, "ICI Chief Public Communications Officer Mike McNamee issued the following statement in response to the Securities and Exchange Commission notice of an open meeting scheduled for June 5 to consider money market fund regulation: "We look forward to seeing the rule proposal on money market funds that the Commission plans to consider at next week's meeting. We expect this proposal will reflect the extensive research and discussion among commissioners and staff since last summer. As Chairman White has said repeatedly, the goals of any reform must include preserving the economic benefits of money market funds -- both for investors and for the businesses and state and local governments that rely upon these funds for financing."

Chamber of Commerce's Center for Capital Markets Competitiveness President and CEO David Hirschmann adds, "We will evaluate the SEC's forthcoming proposal on whether it accomplishes the goal of strengthening money market funds while preserving them as an important cash management tool and vital source of short-term financing for businesses, cities, and states. We have been pleased that all parties in the debate agree that preserving money market funds is necessary to ensure the continued vibrancy of the American economy."

We expect the SEC to issue a brief summary of the proposal next Wednesday (if it passes, as expected), but the full reportedly 500-page proposal should be published in the Federal Register approximately a week later. (In 2009, the SEC held its Open Meeting on June 24 but didn't publish the then 197-page proposal until July 1.) Last time around, there was a 60-day comment period followed by a 4 1/2-month gestation period, and an extended phase in of the various components (3 months to a year in most cases). Given a similar timetable, final rules for this latest round would arrive in January 2014, and a floating NAV, if it survives, would arrive at some point in late 2014 at the earliest, and more likely at some point in 2015.

University of Mary Hardin-Baylor Assistant Professor Larry Locke wrote late last year on "The SEC's Attempted Use Of Money Market Mutual Fund Shadow Prices To Control Risk Taking By Money Market Mutual Funds" (see our Sept. 4, 2012 Crane Data News piece, "Locke Study Shows No Investor Reaction to Low Shadow NAV Prices"). Locke wrote us again recently, describing what he calls, "The Forgotten Alternative to Money Market Reform." He tells us, "The Security and Exchange Commission's money market fund reform proposal is due any day now and their list of possible structures has been narrowed through a lengthy tug of war with the industry. Unfortunately, all the proposed structures from which the SEC is crafting its new regulatory scheme appear to have a common problem -- they all involve coopting the market into preventing money fund failures."

Locke writes, "The reform effort dates back to September 2008 when the Reserve Primary Fund became the first money market fund in over a decade to "break the buck" -- allow its real net asset value to fall below $0.995 per share. That failure contributed to a short-term credit market freeze that had the potential to shut down the entire U.S. financial system. The resulting backstops put in place by the Treasury and the Fed put hundreds of billions of dollars of taxpayer money at risk to restore investor confidence."

He continues, "Just as in Newton's Third Law of Motion, for every governmental action there is an equal and opposite reaction. In the case of money market funds, the reaction to the 2008 bailout has been an ongoing demand by the Financial Stability Oversight Council and the SEC to make money market funds less dangerous to themselves and others. After bouncing around the regulatory landscape for the last four years, the issue is finally coming to a head and the whole industry is waiting nervously to see what the SEC will propose for the new product structure."

Locke explains, "Sadly, the proposals discussed so far have a common flaw -- they are all based on encouraging the market to accurately assess money market risk. The theory is that if investors appreciated the risk of owning money funds, they would expect to sometimes sustain losses and not start a run on funds at the first sign of trouble. Therefore, if money funds can be structured so as to accurately communicate that risk, it will discourage runs by investors and money funds will be much less likely to fail and contribute stress to the short-term credit market. Prior SEC proposals to increase real NAV reporting, to force money funds to float their NAV (instead of being fixed at $1), and to hold back investor funds upon redemption, are all designed to highlight the risk of owning money funds and discourage investors from withdrawing cash from their funds during times of falling share values."

He adds, "The problem with all of these plans is that investors can prove very hard to manipulate. Recent research indicates that investors pay little attention to the reports of real money fund share prices already mandated by the SEC. It is easy to understand why. Historically, money fund failures are very rare and people, generally, aren't good at evaluating remote possibilities. (How many people do you know who bought an overpriced warranty on their new washing machine or new set of tires?)"

The professor writes, "Money market investors, as a group, have not demonstrated superior risk assessment skills than the general population. According to the ICI Fact Book, there were 548 taxable money market funds at the start of 2008. That means if you randomly invested a dollar in a money fund at that time you would have a 1 in 548 chance of putting your money in the Reserve Primary Fund. On the other hand, if you allowed the market to choose your fund (incorporate Reserve Primary Fund's market weighting into the process -- approximately $64 billion in a $2.6 trillion market) your chance of being in the fund that was about to fail would rise to approximately 1 in 41."

Finally, Locke says, "A more precise, and more economic, way of dealing with these types of remote possibilities where people tend to mistake the risk of loss is through insurance. Insurance regimes take the assessment of risk out of the hands of investors and entrust it to actuaries, who can translate the risk into a premium that can then be assessed against everyone entering the market. It is the same method we currently use in the U.S. for bank failures. A money fund insurance regime would be far cheaper than insuring commercial bank deposits not only because money fund failures are more rare than bank failures but also because the losses they ultimately incur are on the order of only 1%. A money market fund analog to the FDIC could be funded from investor returns generated by money funds, themselves, rather than with taxpayer dollars. The assessments could even be designed to increase as the risks thrown off by a particular money fund increased. A government-sponsored insurance regime would combine the power of the government to calm turbulent markets with the political necessity of avoiding another federal bailout."

The final agenda is set and final preparations are being made for our 5th annual Crane's Money Fund Symposium, the largest of Crane Data's three money conferences, which will take place in less than a month at the Baltimore Hyatt Regency (June 19-21). Over 300 have registered to-date, and we expect well over 400 attendees, speakers and sponsors by show-time, which should make thus year's Symposium the largest yet. Unfortunately, our discounted hotel room block is now sold out, though a few rooms remain at the Hyatt at higher prices, and rooms remain at several neighboring hotels. (See the website for details.) There have been several last minute changes, to the agenda and times, so we review these and other event details below.

To accommodate some Treasury schedule changes, we've moved Matt Rutherford from Day 1 to Day 3 of Symposium. The agenda for Wednesday, June 19 is as follows: After an initial "Welcome to Money Fund Symposium 2013" by Peter Crane, President & Publisher of Crane Data, we feature a discussion entitled, "Moving Forward: Money Funds & Washington" with ICI's Paul Schott Stevens. The opening afternoon will then substitute two parts of our "Strategists Speak '13: Cash Plus & Europe" with Alex Roever of J.P. Morgan Securities and Garret Sloan of Wells Fargo Securities in place of "The Treasury Talks," which has been moved to Friday a.m. This will be followed by a session entitled, "Corporate & MMFs: Liquidity Is Still King" with Jeff Glenzer from the Association for Financial Professionals and Tony Carfang of Treasury Strategies. Then, the first day will close with a panel, "Major Money Fund Issues 2013," moderated by Andrew Linton of J.P. Morgan Asset Management and featuring Charlie Cardona of BNY Mellon CIS/Dreyfus, Debbie Cunningham of Federated Investors and Nancy Prior of Fidelity Management & Research. Finally, the Day 1 reception will be sponsored by Bank of America Merrill Lynch.

Day 2 of Money Fund Symposium features: "The State of The Money Market Fund Industry" with Peter Crane of Crane Data and Dave Sylvester of Wells Fargo Funds; "Senior Portfolio Manager Perspectives" with Chris Stavrakos of BlackRock, John Tobin of J.P. Morgan Asset Management, and Joe Lynott of T. Rowe Price and; "Repurchase Agreement Issues & Update" with Joseph Abate of Barclays Capital, Rob Sabatino of UBS Global Asset Management, and Vic Chaikrian of the Federal Reserve Bank of New York; and "Municipal Money Fund Market Update" with Helena Condez of T. Rowe Price Associates, Colleen Meehan of Dreyfus Corp., and Ron Vandenhandel of Deutsche Bank.

The afternoon of Day 2 (after a Dreyfus-sponsored lunch) features: "Dealer Doings: Supply, Innovations, Concerns" moderated by Lu Ann Katz of Invesco and featuring Chris Condetta of Barclays Capital, John Kodweis of J.P. Morgan Securities, and Jean-Luc Sinniger of Citi Global Markets; "Government Agency Issuers & Supernationals" moderated by Dan Davis of CastleOak Securities and featuring Jonathon Hartley of FHL Banks Office of Finanace, Regina Gill of Federal Farm Credit Funding, and Michael Schulze of KfW; "Risks to Ratings: Areas of Concern" with Peter Yi of Northern Trust, Roger Merritt of Fitch Ratings and Peter Rizzo of Standard & Poor's; and "Survivor: Update on European Money Funds" with Jonathan Curry of HSBC Global Asset Management and Dan Morrissey of William Fry. (The Day 2 reception is sponsored by Barclays.)

The third day of Symposium features: "Strategists Speak '13: Fed" with Brian Smedley of Bank of America Merrill Lynch; "FSOC Recommendations & Floating Rate Notes" with Matt Rutherford of the U.S. Department of the Treasury; Regulatory Roundtable: Pending & Potential" with John McGonigle of Federated Investors, Jack Murphy of Dechert, and possibly Sarah ten Siethoff of the Securities & Exchange Commission (invite pending). The last section includes: "Portal Panel: Beyond MMFs & Transparency" with John Carter of Citi Global Transaction Services, Greg Fortuna of State Street's Fund Connect, and Graeme Henderson of Cachematrix; and, finally, "Technology Tools & Software Update" with Peter Crane, Derek Kleinbauer of Bloomberg, and James Morris of Investortools.

We hope to see you in just over 3 weeks in Baltimore! We're still taking registrations, but we expect to sell out soon. Finally, we've also released and updated the agenda for our European Money Fund Symposium, which will be held at the Conrad Hotel in Dublin, September 24-25, 2013, and we've set the dates for our next Crane's Money Fund University (Jan. 23-24, 2014, in Providence) and our next Money Fund Symposium (Boston, June 23-25, 2014). Contact us or watch for more details on these in coming weeks.

Money fund assets had declined by 5.0% year-to-date through April 30 (down $124.0 billion), but it appears that they will show large gains in May. Assets rose strongly for the second time in three weeks according to the latest data from the ICI. Its latest "Money Market Mutual Fund Assets" says, "Total money market mutual fund assets increased by $19.53 billion to $2.601 trillion for the week ended Wednesday, May 22, the Investment Company Institute reported today. Taxable government funds increased by $9.25 billion, taxable non-government funds increased by $10.18 billion, and tax-exempt funds increased by $100 million." Money fund assets moved above the $2.6 trillion level for the first time since prior to the April 15 tax deadline, and assets have risen by $38.1 billion month-to-date.

