News Archives: May, 2014

Money fund assets rebounded slightly in the past week and increased slightly for May. The latest weekly "ICI Money Market Mutual Fund Assets report" release says, "Total money market fund assets increased by $3.33 billion to $2.59 trillion for the week ended Wednesday, May 28, the Investment Company Institute reported today. Among taxable money market funds, treasury funds (including agency and repo) increased by $3.86 billion and prime funds increased by $1.30 billion. Tax-exempt money market funds decreased by $1.83 billion." Year-to-date, money fund assets have declined by $132 billion, or 4.8%, but month-to-date (through May 28) money fund assets have increased by $8.9 billion, according to our Money Fund Intelligence Daily.

ICI writes, "Assets of retail money market funds decreased by $1.23 billion to $903.31 billion. Treasury money market fund assets in the retail category increased by $130 million to $201.58 billion, prime money market fund assets decreased by $130 million to $515.49 billion, and tax-exempt fund assets decreased by $1.23 billion to $186.24 billion. Assets of institutional money market funds increased by $4.58 billion to $1.68 trillion. Among institutional funds, treasury money market fund assets increased by $3.73 billion to $719.22 billion, prime money market fund assets increased by $1.45 billion to $893.99 billion, and tax-exempt fund assets decreased by $600 million to $70.63 billion."

Yesterday, ICI also released its latest "Trends in Mutual Fund Investing, April 2014," which told us that money fund assets decreased by $57.9 billion in April, after decreasing $29.6 billion in March, $47.3 billion in February and $10.5 billion in January. For the 12 months through 4/30/14, ICI's monthly series shows assets up by $4.0 billion, or 0.2%. (For calendar 2013, ICI showed money fund assets up by $25.0 billion, or 0.9%.)

ICI's April "Trends"," >`_ says, "The combined assets of the nation’s mutual funds decreased by $35.43 billion, or 0.2 percent, to $15.20 trillion in April, according to the Investment Company Institute’s official survey of the mutual fund industry. In the survey, mutual fund companies report actual assets, sales, and redemptions to ICI.... Bond funds had an inflow of $7.42 billion in April, compared with an inflow of $12.53 billion in March. Taxable bond funds had an inflow of $6.30 billion in April, versus an inflow of $11.08 billion in March. Municipal bond funds had an inflow of $1.12 billion in April, compared with an inflow of $1.45 billion in March."

It adds, "Money market funds had an outflow of $57.99 billion in April, compared with an outflow of $29.16 billion in March. Funds offered primarily to institutions had an outflow of $39.69 billion. Funds offered primarily to individuals had an outflow of $18.29 billion." Money funds represent 16.9% of all mutual fund assets while bond funds represent 22.2%.

ICI also released its latest "Month-End Portfolio Holdings of Taxable Money Funds," which verified our reported plunge in repo and Treasuries, and jump in CDs, in April. (See Crane Data's May 12 News, "May MMF Portfolio Holdings Show Repo, Treasury Drop, Jump in TD, CD.") ICI's Portfolio Holdings for April 2014 show that Holdings of Certificates of Deposits jumped by $50.3 billion in April (after declining by $54.1 billion in March and $11.6 billion in Feb., jumping by $48.4 billion in Jan., and falling $25.9 billion in Dec.) to $563.1 billion (24.3%); CDs rose to first place among the largest composition segments.

Repos plunged by $38.4 billion, or 7.5%, (after jumping by $41.7 billion in March, declining by $11.6 billion in Feb. and $16.5 billion in Jan., and rising $43.0 billion in Dec.) to $476.4 billion (20.6% of assets). Repo moved down to become the second largest segment of taxable money fund portfolio holdings in April according to ICI's data series. Treasury Bills & Securities, the third largest segment, plummeted $52.7 billion in April (after an increase of $1.6 billion in March and $7.8 billion in Feb., and a decrease of $43.8 billion in Jan.) to $409.5 billion (17.7%).

Commercial Paper, which increased by $5.8 billion, or 1.6%, remained the fourth largest segment just ahead of U.S. Government Agency Securities. CP holdings totaled $366.2 billion (15.8% of assets) while Agencies fell by $15.3 billion to $316.4 billion (13.7%). Notes (including Corporate and Bank) rose by $2.5 billion to $92.8 billion (4.0% of assets), and Other holdings rose by $6.8 billion to $80.9 billion (3.5%).

The Number of Accounts Outstanding in ICI's Holdings series for taxable money funds decreased by 75.9 thousand to 23.766 million, while the Number of Funds decreased by one to 379. Over the past 12 months, the number of accounts fell by 809.4 thousand and the number of funds declined by 13. The Average Maturity of Portfolios declined by one day to 45 days in April. Over the past 12 months, WAMs of Taxable money funds declined by 4 days.

Note: Crane Data updated its May MFI XLS to reflect the 4/30/14 composition data and maturity breakouts for our entire fund universe on May 22. Note again too that we are now producing a "Holdings Reports Issuer Module," which allows subscribers to choose a series of Portfolio Holdings and Issuers and to see a full listing of which money funds own this paper. (Visit our Content Center and the latest Money Fund Portfolio Holdings download page to access the latest version of this new file.)

We wrote almost 2 weeks ago about the release of ICI's "2014 Investment Company Fact Book" (see our May 16 Crane Data News). But today we examine the "Fact Book's" numerous "Data Tables" on "Money Market Mutual Funds (which start on page 196) in more detail. ICI lists annual statistics on shareholder accounts, the number of funds, net assets, net new cash flows, paid and reinvested dividends, composition of prime and government funds, and net assets of institutional investors by type of institution. ICI's "Table 39" (page 198), "Total Net Assets of Money Market Funds by Type of Funds" shows us that total net assets in taxable U.S. money market funds increased about 1 percent to $2.718 trillion in 2013. At yearend 2013, $1.782 trillion was in taxable institutional money market funds (65.6%), while $936 billion was in taxable retail money market funds (34.4%). Breaking the numbers down by fund type, $1.485 billion were in prime funds (54.6%), $962 billion in government money market funds (35.4%), and $270 billion in tax-exempt accounts (9.9%).

ICI's Tables 43 and 44, "Asset Composition of Taxable Government Money Market Funds as a Percentage of Total Net Assets" and "Asset Composition of Taxable Prime Money Market Funds," show that of the $962 billion in taxable government money market funds, 29.4% were in U.S. government agency issues, 27.9% were in Repurchase agreements, 27.1% were in U.S. Treasury bills, and 14.3% were in Other Treasury securities. Another 0.8% was in "Other" assets, 0.3% was in Commercial paper and 0.1% was in corporate notes.

ICI's Fact Book shows that of the $1.485 billion in taxable prime money market funds, 33.3% was in Certificates of deposit, 23.9% was in commercial paper, 15.7% was in Repurchase agreements, 5.7% was in U.S. government agency issues, 4.3% was in Other Treasury securities, 4.2% was in Corporate notes, 2.7% percent in Bank notes, 2.2% in U.S. Treasury bills, 2.3% in Eurodollar CDs, and 5.7% in Other assets (which includes Banker's acceptances, municipal securities and cash reserves).

ICI's annual statistics also show that there's been a steady decline in the number of money market mutual funds over the last 15 years. (See Table 38 on page 197.) In 2013, according to the Fact Book, there were a total of 555 funds, down from 580 in 2012. The number of share classes stood at 1,571 in 2013, down from 1,623 in 2012. Further, there were 26.6 million taxable shareholder accounts in 2013, down 4.7 percent from 27.8 million in 2012. Most (19.1 million) were prime accounts, followed by government (4.9 million) and tax-exempt (2.4 million).

There was $15.2 billion in net new cash flow into money market funds last year, a significant change from 2012 when money market funds experienced a $336 million net outflow. A closer look at the data shows $27.4 billion in net new cash flow into institutional funds and a $12.2 billion cash outflow from retail funds. Paid dividends totaled a mere $8 billion last year, up from $6.6 billion in 2012. (But this is down drastically from the peak of almost $128 billion in annual dividends in 2007.) Also, there was $5.2 billion in reinvested dividends, up from $4.2 billion in 2012. (See Table 42 on page 201.)

Finally, Table 59 on page 218 shows that there was $900.5 billion of total net assets of institutional investors in taxable money market funds in 2013. (Note that $833.2 billion of this total was in Institutional money funds while $67.3 billion was in Retail MMFs.) About $485.8 billion were from business corporations (53.9%), $304.8 billion from financial institutions (33.8%), $46.4 billion from nonprofit organizations (5.1%), and $63.3 billion from Other (7.0%). The total net assets in this category were up 5.6 percent from 2012.

Today, we excerpt the second half of our May Money Fund Intelligence fund "profile," "Deutsche's Joe Sarbinowski & Benevento Talk MMFs." The rest of our interview follows.... MFI: What have been challenges historically? Benevento: The challenge we face now is very different now than the challenges faced 3-4 years ago, prior to the reform. What you face now is a challenge of less short term supply in the market. So your challenges are really finding that diversified supply, and offering a commensurate yield with it. I think as an industry, we all have to face the fact that money funds can only be the size of their available supply, and as that shrinks, we all face challenges.

MFI: What are you buying? Benevento: One of the tools that we have used is the Federal Reserve reverse repo program. That has been a very important tool, because supply has been crunched or squeezed during times of stress (quarter ends, month ends). That's been an attractive new vein of supply for us. The other thing we are looking at as a new entry to the market is the 2-year Treasury floater program.... [It has a] a very rapidly resetting floater, even though it's off of a 3-month bill, and it's based off an auction on a weekly basis. So that's an attractive addition to supply. In general, we spend our time looking for diversified supply, whether it's issuer, sovereign, or sector, trying to well diversify the portfolios.

MFI: Are clients moving out on the curve? Do you have capabilities beyond money market funds? Sarbinowski: Certain clients have accepted that rates will remain low and have moved out longer. Other investors have been desensitized to where we are [in the rate environment]. But that doesn't mean they are not curious about ideas, and that's part of why our job is to bring perspective and solutions and see where they might fit. We call ourselves liquidity management, because it's not just single product offering. We do offer cash plus and short duration portfolios, so the customized account conversation has been one that's been going on for a few years now and continues to be very relevant. In Europe, we do have a few flavors of funds that go beyond the European definition of money market fund.

MFI: What about European MMFs? Sarbinowski: We are a big player in the stable NAV world in Europe in U.S. Dollar, Euro and Sterling. We are a top tier player with all of our funds in excess of 5 billion in all those major currencies. Due to our global platform, we also have a capability in Indian Rupee, and through our joint venture in China, offer investors who have stranded cash in China, an MMF offering in RMB. There are a lot of multinationals with record amounts of cash, and they generate a lot of that offshore. A lot of those [pockets of cash] are scattered around Europe -- Ireland, the Netherlands, Belgium, and Switzerland being some of the key treasury centers. So definitely, the familiarity with the stable NAV concept is what generated the interest in that type of product over there.

MFI: What about the future of MMFs? Sarbinowski: The future of cash investing -- it's not going away. We see cash at heightened levels. We think there is always going to be relevance for investors to have good consultation and the need for a savvy partner in helping them address their liquidity management needs. Benevento: The success of money funds has always been as an intermediary between investors and issuers of debt as an aggregator. It's been a good equilibrium between that supply of available paper and what clients demand on the risk level. I think the challenge and what we face going into the post-reform world is building that or getting to that equilibrium once again, where the supply matches what is in demand by clients and the new supply matches what is in demand from a risk standpoint by clients.

From a market standpoint, I think we face an interesting time as we get in the second half of 2014, as we see tapering take hold. We believe we'll see a gradual backup in that Fed funds rate towards the upper end of the range, not necessarily a tightening. But we believe there will be trading at the upper end of that range, which is a good thing for the market. Sarbinowski: Whatever the outcome, we've been advocates of market-oriented commercial solutions that really give investors choice, transparency, and risk mitigation. So we remain watchful, and where appropriate, we're participating in the overall debate.

A new paper entitled, "Assessing Credit Risk in Money Market Fund Portfolios," written by ICI Economists Sean Collins and Emily Gallagher, counters claims by Boston Federal Reserve President Eric Rosengren and others that money market funds take significant credit risk. The Abstract says, "This paper measures credit risk in prime money market funds (MMFs), studies how such credit risk evolved in 2011-2012, and tests the efficacy of the Securities and Exchange Commission's (SEC) January 2010 reforms, which were designed to improve the ability of MMFs to withstand severe market stresses. To accomplish this, we create a measure called "expected loss-to-maturity" or ELM. This is an estimate of the credit default swap premium (CDS) needed to insure the fund's portfolio against credit losses. We also calculate by Monte Carlo the cost of insuring a fund against losses amounting to over 50 basis points. We find that ELM for prime MMFs was 15 basis points on an asset-weighted average basis over 2011-2012. Credit risk of prime MMFs rose from June to December 2011 before receding in 2012. Contrary to common perceptions, this did not primarily reflect funds' credit exposure to eurozone banks because funds took measures to reduce this exposure. Instead, credit risk in prime MMFs rose because of the deteriorating credit outlook of banks in the Asia/Pacific region. Finally, we find evidence that the SEC's 2010 liquidity and weighted average life (WAL) requirements reduced the credit risk of prime MMFs."

The paper explains, "Money market funds (MMFs) are mutual funds that invest in short-term high quality money market instruments. Unlike banks, money market funds do not hold capital against credit losses, nor are they insured by the federal government. Instead, risks in money market funds are mitigated by SEC Rule 2a-7, which is promulgated under the Investment Company Act. Among other things, Rule 2a-7 sets strict maturity limits on a fund's portfolio, requires funds to hold short-term securities of high credit quality, imposes diversification limits, and requires MMFs to hold a significant portion of their portfolios in very liquid assets. Money market funds have no leverage and must hold only U.S. dollar-denominated assets. These limits are thus in many ways much more stringent than the rules under which banks operate."

It continues, "Money market funds, like banks and other financial institutions, faced extraordinary stresses in September 2008 in light of the U.S. federal government's decision to let Lehman Brothers fail. In January 2010, in an effort to improve the resiliency of money market funds to withstand severe market stresses, the Securities and Exchange Commission (SEC, 2010) adopted a number of wide-ranging revisions to Rule 2a-7. Since 2010, many regulators have called for further reforms to money market funds. One rationale offered for such reforms is the suggestion that money market funds take significant credit risk (Rosengren, 2012). However, to date, there has been little formal research assessing the credit risk in money market funds. This paper seeks to help fill that gap. This paper develops a methodology for assessing MMF credit risk and applies it to the period 2011-2012 to study the influence of the European debt crisis on the credit quality of money market fund portfolios and on the influence of the SEC's 2010 reforms on funds' credit risk."

The paper tells us, "At first glance, the most obvious way to estimate the credit risk on an MMF is by the difference between the yield on a prime money market fund and the yield on a comparable government-only money market fund. Prime MMFs are money market funds that invest in a range of money market securities, including commercial paper, bank CDs, medium-term and floating-rate notes, repurchase agreements (repos) and Treasury and agency securities. Government money market funds typically invest only in Treasury or agency securities or repos backed by Treasuries and agencies and therefore should be default-risk-free. Figure 1 plots month-end values of the difference between the average gross yield on prime MMFs and government MMFs. For comparison, the figure also plots month-end values of the Bloomberg index of 5-year credit default swap (CDS) premiums for U.S. banks, as well as of the iTraxx 5-year CDS premium index for senior European financial debt (which primarily reflects 5-year CDS premiums for eurozone banks). As seen, in comparison with the 5-year CDS premiums for banks, the prime-to-government yield spread is small. Over the period 2011 to 2012, this spread averaged 18 basis points and the maximum spread was 23 basis points. This suggests that the credit risk of prime money market funds is small."