ICI writes, "Assets of retail money market funds increased by $1.33 billion to $893.78 billion. Taxable government money market fund assets in the retail category increased by $430 million to $193.45 billion, taxable non-government money market fund assets increased by $830 million to $513.02 billion, and tax-exempt fund assets increased by $70 million to $187.31 billion." According to ICI's latest numbers, Retail assets represent 34.4% of all money funds assets with Retail Nongovernment (or "Prime") accounting for 19.7%, Retail Government accounting for 7.4%, and Retail Tax Exempt accounting for 7.2%.

ICI also comments, "Assets of institutional money market funds increased by $18.20 billion to $1.708 trillion. Among institutional funds, taxable government money market fund assets increased by $8.82 billion to $711.02 billion, taxable non-government money market fund assets increased by $9.35 billion to $924.35 billion, and tax-exempt fund assets increased by $30 million to $72.13 billion." They show Institutional assets accounting for 65.6% of all money fund assets, with Prime Institutional assets making up 35.5%. Government Inst assets made up 27.3% and Tax Exempt Inst made up 2.8%.

Crane Data's Money Fund Intelligence Daily, which tracks daily assets, yields and information on money funds, shows that the largest weekly asset gains were shown by the following funds: Dreyfus Treas Prime Cash Mg Ins (up $3.3 billion to $27.4 billion), JPMorgan Prime MM Capital (up $2.7B to $64.9B), Dreyfus Tr&Ag Cash Mgmt Inst (up $2.2B to $15.6B), Morgan Stanley Inst Liq Govt Inst (up $1.6B to $20.9B), JPMorgan US Govt MM Capital (up $1.5B to $28.6B), BlackRock Lq T-Fund Inst (up $1.4B to $16.6B), Fidelity Instit MM: Prime MMP I (up $1.3B to $47.8B), Fidelity Instit MM: MM Port I (up $1.1B to $68.9B), Federated US Trs Cash Res IS (up $1.1B to $18.9B), and Fidelity Instit MM: Treas Port I (up $1.0B to $13.4B).

In other news, Wells Fargo Securities published a piece on the "FTT" entitled, "Short-Term Strategy: Taxation Without Representation." Author Garret Sloan summarizes, "On February 14, 2013 the European Commission released a proposal for 11 Member States to implement a Financial Transaction Tax (FTT). If approved in its current form, implementation is expected to occur by January, 2014. The objectives of the proposal are to "harmonize legislation on the indirect taxation of financial transactions", to "ensure that financial institutions make a fair and substantial contribution to covering the cost of the recent crisis", and to create "appropriate disincentives for transactions that do not enhance the efficiency of financial markets.""

Wells tells us, "If implemented, the FTT will have a number of implications, including: The FTT's effects are not limited to the 11 participating Member States; rather, the extra-territorial nature of the tax will impact the way that participants operate in all financial markets around the world. Because the FTT is a flat tax that does not consider the duration of the security or agreement, short-term market liquidity will be heavily impacted as the FTT will overwhelm the yields currently available."

Sloan writes in the piece, "The impact of the FTT on overnight and short-term markets cannot be understated. The transactional nature of the FTT will forcibly impact short-term funding markets more severely than longer-term markets regardless of the underlying risk profiles of the securities in question. The most punitive example of the proposed FTT is in the repo market. While the proposal has provided some relief to repo investors in that it recognizes both legs (i.e. the sale and buyback) as one trade, all repo counterparties and collateral with ties to the EU-11 will be subject to the FTT."

He adds, "The fact that the FTT has made it this far suggests that it has some traction. The final version of the proposal, in our opinion, is likely to differ from the current draft for many of the reasons stated here, but we do think there is sufficient support for the FTT proposal to be approved. Opposition remains, however, and we anticipate many concessions to be made before anything is unanimously agreed upon. In his final monetary policy meeting before retirement, Bank of England governor Mervyn King suggested that the tax has many skeptics, even amongst the countries that have preliminary approval for the tax. He noted that he does not know of a single central banker that believes it is a good idea. Case in point, German finance minister Wolfgang Schauble noted that the EU-11 states are only at the preliminary steps in the process and that any tax could be years away."

Federal Reserve Chairman Ben Bernanke testified on "The Economic Outlook before Congress' Joint Economic Committee. While he didn't give much hope that rates would be rising anytime soon, he did offer hope that the Fed would begin withdrawing its special accommodations soon and again recognized the severe plight of savers. He says, "With unemployment well above normal levels and inflation subdued, fostering our congressionally mandated objectives of maximum employment and price stability requires a highly accommodative monetary policy. Normally, the Committee would provide policy accommodation by reducing its target for the federal funds rate, thus putting downward pressure on interest rates generally. However, the federal funds rate and other short-term money market rates have been close to zero since late 2008, so the Committee has had to use other policy tools."

Bernanke comments, "The first of these alternative tools is "forward guidance" about the FOMC's likely future target for the federal funds rate. Since December, the Committee's post-meeting statement has indicated that its current target range for the federal funds rate, 0 to 1/4 percent, will be appropriate "at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored." This guidance underscores the Committee's intention to maintain highly accommodative monetary policy as long as needed to support continued progress toward maximum employment and price stability."

He continues, "The second policy tool now in use is large-scale purchases of longer-term Treasury securities and agency mortgage-backed securities (MBS). These purchases put downward pressure on longer-term interest rates, including mortgage rates. For some months, the FOMC has been buying longer-term Treasury securities at a pace of $45 billion per month and agency MBS at a pace of $40 billion per month. The Committee has said that it will continue its securities purchases until the outlook for the labor market has improved substantially in a context of price stability. The Committee also has stated that in determining the size, pace, and composition of its asset purchases, it will take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives."

Bernanke explains, "At its most recent meeting, the Committee made clear that it is prepared to increase or reduce the pace of its asset purchases to ensure that the stance of monetary policy remains appropriate as the outlook for the labor market or inflation changes. Accordingly, in considering whether a recalibration of the pace of its purchases is warranted, the Committee will continue to assess the degree of progress made toward its objectives in light of incoming information. The Committee also reiterated, consistent with its forward guidance regarding the federal funds rate, that it expects a highly accommodative stance of monetary policy to remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens."

He adds, "In the current economic environment, monetary policy is providing significant benefits. Low real interest rates have helped support spending on durable goods, such as automobiles, and also contributed significantly to the recovery in housing sales, construction, and prices. Higher prices of houses and other assets, in turn, have increased household wealth and consumer confidence, spurring consumer spending and contributing to gains in production and employment. Importantly, accommodative monetary policy has also helped to offset incipient deflationary pressures and kept inflation from falling even further below the Committee's 2 percent longer-run objective.

But Bernanke tells us, "That said, the Committee is aware that a long period of low interest rates has costs and risks. For example, even as low interest rates have helped create jobs and supported the prices of homes and other assets, savers who rely on interest income from savings accounts or government bonds are receiving very low returns. Another cost, one that we take very seriously, is the possibility that very low interest rates, if maintained too long, could undermine financial stability. For example, investors or portfolio managers dissatisfied with low returns may "reach for yield" by taking on more credit risk, duration risk, or leverage. The Federal Reserve is working to address financial stability concerns through increased monitoring, a more systemic approach to supervising financial firms, and the ongoing implementation of reforms to make the financial system more resilient."

He says, "Recognizing the drawbacks of persistently low rates, the FOMC actively seeks economic conditions consistent with sustainably higher interest rates. Unfortunately, withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions. A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further. Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets. Moreover, renewed economic weakness would pose its own risks to financial stability.

Finally, Bernanke comments, "Because only a healthy economy can deliver sustainably high real rates of return to savers and investors, the best way to achieve higher returns in the medium term and beyond is for the Federal Reserve--consistent with its congressional mandate--to provide policy accommodation as needed to foster maximum employment and price stability. Of course, we will do so with due regard for the efficacy and costs of our policy actions and in a way that is responsive to the evolution of the economic outlook."

Fitch Ratings published its latest update on money fund portfolio holdings, "U.S. Money Fund Exposure and European Banks: Eurozone Rebounds," yesterday, along with a press release, entitled, "Fitch: U.S. Money Funds Return to Eurozone Banks." The release tells us, "U.S. prime money market funds (MMFs) increased their exposure to Eurozone banks in April, although asset allocations to these institutions remain well below 2011 levels, according to Fitch Ratings.As of end-April 2013, MMF allocations to eurozone banks represented 15.1% of assets under management within Fitch's sample of the 10 largest U.S. prime money funds, a 14% increase over the prior month. MMFs' eurozone allocations have almost doubled since end-June 2012, a sign of improving investor sentiment toward the region. This resumption in eurozone allocations also suggests that the March decline was a tentative retreat given the brief market uncertainty after the Cyprus banking system failure." (See also: Crane Data's May 13 News, "Repo Regains No. 1 Spot in April 30 Portfolio Holdings, CDs Again 2nd".)

Fitch comments, "Despite the increase, Fitch notes that MMF eurozone bank exposures remain less than half of their end-May 2011 levels. Fitch believes that eurozone banks likely have a diminished appetite for MMF funding, given the volatility that this form of funding experienced during 2H'11. Furthermore, reductions in some banks' overseas lending have likely curtailed the banks' need for U.S. dollar borrowing, including U.S. MMFs."

They add, "The largest country exposures in Fitch's sample were Canadian and Japanese banks, both at 12% of assets. Canadian bank holdings declined somewhat, but still remain well above May 2011 levels. The proportion of eurozone and European exposure in the form of repos, at less than 20% of these banks' collective exposure, remains well below the levels of roughly 40% of exposure seen during the height of the crisis last summer."

Finally, the Fitch report comments, "Australian, Canadian and Japanese banks collectively represent nine of the top 15 names.... Notably, the only European institutions within the top 15 are Credit Suisse, Societe Generale and Deutsche Bank. By comparison, 10 European banks (including seven from the eurozone) were in the top 15 at end-May 2011. The 15 largest exposures to individual banks, as a group, comprise approximately 41% of total MMF assets."

In other news, a press release entitled, "Horizon Cash Management Promotes Michael Markowitz to President tells us, "Horizon Cash Management LLC, the leading investment advisor specializing in active cash management solutions for the alternative investment industry, today announced that Michael Markowitz has been named president, effective April 24, and continues as chief investment officer. Mr. Markowitz replaces Pauline Modjeski, who served as president since 2008."

The boutique cash manager explains, "Mr. Markowitz joined Horizon in April 2012 as chief investment officer, executive vice president and partner. Over the past year, he has been responsible for the development and implementation of the overall strategies for the firm and management of all investment functions including trading, credit research and the operational aspects of the trading desk. As president, his main focus is on portfolio management and oversight of business operations."

Diane Mix Birnberg, Horizon Founder and Chairman, says, "Michael's 23-years of experience in managing fixed income portfolios has made significant contributions to Horizon's ongoing success. His level of expertise has helped improve our trading desk and operational efficiencies, adding value to our clients' portfolios and overall confidence in the fixed income markets in which we invest. Horizon is very pleased to name Michael the new president."

Finally, the release adds, "Prior to joining Horizon, Mr. Markowitz was managing director and head of short duration fixed income at Guggenheim Partners where he helped launch and manage a short duration, actively managed exchange-traded fund. Previously, he was a managing director and head of short duration fixed income at UBS Global Asset Management and its predecessor firm, where he was responsible for the investment and business side of the short duration division. Mr. Markowitz has been a frequent speaker at fixed income industry conferences."

In late April, we excerpted from the Financial Stability Oversight Council's (FSOC's) "2013 Annual Report," which contained a section on "Money Market Funds" (see our April 26 News "FSOC Report Comments on MMF Reform, Will Stand Down if SEC Moves"). Today, we reprint the report's sections on "Wholesale Funding Markets." FSOC writes, "Short-term wholesale funding markets provide financial intermediaries with funds that supplement retail deposits and long-term debt issuance. These funds include large time deposits, certificates of deposit, repurchase agreements (repos), and commercial paper. Sources of funds in these markets are largely wholesale cash pools, including cash on the balance sheets of nonfinancial companies, reinvestments of cash collateral from securities lending, and cash held by long-term mutual funds, money market mutual funds, pension funds, and sovereign wealth funds. These sources of funds have grown markedly as a percentage of GDP over the past two decades, although this percentage has been declining since early 2008 [note: references to charts have been removed in our excerpt, but see pages 64-67]. Cash on nonfinancial corporate balance sheets, in particular, has been growing at an accelerating rate, a pattern that continued through the fourth quarter of 2012."

It explains, "Domestic banking firms' reliance on short-term wholesale funding continued to decline in 2012, as retail deposits grew. The longer-term stability and cost of deposit inflows during this low interest rate period will be key to funding and interest rate risk projections in the future. Enhanced central bank provisions of liquidity, combined with a significant reduction of European banks' dollar funding needs as they deleverage their balance sheets, has contributed to a reduction in the premium for borrowing dollars via foreign exchange (FX) swap markets to the lowest level since early 2011. This overall normalization in the FX swap market and the improved access to dollar funding for European banks, was supported by the November 2011 decrease in the interest rate charged on central bank liquidity swaps and the ECB's two 3-year longer-term refinancing operations, along with other actions to strengthen the euro area's institutional and fiscal framework. The decision to include a levy on bank deposits in the Cyprus bailout terms was associated to a modest uptick in the premium for borrowing U.S. dollars against the euro in March 2013."

The report says of "Commercial Paper and Asset-Backed Commercial Paper," "Commercial paper (CP) outstanding peaked at $2.2 trillion in July 2007 and stood at $1.0 trillion in February 2013, primarily due to the continuing decline in asset-backed commercial paper (ABCP) outstanding. As of February 2013, ABCP accounts for 28 percent of all outstanding CP, financial CP accounts for 51 percent, and nonfinancial corporate CP accounts for 21 percent. Financial CP and certificates of deposit (CDs) outstanding are around 40 to 50 percent below their pre-crisis peaks. After contracting sharply in 2011, largely due to investor concerns about European debt, CP outstanding at financial institutions with European parents remained stable in the second half of 2012 and has increased notably in early 2013. Even so, financial CP outstanding with European parents remains well below the levels seen in early 2011."

It comments on "Repo Markets," "A repurchase agreement (repo) is the sale of securities for cash with an agreement to repurchase the securities at a specified date and price. This agreement effectively creates a secured loan with securities as collateral. Securities broker-dealers play a significant role in repo markets. There are three repo market segments: the tri-party market, in which broker-dealers obtain funding from cash investors and transact utilizing the collateral management and settlement services of the two tri-party repo clearing banks (JPMorgan Chase and Bank of New York Mellon); the General Collateral Finance (GCF) market, which primarily settles inter-dealer transactions on the tri-party repo platform; and bilateral repo, in which transactions are executed without the services of the two tri-party clearing banks."

FSOC writes, "Repo activity continued to increase in 2012, both as measured in the tri-party repo statistics and in the primary dealer survey. Market participants have noted that some firms have extended maturities for certain repo collateral, indicating an increased willingness of some participants to provide longer-term funding in this market. However, haircuts in the tri-party market on collateral that is not eligible for use in open market operations (OMO) have not declined, indicating an unchanged stance towards collateral quality and potential price volatility."

They add, "The majority of tri-party repo financing remains collateralized by Treasury securities, agency MBS, agency debentures, and agency collateralized mortgage obligations (CMOs). As of February 2013, these types of collateral accounted for 84 percent of all tri-party repo collateral. The other 16 percent of collateral used in tri-party repo includes corporate bonds, equities, private label CMOs, ABS, CP, other money market instruments, whole loans, and municipal bonds. As is true in the securities lending market, repo markets can be used to effect collateral transformation."

The Annual Report's section on "Securities Lending," says, "The largest component of securities lending this past year continued to be undertaken by long-term securities holders such as pension funds, mutual funds, and central banks. The global value of securities lending transactions remained fairly flat through March 2012, at an average value of around $1.7 trillion according to available estimates. Reinvestment of cash collateral from securities lending has declined slowly over the past year, from $659 billion in the fourth quarter of 2011 to $591 billion in the fourth quarter of 2012. The weighted average maturity (WAM) of cash reinvestment has also continued to decline, albeit not as markedly as in previous years. This decline represents a continued trend towards more conservative asset allocation since the financial crisis by cash collateral reinvestment pools."

Below, we excerpt the second half of our May Money Fund Intelligence profile, "Dreyfus Still Roaring at 40 Years; Cardona & Larkin," an interview with Charles Cardona, Chief Executive Officer of BNY Mellon Cash Investment Strategies (CIS) and President of The Dreyfus Corporation, and Patricia Larkin, CIO of the Dreyfus CIS Money Market Mutual Funds.... MFI: What are funds buying now? Larkin: We continue to buy the largest and best-of-class institutions. We have had to adjust to those issuers no longer in the marketplace. Issuance has shifted away from traditional commercial paper borrowers to larger institutional wholesale funding and asset-backed commercial paper programs. We are active in following all 2a-7 eligible securities with a dedicated team of credit research and risk analysts who assist us in maintaining a robust approval list. We remain very disciplined and focused on ample liquidity both in the levels we elect to run and the quality in which we invest.

MFI: Are there any customer concerns currently? Cardona: The Eurozone still comes up in conversation, particularly any time there is a new headline around it. We've been pretty cautious on Europe throughout the crisis with respect to the holdings in our funds. There are certainly some names from a fundamental credit perspective that we think are sound, but we have concerns about trying to handicap the potential political events that may occur. The fact that there is still $2.5-2.6 trillion sitting in money market funds, at these levels of rates, tells you how much people really like these products.

MFI: Are brokerages and intermediaries concerned about potential changes? Cardona: We work with a broad mix of clients, including intermediaries, platforms and record-keepers. All have indicated that a fluctuating NAV would create significant challenges and would require a significant investment in order to support a fluctuating share value structure on their platforms. This is an area the entire industry has raised as a major concern to the regulators -- we are trying to educate them about these challenges in order to arrive at a solution that could work for all constituents.

MFI: Tell us about the impact and prevalence of fee waivers. Cardona: We have a lot of scale, which is good. We remain profitable, but we continue to experience fee waivers given the level of rates. That pressure is not really abating, but we continue to manage through it, recognizing that at some point rates will go up again, and business will ultimately be even more profitable.

MFI: What do you expect might happen with regulations? Cardona: We have been very consistent in our views towards a combination of sensible reforms that would continue to benefit issuers and remain attractive to investors. Clearly, the regulators continue to be concerned primarily about the potential for run risk on prime funds as experienced at the height of the 2008 financial crisis. If you look at our comment letter on the proposed FSOC revisions, you'll see that we're actually not adverse to further reform to 2a-7 which would provide for increased liquidity, enhanced risk control and greater transparency. We believe this would allow the industry to continue to offer the convenience of $1.00 amortized cost pricing in a way that would address concerns articulated by the regulators.

MFI: Do you think the imposition of a floating NAV would be a critical blow to money funds? Cardona: If these changes apply to prime funds only, I think a portion of today's prime fund assets could migrate to government or treasury funds if they continue to operate largely as they do today. Some clients have told us that if fluctuating share value pricing is accompanied with relief from gains and losses, they would continue to use the products. Regardless of the outcome, we will continue to work within the regulatory framework and continue to champion greater transparency, increased liquidity and robust risk analytics -- all that is in the best interests of our shareholders. We'll see.

Federated Investors, the third largest manager of money funds with $233 billion (according to our Money Fund Intelligence XLS), published the brief, "SEC rulemaking: A lengthy process Wednesday. It says, "Recent news articles report that the staff of the Securities and Exchange Commission (SEC) sent the agency's five commissioners a draft release proposing new rules for money market mutual funds (MMFs). While SEC rulemaking generally does not have a typical timeline, Federated thought it helpful to outline the process to illustrate how any potential rule change might be adopted and implemented."

They explain, "Under federal law, rulemaking generally involves multiple stages; the SEC may not simply change regulations overnight. The most critical part of agency rulemaking involves the requirement for both "notice" and "public comment." After the public comment period, the agency must consider and respond to those comments. In this case, if a majority of SEC commissioners vote to propose a new rule, a period for public comment would be specified and the agency would take additional time to evaluate those comments. At that point, the SEC may decide to adopt a rule as proposed, modify the rule or not adopt a rule at all."

Federated tells us, "Even if, at the end of the process, a majority of commissioners votes to adopt a rule, the SEC typically would allow a phase-in period for affected businesses and individuals to adjust before the rule change is effective."

The piece continues, "The anticipated steps that any SEC rulemaking on MMFs would take are as follows: The staff of the SEC would consider and develop a draft proposing release and share it with each of the SEC's five commissioners. Based on news reports, the staff has completed this step. The commissioners and their counsels may engage with the staff in order to evaluate and ask for changes in the draft proposal. Depending upon the nature and level of concern and the changes requested, this could take several weeks or a period of months."

Federated adds, "If there appears to be a majority of commissioners supporting a proposal, the chairman would then schedule a public meeting where the staff would describe the proposal and the individual commissioners would vote on it. Additionally, the chairman may choose not to bring a proposal to a vote as was the case with potential rule changes for money funds in 2012. If a majority of the commissioners votes at the public meeting to issue the proposal, a Notice of Proposed Rulemaking that details the proposed changes and the reasons for the proposed changes would be posted on the SEC website."

They write, "The Notice of Proposed Rulemaking would also be published in the Federal Register, which is the federal government's official newspaper. This is usually done within one to two weeks of the posting on the SEC's website, but may take longer. The Notice will specify a comment period so that any members of the public who wish to comment on the proposed changes may do so. `Comment periods for a significant rule generally will be for a period of at least 60 days. This is the minimum specified in the Obama Administration's orders relating to Executive Branch rulemaking. Although the SEC is not subject to these orders, the SEC typically would have a comment period of at least 60 days, from the date of the publication in the Federal Register."