It continues, "An issue arises, however, because money market funds price their portfolio holdings at amortized cost. A longstanding GAAP provision allows firms, both financial and nonfinancial, to value their holdings of money market securities at amortized cost. A provision of SEC Rule 2a-7, which has its historical roots in the longstanding GAAP provision, allows a money market fund to price all of its securities at amortized cost (but the fund must abide by the risk-limiting requirements of Rule 2a-7). The use of amortized cost may weaken the value of a prime-to-government yield spread as an indicator of a money market fund's credit risk. A fund calculates its yield as income accrued (on an amortized cost basis) over a given period (e.g., one month) divided by the fund's amortized cost value (generally $1.00 per share) at the beginning of the period. If a fund holds a security and that security's credit quality declines, the security's market price should also decline, boosting the security's market yield. But because funds use amortized cost accounting, the rise in the security's yield would not be immediately reflected in the fund's yield. Generally speaking, only if that security matures and the fund rolls over its holding of that security, would the fund's yield then rise to reflect the increased credit risk."

Collins and Gallagher write, "Consequently, it seems appropriate to consider alternative ways to assess the credit risk of prime MMFs. CDS premiums provide one alternative.... Rosengren (2012) uses CDS premiums in an attempt to assess the credit risk of prime money market funds. He matches CDS premiums issuer-by-issuer with the portfolio holdings of prime MMFs. His results suggest that prime MMFs take on significant credit risk: he indicates that 37 percent of the assets of prime money market funds have an associated CDS premium of nearly 300 basis points (287 basis points on an asset-weighted basis). If correct, that premium is large. A shortcoming of Rosengren's approach, however, is that he measures credit risk using 5-year CDS premiums. This is a concern because the term structure of CDS premiums is generally upward sloping for high quality issuers (Agrawal and Bohn, 2006; Han and Zhou, 2011). Thus, it should generally be less costly in terms of CDS premiums to insure against default on a portfolio composed of short-dated, high quality securities. Money market fund portfolios fit these characteristics. Under Rule 2a-7, MMFs must hold securities that mature or can be redeemed with 397 days. In addition, MMFs’ weighted average life (WAL) must be 120 days or less. In practice, many of prime funds maintain even lower WALs.... Thus, Rosengren's use of 5-year CDS premiums likely overstates the credit risk of prime MMFs, but the level of the overstatement is an empirical question."

They state, "Collins, Gallagher, Heinrichs, and Plantier (2013) seek to improve on Rosengren's approach by matching money market funds' holdings with maturity-appropriate CDS premiums. For example, if a fund holds a Ford Motor medium term note that has a remaining maturity of 6 months, that note is matched with a 6-month CDS quote for Ford Motor. Aggregating (on an asset-weighted basis) across all of a fund's holdings provides an estimate of the CDS premium needed to insure the fund's portfolio against any and all credit losses under the assumption that the fund holds each security until it matures (or defaults). We call this credit risk measure "expected loss-to-maturity" (ELM). Collins et al. (2013) find that the expected-loss-to maturity on all prime money market funds averaged 27 basis points in 2011, again suggesting that the credit risk of prime money market funds is small."

The paper also says, "As noted, money market funds hold the bulk of their assets in very short-term securities, typically those maturing in 3 months or less. But CDS premiums are generally not quoted at maturities of less than 6 months. To deal with this, Collins et al. (2013) assume that the CDS premium on a security with one month to maturity is one-fourth the 6-month CDS premium for the same issuer. Collins et al. (2013) present some evidence from short-term credit spreads that this one-fourth assumption is not implausible. Quotes for intervening maturities (say 2 months) are then interpolated from the 6-month quote and 1-month estimate. However, this method does not acknowledge that the CDS market may be thinly traded for some issuers, especially at the 6-month horizon."

It explains, "This paper seeks to improve further on the credit risk measure of Collins et al. (2013) by synthetically creating CDS premiums for short-dated securities using default probabilities collected from the Risk Management Institute (RMI) of the National University of Singapore. RMI generates forward-looking probabilities for about 50,000 worldwide issuers on a daily basis for maturities of 1, 3, 6, 9, 12, 18, and 24 months ahead. RMI produces these default probabilities using a reduced form model of issuer credit risk, which among other things, incorporates the Merton (1974) distance-to-default concept, as well as firm-specific and macroeconomic variables. Research (Chen, 2013) indicates that RMI's default probabilities have a good track record, especially for issuers in developed countries, at maturities of 6 months or less, which is the horizon we are most concerned with in this paper. Given the RMI default probabilities, the estimated (synthetic) CDS premium for a given issuer and given remaining maturity is the relevant default probability times the expected loss given default. We use standard CDS market assumptions about expected loss given default. By interpolating, we are able to obtain estimated CDS premiums for the vast majority of assets that money market funds hold. This, in turn, allows us to calculate ELM for individual prime money market funds and for prime money market funds as a group."

The paper continues, "Investors, fund managers, and policymakers may, however, also be interested in the cost of insuring against the likelihood that a money market fund might "break the dollar." Under Rule 2a-7, a money market fund may offer a per-share price of $1.00 only if its mark-to-market value remains within 1/2 cent (50 basis points) of $1.00. If its mark-to-market value drops below $.995, the fund must lower its per-share price to $.99. This is colloquially known as "breaking the dollar." Policymakers and other experts have expressed concerns that this could lead to a run on money market funds. We assess the cost of insuring against such an event, which we call BDI(l, u), for Break the Dollar Insurance. We allow for a insurance deductible l and a maximum loss of u (u could be the entire value of the fund), where l and u are measured in basis points of a fund's assets."

It tells us, "To undertake the analysis, we create a new dataset comprising the entire record of the portfolio holdings of each prime money market fund over the period January 2011 to December 2012. We obtain funds' portfolio holdings from SEC form N-MFP. This form, which all money market funds have been required to report since November 2010, collects monthly data on a fund's entire list of portfolio securities. By hand, we match the month-end portfolio holdings of prime money market funds issuer-by-issuer and maturity-by-maturity with default probabilities obtained from RMI (Section 3 provide details). We are able to match roughly 90 percent of the assets of prime money market funds with estimated (synthetic) CDS premiums."

Collins and Gallagher add, "Our results indicate that there is generally limited credit risk-to-maturity in prime money market funds. Over the 24 months between January 2011 and December 2012, prime money market funds had an (asset-weighted) average ELM of 15 basis points. The credit risk exposure of prime funds did evolve over this period. Credit exposure was lower (11 basis points) in early 2011. It rose somewhat in the fall of 2011 to a maximum (on an asset-weighted average basis) of 22 basis points in November and December 2011. Thereafter, average credit risk receded and by the end of 2012 was just 9 basis points."

They conclude, "Finally, using fund-by-fund values of ELM, we examine whether the SEC's 2010 reforms reduced the credit risk of money market funds. Using a panel data regression, we find that ELM declines as a fund's liquidity rises and its WAL declines. This suggests that the SEC's decision to impose a minimum liquidity standard and a maximum WAL on MMFs in January 2010 reduced the credit risk of prime funds. It is difficult to gauge how sizable the effect was because funds did not report their monthly portfolio holdings,WALs, or weekly liquidity (according to the SEC definition of weekly liquidity) before November 2010. However, using plausible assumptions about the levels of weekly liquidity and fund WALs before 2010, we show that these two new provisions had the potential to substantially lower a fund's credit risk."

ICI's 2014 General Membership Meeting finished yesterday with a "Breakfast Session: A Conversation with SEC Chair Mary Jo White. While White didn't give any indication about whether the Commission would go with the floating NAV option (for Prime Institutional funds), the "gates and fees" (for all Prime funds), or a combination of the two, she did reiterate her comments from earlier this year that the rules would arrive in the "very near term". ICI President Paul Schott Stevens commented in the Q&A, "You knew I'd mention money market funds." White replied, "I did know that." Stevens continued, "The industry is anxiously awaiting a conclusion of the Commission's work on the money market fund rules, and it seemed to me that this would be a perfect time for some kind of announcement."

White answered, "I remember last year, we had just done our proposal, and I said 'I know you want me to say more and I'm not.' Hopefully, when I'm here next year, we'll talk about what's wrong with it. Seriously, the Commissioners, the full Commission, and the Staff are intensely focused on it [MMF Reform] as we speak, completing the very important rulemaking. I expect it will be completed in the very near term. I won't say what the very near term is. But it's front and center."

Stevens commented, "It's no wonder that it takes such intensive effort, because I think probably the record before the Commission in conncetion with that rule is as extensive and detailed as any in the Commission's history.... Obviously, opinions on what reforms are needed are starkly divided. Your bank regulators colleagues continue to press for changes even beyond what the Commission's proposed. There are a wide array of investors and issuers that have urged the Commission to preserve money market funds more or less intact."

He asked, "The issue has generated a lot of interest in Congress, as you know, and, of course, we haven't been shy about offering our own opinions too. Putting aside the merits of what ultimately will come out in the rule, that's a lot of rough water to navigate.... Looking at the final rule, what do you think constitutes a successful outcome for the Commission?"

White responded, "I think adopting a robust, workable rule. Robust in the sense that we meet the issue we're trying to meet.... But we do it in the most cost-effective way. I've said before again a front-and-center consideration is that we accomplish what we think we need to accomplish by way of structural reform, but in as maximum a way as possible preserving this very important product. Those are not easy issues. There are as many opinions on what should be done as there are people, I think, and nothing is wrong with that frankly."

Finally, she told the ICI GMM, "One of the things that is very strong in the way the Commission goes about it's rulemaking -- not everyone would agree with this statement but -- we really do take very deep dives into all the comments that we receive and consider them very seriously.... Obviously, there's a priority on getting the rules done ... but really getting them done right [is important]. We want to know everything we can know before we actually finalize that rulemaking. I think we've put ourself in the position to do that. But that's not going to mean that people don't have different opinions. Your comments have been enormously useful and we take them very seriously as we go through the process."

Some expect the SEC to release its final Money Market Fund Reform rule as early as late June, while others believe it will be late in the summer or perhaps even into September or October before we see the regulations. While we continue to believe the SEC will abandon the floating NAV and choose the "gates and fees" option on its own, the majority of other industry observers thinks that the combination of floating NAV and gates/fees is the most likely outcome at this point. Stay tuned, and we look forward to discussing the pending rulesvfurther at our Money Fund Symposium next month in Boston.

Today, we excerpt from the latest fund "profile" in our May issue of Money Fund Intelligence.... This month, we interview Deutsche Asset & Wealth Management's Joe Sarbinowski, Global Head of Liquidity Management, Global Client Group & Managing Director, and Joe Benevento, Global Head of Cash Management & Managing Director. We discuss the latest developments in the liquidity markets, get an update on the company's Variable NAV Money Fund, and review offshore and other money fund related issues. Our Q&A follows. [Note: Watch for coverage of SEC Chair Mary Jo White's speech this morning at the ICI GMM later today or Friday.]

MFI: How long have you been involved in the cash markets? Sarbinowski: In August, I will have been at the firm for 25 years, so I can provide the institutional memory. We have been in the liquidity management business since the late 1970's, initially doing private, white-label broker-dealer cash sweeps. In the '80s, we were also running [cash] for our own wealth management trust and securities services custody businesses. So the business has really evolved over that period of time. We cater to a wide spectrum of clients -- everything from wealth management, institutional, and, of course, sweep clients. We've evolved over the many years and now we are at this point united under one brand, Deutsche Asset & Wealth Management. Benevento: It's been about 23 years in the industry for me.

MFI: What are you focused on now? Sarbinowski: We continue to have deeper discussions with our clients, educating them about what is going on in the market. Education of our clients is paramount, and I think that's one of the reasons why clients have really come to appreciate us. We have a lot of experience, and providing them with our global perspective makes us uniquely positioned. Additionally, the low rate environment has been pervasive for many years now. There are clients who, while they love the money market funds for working capital and ease of use, are also saying 'Hey, what is my risk-return tradeoff if I do some customized solutions with you folks?' That's been a trend we've been working on and which continues to this day.

Intermediaries are very important. You want them to be prepared so that way they can assuage any client concerns quite readily. Also, it's our job to make them familiar with the different options in the market. We have an insured deposit sweep service, which continues to grow, and we have other asset wealth management products on our platform that we talk to clients about. So the ideal client is not only able to buy money market funds, but able to buy a whole suite of services that fit their needs. Education and offering solutions are the two big areas of focus on the client side.

Benevento: Of course, the Federal Reserve [has also been a priority] this year. We are at a turning point, where QE is tapering. So watching that Fed balance sheet and seeing how the market reacts as the Fed exits, even though it is gradual, at some point will become a factor here. So we are spending a lot of time working on rates and the Fed in general.

MFI: Can you talk about the VNAV MMF? Sarbinowski: We are very proud to say that "VNAV", as we call it, the Variable NAV Money Fund, achieves its 3rd anniversary this month. We launched it in April 2011, so we now have a 3-year successful track record of managing it.... We've been able to attract outside money, and it's part of every conversation we have, harkening back to my comments about education. We've proven that it can operate T+0, achieve a AAAm-rating; and can be NAIC-1 rated. We also have periods, such as the European sovereign debt crisis a couple years ago, as well as the U.S. budget crisis, where we've gone through some strains in the market. And, as the whole industry has done, we've proven that money market instruments perform as you would expect them to perform. They've performed rather admirably.

Benevento: One thing we've noticed about the portfolio is, as you've stated in the past, the asset class inherently has very little volatility. But in general this fund has been very stable in NAV. It has moved up and down slightly to the third decimal place, and recently we've been able to put that and add the fund to one of the Bloomberg screens so investors can see the pricing on the portfolio historically since inception. You'll see that, even during some challenging times, the portfolio really hasn't moved much as far as NAV. [Note: Contact us for the full article or look for more excerpts in coming days.]

Federal Reserve Bank of New York President William Dudley spoke yesterday on "The Economic Outlook and Implications for Monetary Policy," where he discussed the Fed's eventual "lift-off" of rates from the near zero levels currently and where he talked about the Fed's reverse repo program. Dudley says, "If my forecast is correct, as growth strengthens and inflation drifts higher, the focus will turn to monetary policy. In particular, what will be the timing of lift-off? And when lift-off occurs, how quickly will the Federal Open Market Committee (FOMC) raise rates and to what level? Also, with an exceptionally large balance sheet there will be considerable attention on the methods that the FOMC will likely use in order to exert control over the level of short-term rates. I can't tell you yet how we will do it, but I am fully confident that we have the necessary tools to control the level of short-term rates and the credit creation process, and I will share with you some of my own thoughts on the subject."