Federated tells us, "For example, the last time the SEC amended Rule 2a-7, the comment period was open for 60 days. During the comment period, market participants, investors and other interested members of the public file comments with the SEC in which they oppose, support or suggest changes to the proposal. As part of the comment process, SEC commissioners and staff may also meet with market participants and investors in order to learn more about their positions. The commissioners and staff must carefully evaluate all input received during the comment process. This period of evaluating comments may last for months after the close of the comment period."

They say, "By law, the SEC must consider: Efficiency, competition and capital formation when it considers changing rules or adopting new rules. Whether such changes are necessary or appropriate in the public interest. The economic impact of the rule proposals. SEC rule proposals have been struck down in court on the basis of deficient cost/benefit analyses. Any reasonable alternative to the rules. Responding to substantial problems identified by commenters. If it does not and if affected persons challenge a rule adopted by the SEC, the rule may be struck down by a court as arbitrary and capricious."

Federated also writes, "At a public meeting, announced in advance, a majority of commissioners is required to approve any final rule. Typically, any rule that requires changes in processes and compliance specifies a "compliance date" or a future date by which affected parties need to change their processes or systems."

They add, "As the above suggests, rulemaking can be a lengthy process. For example, the last time the SEC amended Rule 2a-7 after significant conversation with market participants in 2008 and 2009, it voted to propose the rule changes on June 30, 2009; the proposal was then published in the Federal Register on July 8, 2009; and the period for public comment ran from that date until Sept. 8, 2009. The SEC took nearly six months to consider the comments and make changes to the proposal before approving final rule changes on Feb. 23, 2010. The SEC then gradually phased in the implementation of the changes to Rule 2a-7 by allowing compliance periods that ran from two months for some of the new requirements to more than 20 months for others. This was a relatively fast proceeding. Other SEC rule changes have taken years to complete. Some proposed rules are never adopted."

Finally, the piece comments, "Of course, Federated continues to be interested in any regulatory proposals that impact the utility of money funds. Most of the ... comments to the file of the President's Working Group on Money Fund Reform last year agreed. If the SEC does propose rule changes, Federated would encourage investors in Federated money funds to express their views on any proposed changes to Rule 2a-7 by sending a comment letter to the SEC."

Today, we excerpt from the latest issue of our Money Fund Intelligence newsletter.... For our May issue, MFI interviews Charles Cardona, Chief Executive Officer of BNY Mellon Cash Investment Strategies (CIS) and President of The Dreyfus Corporation, and Patricia Larkin, CIO of the Dreyfus CIS Money Market Mutual Funds. The two joined Dreyfus in the early 1980's. Dreyfus, which launched its flagship retail fund, Dreyfus Liquid Assets, in early 1974, is approaching its 40th birthday in the money fund business. We discuss the company's history, current events, and a number of money fund related issues below.

MFI: How long have you been running money funds? Cardona: Dreyfus has been involved in the money fund business for a long time. Ironically, given current regulatory debate, when we introduced Dreyfus Liquid Assets in 1974, it was actually a fluctuating share value fund, priced at $10 per share. Amortized cost pricing had not yet been adopted. Eventually, with SEC approval or exemptive relief, the industry migrated to $1 pricing. We created our Dreyfus Cash Management Funds in the mid-80's, which were pioneers of today's lower cost model. We were the first to price the funds at a total expense ratio of 20bps with a higher investment minimum and omnibus account processing only.

MFI: What are you focusing on? Cardona: Our strategy with the brand is to leverage the best of both Dreyfus and BNY Mellon. Dreyfus is a wholly-owned subsidiary of BNY Mellon; CIS, a division of Dreyfus, represents one of 16 different investment boutiques that comprise our asset management business. As an enterprise, BNY Mellon Investment Management is responsible for approximately $1.4 trillion in assets under management. CIS focuses on short-duration fixed-income cash products. The Dreyfus name remains very important to us. It is the name that's on the funds and co-branded on all the fund materials that we use. But we also like to promote the fact that we're part of a much larger and very sound financial organization. So we clearly benefit by combining it with BNY Mellon, hence the name of the CIS division -- BNY Mellon Cash Investment Strategies, with the Dreyfus money market funds being a very important part of that.

MFI: How much cash is the unit managing approximately now? Cardona: We manage in excess of $350 billion in domestic money market funds, offshore money market funds, sub-advised money market portfolios, bank commingled collective funds and cash collateral reinvestment products.

MFI: What's the biggest challenge in managing the funds today? Larkin: The current interest rate environment is certainly a challenge. Rates are at historic lows and it appears they will remain so for a period of time. So, this asset class is challenged to remain competitive. We fully expect that there may be changes to Rule 2a-7 and will address that at the appropriate time. In the meanwhile, we continue to manage our funds with large liquidity positions and try to capitalize on yield opportunities where we can.

MFI: Is there a lot more scrutiny of money funds in general these days? Cardona: There certainly is. We've been an advocate of trying to be as transparent as we can be, because we think that's what clients need and want. So, in 2007, when you were first going through the early stages of what was leading up to the height of the financial crisis in 2008, we actually made a decision to post all of our portfolio holdings daily on the web. That way we were transparent. If the client wanted to see what we owned they could see it. We could talk about what we owned and what we didn't. I believe we were the first to actually proceed with daily portfolio disclosures. We were also one of the first in the industry who, earlier this year, disclosed market NAVs on a daily basis. That's an addition to what 2a-7 has required us to do in reporting them to the regulators.

As we mentioned in yesterday's "Link of the Day," Fitch Ratings released the report, "U.S. Corporate Cash Part I: Growth at an Inflection Point?" earlier this week. Today, we highlight more of the paper. Fitch writes, "Much has been made about the high levels of cash held by corporations, which have risen substantially over the past decade, as illustrated by the chart below [it show U.S. nonfinancial corporate cash holdings rising from under $0.4 trillion in 2000 to just under $1.0 trillion in 2008 and to almost $1.5 trillion in 2012], which shows total cash and short-term marketable securities of our very large sample. However, merely examining cash levels in the aggregate does not tell us much about their nature, distribution and future use."

The report tells us, "This report explores the distribution and trend over time of U.S. corporate cash holdings by examining a large universe of significant U.S. corporate cash holders, breaking down the universe by size and broad industry category.... The increase in cash levels has been broad-based, not just for the largest holders.... Historically and currently, the top 10 holders have approximately one-quarter of the total cash exposure of our broad universe, which consists of more than 1,000 different companies."

Fitch says, "Cash levels have increased over time, although the annual growth rate has been far from constant.... The median company increased cash reserves by as much as approximately 35% for just one year at the height of both the most recent downturn and the tech bust earlier in the past decade. Interestingly, the cash balance of the median company in our sample never falls over the past 20 years, despite experiencing large percentage gains during many years, especially in more turbulent periods.... Significantly, it does appear that, for the past few years, cash levels have not grown much at all for the "typical" company, as evidenced by year/year median growth rates approaching zero in 2011 and 2012."

They explain in a sidebar, "Corporates as engines and catalysts of globalization have become increasingly internationalized, with a significant proportion of their earnings originating from outside their domestic markets. As such, corporates can avoid paying taxes on foreign earnings not remitted to the U.S.... To fund their domestic activities and provide shareholder returns, companies can borrow at the holding-company level, despite having significant cash balances on a consolidated basis.... The technology and pharmaceutical sectors are typical examples of companies that are not inherently local in nature, in contrast to, for example, utilities, and, thus, tend to operate on a global basis. As a result, a large part of their cash balances is located outside their domestic market."

The Fitch paper continues, "While corporate cash and short-term holdings include those amounts held for future capital expenditures, acquisitions, dividend payouts and share repurchases, they also are necessary to maintain a certain level of business activity, including for transactional purposes and expenditures on maintenance and "routine" capital expenditures and the like. Consequently, there should be a certain structural element to cash holdings that varies with the level of business activity."

Finally, it comments, "While the relative figures show a general stabilization in cash holdings more recently, over the longer term, cash levels have outpaced business activity substantially. In addition to the tax incentive some U.S. multinationals have for holding overseas cash, all U.S. nonfinancials have two additional incentives to hold cash. First, inflation is at very low levels, lowering the opportunity cost of holding cash versus inventory, for example, making the assumption that the value of inventory held would keep pace with inflation. Second, capacity utilization is still somewhat below previous peaks and below the level (80%85%) historically associated with expansions."

Moody's Investor Service published a "Special Comment" entitled, "Money Market Funds and Regulatory Reform: A Business Model Hangs in the Balance" yesterday, which says, "Recent changes in market dynamics, and particularly low interest rates, constrained asset supply, regulatory scrutiny and evolving investor preferences have begun to transform the liquidity and investment characteristics of money market funds (MMFs). We expect that additional and more substantial regulatory change will provide further protections to MMF investors and reduce systemic risk, but at the same time lead to a reshaping of the industry, as some funds close or consolidate, and some of the smaller MMF managers either exit the business or reassess their business models. In addition, the potential transformation of the traditional constant net asset value (CNAV) MMF product would have a significant impact on the overall liquidity product landscape, investor preferences and industry composition."

The press release announcing the report, titled, "Regulatory reforms will transform MMF industry and drive growth of alternative liquidity products," tells us, "Changes in the money market industry will continue, as regulatory developments coupled with market dynamics force some money market funds (MMFs) to close or consolidate, says Moody's Investors Service in its latest special comment "Money Market Funds and Regulatory Reform: A Business Model Hangs in the Balance.""

Yaron Ernst, Managing Director of Moody's Managed Investments Group, comments, "Low interest rates, constrained asset supply, regulatory scrutiny and evolving investor preferences have already begun to transform the characteristics of money market funds.... Due to the changing product dynamics, we expect industry consolidation to accelerate, combined with a significant impact on the overall liquidity product landscape and investor preferences."

Moody's release explains, "Proposed regulatory reforms in the US and Europe that threaten the traditional constant net asset value (CNAV) structure are one of the three key drivers of the changing MMF landscape, says Moody's. MMFs are also faced with persistently low interest rates that continue to push investors to higher-yielding fund products, further reducing already-slim profits. In addition, the diminishing supply of highly rated investments are forcing managers to develop and launch new products, as the industry changes shape and business models follow suit, says the rating agency."

It continues, "The report lays out three scenarios for the industry, as well as the expected implications for fund managers and investors: (A) Variable net asset value (VNAV) MMFs entirely replace CNAV MMFs -- there is a regulatory prohibition on the CNAV product generally. The probability of this scenario is low in the US and in Europe; (B) Bifurcation of MMFs -- Only government/treasury MMFs are allowed to maintain their CNAV structure, while prime and tax-exempt MMFs can only be VNAV. In Moody's view, this scenario is the most likely in the US, but does not apply in Europe because a separate framework for government funds does not exist; (C) Buffers/Holdbacks - Requirement for capital buffers and/or redemption limits for all CNAV MMFs. This is the most likely scenario in Europe, with moderate probability of implementation in the US."