He explains, "Given my outlook for above-trend growth and inflation gradually drifting higher, the inevitable question is what this means for the monetary policy outlook. Over the near-term, if circumstances evolve relatively close to my forecast, I would continue to favor gradually reducing the pace of asset purchases by staying on the same glide path of a $10 billion reduction in the monthly purchase pace following each FOMC meeting. Assuming asset purchases end sometime this fall, the focus will shift to the timing of lift-off, the pace of tightening once lift-off occurs and where short-term rates are ultimately headed over the longer-term. The issue of how the Fed will manage its balance sheet will also be relevant, as well as how monetary policy will be conducted during a period when the amount of excess reserves in the banking system is unusually large. I will give you some of my early thinking on each of these issues in the remainder of my remarks."

Dudley comments, "Turning first to the timing of lift-off, how the outlook evolves matters. We currently anticipate that a considerable period of time will elapse between the end of asset purchases and lift-off, but precisely how long is difficult to say given the inherent uncertainties surrounding the outlook.... With respect to the trajectory of rates after lift-off, this also is highly dependent on how the economy evolves. My current thinking is that the pace of tightening will probably be relatively slow.... In terms of the level of rates over the longer-term, I would expect them to be lower than historical averages."

He continues, "With respect to the issue of how the FOMC will control money market rates with an enlarged balance sheet, the Federal Reserve already has the necessary tool -- the ability to pay interest on excess reserves. However, the degree of control could be further buttressed. Enhancing confidence in the Fed's ability to control money market rates, and hence, inflation, might also help keep inflation expectations well anchored."

Dudley tell us, "One method the Fed has been testing is an overnight, fixed rate, reverse repo (RRP) facility. The Federal Reserve posts a fixed interest rate and accepts cash from counterparties, which include some banks, dealers, money market funds, and government sponsored enterprises, on an overnight basis in return for a security. The repo facility is "reverse" because the direction in which the funds and securities move -- participants are lending funds to the Fed rather than vice versa. Users of the facility are making the economic equivalent of an overnight collateralized loan of cash to the Federal Reserve. If implemented, the facility could be set up as "full allotment," which means that there is no cap on the amount of funds accepted from any of its counterparties at the posted overnight interest rate. Or, caps could be imposed on either an aggregate or per counterparty basis in order to limit total usage."

He states, "The amount of funds invested in the facility is likely to be sensitive to the spread between the posted interest rate and comparable money market rates and the level of caps placed on usage. The narrower the spread to comparable money market rates, the greater the participation is likely to be. In our ongoing tests with this facility, the New York Desk has varied the RRP rate from 1 to 5 basis points and the cap on usage by counterparty has gradually been increased to its current level of $10 billion. As expected, narrower spreads to comparable money market rates and larger caps have led to greater usage. Although the testing process is still ongoing, early results suggest that the overnight RRP facility will set a floor under money market rates. Treasury repo rates have generally traded no more than a basis point or two below the overnight RRP rate. Thus, the early evidence suggests that this facility would help strengthen our control over money market rates."

Dudley explains, "Two issues with the overnight reverse repo rate warrant careful consideration. The first is how big a footprint the facility should have in terms of volume. To the extent that the overnight RRP rate were set very close or equal to the interest rate on excess reserves (IOER) without caps, then this might result in a large amount of disintermediation out of banks through money market funds and other financial intermediaries into the facility. This could encourage further development of the shadow banking system. If this were deemed undesirable, this would argue for a wider spread between the overnight RRP and the IOER in order to reduce the volume of flows into the facility. The second issue is the facility's potential impact on financial stability. In particular, would such a facility make financial instability less likely? And, when financial stress did occur, would such a facility amplify or dampen financial strains?"

He says, "On the first point, it seems that such a facility would tend to make financial instability less likely. The overnight RRP facility allows us to make a short-term safe asset more widely available to a broad range of financial market participants. The provision of short-term safe assets by the official sector might crowd out the private creation of runnable money-like liquid assets. This might enhance financial stability by reducing the likelihood of a financial crisis. However, if a financial crisis were to occur, the existence of a full allotment, overnight, RRP facility might exacerbate instability by encouraging runs out of more risky assets into the facility. That is because the supply of a full allotment facility would be completely elastic at the given fixed rate. Money market mutual funds and other providers of short-term financing could rapidly shift funds into the facility away from assets such as commercial paper that support the private sector. In contrast, in the current regime, when financial crises lead to flows into less risky assets, their interest rates fall, limiting the appetite for these less risky assets. Consequently, under a full allotment setup, runs could be larger and these runs could exacerbate the fall in the prices of riskier assets. Note that the risk here is how quickly financial flows could reverse from one day to the next, not the average level of take-up of the facility over time."

Dudley also comments, "Fortunately, this risk seems relatively easy to address. One could design the facility to prevent rapid inflows during times of financial stress. This could be done by building in circuit breakers such as caps on overall usage of the facility. The circuit breakers would not affect the amount of take-up during normal times or prevent take-up from rising at moderate rates. Instead, they would be in place to limit the pace and magnitude of inflows during times of stress. A second option to improve the Fed's control over short-term rates is to drain reserves by offering banks term deposit accounts in which to invest funds for longer terms than overnight. There are two issues that might make this option somewhat less attractive. First, to strengthen monetary policy control significantly through this course, it might be necessary to drain most of the $3 trillion of reserves. This could be done of course with effort, but is the effort worth it?"

He adds, "Second, the Fed would undoubtedly have to "pay up" to induce banks to hold term deposit accounts relative to keeping their monies in reserves at the excess reserves interest rate. `This would likely result in higher Fed interest expenses relative to relying on an overnight RRP facility to set a floor on money market rates. The choices here are important and I expect that considerable testing, analysis and discussion will be necessary to reach firm conclusions about the appropriate course. My goal would be to clarify our intentions later this year, long before we begin to contemplate raising short-term rates."

Finally, Dudley says, "I also think that the choices are about how to conduct monetary policy during the transitional phase, not about the long-term monetary policy framework. Longer term, the issue will be whether to return to the type of corridor system that was in place prior to the crisis or to instead to stay with the type of floor system that will likely be the type of regime that is in place as the balance sheet gradually normalizes. I expect that the choices made over the near-term can be implemented in a way so as not to forestall either a corridor or a floor system over the longer term. The experience we gain with operating monetary policy effectively with a very large balance sheet will undoubtedly inform that choice. But, that topic is putting the cart far before the horse. First, we need an economy that is strong enough to more fully utilize the nation's labor resources and to begin to push inflation back towards the Federal Reserve's long-term objective. Only then can the monetary policy normalization process proceed. Although we are making progress towards our goals, we still have a considerable way to go."

Attorney David Freeman, Jr. of Arnold and Porter LLP has posted another letter to the SEC's "Comments on Proposed Rule: Money Market Fund Reform" on behalf of Federated Investors. The latest summarizes the arguments and comment letters opposed to a floating NAV ("Alternative I") and in support of Alternative II (the emergency "gates and fees" option). Freeman writes, "We are writing on behalf of our client, Federated Investors, Inc. and its subsidiaries ("Federated"), to provide concluding comments concerning the Securities and Exchange Commission's ("Commission's") rulemaking file on money market fund ("MMF") reform. The stated goal of the rulemaking is to address the Commission's concerns about the potential for large-scale redemptions from MMFs during a period of financial stress or in response to a significant credit event at a MMF. The Commission in its Release and Chair White in public statements have assured investors that the Commission seeks to preserve the benefits of MMFs for investors. The question confronting the Commission as it moves toward adoption or reproposal is whether these two goals can be reconciled in a manner consistent with the Commission's obligations in conducting rulemakings."

He tells us, "The data, studies, and commentary in the Commission's extensive comment file point to a clear answer: Give due consideration to the comments, follow the facts, and insist upon a data-driven, cost-effective rule that best provides the benefits the Commission seeks to achieve, including, especially, the protection of investors. There is no question that authorizing MMF boards in rare and limited circumstances to temporarily halt redemptions for periods of short duration will stop a run. Forcing prime MMFs to float their net asset values ("NAVs") will not. Importantly, a tailored gates and fees proposal will preserve the day-to-day utility of MMFs for investors. Forcing investors to redeem at a fluctuating NAV will not. As the overwhelming comments, surveys, data, and other materials in the comment file make clear, adopting a limited gates and fees rule will fulfill the Commission's articulated rulemaking objectives; imposing a floating NAV will not."

The Federated letter continues, "Moreover, after reviewing the great weight of the evidence in the comment file, it also is clear that the Commission cannot reach a decision to impose both a floating NAV and gates/fees in combination on certain MMFs; commenters are clear that the combination would make those funds a product no rational investor would ever buy and would “lead nearly all investors to choose other options -- further exacerbating the costs associated with a massive migration of assets to government money market funds and riskier and less-regulated alternatives."

It states, "The Commission and its rule writers are well aware of the Commission's obligations under the Administrative Procedure Act, the Investment Company Act of 1940 and other Federal laws, the holdings of federal courts regarding applicable statutory requirements, as well as the Commission's own binding rulemaking guidance ("Guidance"). Those obligations compel the Commission to consider the protection of investors and the impact of the various alternatives on efficiency, competition, and capital formation. They further require the Commission to weigh the benefits and costs of alternatives and make cost-effective regulatory choices. The Commission cannot meet those obligations if it arbitrarily chooses a regulatory alternative that, according to the overwhelming weight of commentary, data, studies, and other evidence in the comment file, costs the most but does the least in terms of accomplishing the Commission's objectives. Indeed, the Commission will violate those requirements if it makes a regulatory choice that would destroy a product for a large segment of investors, when a far less disruptive alternative that better achieves its regulatory goals, better protects investors, and preserves the product is available."

Freeman tells us that, "Imposing a floating NAV on institutional investors does not achieve the Commission's stated regulatory goals, imposes far greater costs and burdens on investors and market participants than other alternatives, and negatively impacts efficiency, competition, and capital formation. The floating NAV does not prevent or mitigate run risk in a crisis. The overwhelming number of comments in the Commission's current comment file (as well as comments filed in other dockets over the past three years) from MMF users, service providers, academics and analysts, and most fund sponsors reject the proposition that a floating NAV would prevent or reduce the potential for large-scale redemptions from MMFs in a crisis or in response to a significant credit event. Data from the financial crisis showing that investors ran from floating NAV funds in Europe and ultra-short bond funds in the U.S. provides a real-world example of investor behavior. Although the Commission's Release speculated that a floating NAV "could alter investor expectations," and that investors therefore "should become more accustomed to, and tolerant of," fluctuations in MMF NAVs, and that investors therefore "may be less likely to redeem shares in times of stress," there is no data in the comment file or the Release to support what is merely the Commission's predictive judgment. Indeed, the majority of commenters who address this issue reject the Commission's theory, and the Commission itself has conceded that "a floating NAV may not eliminate investors' incentives to redeem fund shares, particularly when financial markets are under stress and investors are engaging in flights to quality, liquidity, or transparency." The Commission has acknowledged, however, in contrast, that "[G]ates are the one regulatory reform in this Release ... that definitely stops a run on a fund (by blocking all redemptions).""

He adds, "A floating NAV is an unnecessary and excessively burdensome means of communicating MMF risks to institutional investors. Moreover, a floating NAV is a wholly unnecessary means to communicate what investors -- particularly institutional prime MMF investors who are the target of the Commission's proposed floating NAV reform -- already know, that the underlying fair value of a MMF portfolio fluctuates and that a MMF may lose value. Here, the Commission has a very stark cost-benefit calculation to make in choosing among regulatory alternatives designed to inform investors of the risk of investing in MMFs. It can choose to impose multi-billion dollar costs on institutional investors, fund sponsors and intermediaries, to overhaul and convert systems to accommodate an NAV that fluctuates, based upon mark-to-model fair valuations, to the fourth decimal point -- for the benefit of informing institutional investors of facts they already know. In the alternative, if the Commission concludes that there are marginal benefits in providing more information to investors, it could choose the more cost-effective approach of requiring daily mark-to-model NAV disclosure (which is already provided by many funds), additional portfolio disclosure and other enhanced disclosures as proposed in the Commission's rulemaking. Of course, if the Commission chooses to adopt the gates/fees alternative (the most effective alternative to address run risk), the accompanying disclosures will make clear to investors that MMFs are subject to the risk of temporary loss of liquidity or redemption fees."

The letter says, "Moreover, the Commission has not provided any basis, apart from creating arbitrary and trivial fluctuations in the share price, for requiring MMFs to calculate their NAV to the nearest basis point for shareholder transactions, when all other mutual funds are held to only a ten basis point standard of valuation. Even MMF managers who expressed qualified support for Alternative One objected to requiring their funds to transact at a four decimal place NAV. The Investment Company Act of 1940 authorizes the Commission to regulate the NAV of redeemable securities only for "the purpose of eliminating or reducing so far as reasonably practicable any dilution of the value of other outstanding securities of such company or any other result of such purchase, redemption, or sale which is unfair to holders of such other outstanding securities...." The Release did not articulate any risk of dilution or other unfair results unique to MMFs that would require a different standard of valuation for their NAVs. Furthermore, nothing in the Release or comment file justifies the abandonment of amortized cost method of valuing MMF portfolios -- a method MMF boards may use under Rule 2a-7 only if it fairly represents market-based valuation."

It explains, "The billions of dollars of costs associated with a floating NAV cannot be justified. The Commission concedes that a floating NAV will have a more disruptive effect than gates and fees, stating in the Release that "investors may withdraw more assets under the floating NAV proposal than they would under the liquidity fees and gates alternative because the floating NAV proposal may have a more significant effect on investors' day-to-day experience with and use of money market funds than the liquidity fees and gates alternative and because many investors place great value on principal stability in a money market fund." Comments in the file support this view."

The Federated letter tells us, "The Commission's need to choose a regulatory alternative that preserves MMFs for investors further is compelled by the statutory obligation to consider the effects of its rules on investor protection, efficiency, competition, and capital formation. Neither the Commission's Release nor the comment file provide adequate support for a finding that a floating NAV would protect investors or promote efficiency, competition, or capital formation. The record does support a finding that Alternative Two maintains MMFs as an efficient, pro-competitive investment that positively impacts short-term funding markets and that it avoids the negative impacts of a floating NAV."

It explains, "Alternative Two, as compared to a floating NAV -- Preserves MMFs as a cash management option for investors, rather than forcing investors to shift funds to less transparent and more risky assets such as bank deposits because of statutory or other legal barriers to investing in floating NAV assets; Provides MMF boards with an additional tool to protect investors by ensuring equitable outcomes in a crisis; Promotes efficiency by preserving the existing tax, recordkeeping, and operational benefits of stable value MMFs (including same-day settlement periods) rather than adding additional burdens; Avoids increasing systemic risk by avoiding the possibility that MMF assets will shift to too-big-to-fail banks or that pricing vendor outages will lead to cascading payment system failures; Promotes competition by preserving a higher yield, more transparent, less risky alternative to bank deposits (particularly for funds in excess of FDIC insurance limits) or other less regulated products; Avoids the possibility that the bulk of prime and municipal MMF assets would shift into government securities MMFs and potentially overwhelm the available supply of short-term government securities; and Promotes capital formation by preserving the role of MMFs as suppliers of lowercost short-term funding to issuers, including corporations and state and local governments, rather than reducing the role MMFs play in short-term funding markets as investors shift assets away from prime MMFs."

Finally, the letter concludes, "The record justifies adoption of Alternative Two, which would be more effective if modified along the lines that Federated and other commenters have proposed. We urge the Commission to adopt Alternative Two with the suggested modifications, along with appropriate enhanced disclosures, to achieve its stated reform goals. The record is utterly bereft of data, analyses, or fact-based evidence supporting adoption of Alterative One. Therefore, we urge the Commission to reject Alternative One given the Commission's statutory obligations and binding Guidance. We hope this letter proves helpful to the Commission as it considers final rules for MMF reform. We appreciate the opportunity to provide comments on the Release."

As we mentioned in our "Link of the Day" Friday, U.S. S.E.C. Commissioner Daniel Gallagher recently issued a "Comment Letter on the OFR Asset Management and Financial Stability Report" ahead of Monday's "FSOC Public Conference on Asset Management." Today, we excerpt more extensively from Gallagher's letter. He says in his comment letter (available at, "It is my hope that my comments will prove useful to the discussion at the conference on the asset management industry and its activities to be held by the Financial Stability Oversight Council on May 19, 2014... To be clear, like FSOC, despite its broad remit encompassing by its own terms the entire field of "financial sector policies," the FSB and its agenda are dominated by banking regulators and appear to be guided by the principle that regulations designed for banks should be applied as widely as possible. What's good for the goose is good for the gander, they believe -- but the gander has had enough of this power grab, and is calling for an honest debate on these issues."

Gallagher continues, "The FSOC and FSB initiatives are pure-and dangerous-folly. Applying bank regulatory principles to capital markets regulation is a fatally misguided approach, the regulatory equivalent of trying to jam a square peg into a round hole. Bank regulators should resist their apparently innate urge to regulate asset managers -- and, for that matter, all other non-bank entities -- like banks. Forcibly imposing bank-like regulation on these capital market participants will negatively impact the U.S. economy and work to the detriment of the investing public while doing nothing at all to protect taxpayers or investors."

He tells us, "I appreciate the concept of an entity tasked with playing a coordinating and information sharing role. FSOC, however, emerged from the final legislation with unprecedented and extraordinary regulatory powers, in particular the authority to subject non-bank financial institutions to prudential regulation by the Federal Reserve if such institutions are deemed to pose a threat to the financial stability of the U.S. economy, and to make a "recommendation" that an independent agency engage in a particular rulemaking. FSOC soon showed it had no hesitation to exercise this power, as the SEC learned with respect to the regulation of money market mutual funds. In November 2012, the members of FSOC voted unanimously to propose for public comment "Proposed Recommendations Regarding Money Market Mutual Fund Reform," a proposal that, if adopted, would allow FSOC to issue a formal "recommendation" to the SEC."

Gallagher comments, "The example of money market mutual funds, the subject of FSOC's proposed "recommendation" to the SEC, provides a useful illustration. These funds were created in the early 1970s as a response to the prohibition on paying interest on demand deposit accounts at U.S. banks and have been regulated by the SEC ever since. Over time, these funds grew to the point where they represented a significant alternative to banking products -- and a constant thorn in the side of the bank regulators unable to extend their jurisdiction to include this so-called "shadow banking" alternative. Having proven its ability and willingness to take steps to impose its "recommendations" upon purportedly independent agencies, last year FSOC commenced a review of the activities of asset management firms to determine whether such firms should be designated as SIFIs and therefore subject to enhanced prudential standards and supervision. In connection with this review, FSOC asked the Treasury-based OFR to perform an analysis of the asset management industry, including its vulnerability to financial shocks and the potential risks it poses to the financial markets."

He continues, "In September 2013, OFR released its findings in the OFR Report, a document riddled with fundamentally flawed conclusions that were the inevitable result of the deeply unsound process followed by OFR in its performing its analysis. Not only does the OFR Report inaccurately define and describe the activities and participants in the asset management business, it makes matters worse by analyzing the purported risks posed by asset managers in a vacuum instead of in the context of the broader financial markets. It offers up speculative conclusions of systemic risk without any reference to the data used to support them -- unsurprising, given that clearly, little if any data was actually considered -- and without any reasoned policy arguments about how to address them. The end product was a botched analysis that grossly overstates indeed, in many cases simply invents without supporting data -- the potential risks to the stability of our financial markets posed by asset management firms."

Gallagher adds, "Exponentially compounding the mistakes of fact and poor substantive analysis contained in the OFR Report was OFR's brazen refusal to consider the comments and input of experts from the SEC, the very agency charged by Congress with regulating asset managers. The Commission has had regulatory authority for over seventy years to oversee the asset management industry, yet the comments of SEC staff -- many of which were meant to correct or clarify plainly inaccurate statements and non-sequiturs -- fell on deaf ears. As members of Congress aptly noted in a recent letter to Treasury Secretary Lew, thanks to the cavalier attitude of the OFR Report's authors, the SEC staff "left little more than fingerprints, while their attempts to substantively improve the final product were summarily rejected.""

He writes, "In a letter sent to Congress on May 14, 2014, the Treasury Department argued that OFR had, indeed, consulted extensively with the SEC on its report, and cited numerous emails and staff meetings to support the claim. Being an outsider to all things FSOC, and certainly never having received any of the cited emails or participated in any of the referenced meetings, I will not wade into this suddenly lively factual dispute. I am compelled, however, to point out one fact that I found astonishing. Apparently, even the Treasury Department, the Secretary of which is the Chairman of FSOC, does not understand the membership structure of FSOC. The letter repeatedly cites to "member agencies," of which there are none. Anyone who has paid any attention to the flawed construct of FSOC knows that its membership consists only of the chairpersons, directors, and secretaries of selected federal entities. With respect to the independent agencies, the "agencies" are not members, and therefore non-chairperson presidential appointees to those entities such as myself and my fellow Commissioners at the SEC do not belong to the club. This is not just semantics -- as FSOC painfully learned in the context of money market funds, an "agency" isn't really involved in a matter unless all of the presidential appointees are. A chairperson and selected staffers do not an agency make."

Gallagher continues, "Having been warned that my comments would not be considered, as well as having experienced FSOC's blatant and complete disregard for any input whatsoever from the primary regulator during the money market mutual funds debate, I declined to grasp at straws in the unrealistic hope of leaving even my "fingerprints" on the OFR Report. That the presidentially appointed Commissioners of the agency responsible for regulating the asset management industry were not afforded a meaningful opportunity to comment on the report is strong evidence that, as the same members of Congress observed in their letter to Secretary Lew, "OFR produced the report as simply a pretext for further action to designate asset managers as systemically important, and not as an unbiased and objective review of the industry.""

He adds, "In short, the OFR Report completely failed to provide a legitimate rationale for systemic risk designation. I am sure that its myriad inaccuracies and unsupported conclusions would make excellent fodder for the litigation that would be sure to follow any decision to designate asset managers as SIFIs. Nevertheless, it appears that FSOC is intent on marching forward with its analysis. While I appreciate the efforts of FSOC to provide at least a veneer of willingness to consider outside input by holding a public conference on May 19th, it is nonetheless clear to me that the bank regulators riding herd over FSOC have decided that neither the professional staff nor any non-Chair Commissioners of the SEC will be invited to the party. We can only pray that other voices of reason will step up and demand to be heard. In the meantime, I hereby register a vote of "NO" in the court of public opinion on the issue of whether to designate asset managers as SIFIs."

Gallagher's letter comments, "To make matters worse for investors and the U.S. economy as a whole, FSOC isn't the only player with its thumb on the scale in the world of SIFI designations. FSOC carries out its self-appointed missions in the shadow of the FSB, an international body created in 2009 in the wake of the financial crisis ostensibly to make recommendations about the global financial system. Dominated by European central bankers, the FSB includes representatives from all of the G-20 countries (including, notably given recent geopolitical events, Russia), the Financial Stability Forum, and the European Commission. Not surprisingly for an institution dominated by bank and non-U.S. regulators, the SEC, while nominally a member of the FSB, does not have a seat at the "grown-ups' table," and our voice is consistently ignored unless we are telling them what they want to hear."

He says, "In addition to the general folly of attempting to force bank regulatory principles upon the capital markets, there are a number of specific reasons why it defies reason to designate asset managers in particular as SIFIs and subject them to prudential regulation. First, and most importantly, the resolution process for asset managers is vastly simpler than those for most other types of financial institutions. Asset management is an agency activity.... Assets are held by custodians on behalf of clients, not by the asset managers themselves. As such, unlike banks, asset managers do not have balance sheet obligations that complicate the unwinding process.... There are no investor assets in danger of being consumed by an imploding balance sheet. There is -- to put it as simply as possible -- no need for a backstop or bailout. It is also crucial to understand that asset managers do not participate directly in the capital markets. Unlike banks (and some insurance companies), asset managers do not lend money or act as counterparties. Therefore, they have lean balance sheets that do not carry the potential systemic risk of other capital-heavy financial institutions."

Gallagher writes, "People deposit money in banks to avoid risk, in the form of a federally insured guarantee on their deposits. People invest with asset managers in the capital markets because they seek risk and the corresponding potential for a higher return on their investment. These two fundamentally different objectives simply cannot both be achieved under the same regulatory paradigm. In addition, the activities of asset managers already are highly regulated and subject to extensive public disclosure requirements. The Investment Advisers and Investment Company Acts provide an effective, overarching regulatory framework that protects investors from the risk. The existing regulatory regime recognizes that asset managers are participants in the capital markets and is appropriately tailored to address the risks inherent in that role."

He concludes, "FSOC is charged in the Dodd-Frank Act with the responsibility to identify risks to the financial stability of the United States, to promote market discipline, and to respond to emerging threats to the stability of the United States financial system. Unfortunately, like its alter ego the FSB, FSOC has pushed the outer limits and overstepped its bounds in defining the scope of its mandate. It is time to acknowledge that "systemically important" is bank regulator speak for "too big to fail" -- or, alternatively, "bailout eligible." FSOC and the FSB are, in essence, determining which financial entities must stay solvent under any conditions and applying a one size fits all regulatory paradigm in an attempt to make failure of those entities impossible. This is irrational and shortsighted, especially given the vastly different resolvability considerations attendant to the wind-down of agency actors such as asset managers as compared to banks and other financial institutions."

Finally, Gallagher tells us, "The decisions made by FSOC, a body that will almost always be comprised exclusively or almost exclusively of members of the same party led by a member of the President's cabinet, take place behind closed doors with no checks or balances in place to safeguard against overreaching, no appeals process, and no disinterested fact finder. These factors ensure that there is no mechanism in place to stop the blatant regulatory creep that is taking place before our eyes. It is high time we all acknowledge that the FSOC process itself is far more dangerous to our financial markets than the purported risk factors it was purportedly created to address. Once again, although I have no vote in FSOC, in the court of public opinion, I vote NO."

The ICI released its "2014 Investment Company Fact Book" in PDF form yesterday afternoon, ahead of the Institute's General Membership Meeting (GMM) next week in Washington. As usual, the "Fact Book" is loaded with useful statistics and analysis of mutual funds, and of money market mutual funds. Under the section, "Demand for Money Market Funds (on page 45)," the Fact Book says, "In 2013, money market funds received a modest $15 billion -- the first annual inflow since 2008. Demand for money market funds was not uniform throughout 2013, however. Various factors, including tax events, rising long term interest rates, and a U.S. debt ceiling standoff, influenced money market fund flows during 2013."

It explains, "Outflows from money market funds were concentrated in the first four months of 2013, during which investors redeemed $125 billion, on net (Figure 2.16). Tax payments by corporations in mid-March and individuals in mid-April were likely key drivers behind these redemptions. In addition, in early 2013, investors appeared to have unwound money market fund investments made near year-end 2012 as a result of uncertainties surrounding the fiscal cliff. In the last two months of 2012, money market funds received $145 billion in new cash as some investors sold equity mutual funds to lock in capital gains tax liabilities in anticipation that capital gains tax rates would increase in 2013. Also, in advance of increases in tax rates at the end of 2012, some corporations paid out hefty special dividends to stockholders and part of this cash was funneled to money market funds."

ICI comments, "After these tax-related influences waned in early 2013, outflows abated and money market funds received inflows of $129 billion over the second half of the year (Figure 2.16). Rising long-term interest rates over this period likely caused investors to divert some cash to money market funds to avoid capital losses in long-term bond funds by shifting toward shorter-horizon investments."

The Fact Book also says, "Net inflow into money market funds during the second half of 2013 was briefly interrupted in October by a prolonged U.S. government shutdown and a congressional stalemate over whether to raise the U.S. borrowing limit. Concern regarding the implications of a temporary suspension of debt payments on maturing short-dated Treasury securities by the U.S. government prompted investors to redeem $57 billion from government money market funds, which invest almost exclusively in U.S. Treasury and agency securities, in the first 16 days of October."

On "Retail Money Market Funds," ICI comments, "Because of Federal Reserve monetary policy, short-term interest rates continued to remain near zero in 2013. 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 2.17). Individual investors tend to withdraw cash from money market funds when the difference between yields on money market funds and interest rates on bank deposits narrows or becomes negative. Retail money market funds, which principally are sold to individual investors, saw an outflow of a little more than $12 billion in 2013, following an outflow of $1 billion in 2012 (Figure 2.18)."

They write about "Institutional Money Market Funds," "Institutional money market funds -- used by businesses, pension funds, state and local governments, and other large-account investors -- had a net inflow of $27 billion in 2013, following an inflow of $1 billion in 2012 (Figure 2.18). Some of the cash generated by rising corporate profits in 2013 was likely held in money market funds as well as in bank deposits. U.S. nonfinancial businesses are important users of institutional money market funds. In 2013, U.S. nonfinancial businesses' portion of cash balances held in money market funds was 20 percent (Figure 2.19) [a record low]. This portion reached a peak of 37 percent in 2008 and has declined since then."

Finally, ICI adds in "Recent Reforms to Money Market Funds," "In 2010, the U.S. Securities and Exchange Commission (SEC) significantly reformed Rule 2a-7, a regulation governing money market funds. Among other things, the reforms required money market funds to hold a certain amount of 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. Repos are collateralized -- typically by 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 a peak of 36 percent in November 2012. In December 2013, this share was 28 percent of prime fund assets, still more than double the value prior to the financial crisis and subsequent reforms (Figure 2.20). For more complete data on money market funds, see section 4 in the data tables on pages 196–203."

Mutual fund industry trade association the Investment Company Institute, which will host its annual General Membership Meeting next week in Washington (May 20-22) and which will release its annual "Mutual Fund Fact Book" then too, published a study entitled, "Trends in the Expenses and Fees of Mutual Funds, 2013" yesterday. (See the press release here.) The "Trends study (see pages 9-11) comments on "Money Market Funds," "The average expense ratio of money market funds fell to 17 basis points in 2013, a 1 basis point drop from 2012. Money market fund expense ratios have remained steady or fallen each year since 1994." (ICI's chart, which uses Lipper data shows money fund expenses dropping from 49 bps in 2000 to 42 bps in 2003, and 35 bps in 2008.)