The Moody's report explains, "The implementation of regulation in the US and Europe is likely to unfold along different timeframes and with different outcomes. Given this, there is the risk that funds suffer an increase in outflows arising from investors shifting their investments across regions to remain invested in a CNAV fund. In the event that Europe is the first to modify the CNAV MMF by imposing buffer provisions or mandating a shift to VNAV, CNAV investors with domiciles outside of the European Union may decide to repatriate some of their cash to the US to remain invested in CNAV MMFs. According to estimates by the European Systemic Risk Board (ESRB), the E433 billion in European CNAV MMFS could see a potential outflow of E257 billion, or 59%. This risk likely is to be mitigated by the aversion of corporate treasurers to creating a tax liability in the shift of offshore cash balances to onshore."

It adds, "In addition, some managers may consider relocating their funds to an offshore domicile, such as the Cayman Islands, to avoid the expected regulations in Europe and/or the US. However, this solution seems temporary in nature, as regulators may act to reduce the benefits of a new fund domicile, either by applying certain restrictions on fund managers, or by imposing unfavorable accounting or tax treatment on investors that invest in these offshore funds. It also remains to be seen what investors' reaction would be to such a change in a fund's domicile."

Crane Data released its May Money Fund Portfolio Holdings late last week, and our collection for the month ended April 30, 2013, shows Repurchase Agreements (repos) rebounding sharply to regain their spot as the largest segment of money fund holdings from Certificates of Deposit (CDs). Money market securities held by Taxable U.S. money funds overall decreased by $9.9 billion in April (after falling $34.6 billion in March) to $2.351 trillion. (Note that our Portfolio Holdings collection is a separate series from our monthly Money Fund Intelligence XLS totals and from our MFI Daily universe.) As usually happens during the first month of a new quarter, Repos jumped (by over $50 billion) while Treasuries, CDs and Other (which includes Time Deposits) securities plunged. Repo regained its spot as the largest holding among taxable money funds, followed by CDs, Treasuries, CP, Agencies, Other, and VRDNs. Money funds' European-affiliated holdings (including repo) rebounded to just above the 30% level on the jump in repo and drop in U.S. Treasuries. Below, we review our latest portfolio holdings aggregates.

Repurchase agreement (repo) holdings increased by $50.3 billion (after falling $70.9 billion last month) to $523.6 billion, or 22.3% of fund assets.. Certificates of Deposit (CD) holdings decreased by $21.0 billion to $466.2 billion, or 19.8% and Treasury holdings decreased by $32.9 billion to $443.2 billion (18.9% of holdings). Commercial Paper (CP) remained the fourth largest segment, rising by $7.0 billion to $400.7 billion (17.1% of holdings). Government Agency Debt declined by $13.3 billion (after rebounding $21.3 billion last month); it now totals $318.8 billion (13.6% of assets). Other holdings, which include Time Deposits, fell by $10.2 billion to $140.6 billion (6.0% of assets). VRDNs, which are getting some "buy" mentions from managers and strategists lately but which remain a minor segment of money fund holdings, rose by $10.1 billion to $57.4 billion (2.4% of assets).

European-affiliated holdings rebounded by $47.9 billion in April to $724.5 billion; their share of holdings rose to 30.8%. Eurozone-affiliated holdings rose to $387.0 billion in April; they now account for 16.5% of overall taxable money fund holdings. Asia & Pacific related holdings dipped to $283.3 billion (12.1% of the total), while Americas related holdings fell to $1.342 trillion (57.1% of holdings), primarily on the decline in Treasuries.

The Repo totals were made up of: Government Agency Repurchase Agreements (up $31.3 billion to $276.2 billion, or 11.8% of total holdings), Treasury Repurchase Agreements (up $15.1 billion to $176.5 billion, or 7.5% of assets), and Other Repurchase Agreements (up $3.9 billion to $71.0 billion, or 3.0% of holdings). The Commercial Paper totals were comprised of Financial Company Commercial Paper (up $3.3 billion to $230.9 billion, or 9.8% of assets), Asset Backed Commercial Paper (down $4.9 billion to $101.8 billion, or 4.3%), and Other Commercial Paper (up $8.6 billion to $68.1 billion, or 2.9%).

The 20 largest Issuers to taxable money market funds as of April 30, 2013, include the US Treasury (18.9%, $443.2 billion), Federal Home Loan Bank (6.7%, $154.9 billion), Deutsche Bank AG (3.2%, $75.2B), Federal National Mortgage Association (2.9%, $67.5B), Federal Home Loan Mortgage Co (2.7%, $63.3B), Societe Generale (2.6%, $60.2B), JP Morgan (2.5%, $59.2B), Bank of America (2.5%, $58.3B), Barclays Bank (2.5%, $57.5B), Bank of Nova Scotia (2.4%, $56.9B), RBC (2.4%, $56.3B), BNP Paribas (2.4%, $56.3B), Bank of Tokyo-Mitsubishi UFJ Ltd (2.2%, $52.8B), Sumitomo Mitsui Banking Co (2.2%, $52.4B), Credit Suisse (2.1%, $49.2B), Citi (2.0%, $47.6B), Credit Agricole (1.9%, $44.5B), Toronto-Dominion Bank (1.5%, $34.5B), Mizuho Corporate Bank Ltd (1.4%, $33.8B), and Bank of Montreal (1.4%, $33.1B).

The 10 largest Repo issuers (dealers) (with the amount of repo outstanding and market share among the money funds we track) include: Deutsche Bank ($52.9B, 10.1%), Bank of America ($51.1B, 9.8%), BNP Paribas ($40.4B, 7.7%), Barclays Bank ($40.1B, 7.7%), Societe Generale ($33.7B, 6.4%), Citi ($29.2B, 5.6%), Credit Suisse ($27.0B, 5.2%), RBS ($26.5B, 5.1%), JP Morgan ($25.8B, 4.9%), and Goldman Sachs ($25.6B, 4.9%).

The 10 largest issuers of CDs (with the amount of CDs issued to our universe and market share include: Sumitomo Mitsui Banking Co ($45.8B), Bank of Tokyo-Mitsubishi UFJ Ltd ($37.3B, 8.0%), Bank of Nova Scotia ($29.1B, 6.3%), Bank of Montreal ($28.4B, 6.1%), Toronto-Dominion Bank ($27.9B, 6.0%), National Australia Bank Ltd ($23.3B, 5.0%), Mizuho Corporate Bank Ltd ($19.2B, 4.1%), RBC ($15.7B, 3.4%), Rabobank ($15.1B, 3.2%), and Svenska Handelsbanken ($14.0B, 3.0%).

The 10 largest issuers of CP (owned by money funds) as of April 30 include: Westpac Banking Co ($21.0B, 6.0%), JP Morgan ($19.5B, 5.6%), Commonwealth Bank of Australia ($15.7B, 4.5%), FMS Wertmanagement ($14.4B, 4.1%), Societe Generale ($11.9B, 3.4%), NRW.Bank ($10.9B, 3.1%), Lloyds TSB Bank PLC ($10.5B, 3.0%), Barclays Bank ($10.0B, 2.9%), General Electric ($9.8B, 2.8%), and Australia & New Zealand Banking Group Ltd ($9.6B, 2.7%).

The largest increases among Issuers of money market securities (including Repo) in April were shown by: Societe Generale (up $26.4B to $60.2B), Deutsche Bank AG (up $17.1B to $75.2B), Lloyd's TSB Bank (up $10.9B to $18.5B), Bank of America (up $8.4B to $58.3B), and Mizuho Corporate Bank Ltd (up $6.9B to $33.8B). The largest decreases among Issuers included: US Treasury (down $32.9B to $443.2B), Australia & New Zealand Banking Group (down $9.7B to $19.8B), DnB NOR Bank ASA (down $6.4B to $26.8B), and Goldman Sachs (down $6.0B to $25.8B).

The United States is still by far the largest segment of country-affiliations with 48.1%, or $1.130 trillion. Canada (9.0%, $210.5B) remained the second largest country and France increased sharply but remained in third place (8.7%, $205.5B). Japan was again fourth (6.9%, $161.3B) and the UK (6.2%, $146.4B) remained fifth. Germany (5.1%, $120.9B) rebounded to sixth, followed by Australia (4.5%, $104.6B) among country-affiliated securities and dealers. (Note: Crane Data attributes Treasury and Government repo to the dealer's parent country of origin, though funds themselves "look-through" and consider these U.S. government securities. All money market securities must be U.S. dollar-denominated.) Sweden (3.7%, $85.9B), Switzerland (3.3%, $77.6B), and the Netherlands (2.4%, $56.4B) continued to round out the top 10.

As of April 30, 2013, Taxable money funds held 22.9% of their assets in securities maturing Overnight, and another 14.5% maturing in 2-7 days (37.3% total in 1-7 days). Another 19.2% matures in 8-30 days, while 24.8% matures in the 31-90 day period. The next bucket, 91-180 days, holds 13.2% of taxable securities, and just 5.4% matures beyond 180 days.

Crane Data's Taxable MF Portfolio Holdings (and Money Fund Portfolio Laboratory) were updated late last week, and our MFI International "offshore" Portfolio Holdings will be updated tomorrow (the Tax Exempt MF Holdings will be released later today). Visit our Content center to download files or visit our Portfolio Laboratory to access our "transparency" module and contact us if you'd like to see a sample of our latest Portfolio Holdings Reports or our new Weekly Money Fund Portfolio Holdings collection.

Federal Reserve Chairman Ben Bernanke spoke today a the Federal Reserve Bank of Chicago on "Monitoring the Financial System" and mentioned money market funds on a couple of occasions. He says, "Shadow banking, a second area we closely monitor, was an important source of instability during the crisis. Shadow banking comprises various markets and institutions that provide financial intermediation outside the traditional, regulated banking system. Shadow banking includes vehicles for credit intermediation, maturity transformation, liquidity provision, and risk sharing. Such vehicles are typically funded on a largely short-term basis from wholesale sources. In the run-up to the crisis, the shadow banking sector involved a high degree of maturity transformation and leverage. Illiquid loans to households and businesses were securitized, and the tranches of the securitizations with the highest credit ratings were funded by very short-term debt, such as asset-backed commercial paper and repurchase agreements (repos). The short-term funding was in turn provided by institutions, such as money market funds, whose investors expected payment in full on demand and had little tolerance for risk to principal."

Bernanke explains, "As it turned out, the ultimate investors did not fully understand the quality of the assets they were financing. Investors were lulled by triple-A credit ratings and by expected support from sponsoring institutions--support that was, in fact, discretionary and not always provided. When investors lost confidence in the quality of the assets or in the institutions expected to provide support, they ran. Their flight created serious funding pressures throughout the financial system, threatened the solvency of many firms, and inflicted serious damage on the broader economy."