It explains, "Declines in money market fund expense ratios from 2004 to 2009 reflected a number of factors. First, the average expense ratio of retail share classes of money market funds declined 9 basis points (Figure 7; from 58 bps to 49 bps). The average expense ratio of institutional share classes declined by less, only 4 basis points (from 30 bps to 26 bps). At the same time, however, the market share of institutional share classes increased substantially (Figure 8). Because institutional share classes serve fewer investors with larger average account balances than do retail share classes, they tend to have lower expense ratios. Thus, the increase in the institutional market share helped reduce the average expense ratio of all money market funds."

ICI's study continues, "By contrast, the market share of institutional share classes of money market funds has decreased slightly since 2009, indicating that other factors have been pushing down the average expense ratios of these funds -- primarily developments stemming from the current low interest rate environment." ICI's chart shows the market share of Institutional money funds at 55% in 2004, 64% in 2008, and 66% in 2013. It also shows Retail expenses falling from 49 bps in 2009 to 32 bps in 2010, 25 bps in 2011, 21 bps in 2012, and 19 bps in 2013. Institutional money fund expense ratios were 26 bps in 2009, 21 bps in 2010, 18 bps in 2011, 16 bps in 2012 and 16 bps in 2013.

It tells us, "In 2007 and 2008, to stimulate the economy and respond to the financial crisis, the Federal Reserve sharply reduced short-term interest rates. By early 2009, the federal funds rate and yields on U.S. Treasury bills had hit historic lows, both hovering just above zero. Yields on money market funds, which closely track short-term interest rates, also tumbled (Figure 9). The average gross yield (the yield before deducting fund expense ratios) on taxable money market funds has remained below 25 basis points since February 2011 and fell to a low of 13 basis points at the end of 2013." (Note: ICI uses iMoneyNet data for its gross and net yield, and waiver data.)

ICI's research says, "In this setting, money market fund advisers increased expense waivers to ensure that net yields (the yields after deducting fund expense ratios) did not fall below zero. Waivers raise a fund's net yield by reducing the expense ratio that investors incur. Historically, money market funds often have waived expenses, usually for competitive reasons. For example, in 2006, before the onset of the financial crisis, 62 percent of money market fund share classes were waiving at least some expenses (Figure 10). By the end of 2013, that figure had risen to 99 percent."

The piece adds, "Fund advisers and their distributors pay for these waivers, forgoing profits and bearing more, if not all, of the costs of running the funds. Money market funds waived an estimated $5.8 billion in expenses in 2013, more than four times the amount waived in 2006 (Figure 11). These waivers substantially reduced revenues of fund advisers. If gross yields on money market funds rise, advisers might reduce or eliminate waivers, which could cause expense ratios to rise somewhat." The study shows total "waivers" increasing from $1.3 billion in 2004 to $1.8 billion in 2008, $4.5 billion in 2010, and $4.8 billion in 2012.

Finally, the ICI "Trends" study explains in its introduction, "Fund expenses cover portfolio management, fund administration and compliance, shareholder services, recordkeeping, certain kinds of distribution charges (known as 12b-1 fees), and other operating costs. A fund's expense ratio, which is shown in the fund's prospectus and shareholder reports, is the fund's total annual expenses expressed as a percentage of its net assets. Unlike sales loads, fund expenses are paid from fund assets. Many factors affect a mutual fund's expenses, including its investment objective, its assets, the average account balance of its investors, the range of services it offers, fees that investors may pay directly, and whether the fund is a load or no-load fund."

Crane Data's latest expense data show money funds averaging 0.12% (our Crane Money Fund Average) for all taxable funds and 0.14% for the largest funds (our Crane 100 MF Index). Funds' gross yields average 0.13% (Crane MFA) and 0.16% (Crane 100), respectively. For more on individual fund expense information, see our Money Fund Intelligence XLS and see our historical Crane Indexes for data going back to 2006.

The agenda is set and final preparations are being made for Crane Data's 6th annual Money Fund Symposium, which will take place June 23-25, 2014 at The Renaissance Boston Waterfront. Money Fund Symposium is the largest gathering of money market fund managers and cash investors in the world. Last summer's event in Baltimore attracted over 450 attendees, and we expect approximately 500 to gather in Boston next month. Participants include money fund managers, marketers and servicers, cash investors, money market securities dealers, issuers, and regulators. See our latest Agenda here and more details on the Symposium website ( We are still accepting registrations ($750) and hotel reservations (our discounted hotel block expires soon though). Contact us at to request the full brochure.

The June 23 opening afternoon agenda includes: "Welcome to Money Fund Symposium 2014" by Peter Crane, President & Publisher of Crane Data; the keynote speech, "Money Market Funds - Past & Future" by Fidelity Investment's Nancy Prior; "Strategists Speak '14: Fed Taper, Repos, Regs" with Brian Smedley of Bank of America Merrill Lynch, Joseph Abate of Barclays , and Garret Sloan of Wells Fargo Securities; a panel entitled, "The Growing Role of Online Trading Portals," moderated by Dave Agostine of Cachematrix and including Greg Fortuna of State Street's Fund Connect, Justin Meadows of MyTreasury, and Jonathan Spirgel of BNY Mellon Liquidity Services; and, a panel, moderated by Fitch Ratings' Roger Merrritt entitled, "Major Money Fund Issues 2013," featuring Charlie Cardona of BNY Mellon CIS/Dreyfus, Andrew Linton of J.P. Morgan A.M., and Steve Meier of State Street. The opening reception will be sponsored by Bank of America Merrill Lynch. (Note: we've also added an opening night reception on Sunday, June 22, sponsored by Rabobank, which will feature the USA vs. Portugal World Cup game.)

Day 2 of Money Fund Symposium features: "The State of The Money Market Fund Industry" with Peter Crane of Crane Data, Debbie Cunningham of Federated Investors, and Alex Roever of J.P. Morgan Securities; "Senior Portfolio Manager Perspectives," moderated by Joel Friedman of Standard & Poor's Ratings and including Rich Mejzak of BlackRock, Rob Sabatino of UBS Global Asset Management, and John Tobin of J.P. Morgan Asset Management; "Government MF Issues & Repo Update," with Andrew Hollenhorst of Citi, Marques Mercier of Invesco, and Mike Bird of Wells Fargo Advantage Funds; and "Treasury Dept. on FRNs & Risk Agenda" with U.S. Department of the Treasury's James Clark.

The afternoon of Day 2 (after a Dreyfus-sponsored lunch) features: "Dealer Panel: Supply Outlook, New Products," moderated by Dave Sylvester of Wells Fargo Funds and featuring Chris Condetta of Barclays, John Kodweis of J.P. Morgan Securities, and Jean-Luc Sinniger of Citi Global Markets; "Accounting Issues, Disclosure & Floating NAVs," with Chris May of PriceWaterhouseCoopers; "Enhanced Cash, ETF & Ultra‐Short Bond Growth," with Alex Roever of J.P. Morgan Securities, Dave Fishman of Goldman Sachs, Jonathan Carlson of BofA Global Capital Management, and Peter Yi of Northern Trust; and, "European & Global Money Fund Outlook" with Jonathon 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: "Money Fund Reforms A Look at the Final Rule," with Stephen Keen of Reed Smith and Jack Murphy of Dechert LLP; "Regulatory Roundtable: Discussing New Rules" with Jane Heinrichs of the Investment Company Institute, Kevin Meagher of Fidelity, and Sarah ten Siethoff of the U.S. Securities & Exchange Commission; and, "Corporate Cash Investor Issues & Alternatives, with Tony Carfang of Treasury Strategies, Lance Pan of Capital Advisors, and Jamie Cortas of EMC Corp. Finally, the last session is entitled, "FDIC, Brokerage & Retail MMF Update," and features Rick Holland of Charles Schwab, Ted Hamilton of Promontory Interfinancial Network, and Tim Schiltz of Ameriprise Financial.

We hope you'll join us in Boston next month! Finally, in other conference news, our 2nd annual "offshore" money fund event, European Money Fund Symposium, is scheduled for Sept. 22-23, 2014 in London, England, and our next Crane's Money Fund University "basic training" event is scheduled for Jan. 22-23, 2015, in Stamford, Conn.

Economists from the Federal Reserve Board of Governors recently published a paper in their "Finance and Economics Discussion Series," entitled, "Gates, Fees, and Preemptive Runs." (See our May 2 "Link of the Day" "More Reform Comments: Arnold and Porter's Freeman Writes for Federated," which is a response to this paper.) Written by Marco Cipriani, Antoine Martin, Patrick E. McCabe, and Bruno M. Parigi, its Abstract says, "We build a model of a financial intermediary, in the tradition of Diamond and Dybvig (1983), and show that allowing the intermediary to impose redemption fees or gates in a crisis -- a form of suspension of convertibility -- can lead to preemptive runs. In our model, a fraction of investors (depositors) can become informed about a shock to the return of the intermediary's assets. Later, the informed investors learn the realization of the shock and can choose their redemption behavior based on this information. We prove two results: First, there are situations in which informed investors would wait until the uncertainty is resolved before redeeming if redemption fees or gates cannot be imposed, but those same investors would redeem preemptively, if fees or gates are possible. Second, we show that for the intermediary, which maximizes expected utility of only its own investors, imposing gates or fees can be ex post optimal. These results have important policy implications for intermediaries that are vulnerable to runs, such as money market funds, because the preemptive runs that can be caused by the possibility of gates or fees may have damaging negative externalities."

The Fed staff working paper explains, "There is a longstanding view in the banking literature that the suspension of convertibility of deposits into cash can prevent self-fulfilling bank runs. However, this paper shows that the possibility that a bank might suspend convertibility can itself lead to preemptive runs. This result is relevant not only for an understanding of banking history and policy, but also for policy making in today's financial system. For example, recent regulatory proposals aimed at reducing the likelihood of runs on money market funds (MMFs) would give them the option to halt ("gate") redemptions or charge fees for redemptions when liquidity runs short, actions analogous to suspending the convertibility of deposits into cash at par. Our results show that the option to suspend convertibility has important drawbacks; a bank or MMF with the option to suspend convertibility may become more fragile and vulnerable to runs."

It continues, "Our focus is on preemptive runs that occur following a change in the economy's fundamentals, rather than because of a coordination failure. Hence, we build a model of a financial intermediary, in the tradition of Diamond and Dybvig (1983, hereafter "DD"). A fraction of investors become informed about an unexpected shock to the return of the investment technology, similar to that in Allen and Gale (2000). At first, informed investors only know that the return has become stochastic, but they later learn the exact realization of the shock. Our first result is that, when a gate or a fee can be imposed, informed investors may withdraw as soon as they learn about the shock, rather than waiting until they learn its exact realization. That is, they run preemptively. Our second result is that, for the intermediary that maximizes the expected utility of only its own investors, it can be ex-post optimal to impose gates or fees. To be sure, in a broader context that is beyond the scope of our model, the use of these instruments likely would not be socially optimal, as the intermediary would not weigh the negative externalities that might be associated with a preemptive run, such as increasing the likelihood of runs on other similar intermediaries. Hence, absent commitment, the intermediary will impose a gate or fee, justifying the beliefs of informed agents who run preemptively."

The economists write, "In the banking literature, suspension of convertibility of deposits into cash was long seen as a mechanism to prevent self-fulfilling bank runs because a suspension might eliminate the need to liquidate the investment technology. For example, in the DD model, where bank runs can occur in equilibrium as a result of a pure coordination failure, limiting withdrawals to the available liquidity is sufficient to eliminate investors' incentive to run. This suggests that the option to suspend convertibility could eliminate a centuries-old source of financial instability. However, several papers have challenged this notion."

They add, "Our paper is the first to show that the possibility of suspending convertibility, including the imposition of gates or fees for redemptions, can create runs that would not otherwise occur. This contrasts with the existing literature, which focuses on whether suspension of convertibility can prevent runs. In other words, we show that rather than being part of the solution, redemption fees and gates can be part of the problem."

Finally, the Fed paper says, "Our results, including our finding that restrictions on redemptions or withdrawals can be ex post optimal for the financial intermediary, provide a theoretical basis for understanding why such restrictions may have been forbidden. An intermediary's ability to impose restrictions can trigger preemptive runs with broader welfare costs that are not internalized by the intermediary or its investors. Of note, neither individual U.S. banks nor individual MMFs have had the legal option to suspend convertibility, although both types of intermediaries have done so, particularly in times of crisis. Subsequently, legislatures and courts struggled with whether and how to punish such transgressions without revoking banks' charters and forcing their liquidation after the crises had subsided (Gorton 2012)."

In other news, the Investment Company Institute published the "Viewpoint: Size by Itself Doesn’t Matter—Leverage Does". ICI's "Second in a series of Viewpoints postings on funds and financial stability," says, "The threshold set by the Financial Stability Board (FSB) for examining whether a regulated fund could pose risk to the financial system should be redrawn -- or better yet, withdrawn. The FSB's consultation puts size front and center, saying that funds with more than $100 billion in assets under management should automatically be reviewed as candidates for designation as global systemically important financial institutions, or global SIFIs. But size alone is not an accurate indicator of systemic risk. Regulators should instead prominently focus on balance-sheet leverage -- the essential fuel for financial crises."

ICI's Mike McNamee explains, "Leverage can tell a lot about a financial institution's capacity for systemic risk. In times of market stress, leverage helps turn small decreases in asset values into large losses, and spreads those losses across the financial system. Financial crises -- including the most recent meltdown -- generally stem from institutions whose losses were magnified by high amounts of leverage, and then spread throughout the financial system. Because banks are highly leveraged, focusing regulators' attention on the biggest banks makes sense. Outside the banking system, size alone is less useful as an indicator of risk. One must consider it along with leverage. Yet funds use virtually no leverage, so a threshold that concentrates only on assets under management as an indicator of possible risk is not appropriate."

Crane Data released its May Money Fund Portfolio Holdings Friday afternoon, and our latest collection of taxable money market securities, with data as of April 30, 2014, shows a big drop in Repo (including NY Fed repo) and Treasuries, and a jump in Time Deposits (the SEC's "Other" category) and CDs. Money market securities held by Taxable U.S. money funds overall (those tracked by Crane Data) decreased by $39.1 billion in April to $2.392 trillion. Portfolio assets decreased by $43.0 billion in March, $32.7 billion in February, and $258 million in January, after an increase of $55 billion in December. CDs remained the largest holding among taxable money funds, followed by Repo, then by Treasuries, CP, Agencies, Other, and VRDNs. Money funds' European-affiliated holdings rebounded after quarter-end on a shift from Fed repo back into TDs and CDs; European holdings are now below 29.2% of holdings (up from below 25% last month). Below, we review the latest portfolio holdings statistics.

Among all taxable money funds, Certificates of Deposit (CD) rebounded in April, increasing $17.4 billion to $560.5 billion, or 23.4% of holdings. Repurchase agreement (repo) holdings plunged $51.5 billion to $482.5 billion, or 20.2% of fund assets. (Money funds' repo at the NY Fed dropped sharply, falling from $203.1 billion to $146.1 billion, accounting for the entire repo drop and then some.) Treasury holdings, the third largest segment, slid by $49.8 billion to $424.3 billion (17.7% of holdings). Government Agency Debt continued its slide, falling by $17.0 billion. Agencies now total $313.5 billion (13.1% of assets). Commercial Paper (CP), the fifth largest segment, increased by $8.6 billion to $389.4 billion (16.3% of holdings). Other holdings, which include Time Deposits, rebounded sharply (up $45.2 billion) to $181.8 billion (7.6% of assets). VRDNs held by taxable funds increased by $8.0 billion to $40.0 billion (1.7% of assets). (Crane Data's Tax Exempt fund data will be released in a separate series late Tuesday and our "offshore" holdings will be released Wednesday.)

Among Prime money funds, CDs still represent over one-third of holdings with 37.2% (up from 35.2% of a month ago), followed by Commercial Paper (25.8%, up from 24.7%). The CP totals are primarily Financial Company CP (15.7% of holdings) with Asset-Backed CP making up 6.1% and Other CP (non-financial) making up 4.0%. Prime funds also hold 4.8% in Agencies (down from 5.2%), 5.0% in Treasury Debt (up from 6.6%), 2.5% in Other Instruments, and 5.0% in Other Notes. Prime money fund holdings tracked by Crane Data total $1.507 trillion (down from $1.542), or 63.0% of taxable money fund holdings' total of $2.392 trillion.

Government fund portfolio assets totaled $433.2 billion, down fractionally from $434.3 billion last month, while Treasury money fund assets totaled $451.6 billion, down slightly from $454.7 billion at the end of March. Government money fund portfolios were made up of 55.0% Agency securities, 21.1% Government Agency Repo, 6.1% Treasury debt, and 17.1% Treasury Repo. Treasury money funds were comprised of 71.5% Treasury debt and 27.2% Treasury Repo.

European-affiliated holdings rebounded, up $99.2 billion in April to $699.1 billion (among all taxable funds and including repos); their share of holdings is now 29.2%. Eurozone-affiliated holdings also jumped (up $42.4 billion) to $390.3 billion in April; they now account for 16.3% of overall taxable money fund holdings. Asia & Pacific related holdings fell by $3.9 billion to $280.1 billion (11.7% of the total), while Americas related holdings fell $133.5 billion to $1.412 trillion (59.0% of holdings).

The overall taxable fund Repo totals were made up of: Treasury Repurchase Agreements (down $52.8 billion to $248.0 billion, or 10.4% of assets), Government Agency Repurchase Agreements (up $1.6 billion to $150.4 billion, or 6.3% of total holdings), and Other Repurchase Agreements (down $331 million to $84.0 billion, or 3.5% of holdings). The Commercial Paper totals were comprised of Financial Company Commercial Paper (up $9.4 billion to $237.0 billion, or 9.9% of assets), Asset Backed Commercial Paper (up $3.1 billion to $91.4 billion, or 3.8%), and Other Commercial Paper (down $4.0 billion to $61.0 billion, or 2.6%).

The 20 largest Issuers to taxable money market funds as of April 30, 2014, include: the US Treasury ($424.3 billion, or 19.5%), Federal Home Loan Bank ($184.7B, 8.5%), Federal Reserve Bank of New York ($146.1B, 6.7%), BNP Paribas ($65.4B, 3.0%), Bank of Nova Scotia ($58.5B, 2.7%), Credit Agricole ($55.5B, 2.6%), JP Morgan ($54.8B, 2.5%), Bank of Tokyo-Mitsubishi UFJ Ltd ($54.2B, 2.5%), RBC ($49.8B, 2.3%), Sumitomo Mitsui Banking Co ($47.0B, 2.2%), Credit Suisse ($46.9B, 2.2%), Deutsche Bank AG ($46.4B, 2.1%), Citi ($45.8B, 2.1%), Wells Fargo ($45.1, 2.1%), Federal Home Loan Mortgage Co ($44.4B, 2.0%), Federal National Mortgage Association ($43.7B, 2.0%), Bank of America ($42.3B, 1.9%), Barclays Bank ($41.9B, 1.9%), Federal Farm Credit Bank ($38.2B, 1.8%), and Societe Generale ($35.7B, 1.6%).

In the repo space, Federal Reserve Bank of New York's RPP program issuance (held by MMFs) remained the largest program by far with 30.3% of the repo market. The 10 largest Repo issuers (dealers) (with the amount of repo outstanding and market share among the money funds we track) include: Federal Reserve Bank of New York ($146.1B, 30.3%), BNP Paribas ($37.9B, 7.8%), Bank of America ($32.2B, 6.7%), Deutsche Bank AG ($25.4B, 5.3%), Barclays ($25.4B, 5.3%), Credit Agricole ($19.8B, 4.1%), Citi ($19.5B, 4.0%), Wells Fargo ($19.4B, 4.0%), Credit Suisse ($18.6B, 3.9%), and RBC ($18.4B, 3.8%). Crane Data shows 58 money funds buying the Fed's repos, with just 4 funds -- Morgan Stanley Inst Lq Gvt, Northern Trust Trs MMkt, JP Morgan US Govt and State Street Inst Lq Res -- investing over the previous $7 billion limit (but well under the new $10 billion limit).

The 10 largest CD issuers include: Sumitomo Mitsui Banking Co ($40.3B, 7.2%), Bank of Tokyo-Mitsubishi UFJ Ltd ($39.3B, 7.1%), Bank of Nova Scotia ($36.0B, 6.5%), Toronto-Dominion Bank ($28.3B, 5.1%), Bank of Montreal ($27.9B, 5.0%), Rabobank ($24.8B, 4.5%), Mizuho Corporate Bank Ltd ($23.7B, 4.3%), Credit Suisse ($19.9B, 3.6%), BNP Paribas ($18.6B, 3.3%), and Citi ($17.9B, 3.2%).

The 10 largest CP issuers (we include affiliated ABCP programs) include: JP Morgan ($25.3B, 7.5%), Westpac Banking Co ($16.5B, 4.9%), Commonwealth Bank of Australia ($13.6B, 4.0%), Lloyds TSB Bank PLC ($11.6B, 3.4%), RBC ($11.1B, 3.3%), HSBC ($10.9B, 3.2%), FMS Wertmanagement ($10.5B, 3.1%), Skandinaviska Enskilda Banken AB ($9.8B, 2.9%), Barclays PLC ($9.5B, 2.8%), and ING Bank ($9.4B, 2.8%).

The largest increases among Issuers include: Lloyd's TSB Bank PLC (up $16.4B to $27.0B), Societe Generale (down $15.6B to $29.2B), DnB NOR Bank ASA (up $13.9B to $29.8B), Swedbank (up $10.3B to $22.6B), National Australia Bank (up $7.8B to $26.8B), and Societe Generale (up $6.5B to $35.7B). The largest decreases among Issuers of money market securities (including Repo) in April were shown by: the Federal Reserve Bank of New York (down $57.0B to $146.1B), the US Treasury (down $49.8B to $424.3B), Federal Home Loan Bank (down $12.5B to $184.7B), Bank of Tokyo-Mitsubishi UFJ Ltd (down $8.6B to $54.2B), and Goldman Sachs (down $7.4B to $15.0B).

The United States remained the largest segment of country-affiliations; it now represents 50.3% of holdings, or $1.203 trillion. France (9.3%, $222.0B) moved into second place ahead of Canada (8.6%, $206.7B), and Japan (7.2%, $171.3B) remained the fourth largest country affiliated with money fund securities. The UK (4.6%, $109.2B) remained in fifth place, and Sweden (4.4%, $105.4B) remained in sixth. Australia (3.5%, $83.7B) remained in seventh while Germany (3.4%, $80.5B) stayed in 8th. The Netherlands (3.1%, $74.5B) was ninth and Switzerland (2.7%, $63.9B) was tenth among country affiliations. (Note: Crane Data attributes Treasury and Government repo to the dealer's parent country of origin, though money funds themselves "look-through" and consider these U.S. government securities. All money market securities must be U.S. dollar-denominated.)

As of April 30, 2014, Taxable money funds held 23.8% of their assets in securities maturing Overnight, and another 12.9% maturing in 2-7 days (36.6% total in 1-7 days). Another 21.5% matures in 8-30 days, while 23.8% matures in the 31-90 day period. The next bucket, 91-180 days, holds 14.4% of taxable securities, and just 3.6% matures beyond 180 days.

Crane Data's Taxable MF Portfolio Holdings (and Money Fund Portfolio Laboratory) were updated Friday, and our MFI International "offshore" Portfolio Holdings will be updated Wednesday (the Tax Exempt MF Holdings will be released Tuesday). Visit our Content center to download files or visit our Portfolio Laboratory to access our "transparency" module. Contact us if you'd like to see a sample of our latest Portfolio Holdings Reports or our new Reports Issuer Module.

As we mentioned yesterday, FSOC released its "2014 Annual Report", which reviews "significant financial market and regulatory developments" and "potential emerging threats to the financial stability," on Wednesday. Today, we continue our excerpts.... The report says in section 5.5.1 Money Market Funds, "MMFs are a type of mutual fund that invests in certain high quality short-term securities as defined by the SEC. Subject to compliance with the investment restrictions, MMFs are permitted to use the amortized cost method of valuation and/or the penny-rounding method of pricing to facilitate a stable NAV, commonly $1 per share, for subscriptions and redemptions. There are three main categories of MMFs: prime funds, which invest primarily in corporate debt securities; government and Treasury funds, which invest primarily in U.S. federal government securities; and tax-exempt funds, which invest primarily in short-term, tax-exempt securities of local and state governments. Prime MMF assets increased slightly in 2013 from $1.76 trillion to $1.79 trillion, while government and Treasury MMF assets increased from $949 billion to $981 billion (Chart 5.5.1). Tax-exempt MMFs declined from $299 billion to $281 billion. Taken together, MMFs held just over $3 trillion in assets as of December 2013, or about 18 percent of total mutual fund assets under management (AUM), according to the Investment Company Institute."

It continues, "The last two years have been a period of persistent consolidation in the MMF industry, with the number of MMFs dropping from 629 at the start of 2012 to 555 at the end of 2013. In the sustained low-interest rate environment, competitive measures have led fund managers to offer fee waivers to MMF investors to prevent negative net yield, which contributed to fund consolidation. During 2013, MMFs decreased liquidity levels and increased the weighted-average life of their fund portfolios (Charts 5.5.2, 5.5.3). In particular, the weighted-average life of non-traditional repo held in MMF portfolios lengthened from 17.7 days at the end of 2012 to 30.3 days at the end of 2013."

The report tells us, "While the ranking changed slightly from 2012 to 2013, prime MMFs continued to have the heaviest geographical exposures to the United States, Canada, Japan, France, and Australia/ New Zealand. Notably, MMF exposure to Chinese banks has increased steadily since exposures first appeared in portfolios in November 2011. However, at $5.9 billion at the end of 2013, it is still a very small percentage of prime MMF assets (0.3 percent)."

It adds, "Another notable change for MMFs in 2013 was the introduction of the Overnight Fixed-Rate Capped-Allotment Reverse Repurchase Agreement Operational Exercise, which the Federal Reserve has undertaken as part of its effort to test potential tools for future implementation of monetary policy. As a consequence of this exercise, investors in short-term funding markets, including MMFs, now have an additional, albeit potentially temporary, high-quality liquid investment option. As of December 31, 2013, prime MMFs held 44 percent of these repos, and all MMFs together held over 78 percent."

FSOC writes in section "6.2.3 Money Market Mutual Fund Reform," "In June 2013, the SEC proposed further reforms for the regulation of MMFs. The reforms were intended to make MMFs less susceptible to runs that could threaten financial stability and harm investors. The SEC's proposal includes two principal reforms that could be adopted alone or in combination. One alternative would require a floating NAV for prime institutional MMFs. The other alternative would allow the use of liquidity fees and redemption gates in times of stress. The proposal also includes additional diversification, disclosure, and stress testing measures that would apply under either alternative. The public comment period has closed, and the SEC is currently reviewing the comments and working to develop a final rule."

They add, "The SEC began evaluating the need for MMF reform after the Reserve Primary Fund "broke the buck" at the height of the financial crisis in September 2008. In 2010, the SEC adopted reforms enhancing the risk-limiting conditions on MMFs by reducing maturities, improving credit quality and imposing new liquidity requirements. The SEC's proposed rules would supplement the 2010 reforms. In November 2012, the Council issued for public comment a proposed recommendation that the SEC implement structural reforms to mitigate the vulnerability of MMFs to runs. The Council's proposed recommendation was issued under Section 120 of the Dodd-Frank Act. Under Section 120, if the Council determines that a financial activity or practice conducted by BHCs or nonbank financial companies could create or increase the risk of certain problems spreading among financial companies or markets, the Council may, after seeking public comment, issue recommendations to the relevant regulator to apply new or heightened standards or safeguards."

Finally, the report says on "Private Fund Data," "In July 2013, the SEC released a report on the use of data and records on private investment funds derived from the new Form PF. The SEC has received a complete set of initial filings from registered investment advisers on the form. As of mid-2013, private funds were reporting on more than $7 trillion in regulatory AUM with Form PF. The Council and OFR are using certain Form PF data to evaluate potential risks to financial stability. The OFR published preliminary results from analysis of Form PF data in its 2013 annual report, including analysis of leverage and VaR. SEC staff has begun to assess the quality of the data collected -- including evaluating the consistency of filer responses and differences in approaches or assumptions made by filers -- and has used the data to obtain information regarding certain private funds. The SEC also has identified a number of uses of the information, including incorporating Form PF data into SEC analytical tools, using Form PF information to monitor the risk-taking activities of investment advisers to private funds, conducting pre-examination due diligence and in risk identification, and providing certain aggregated Form PF data to IOSCO regarding large hedge funds to offer a more complete overview of the global hedge fund market."

The Financial Stability Oversight Council, or FSOC, released its 2014 Annual Report yesterday, which includes sections on wholesale funding, tri-party repo, and of course money market mutual funds. (See pages 3, 8, 57-61, 81-82, 100-101, 108, and 113.) The report says of the "Short-Term Wholesale Funding Markets," "The influx of customer deposits in recent years has afforded banks the opportunity to reduce their dependence on short term wholesale funding. Although the usage of commercial paper (CP), repo, time deposit, and other sources of wholesale funding fell this past year, financial institutions without access to customer deposits and prohibited from using customer cash and securities for proprietary purposes, such as broker-dealers, remain dependent on wholesale markets for funding. Since the Council's inaugural annual report nearly three years ago, the structural vulnerabilities of the tri-party repo markets have been highlighted. This past year witnessed important progress in tri-party repo reform. For example, through supervisory authority, the Federal Reserve has worked with the two clearing banks and market participants to greatly improve operational efficiencies and controls in the management and transfer of tri-party repo collateral. As a result, intraday credit exposure was reduced below the 10 percent goal for one clearing bank while the other is expected to have less than 10 percent of this exposure by the end of 2014."

It continues, "In addition, reform efforts continue for MMFs, with the SEC releasing a proposed rulemaking in June 2013. Currently, the SEC is assessing comment letters and other data and information to determine the best approach to prevent possible runs on MMFs in the event of a severe liquidity or credit shock to MMFs, such as occurred during the financial crisis. Until structural reforms are adopted, the potential for run risk remains significant. Similarly, the possibility of tri-party repo collateral fire sales still poses significant risks for the financial system. Policymakers continue to examine ways to minimize potential tri-party repo spillover effects if such fire sales were to occur."