He continues, "Securities broker-dealers play a central role in many aspects of shadow banking as facilitators of market-based intermediation. To finance their own and their clients' securities holdings, broker-dealers tend to rely on short-term collateralized funding, often in the form of repo agreements with highly risk-averse lenders. The crisis revealed that this funding is potentially quite fragile if lenders have limited capacity to analyze the collateral or counterparty risks associated with short-term secured lending, but rather look at these transactions as nearly risk free. As questions emerged about the nature and value of collateral, worried lenders either greatly increased margin requirements or, more commonly, pulled back entirely. Borrowers unable to meet margin calls and finance their asset holdings were forced to sell, driving down asset prices further and setting off a cycle of deleveraging and further asset liquidation."

Bernanke tells us, "We have other potential sources of information about shadow banking. The Treasury Department's Office of Financial Research and Federal Reserve staff are collaborating to construct data sets on triparty and bilateral repo transactions, which should facilitate the development of better monitoring metrics for repo activity and improve transparency in these markets. We also talk regularly to market participants about developments, paying particular attention to the creation of new financial vehicles that foster greater maturity transformation outside the regulated sector, provide funding for less-liquid assets, or transform risks from forms that are more easily measured to forms that are more opaque."

He adds, "A fair summary is that, while the shadow banking sector is smaller today than before the crisis and some of its least stable components have either disappeared or been reformed, regulators and the private sector need to address remaining vulnerabilities. For example, although money market funds were strengthened by reforms undertaken by the Securities and Exchange Commission (SEC) in 2010, the possibility of a run on these funds remains--for instance, if a fund should "break the buck," or report a net asset value below 99.5 cents, as the Reserve Primary Fund did in 2008. The risk is increased by the fact that the Treasury no longer has the power to guarantee investors' holdings in money funds, an authority that was critical for stopping the 2008 run. In November 2012, the FSOC proposed for public comment some alternative approaches for the reform of money funds. The SEC is currently considering these and other possible steps."

Finally, Bernanke says, "With respect to the triparty repo platform, progress has been made in reducing the amount of intraday credit extended by the clearing banks in the course of the daily settlement process, and, as additional enhancements are made, the extension of such credit should be largely eliminated by the end of 2014. However, important risks remain in the short-term wholesale funding markets. One of the key risks is how the system would respond to the failure of a broker-dealer or other major borrower. The Dodd-Frank Act has provided important additional tools to deal with this vulnerability, notably the provisions that facilitate an orderly resolution of a broker-dealer or a broker-dealer holding company whose imminent failure poses a systemic risk. But, as highlighted in the FSOC's most recent annual report, more work is needed to better prepare investors and other market participants to deal with the potential consequences of a default by a large participant in the repo market."

The Federal Reserve Bank of New York published the research paper, "The Risk of Fire Sales in the Tri-Party Repo Market" earlier this week. The Abstract says, "This paper studies the risk of "fire sales" in the tri-party repo market, a large and important market where securities dealers find short-term funding for a substantial portion of their own and their clients' assets. We distinguish between fire sales of assets by a dealer who, facing a run that could lead to default, sells securities to generate liquidity, and fire sales of assets by repo investors after a dealer's default has occurred. While fire sales do cause damage no matter how they arise, the tools available to lessen the harm from the two types of fire sales are different. We find that limited tools are available to mitigate the risk of pre-default fire sales and that no established tools currently exist to mitigate the risk of post-default sales."

The paper explains, "The risk of "fire sales," rapid sales of assets in large amounts that temporarily depress their market prices, is a major source of financial instability. Policymakers' concern for fire sales was one of the driving forces behind the creation of the Term Securities Lending Facility and the Primary Dealer Credit Facility in 2008. Fire sales can amplify problems faced by a financial firm because the reduced sale price of the assets can result in realized losses that lead to a decrease in capital and the possible need for additional asset sales. Excessive sales by a single firm can also propagate stress to other institutions if they face margin calls and are forced to sell assets. The presence of such externalities suggests that market outcomes may not be efficient. As a consequence, mitigating the risk of fire sales is an important objective in the effort to promote financial stability."

The NY Fed's research tells us, "In this paper, we discuss the risk of fire sales in the tri-party repo market, a large and important market where securities dealers find short-term funding for a substantial portion of their own and their clients' assets. Because of the size of this market and the fact that some of its participants are vulnerable to runs, fire sales are particularly likely in this market. They can result if a securities dealer defaults and its secured creditors decide to liquidate the collateral -- or even in the absence of a formal default if funding becomes difficult to obtain, spurring a rapid reduction in positions."

It adds, "Fire sales are one of the three systemic risk concerns highlighted in a May 2010 whitepaper by the Federal Reserve Bank of New York on tri-party repo infrastructure reform (Federal Reserve Bank of New York, 2010). These three risks are 1) the market's excessive reliance on clearing-bank provision of intraday credit to complete settlement, 2) poor liquidity and credit risk management practices on the part of various classes of tri-party repo market participants, and 3) the absence of any mechanism to mitigate the risk of fire sales of collateral in the aftermath of a large-dealer default."

The paper tells us, "Progress is being made in addressing two of these three risks. Industry work currently under way will result in sharply reduced intraday credit usage by the end of 2014. The required behavioral and process changes associated with this reduction are also expected to bring improvements in market participants' risk management practices. However, these efforts will not mitigate the risk of fire sales of tri-party repo collateral in the event of a large dealer's default on its repo obligations. Fire sales remain a concern of regulators; the 2013 report of the Financial Stability Oversight Council points to the vulnerability of the wholesale funding markets to runs that can lead to destabilizing fire sales. Also, a recent speech by New York Fed President William C. Dudley at the 2013 Annual Meeting of the New York Bankers Association focused on the danger of spiraling asset sales during the crisis."

Finally, the NY Fed research says, "In this paper we argue that, in the tri-party repo market, it is important to distinguish between fire sales of assets by a dealer who, facing a run that could lead to default, sells securities to generate liquidity, and fires sales of assets by repo investors after a dealer's default has occurred. While fire sales do damage no matter how they arise, the tools available to lessen the harm from the two types of fire sales are different. The risk of pre-default fire sales by dealers comes from the fact that dealers perform maturity and liquidity transformation (explained in more detail later), and they cannot expect to liquidate longer-maturity assets as quickly as their short-term funding may evaporate. In contrast, the risk of post-default fire sales by counterparties to a defaulted dealer is posed by the exemption from the automatic stay of bankruptcy that repo contracts enjoy, which means creditors may immediately take possession of collateral in a bankruptcy. While this exemption is very important for the secured funding model, the lack of a process, or mechanism, to ensure an orderly disposal of the assets collateralizing repos across all creditors of a defaulting dealer could lead to rapid sales, price dislocations, and a deleveraging spiral."

J.P. Morgan Securities released a special "Short-Term Fixed Income Markets Research Note" yesterday, entitled, "Beyond money markets: An overview of short-term bond fund strategies." The update, written by Alex Roever, Teresa Ho, and Chong Sin, says, "Short duration funds have been one of the most popular investment products over the last few years. Demand has been driven by zero rate fatigue from money market fund investors seeking higher yielding products offering principal stability and limited mark-to-market volatility and more recently, from some longer duration investors who are cautious about the potential for rising rates. In this note, we provide an overview of short duration open-end mutual fund and exchange traded fund (ETF) flows, performance, and asset allocation. We note that short duration mutual funds and ETFs are mainly retail products. Institutional investors often utilize separately managed accounts, typically using similar strategies but for which there is extremely limited data currently."

The piece explains, "Short duration funds have experienced exponential growth over the past five years, spurred on by an extended low rate environment and flood of liquidity from central bank quantitative easing. ETFs, in particular, have become increasingly popular due to their cost efficiency relative to mutual funds. While money market funds have seen returns near zero for the last few years, short duration funds have been able to return about 1% to 3%, on average, per year over the last 3 years depending on strategy while return volatility has continued to fall. Short duration fund strategies run the gamut but most funds maintain durations below 3.5 and tend to allocate their assets more heavily towards corporate credit, mortgages, asset-backed securities, US Treasuries, and US agency debt."

Roever, Ho and Sin write, "This exponential growth have been a direct result of the Fed's zero interest rate policy coupled with asset purchases, which have suppressed yields and flooded the market with liquidity, rendering cash products such as money market products unattractive from a yield standpoint. In response, many investors who value principal protection and minimal volatility reallocated their cash from money market products to short duration funds, which aim to achieve the aforementioned goals but at the same time, provide higher returns than money market products. And more recently, some concerns over rising rates have created additional demand for these products from some longer duration investors who are shortening duration."

They tell us, "The investment styles of these funds run the gamut but, generally speaking, short duration funds are those that maintain average effective portfolio durations of 3.5 and below. Using data from Morningstar, we've categorized all short duration mutual funds and ETFs into 3 categories using the following 3 simple criteria in order of importance: 1) average monthly or quarterly effective portfolio duration over the last 3 years, 2) best fit short duration index over the last 3 years2 and 3) stated primary prospectus benchmark index."

The JPM piece adds, "We note that mutual funds and ETFs mainly cater to retail investors who may have more flexibility to reallocate their investments based on market conditions whereas, institutional investors often have liquidity preferences. This is especially true in the front-end, where large pools of institutional cash have a strong aversion to principal loss and mark-to-market volatility due to the operational nature of this cash. Institutional cash that leave 2a-7 money market funds that currently provide constant NAV or commercial bank deposits often end up in separately managed accounts that aim for principal stability and minimal volatility while providing higher yields than money market products. However, transparency into this investment pool is extremely limited so we limit our analysis to observable mutual funds and ETFs whose management companies also manage much of the institutional separately managed accounts."

They also comment, "Short duration open-end mutual fund and ETF net assets totaled $383bn as of the end of 1Q13, growing by 18% over the past year. [Ultrashort bond funds account for just $58 billion of this total according to a table accompanying the article.] 3y and 5y growth were 52% and 158%, respectively. Short-term bond fund net assets experienced the largest growth in the last 3 years and 5 years at 67% and 208%, respectively. In the past year, ultrashort fund net asset growth outpaced those of others at 30%. Short-term government funds, on the other hand, lost 9% in net assets over the past year and 5% over the last 3 years given the lack of relative performance. However, its 5y growth was 34%."

Finally, the Note says, "Short duration funds have been able to achieve relatively attractive returns in spite of the extended low rate environment mainly by employing active sector rotation and reaching down in credit quality.... In an environment where yields are not easy to come by, we think asset allocation and credit quality decisions will continue to drive returns for short duration funds. We expect credit to continue to outperform as spreads, as tight as they are, still have room to compress."