FSOC discusses "Reforms of Wholesale Funding Markets and "Tri-party Repo," writing, "In its 2013 annual report, the Council highlighted three vulnerabilities in the tri-party repo market: Heavy reliance by market participants on intraday credit extensions from the clearing banks. Weakness in the credit and liquidity risk management practices of many market participants. Lack of a mechanism to ensure that tri-party repo investors do not conduct disorderly, uncoordinated sales of their collateral immediately following a broker-dealer's default."

They tell us, "Significant progress has been made over the past year in reducing market participants' reliance on intraday credit from the clearing banks. The share of volume funded intraday by the clearing banks fell from 92 percent in December 2012 to under 20 percent in December 2013, and is projected to fall below the Tri-Party Repo Infrastructure Reform Task Force's goal of 10 percent by December 2014. Both clearing banks have re-engineered the settlement process in ways that require much less intraday credit extension and have increased the price of credit they still provide. Market participants now face stronger incentives to manage their risk prudently; many dealers have extended the weighted-average maturity of their tri-party repo funding thereby sharply reducing their rollover risk exposure."

FSOC adds, "The risk of fire sales of collateral by creditors of a defaulted broker-dealer, many of whom may themselves be vulnerable to runs in a stress event, remains an important financial stability concern given the destabilizing effect such sales may have on markets and their potential to transmit risk across a wide range of participants. The Council recognizes that regulatory reforms implemented since the crisis, such as increases in the amount of capital, liquidity, and margin changes for U.S. broker-dealers, may help to mitigate the risk of default. However, the Council advises all U.S. regulators of firms that rely on this market for funding to assess whether additional steps may need to be taken to further increase tri-party repo borrowers' protection against funding runs in the broader context of liquidity regulation. The Council also urges coordination between market participants and financial regulators to address the risk of post-default fire sales of assets by tri-party repo investors."

The Annual Report writes about "Money Market Funds," "In June 2013, the SEC proposed rules to reform the structure of MMFs in order to make them less susceptible to runs. The SEC's proposal includes two principal changes that could be adopted alone or in combination. One alternative would require a floating net asset value (NAV) for prime institutional MMFs. The other alternative would allow the use of liquidity fees and redemption gates in times of stress. The proposal also includes additional diversification, disclosure, and stress testing measures that would apply under either alternative. The SEC's proposed reforms would supplement the MMF reforms adopted by the SEC in 2010 that were designed to improve the risk-limiting conditions on MMFs by, among other things, instituting minimum liquidity requirements, reducing MMFs' weighted-average maturities, and enhancing the credit quality of holdings."

It explains, "In November 2012, the Council, under Section 120 of the Dodd-Frank Act, issued a proposed recommendation that the SEC implement structural reforms to mitigate the vulnerability of MMFs to runs. That proposed recommendation included three alternatives for public consideration: (1) a floating NAV; (2) a stable NAV with a NAV buffer of up to 1 percent and a minimum balance at risk of roughly 3 percent of a shareholder's account value; and (3) a stable NAV with a 3 percent NAV buffer in addition to other measures, including more stringent diversification, liquidity, and disclosure requirements."

FSOC tells us, "When making the proposed recommendation, the Council stated and reiterates today that the SEC, by virtue of its institutional expertise and statutory authority, is best positioned to implement reforms to address the risk that MMFs present to the economy. The Council does not expect that it would issue a final Section 120 recommendation to the SEC, if the SEC moves forward with meaningful structural reforms of MMFs. The Council understands the SEC is currently in the process of reviewing public comments on its proposed reforms, and the Council recommends that the SEC move forward and adopt structural reforms designed to address MMF run risk."

Finally, the report adds, "The Council recommends that its member agencies examine the nature and impact of any structural reform of MMFs that the SEC implements to determine whether the same or similar reforms are appropriate for other cash-management vehicles, including non-Rule 2a-7 MMFs. Such an examination would provide for consistency of regulation while also decreasing the possibility of the movement of assets to vehicles that are susceptible to large-scale runs or otherwise pose a threat to financial stability."

The May issue of Crane Data's Money Fund Intelligence will be sent out to subscribers on Wednesday morning. The latest edition of our flagship monthly newsletter features the articles: "Crane Data Celebrates 8 Yrs; MMF Reforms Still Pending," which reviews our company history and the latest on regulations; "Deutsche's Joe Sarbinowski and Benevento Talk MMFs," which interviews Deutsche Asset and Wealth Management's two MDs; and, "Funds Critical of SEC Mini Studies; DERA Misses Mark," which reviews feedback on the SEC's recent "Staff Analysis of Data and Academic Literature Related to Money Market Fund Reform". We also updated our Money Fund Wisdom database query system with April 30, 2014, performance statistics and rankings this morning, and we'll send out our MFI XLS spreadsheet shortly. (MFI, MFI XLS and our Crane Index products are available to subscribers at our Content center.) Our April 30 Money Fund Portfolio Holdings data are scheduled to go out on Friday, May 9.

The latest MFI newsletter's lead article comments, "Crane Data, the publisher of Money Fund Intelligence, celebrates its 8th birthday this month. As we've done in past May issues, we’d like to review our progress and update you on our efforts. We also review the latest regulatory reform news. Crane Data was launched in May 2006 by money fund expert Peter Crane and technology guru Shaun Cutts to bring faster, cheaper and cleaner information to the money fund space. We began with our MFI newsletter and have grown to offer a full range of daily and monthly spreadsheets, database query systems and reports on U.S. and "offshore" money funds and other cash investments."

The article explains, "Crane Data has also become the leader in the money fund conference business. Our 6th annual Money Fund Symposium will take place in Boston, June 23-25, and we expect record attendance once again (as many as 500 attendees). We're also preparing for our second annual European Money Fund Symposium, which will take place in London at the Hilton London Tower Hotel on Sept. 22-23, 2014; it follows our successful entry into the "offshore" money fund marketplace last September with our inaugural event in Dublin. We also run Money Fund University, a "basic training" conference. The next one will be held Jan. 22-23, 2015, in Stamford, Conn."

The "profile" with Deutsche says, "This month, we interview Deutsche Asset & Wealth Management's Joe Sarbinowski, Global Head of Liquidity Management, Global Client Group & Managing Director, and Joe Benevento, Global Head of Cash Management & Managing Director. We discuss the latest developments in the liquidity markets, get an update on the company's Variable NAV Money Fund, and review offshore and other money fund-related issues. Our Q&A follows."

We ask Sarbinowski and Benevento, "MFI: How long have you been involved in the cash markets? Sarbinowski: In August, I will have been at the firm for 25 years, so I can provide the institutional memory. We have been in the liquidity management business since the late 1970's, initially doing private, white-label broker-dealer cash sweeps. In the '80s, we were also running [cash] for our own wealth management trust and securities services custody businesses. So the business has really evolved over that period of time. We cater to a wide spectrum of clients -- everything from wealth management, institutional, and of course sweep clients. We've evolved over the many years and now we are at this point united under one brand, Deutsche Asset & Wealth Management. Benevento: It's been about 23 years in the industry for me." (Watch for excerpts of this interview later this month, or write us to request the full article.)

The May MFI article on Funds Critical of SEC Mini Studies; DERA Misses Mark explains, "Over a dozen letters have been posted recently on the SEC's "Comments on Proposed Rule: Money Market Fund Reform" website, most in response to the SEC's "Staff Analysis of Data and Academic Literature Related to Money Market Fund Reform." Almost all of the commenters all took issue with these "mini" studies, with particular criticism directed at the SEC's "Safe Assets" piece. (Note: SEC Chief Economist and Division of Economic and Risk Analysis (DERA) Director Craig M. Lewis left the agency last week, but we don't believe this was related. The departure, and the negative reactions to these studies, though, could slow the Commission's recent infatuation with "data".)"

Crane Data's May MFI with April 30, 2014 data shows total assets falling by $59.3 billion $25.9 billion (after falling by $25.9 billion last month and $44.9 billion in February) to $2.489 trillion (1,238 funds, the same number as last month). Our broad Crane Money Fund Average 7-Day Yield and 30-Day Yield remained at a record low 0.01% while our Crane 100 Money Fund Index (the 100 largest taxable funds) yielded 0.02% (7-day and 30-day). On a Gross Yield Basis (before expenses were taken out), funds averaged 0.13% (Crane MFA, unchanged) and 0.16% (Crane 100) on an annualized basis for both the 7-day and 30-day yield averages. (Charged Expenses averaged 0.12% and 0.14% for the two main taxable averages.) The average WAM for the Crane MFA and the Crane 100 were 43 and 46 days, respectively, down 2 days and one day, respectively. (See our Crane Index or craneindexes.xlsx history file for more on our averages.)

Wells Fargo Advantage Funds' latest "Overview, strategy, and outlook", entitled, "A tale of two markets," tells us, "With the likelihood that the Federal Reserve (Fed) will raise its target federal funds rate from its zero interest rate bound sometime in the next year or two, the timing of that landmark move will come to dominate the money markets over the next year. Landmark might seem like a lofty word for what may be a modest 25-basis-point (bp; 100 bps equals 1.00%) increase, but any move higher after more than six years of zero -- brought about by a bevy of extraordinary stimulus measures (quantitative easing, Operation Twist, etc.) -- would be noteworthy."

It explains, "As the calendar advances and/or as the timing of the first rate hike moves closer in response to a stronger economy, the 13-month maturity limit for money market fund investments will begin to include time periods that incorporate expectations for higher overnight interest rates, and investments with a higher yield may finally become available to short-term investors. Over time, the market will refine its consensus opinion of the economy and the Fed, and that date will move around accordingly. Money market investors, who haven't enjoyed yield for years, will then potentially be exposed to something else they haven't seen in years -- namely, interest-rate risk."

Wells continues, "An expectation of higher interest rates likely will begin to affect the yield curve with the passage of time as we close the gap until the first rate hike; however, the market could be reshaped sooner, with uncertain timing, by preparations the Fed makes in advance of that hike. Advance work will be needed because the world of the $4 trillion Fed balance sheet is ompletely novel and foreign; in terms of institutional experience, the Fed could just as well be trying to raise interest rates on Mars. Conventional attempts to raise rates would be countered by the trillions of dollars of reserves in the system, so the Fed -- fully aware of the problem -- will need to act in this novel environment with novel tools."

They comment, "The Fed began taking these steps last September when it introduced and began testing its reverse repo (RRP) program. The RRP facility debuted with a per-counterparty limit of $500 million and took in $12 billion at 1 bp on its first day; by the end of April, after the Fed had raised the limit to $10 billion and the rate to 5 bps, the facility drew $208 billion from 77 different counterparties. When it was announced, we thought the RRP facility could prove to be a game changer, especially in the government money markets, and this seems more likely now than ever. At the same time, the supply of eligible money market investments continues to erode across the curve and in virtually all sectors: regulatory pressures are shrinking the traditional repo market; bank issuance is being pushed into longer maturities; Fannie Mae and Freddie Mac are in a gradual state of wind-down, constraining agency issuance; asset-backed commercial paper issuance is a small fraction of what it once was; and the higher tax receipts generated by a strengthening U.S. economy are keeping Treasury bill (T-bill) issuance muted. In the form of the RRP facility, the Fed is seemingly becoming the investment of last resort. The continuing growth of the RRP facility is highlighted in the chart below, with usage not only gradually increasing over time but also moving sharply higher when market repo rates fall near the Fed's RRP rate."

Wells' Portfolio Manager Commentary adds, "Recent activity in the T-bill market, however, demonstrates the potential difficulties the Fed will encounter as it attempts to control short-term rates in a system awash with cash. Much as the federal funds market has not been bound by the Fed's official interest-rate target due to leakage in the system, the government securities market has traded below the floor set by the RRP rate. As T-bill issuance rose and then fell with the Treasury's seasonal cash outflows and inflows, respectively, a T-bill drought pushed yields well below the Fed's RRP rate. At month-end, T-bills with maturities out to three months yielded 1 bp, while T-bills with six-month maturities yielded 4 bps. Because of leakage in the system, largely the result of actions by investors who have no access to the RRP facility, this segment of the government money market is trading well through the Fed's RRP rate. To even approach the Fed's overnight rate, investors must move more than six months out the curve. The Fed has, however, been more successful in keeping repo rates close to the RRP level, as those have generally stayed within 1 bp of the Fed's level, while prime and municipal money market instruments have mostly traded above it."

In other news, Federated's latest "Month in Cash" writes, "The Fed repo man is on our side." It says, "Quantitative easing and zero-bound interest rates get all the attention when analysts and investors talk about the Federal Reserve. Certainly speeches in April by Chair Janet Yellen and the Federal Open Market Committee statement released at the conclusion of the FOMC meeting on the last day of the month affirmed that it will continue to base its policy decisions on a broader, more qualitative approach rather than anchoring actions to specific numbers of unemployment and inflation (although policy is still data dependent). But much can be read into its motives from an end-of-quantitative-easing perspective. When the FOMC announced in its recent meeting that it will taper the amount of monthly asset purchases on the open market down to $45 billion a month, it also signaled faith in an improving economy. So policy is steady as we go and that is where we will be for some time, although it looks like we are pulling out of the winter slump."

The piece adds, "But for cash management, a lesser-known program has been just as big a factor as QE. The New York Fed's Overnight Reverse Repo Facility -- a relatively new Fed program that is aimed at giving the central bank better control over short-term rates -- has kept money-market funds in a better position in 2014 than they probably could have been. The facility, first launched as an experiment and now afforded operation status, has helped to provide a floor to the market even in this time of exceptionally low rates."

While most of the recent "Comments on Proposed Rule: Money Market Fund Reform; Amendments to Form PF posted on the SEC's website have been related to the SEC's recent posting of 4 "mini" studies, the latest related to tax issues and floating NAVs and comes from George C. Howell, III, Hunton & Williams LLP, on behalf of Federated Investors, Inc.. Howell writes, "We are writing on behalf of our client, Federated Investors, Inc., and its subsidiaries ("Federated"), to provide comments in response to the Securities and Exchange Commission's (the "Commission's") proposed rule on Money Market Fund Reform; Amendments to Form PF (the "Release"). Our comments in this letter will address the tax compliance issues that would result from the proposed rule's requirement that money market mutual funds ("MMFs") adopt a floating net asset value ("NAV"), unless specifically exempted."

The Federated letter continues, "As the Release acknowledges, if modifications to current federal income tax law are not made, "the tax reporting effects of a floating NAV could be quite burdensome for money market investors that typically engage in frequent transactions." These effects would be particularly burdensome for institutional investors, as such investors generally must make their own tax calculations rather than receiving reporting from the fund. As discussed in further detail below, significant changes would be needed to the existing federal income tax rules regarding gain and loss recognition to eliminate the substantial tax compliance burdens associated with applying the floating NAV requirement to MMFs. Furthermore, it is not clear that the Treasury Department and the Internal Revenue Service (the "IRS") currently have the regulatory authority necessary to implement the required tax law changes. To the extent that the Treasury Department and the IRS view themselves as not having the necessary regulatory authority or are unwilling to exercise it, a legislative fix would be required. Regardless of whether an administrative or legislative approach is taken, the tax compliance issues, which are described below, must be completely resolved and final legislation or administrative guidance in place prior to applying a floating NAV concept to institutional MMFs to avoid a potentially disastrous exodus of capital from the affected MMFs."