Last night, Reuters wrote "SEC has internally released money market fund draft rule: sources", which says, "Staff at the Securities and Exchange Commission have circulated a long-awaited draft proposing new reforms for the $2.6 trillion money market fund industry, people familiar with the matter told Reuters. Details on the exact contents of the roughly 500-page proposal could not be immediately obtained." If true and if the proposal is acceptable to a majority of SEC Commissioners, this means we could see a reform proposal in as soon as 30 days.

On Friday, SEC Chair Mary Jo White said at the Investment Company Institute's annual meeting, "As the SEC works to develop and propose meaningful money market fund reform, our goal is to preserve the economic benefits of the product while addressing potential redemption pressures and the susceptibility of these funds to runs -- runs in which retail investors are especially likely to suffer losses. While I'm sure that you would like me to say more about this today, I'll stop there as the staff and Commissioners are actively engaged in discussions designed to yield an appropriate and balanced proposal in the near future."

The Reuters story explains, "People familiar with the staff's thinking expect the draft will address in some form or another whether to require only certain target prime funds to float their net asset value, an idea that has previously been suggested by major money fund players such as Charles Schwab in an effort to strike a compromise. Previously, former SEC head Mary Schapiro had pushed for tougher measures, including capital buffers and redemption holdbacks, or moving from a stable to a floating net asset value on a broader scale."

The piece adds, "The lengthy money fund draft arrived in SEC officials' inboxes on Friday afternoon, just hours after new SEC Chair Mary Jo White publicly addressed the fund industry's largest trade association, the Investment Company Institute."

Friday's Wall Street Journal in wrote, "U.S. securities regulators, under pressure to address risks posed by the $2.6 trillion money-market-mutual fund industry, are considering a scaled-​back approach that would tighten rules for about half of the sector that is seen as most vulnerable to investor runs, according to people familiar with staff discussions. The approach, one of several being contemplated at the Securities and Exchange Commission, would require only the riskiest funds to abandon their fixed $1 share price and allow shares to float in value like other mutual funds, these people said."

The May issue of Crane Data's Money Fund Intelligence newsletter was e-mailed to subscribers this morning. It features the articles: "Crane Data Celebrates 7th Year; Wait for Regs Goes On," which talks about our latest birthday and possibly pending regulations; "Dreyfus Still Roaring at 40 Years; Cardona & Larkin," which interviews two money fund industry veterans; and, "ICI's 2013 Fact Book Analyzes MMF Trends," which excerpts from the Institute's latest research. We've also updated our Money Fund Wisdom database query system with April 30, 2013, performance statistics and rankings, and our MFI XLS was sent out earlier this a.m. Our April 30 Money Fund Portfolio Holdings are scheduled to go out on Thursday, May 9. Note that we've also announced the agenda for our new European Money Fund Symposium, which will take place Sept. 24-25 in Dublin, and we're entering the home-stretch for our Crane's Money Fund Symposium, which will be held June 19-21, 2013, in Baltimore, Md. Registrations ($750). We urge attendees to book Symposium hotel reservations soon (our block is almost sold out) via our website at

Our 7th Anniversary piece says, "Crane Data, the publisher of Money Fund Intelligence, celebrates its 7th birthday this month. As we've done in many of our past May issues, we'd like to take some time here to review our progress and update you on our efforts. We also review the latest regulatory reform news below. Crane Data was launched in May 2006 by money fund expert Peter Crane and technology guru Shaun Cutts to bring affordable and more accessible information to the money fund space. We began with our MFI newsletter and have grown to offer a full product range of daily and monthly spreadsheets, database query systems and reports on U.S. and "offshore" money funds, as well as other cash investments."

It adds that "Conferences are Now a Major Business <b:>`_," explaining, "Crane has also become the leader in the money fund conference business. Our 5th annual Money Fund Symposium will take place in Baltimore, June 19-21, and we again expect well over 400 attendees. We're also launching our third event this year, Crane's European Money Fund Symposium, which will take place in Dublin at the Conrad Hotel on Sept. 24-​25, 2013, and will feature many of the world'​s foremost experts on "​offshore" money market mutual funds."

MFI writes in its monthly "profile," "For our May issue, MFI interviews Charles Cardona, Chief Executive Officer of BNY Mellon Cash Investment Strategies (CIS) and President of The Dreyfus Corporation, and Patricia Larkin, CIO of the Dreyfus CIS Money Market Mutual Funds. The two joined Dreyfus in the early 1980's. Dreyfus, which launched its flagship retail fund, Dreyfus Liquid Assets, in early 1974, is approaching its 40th birthday in the money fund business. We discuss the company's history, current events, and a number of money fund related issues below."

The article on ICI's Fact Book explains, "The Investment Company Institute published its "2013 Investment Company Fact Book: A Review of Trends and Activities in the U.​S. Investment Company Industry" last week. The fact-filled work writes on the "Demand for Money Market Funds," "In contrast to the sizable outflows in the previous three years, money market funds experienced only a small aggregate net outflow of $336 million for 2012. This likely was the result of fiscal cliff uncertainties near year-​end. In the 10 months prior to the presidential election, money market funds had outflows of $​145 billion, a somewhat faster pace than in 2011. Some of the factors that limited inflows to money market funds in 2011 -- the low short-​term interest rate environment, lingering concern about the creditworthiness of some European financial institutions, and unlimited deposit insurance on non-​interest-​bearing checking accounts -- continued into and throughout 2012."

See the latest issue and future excerpts for more, or contact us to request the latest issue.

On Friday, Federal Reserve Governor Daniel K. Tarullo gave a speech entitled, "Evaluating Progress in Regulatory Reforms to Promote Financial Stability. Tarullo, who has been one of money market funds' most outspoken critics, discussed "Vulnerabilities Exposed by the Crisis," and said, "Beginning in the 1970s, the separation of traditional lending and capital markets activities established by New Deal financial regulation began to break down under the weight of macroeconomic turbulence, technological and business innovation, and competition. During the succeeding three decades these activities became progressively more integrated, fueling the expansion of what has become known as the shadow banking system, including the explosive growth of securitization and derivative instruments in the first decade of this century."

He explained, "This trend entailed two major changes. First, it diminished the importance of deposits as a source of funding for credit intermediation, in favor of capital market instruments sold to institutional investors. Over time, these markets began to serve some of the same maturity transformation functions as the traditional banking systems, which in turn led to both an expansion and alteration of traditional money markets. Ultimately, there was a vast increase in the creation of so-called cash equivalent instruments, which were supposedly safe, short-term, and liquid. Second, this trend altered the structure of the industry, both transforming the activities of broker-dealers and fostering the emergence of large financial conglomerates."

Tarullo continued, "There was, in fact, a symbiotic relationship between the growth of large financial conglomerates and the shadow banking system. Large banks sponsored shadow banking entities such as Structured Investment Vehicles (SIVs), money market funds, asset-backed commercial paper conduits, and auction rate securities. These firms also dominated the underwriting of assets purchased by entities within the shadow banking system."

He said, "Though motivated in part by regulatory arbitrage, these developments were driven by more than regulatory evasion. The growth and deepening of capital markets lowered financing costs for many companies and, through innovations such as securitization, helped expand the availability of capital for mortgage lending. Similarly, the rise of institutional investors as guardians of household savings made a wide array of investment and savings products available to a much greater portion of the American public."

Tarullo added, "But these changes also helped accelerate the fracturing of the system established in the 1930s. While the increasingly outmoded regulation of earlier decades was eroded, no new regulatory mechanisms were put in place to control new risks. When, in 2007, questions arose about the quality of some of the assets on which the shadow banking system was based--notably, those tied to poorly underwritten subprime mortgages--a classic adverse feedback loop ensued. Investors formerly willing to lend against almost any asset on a short-term, secured basis were suddenly unwilling to lend against a wide range of assets, notably including the structured products that had become central to the shadow banking system."

He commented, "Severe repercussions were felt throughout the financial system, as short-term wholesale lending against all but the very safest collateral froze up, regardless of the identity of the borrower. Moreover, as demonstrated by the intervention of the government when Bear Stearns and AIG were failing, and by the aftermath of Lehman Brothers' failure, the universe of financial firms that appeared too-big-to-fail during periods of stress extended beyond the perimeter of traditional safety and soundness regulation."

The Fed Governor also writes, "In short, the financial industry in the years preceding the crisis had been transformed into one that was highly vulnerable to runs on the short-term, uninsured cash equivalents that fed the new system's reliance on wholesale funding. The relationship between large firms and shadow banking meant that strains on wholesale funding markets could both reflect and magnify the too-big-to-fail problem. These were not the relatively slow-developing problems of the Latin American debt crisis, or even the savings and loan crisis, but fast-moving episodes that risked turning liquidity problems into insolvency problems almost literally overnight."

Finally, Tarullo said, "As you can tell, there is not yet a blueprint for addressing the basic vulnerabilities in short-term wholesale funding markets. Accordingly, the risks of runs and contagion remain. For the present, we can continue to work on discrete aspects of these markets, such as through the diminution of reliance on intraday credit in triparty repo markets that is being achieved by Federal Reserve supervision of clearing banks and through the money market fund reforms that I expect will be pursued by the Securities and Exchange Commission. We might also think about less comprehensive measures affecting SFTs, such as limits on rehypothecation, when an institution uses assets that have been posted as collateral by its clients for its own purposes. But I do not think that the post-crisis program of regulatory reform can be judged complete until a more comprehensive set of measures to address this problem is in place."

This morning, new SEC Chair Mary Jo White speaks at the Investment Company Institute annual "General Membership Meeting," the largest gathering of mutual fund professionals in the world. Her talk, entitled, "Regulation in a Global Financial System," touched on a number of issues and she only spent a few paragraphs on money market mutual funds. But White seems to imply that it will be a much kinder, gentler SEC, using terms like "preserve the economic benefits of the product," "appropriate and balanced proposal," and "investor-oriented result." (We excerpt all her money fund comments below, but the full speech may be accessed here.) Today's Wall Street Journal (page C1) also addresses potential reforms with the article, "SEC Zeroing In on 'Prime' Funds". (Note too our "Link of the Day" where Charles Schwab's Marie Chandoha discusses money fund waivers with CNBC from the ICI GMM.)

SEC Chair White says on "Money Market Fund Regulation," "While the U.S. has been the focus of much of the policy debate surrounding money market funds, these funds are global investors and are an area of focus for international regulators as well. As regulation moves forward on a several parallel paths, I am hopeful that we can build upon the SEC's past coordination with global regulators to develop approaches that are consistent, workable, and effective."

She explains, "As the SEC works to develop and propose meaningful money market fund reform, our goal is to preserve the economic benefits of the product while addressing potential redemption pressures and the susceptibility of these funds to runs -- runs in which retail investors are especially likely to suffer losses."

White adds, "While I'm sure that you would like me to say more about this today, I'll stop there as the staff and Commissioners are actively engaged in discussions designed to yield an appropriate and balanced proposal in the near future.