It tells us, "It is a fundamental tenet of the federal income tax law that, when an investor sells or redeems a security for more or less than the seller's cost, the investor recognizes the resulting gain or loss and must report it on the investor's tax return for the year of the sale. To calculate this gain or loss, the taxpayer must track both its cost or tax basis for the security and the price at which it sold or redeemed the security. Certain taxpayers, such as individuals, receive annual reporting of such information and the amount of the resulting gains or losses from the issuer of the security or the broker through which the sale was made. For taxpayers that are "exempt recipients," including corporations and most other institutional investors, the taxpayer must track this information and calculate the resulting gains and losses on its own."

Howell explains, "The Commission's floating NAV concept is proposed to apply only to institutional MMFs. Investors in institutional MMFs generally are corporations and other large institutional investors who use MMFs as a short-term investment vehicle and cash management tool. The amount of their investment in an MMF will vary from day to day as their cash balances go up or down. With stable NAV MMFs, there is no need for an investor to calculate or report gain or loss because the MMF maintains a stable $1 NAV per share and the redemption price of fund shares therefore always equals their cost. Thus, "money market fund shareholders therefore generally need not track the timing and price of purchase and sale transactions for capital gains or losses.""

He says, "Under the floating NAV proposal, the price of institutional MMF shares would change daily, albeit by a small amount. As a result, taxable investors would be required to track the cost or tax basis and redemption price of all shares that they purchase and redeem. In addition, such investors would be required to track the timing of individual purchase and redemption transactions to determine whether the "wash sale" rules applicable under federal income tax law disallow any of the losses. The existence and nature of this tax compliance burden is described in the IRS's recent proposed guidance regarding the application of the wash sale rules to floating NAV MMF shares. The examples in that guidance clearly indicate the need for investors to track the small gains and losses that would be associated with redemptions of floating NAV MMF shares. Furthermore, because the investors in institutional MMFs generally are "exempt recipients," the tax compliance burden would fall squarely on the investors, rather than on the funds. For institutional investors that themselves hold accounts for non-retail customers, this could require calculating small gains and losses on hundreds or thousands of accounts."

Federated's letter states, "Based on the foregoing, it is clear that, if the tax compliance burden associated with a floating NAV cannot be eliminated, the application of that concept would be damaging to institutional MMFs and investors. It would also be counterproductive to the Commission's stated goals with respect to such funds, which include "preserv[ing] as much as possible the benefits of money market funds for investors and the short-term financing markets." The remainder of this letter addresses the difficulty of eliminating that tax compliance burden without resorting to a legislative fix, which, of course, presents its own set of political and procedural challenges."

It comments, "To date, the only guidance that has been issued by the IRS with respect to the floating NAV concept is a proposed revenue procedure that would make the wash sale rule inapplicable to purchases and sales of MMF shares if the losses are below a specified threshold. The Release indicates that the Treasury Department and the IRS are also considering guidance that would allow (i) mutual funds to report net information regarding gains and losses recognized on sales of their shares and (ii) shareholders to report summary information on their returns regarding sales of mutual fund shares. However, eliminating the tax compliance burden on institutional MMF shareholders associated with the floating NAV concept would require much more in the way of guidance. The proposed revenue procedure would not make the wash sale rule inapplicable to all sales of MMF shares, but would merely disengage it if the recognized losses are below a specified threshold. As a result, MMF shareholders would still be required to gather and retain information regarding the possible application of the wash sale rule for fear that losses might exceed the threshold. Similarly, simplifying the reporting of gains and losses from sales of MMF shares on a shareholder's tax return is helpful in a limited sense, but it does not obviate the need to track and retain the information necessary to calculate the gains and losses that would be recognized on individual share redemptions, which can occur on a daily basis."

Federated writes, "Eliminating the tax compliance burden on institutional MMF shareholders associated with the floating NAV concept would require the issuance of two types of guidance. First, it would be necessary to provide full relief from the wash sale rule to the extent that losses are recognized on MMF investments. Without this full relief, institutional MMF shareholders would still have significant tax compliance obligations relating to the wash sale rule. The second and more important type of guidance that would be required is a modification of the basic gain and loss recognition regime that would eliminate the need to track gains and losses from individual MMF share redemptions. One way to achieve this goal would be to use to a "mark-to-market" tax accounting method for floating NAV MMF investments.... A final option, which represents an even further departure from existing federal income tax law, would be to provide that gains and losses from MMF share redemptions are ignored and never recognized for tax purposes under the theory that such amounts are always de minimis. As indicated in the next section, it is unclear whether the Treasury Department and the IRS have the regulatory authority to implement any of the foregoing guidance."

Finally, the letter concludes, "As discussed above, converting to a floating NAV would cause fund shareholders to recognize small gains and losses with respect to redemptions of MMF shares. Because the floating NAV proposal applies only to institutional MMFs, it is expected that, in general, fund shareholders, rather than the funds themselves, will be required to track and calculate these gains and losses. Because institutional investors use MMFs as a cash management tool, they typically engage in share purchases and redemptions on a daily or weekly basis. Accumulating and maintaining the information necessary to calculate the numerous small gains and losses resulting from frequent share redemptions would require significant time and expense on the part of fund shareholders. If this tax compliance burden cannot be eliminated, it is likely that most taxable institutional investors would abandon MMFs for other short-term investment alternatives that have a stable NAV and therefore do not require tracking and calculating cost or tax basis and redemption price. This exodus of capital from institutional MMFs would be damaging to the funds and the issuers of securities that are purchased by such funds. At the same time, institutional investors would be damaged because they will be precluded from using their preferred cash management tool merely because of the unsupportable tax administrative burden that would be imposed by the floating NAV concept. Finally, it also would be counterproductive to the Commission's stated goals with respect to MMFs, including preserving the benefits of MMFs for investors. For these reasons, the Commission should not implement the floating NAV proposal unless and until the Treasury Department or the IRS has issued administrative guidance that in fact eliminates the tax compliance burden on institutional MMF shareholders."

Money fund assets declined again over the past week following last week's $7.3 billion rebound (which broke a 7-week losing streak). The latest weekly "ICI Reports Money Market Mutual Fund Assets" release says, "Total money market fund assets decreased by $10.20 billion to $2.57 trillion for the week ended Wednesday, April 30, the Investment Company Institute reported today. Among taxable money market funds, treasury funds (including agency and repo) increased by $4.55 billion and prime funds decreased by $12.09 billion. Tax-exempt money market funds decreased by $2.66 billion. Year-to-date, money fund assets have declined by $145 billion, or 5.3%, but we expect them to increase going forward and regain these lost assets over the remainder of 2014, following the seasonal patterns of the last several years (down through May but up slightly for the year).

ICI writes, "Assets of retail money market funds decreased by $5.97 billion to $901.34 billion. Treasury money market fund assets in the retail category decreased by $970 million to $199.48 billion, prime money market fund assets decreased by $3.10 billion to $515.15 billion, and tax-exempt fund assets decreased by $1.90 billion to $186.71 billion. Assets of institutional money market funds decreased by $4.24 billion to $1.67 trillion. Among institutional funds, treasury money market fund assets increased by $5.52 billion to $707.66 billion, prime money market fund assets decreased by $8.99 billion to $894.81 billion, and tax-exempt fund assets decreased by $770 million to $70.28 billion."

Earlier this week, ICI also released its latest "Trends in Mutual Fund Investing, March 2014," which told us that money fund assets decreased by $29.6 billion in March, after decreasing $47.3 billion in February and $10.5 billion in January, and increasing $45.1 billion in December and $4.8 billion in November. For the 12 months through 3/31/14, ICI's monthly series shows assets up by $37.5 billion, or 1.4%. (For calendar 2013, ICI showed money fund assets up by $25.0 billion, or 0.9%.)

The Institute's March asset totals show an increase in both stock fund and bond fund assets; bond funds were up $12.7 billon after being up $37.8 billion in Feb. and $28.5 billion in January (but down $116.6 billion over the past year). ICI's March "Trends" says, "The combined assets of the nation's mutual funds decreased by $1.0 billion, or 0.0 percent, to $15.23 trillion in March, according to the Investment Company Institute's official survey of the mutual fund industry. In the survey, mutual fund companies report actual assets, sales, and redemptions to ICI.... Bond funds had an inflow of $12.54 billion in March, compared with an inflow of $7.75 billion in February. Taxable bond funds had an inflow of $11.09 billion in March, versus an inflow of $6.17 billion in February. Municipal bond funds had an inflow of $1.45 billion in March, compared with an inflow of $1.58 billion in February."

It adds, "Money market funds had an outflow of $29.16 billion in March, compared with an outflow of $46.73 billion in February. Funds offered primarily to institutions had an outflow of $27.47 billion. Funds offered primarily to individuals had an outflow of $1.69 billion." Money funds represent 17.3% of all mutual fund assets while bond funds represent 22.8%.

ICI also released its latest "Month-End Portfolio Holdings of Taxable Money Funds," which verified our reported jump in repo and drops in most other composition segments in March. (See Crane Data's April 10 News, "March MF Holdings Show Fed Repo Skyrockets, Other Securities Plummet.")

ICI's Portfolio Holdings for March 2014 show that Holdings of Repos jumped by $41.7 billion, or 8.8%, (after declining by $11.6 billion in Feb. and $16.5 billion in Jan., and rising $43.0 billion in Dec.) to $513.8 billion (21.8% of assets). Repo moved up to become the largest segment of taxable money fund portfolio holdings in March according to ICI's data series. Certificates of Deposits declined by $54.1 billion (after declining by $11.6 billion in Feb., jumping by $48.4 billion in Jan., and falling $25.9 billion in Dec.) to $512.8 billion (21.7%); CDs fell to second place among the largest composition segments. Treasury Bills & Securities, the third largest segment, showed an increase of $1.6 billion in March (after an increase of $7.8 billion in Feb. and a decrease of $43.8 billion in Jan.) to $462.1 billion (19.6%).

Commercial Paper, which decreased by $4.6 billion, or 0.5%, remained the fourth largest segment just ahead of U.S. Government Agency Securities. CP holdings totaled $360.4 billion (15.3% of assets) while Agencies fell by $7.8 billion to $331.7 billion (14.0%). Notes (including Corporate and Bank) fell by $6.2 billion to $89.5 billion (3.8% of assets), and Other holdings fell by $2.7 billion to $76.0 billion (3.2%).

The Number of Accounts Outstanding in ICI's Holdings series for taxable money funds increased by 96.3 thousand to 23.842 million, while the Number of Funds decreased by one to 380. Over the past 12 months, the number of accounts fell by 712.5 thousand and the number of funds declined by 17. The Average Maturity of Portfolios declined to 46 days in March. Over the past 12 months, WAMs of Taxable money funds remain declined by three days.

Note: Crane Data updated its April MFI XLS to reflect the 3/31/14 composition data and maturity breakouts for our entire fund universe on April 24. Note again too that we are now producing a "Holdings Reports Issuer Module," which allows subscribers to choose a series of Portfolio Holdings and Issuers and to see a full listing of which money funds own this paper. (Visit our Content Center and the latest Money Fund Portfolio Holdings download page to access the latest version of this new file.)

Below, we continue to excerpt from our recent "profile" article, "Plaze Says Doing Nothing Better Than SEC Proposals," which interviews Robert Plaze from Stroock & Stroock & Lavan. MFI: What about the alternative to require redemption fees and gates? Plaze: The liquidity fee fees and gates alternative is perhaps even more troublesome. There are two things investors in money market funds worry about -- one is losses of principal, and the other is loss of liquidity. In my view, the loss of liquidity is a more serious fear than loss of a small amount of value.

I suspect fund investors will treat imposition of a liquidity fee or a gate as if it were a "break the buck event." Here the proposed cure may be as bad as the disease. Investors will redeem in anticipation of the imposition of a fee or a gate. [I]f there was only one fund in the world and none of the investors understood that the manager could impose a fee or suspend redemptions, it all might work. But investors are smarter than that. After 2008, investors are acutely aware of the advantages of getting out of a fund before the door is shut.

It's also not clear to me that a fund that imposes a gate would ever re-open for business, because its investors will likely all submit redemption requests. The current SEC rules are predicated on the assumption that a fund suspending redemptions won't open again. By permitting suspension of redemption only when a fund is liquidating, they are designed to prevent a fund board from precipitously suspending redemptions with the potential consequence to other funds and short-term markets. While the SEC proposals theoretically allow a fund putting up a gate to bring it down, most industry participants I've spoken to don't believe that will ever really happen.

Believe it or not, I think that doing nothing would be better than adopting either of the two alternative proposals the SEC has offered up. In the short run, there is pressure on the SEC to do something and get it over with and to forestall separate action by FSOC. But everybody is supporting one of their preferred alternatives based upon how it will affect their current business model. No one is imagining how they might benefit from a new paradigm around which they could build a new business model. But the problem for the money market fund industry is the long-term consequences of the failure of the SEC to fix the problem, which could be devastating. There isn't going to be another government bailout under current laws. Even if there is, there will be no third bite at the apple: money market funds will be folded into the banking system, which will be a tragedy.

MFI: What about the FSOC? Plaze: I feel the frustration of everyone, although I sense a tendency on both the Office of Financial Research (OFR) and the asset management industry to exaggerate concerns. Some financial regulators are frustrated that they do not have direct authority to deal with some types of systemic risk, and that they must rely on the SEC to fix the problems.... The problem is if they don't exercise that jurisdiction or responsibility, at some point either the FSOC or the other financial regulators will need to step in to prevent another financial crisis. The asset management industry is frustrated because it feels that the other financial regulators don't understand their industry, and they're worried that they won't have the leverage with them to prevent change from happening. Will FSOC act if it collectively concludes what the SEC has done is inadequate, which is perhaps unlikely, or will it act later after there is another market event that demonstrates that what the SEC has done is inadequate?

MFI: What about other parts of the proposal? Plaze: One of the issues I believe industry participants are missing, and that is really important, is the daily disclosure of liquidity and portfolio information. I know some fund groups are already providing this disclosure voluntarily, but it worries me that it could accelerate a crisis. If a few large shareholders redeem one day for completely unconnected reasons, the following morning the fund will report a loss of liquidity.... How do investors respond? Will some institutional investors establish automatic redemption triggers? As a consequence of this part of the proposal, the impact of what might otherwise be a hiccup could be accelerated.

Another thing I worry about is that there is sort of an "arms race" going on. Funds are better invested, better positioned, more liquid, and better managed today than they were in 2008. But their institutional investors also learned something from 2008. They learned that the people in the Reserve Fund that got out in the morning were better off than the people who tried to get out in the afternoon.

MFI: Any thoughts on the future? Plaze: I think that the industry has to accept some significant changes in order to make money funds viable in the long run. As you know, working for Mary Schapiro at the SEC, we and some people working in the Fed and Treasury came up with some ideas that were rejected by the SEC Commissioners. Those ideas aren't the only possibilities, but whatever the Commission does it has to create a different set of incentives on both fund sponsors as well as investors.... I think the industry has to come to terms with long-run solution to change the destabilizing dynamics while still maintaining the best features of money market funds, which provide a significant source of competition for banks and an important source of short term capital for the markets. But we have got to figure out how to change the dynamics that can lead investors acting in their own rational interests do act in ways that damage the enterprise in the fund itself.

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