She tells the ICI GMM, "I am confident that the ultimate result of this process will take into account the views of Commissioners who vary in background and perspective, but share the goals of protecting investors and promoting market efficiency and capital formation. The SEC regulatory process is grounded in sound economic analysis and is well-informed by public comment, including helpful comments from the ICI fund investors and others with important and relevant perspectives on money market funds."

Finally, White adds, "This is the process the SEC will bring to bear as it considers proposing money market fund reform. And I hope that ultimately it will lead to a good, investor-oriented result that has been informed by and can be shared with other regulators in the global marketplace."

Today's Journal writes, "U.S. securities regulators, under pressure to address risks posed by the $2.6 trillion money-market-mutual fund industry, are considering a scaled-back approach that would tighten rules for about half of the sector that is seen as most vulnerable to investor runs, according to people familiar with staff discussions. The approach, one of several being contemplated at the Securities and Exchange Commission, would require only the riskiest funds to abandon their fixed $1 share price and allow shares to float in value like other mutual funds, these people said."

The piece, which features our data on market share of Prime vs. Nonprime MMF assets, adds, "The SEC may require only "prime" money funds, which invest in short-term corporate debt, to make the switch. Those funds, which comprise about 54% of the industry, according to Crane Data LLC, are seen as most vulnerable because they were the source of investor runs during the height of the 2008 financial crisis.... One concern is whether identifying certain funds as more vulnerable to runs could create a self-fulfilling prophecy, with jittery investors fleeing at the first signs of market stress. But supporters argue that switching to a floating share price would make prime funds less susceptible because investors would know the current share price and wouldn't race to sell in anticipation that it could fall below $1."

The only other mention of money funds we've seen at the ICI's GMM was from Chairman Gregory Johnson, President and CEO of Franklin Resources. He spoke Wednesday on "Facing a Changing World," and said, "International expansion has brought another trend -- increased global regulation.... These trends pose a significant challenge for global funds -- as, for example, U.S. and European regulators both focus on money market funds with proposals that could severely undermine the value of these funds to their investors.... Working with its members, ICI Global is pursuing an active policy agenda. It's involved in debates over the role of funds in financial stability, covering such issues as money market fund regulation and securities lending.... On trading and market structure, ICI Global has emerged as the first group to provide an organized global voice for the buy-side."

Finally, in other news, ICI reported its latest weekly "Money Market Mutual Fund Assets" late yesterday. The release says, "Total money market mutual fund assets decreased by $30.24 billion to $2.563 trillion for the week ended Wednesday, May 1, the Investment Company Institute reported today. Taxable government funds decreased by $14.41 billion, taxable non-government funds decreased by $13.67 billion, and tax-exempt funds decreased by $2.17 billion."

The Investment Company Institute published its "2013 Investment Company Fact Book: A Review of Trends and Activities in the U.S. Investment Company Industry yesterday, which coincided with the opening of ICI's General Membership Meeting in Washington. ICI's "Fact Book writes on the "Demand for Money Market Funds," "In contrast to the sizable outflows in the previous three years, money market funds experienced only a small aggregate net outflow of $336 million for 2012. This likely was the result of fiscal cliff uncertainties near year-end. In the 10 months prior to the presidential election, money market funds had outflows of $145 billion, a somewhat faster pace than in 2011. Some of the factors that limited inflows to money market funds in 2011 -- the low short-term interest rate environment, lingering concern about the creditworthiness of some European financial institutions, and unlimited deposit insurance on non-interest-bearing checking accounts -- continued into and throughout 2012."

It continues, "In the last two months of 2012, however, money market funds received $145 billion, on net. Some investors who had sold equity mutual funds moved to cash in the face of the uncertainties regarding possible higher taxes and the effect on the financial markets in early 2013 from automatic spending cuts. In addition, some corporations paid out hefty special dividends to shareholders at the end of 2012 in advance of increases in tax rates, and part of this cash was funneled to money market funds. It is unlikely that the impending expiration of the Federal Deposit Insurance Corporation's unlimited insurance coverage on non-interest-bearing transaction accounts at yearend contributed to inflows to money market funds, as bank deposits also increased substantially in the last two months of 2012."

ICI tells us, "Owing to Federal Reserve monetary policy, short-term interest rates continued to remain near zero in 2012. Yields on money market funds, which track short-term open market instruments such as Treasury bills, also hovered near zero and remained below yields on money market deposit accounts offered by banks (Figure 2.15). Individual investors tend to withdraw cash from money market funds when the difference in interest rates between bank deposits and money market funds narrows or becomes negative. Retail money market funds, which principally are sold to individual investors, saw an outflow of a little more than $1 billion in 2012, following an outflow of $4 billion 2011 (Figure 2.14). For the first 10 months of 2012, retail money market funds had outflows of $56 billion, but had inflows of $55 billion in November and December."

They add, "Institutional money market funds -- used by businesses, pension funds, state and local governments, and other large-account investors -- had an inflow of nearly $1 billion in 2012, following an outflow of $120 billion in 2011 (Figure 2.14). Similar to retail funds, the pattern of flows at the end of 2012 was driven by fiscal cliff concerns. For the first 10 months of 2012, institutional money market funds had outflows of $89 billion, but inflows of $90 billion in November and December. U.S. nonfinancial businesses are important users of institutional money market funds. In 2012, U.S. nonfinancial businesses' portion of cash balances held in money market funds was 21 percent (Figure 2.16). This portion reached a peak of 36 percent in 2008 and fell to 22 percent by year-end 2011."

Finally, the "Fact Book" says, "In 2010, the U.S. Securities and Exchange Commission (SEC) significantly reformed Rule 2a-7, a regulation governing money market funds. Among other requirements, these reforms required money market funds to hold significant liquidity and imposed stricter maturity limits. One outcome of these provisions is that prime funds have become more like government money market funds. To a significant degree, prime funds adjusted to the SEC's 2010 amendments to Rule 2a-7 by adding to their holdings of Treasury and agency securities. They also boosted their assets in repurchase agreements (repos). A repo can be thought of as a short-term collateralized loan, such as to a bank or other financial intermediary. They are backed by collateral -- typically Treasury and agency securities -- to ensure that the loan is repaid. Prime funds’ holdings of Treasury and agency securities and repos have risen substantially as a share of the funds’ portfolios from 12 percent in May 2007 to 31 percent in December 2012 (Figure 2.17). The dip at year-end 2012 was largely driven by a decline in repo holdings by money market funds, which stemmed from a reduction in repo borrowing by brokers and dealers at year-end."

Watch for coverage of SEC Chair Mary Jo White's speech to the ICI GGMM on Friday morning, and look for excerpts of some of the Fact Book's Data Tables related to money funds in the May issue of our Money Fund Intelligence.

In our April issue, Money Fund Intelligence interviews Standard & Poor's Financial Services' Peter Rizzo, Managing Director and Joel Friedman, Senior Director in S&P's Funds Ratings Group. Each of them have been involved in rating money funds for over 20 years, and S&P's funds rating business is preparing to mark its 30th anniversary later this year. S&P currently rates about 450 funds 'AAAm' for principal stability which account for $2.48 trillion globally. We excerpt from our Q&A below.

Q: What made fund ratings important? Rizzo: I believe it was originally due to institutional investors and regulatory requirements. For instance, insurance companies under the NAIC had a potential benefit of reduced capital reserves to be set aside if it was rated versus unrated. It was 0% [capital] if you invested in AAAm rated money market funds versus about 30% if they were not rated. Friedman: And the capital reserve requirements would be reduced to 1% if they invested in AAm or Am rated MMFs. Rizzo: Some corporate treasurers had internal guidelines that said they wanted it to be in a rated fund to put some checks and balances on their investments. These kinds of factors drove the initial impetus to get ratings.

Q: What is the biggest recent change in rating funds? Rizzo: Our criteria, which were updated in 2011, is a lot more granular. So just walking through the nuances of the criteria and details to make sure everyone is on the same page and understands why it is the way it is and [explaining] how we go about monitoring, implementing, and applying it can be a challenge. Prior to the 2011 update, it was more open-ended and any breeches in the criteria were handled case by case. Now there are pre-defined cure periods; it is black and white. That is a plus to the new criteria; the transparency is enormous. The one drawback you might hear from fund managers is because it is so detailed and black and white, there is no flexibility. Friedman: There are definitely more metrics that portfolio managers now have to follow, both in terms of regulations and also in the different rating agency criteria. So I think that makes it challenging for them as well.

Q: What is your biggest concern today? Rizzo: Obviously, regulatory changes and the impact they have is a concern to the market. Also, headline risk that could send a shockwave through the markets and cause a run on the industry [is a concern]. However, given the amendments to 2a-7, there is a lot more liquidity. Funds are in a better position to deal with any sort of market event these days. Friedman: My concern would be if interest rates actually start rising for the first time in so long and rise faster than anticipated. This is where you could have some big issues like we did in 1994. The good news now is that funds are all doing their own stress testing, so they will understand the potential impact of those rate rises. Still, it's definitely something managers will have to watch.

Q: How else have ratings requirements and fund management changed? Rizzo: There is much more transparency and we've come up with additional metrics. Like 2a-7, there was no weighted average life requirement in the prior criteria. Now we have introduced the WAM-to-final, which is, effectively, the WAL criteria. There are others including stress testing, increased credit quality restrictions, and liquidity. We don't set liquidity guidelines, but we are much more focused on fund managers being able to manage their own liquidity. Those are the main areas. Friedman: We have noticed though that funds have been managing more conservatively. They have been focused really on liquidity, and that is the number one thing that we believe managers saw in '07 and '08, that liquidity was at a premium. So they have certainly enhanced their liquidity buckets, and likely would have even without the 2a-7 changes.

Q: How might regulatory changes impact ratings? Rizzo: Like everyone else, we are still waiting to see which regulatory changes could occur. Clearly, one of them is floating the NAV. From our perspective, while the methodology does reference the one dollar anchor point, that is only a reference point. Effectively, if they say 'float the NAV' and fund managers, as we would expect, would continue to manage in the same manner, we wouldn't need to adjust the methodology.... Other regulatory considerations include capital, on which we published a piece in the fall of last year that walked through different scenarios. Along those lines, if you have a pool of assets that can support a problem, then that would be a ratings positive.

Q: Any thoughts on future of the money funds and ratings? Rizzo: Obviously, regulatory changes and what they may mean are a concern. However, we rate a lot of non 2a-7 registered funds or pools, and separate accounts. There are probably 65 to 75 'm'-rated pools that are not 2a-7 registered. Outside the U.S., there is a large demand for principle stability fund ratings. Obviously, it would be a big challenge to us if the industry changes in a negative way. But as always, we will evaluate the changes, and make any necessary adjustments to our criteria we feel are needed to issue ratings that reflect the relative risk. Friedman: I think that the good news for the industry thus far is that, even during this prolonged period of extremely low interest rates, investors have stuck with money funds. Why? Because they like the product. So barring any very significant change to that product, I think they will maintain a good amount of their assets [there].... We'll see.

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