The nation's largest money market fund manager, Fidelity Investments, has begun producing a series of white papers on money fund regulatory reforms. The first in Fidelity's "Money Market Reform Communication Series" is entitled, Understanding Government & U.S. Treasury Money Market Funds. "Fidelity is well prepared for the new rules. Where needed, we will make changes to our product offerings and fund operations to comply with these rules. Fidelity remains fully committed to the money market mutual fund business and to educating investors through a series of publications that discuss how these new regulatory requirements will impact various types of money market mutual funds," writes Fidelity's `Nancy Prior, president fixed income, and Kevin Meagher senior vice president, deputy general counsel.
They explain about "Government and U.S. Treasury money market mutual funds," "Government money market mutual funds invest primarily in U.S. Treasury securities, government agency securities, and repurchase agreements backed by these same securities. There are four common types of money market mutual funds under current SEC regulations. Under the new rules, government money market mutual funds will be defined as money market mutual funds that invest 99.5% of their total assets in cash, government securities, or repurchase agreements collateralized by government securities."
Fidelity writes, "U.S. Treasury money market mutual funds and U.S. Treasury Only money market mutual funds are expected to meet the new definition of a government money market mutual fund. As a result, government and U.S. Treasury money market mutual funds will be eligible to price and transact at a stable $1.00 net asset value (NAV). Additionally, government and U.S. Treasury money market mutual funds will not be subject to liquidity fees and redemption gates. Typically, government and U.S. Treasury money market mutual fund liquidity levels far exceed SEC requirements. Even those fund holdings that do not technically qualify as either daily liquid assets or weekly liquid assets generally exhibit favorable liquidity characteristics compared to non-government securities."
They add, "Government and U.S. Treasury securities generally are perceived to have the lowest credit risk in the U.S. debt markets. During past periods of market stress and uncertainty, the market value of government and U.S. Treasury money market mutual fund holdings typically has increased as investors have sought safety in high-quality securities, which has provided further support to these funds in times of crisis." Note: According to Crane Data's latest Money Fund Intelligence XLS, Treasury Institutional MMFs account for 13.0% of total assets, Government Inst MMFs account for 12.2%, and Treasury and Government Retail MMFs account for 9.9% more. (Prime Inst MMFs account for 32.3% of the $2.5 trillion total and Prime Retail MMFs account for 22.5%.)
The Fidelity series is one example of how money market fund managers are proactively reaching out to clients to communicate about the reforms and the potential impacts. Most of the large money fund complexes have held informational calls with investors or put out papers since last Wednesday's vote to adopt reforms, including Fidelity, Federated, SSgA, Barclays, JP Morgan, UBS, and BlackRock, to name a few. Like Fidelity, BlackRock will be producing a series of materials over the coming months to help its clients navigate the upcoming changes.
Among the other recent comments, an "Investor Update" from UBS" published June 24, explains, "There will be no immediate changes to our funds. These changes will be subject to a lengthy implementation process, and in the interim we expect to continue to manage the funds in the same disciplined, conservative manner. We remind our investors that these changes are subject to a lengthy implementation process (two years for the move to floating NAVs for institutional prime and institutional municipal money market funds). In addition, yesterday the SEC also proposed a separate set of changes to money market fund regulations; as required by the Dodd-Frank Act, the proposed changes would in the future remove references to credit ratings from money fund regulations and would also further refine an issuer diversification requirement applicable to securities with certain types of guarantees. We expect that the regulators may make additional announcements/interpretations in the coming months and expect to provide further updates as more information becomes available. As such, we advise our clients to take the time to understand all the facts and to make a carefully considered evaluation of their investment alternatives. We look forward to working with our clients to help them understand these changes and their implications, and to help determine the optimal solution(s) for them."
Credit Suisse research analysts Ira Jersey and William Marshall also penned a report with their initial thoughts on reform. "The heightened information provided by a floating rather than stable $1.00 per share NAV is supposed to help mitigate the risks of a run on a fund. Although this technically gets rid of the potential for a fund to "break the buck," we are skeptical that it will have the desired effect in a stressed scenario, as a substantial move away from $1.0000 is likely to bring in fund redemptions regardless and increase sell-offs in short end securities. We suggested last year our belief that floating NAV does little to disrupt runs. This might then cause a fund board to invoke gates or fees, likely increasing the severity of any funding stresses. The IRS tax rule changes should mitigate a substantial portion of the technical hurdles of a floating NAV and make it more palatable on the margin, but it does not eliminate the related headaches. With some large institutions having indicated plans to shift out of floating NAV funds, the SEC may have inadvertently reduced the scope for large runs on such funds simply by driving short-end money elsewhere."
They continue, "With respect to the liquidity fees and redemption gates, we see these as less disruptive than the floating NAV, but still extremely detrimental to MMMF's usefulness as liquidity vehicles. The risk that such an investment could effectively become completely illiquid when it is supposed to be a cash equivalent will likely prompt investors to either diversify across funds -- a relatively unappealing option -- or simply look to different investment opportunities (see here for more of our thoughts on the benefits and risks). That said, the discretion is given to the fund boards, so it is possible that the boards could inform their investors that use of the gates or fees would only be in true crisis situations and not when there is a technical move below liquidity thresholds due to temporary factors such as a single large redemption."
The Credit Suisse analysts add, "One option for corporations that wish to continue to use MMMFs as liquidity vehicles with a stable NAV is to move their cash to government funds. According to Crane Data LLC's daily MMMF update, the annualized pick-up of Prime Institutional funds versus Government or Treasury funds over the last 30 days was a mere 2bp -- Prime funds offered 3bp versus Government and Treasury funds' 1bp. These returns underscore the idea that MMMF investors are not using these as opportunities to generate additional income, but view them as liquidity vehicles. The knock-on effects of this rule cannot be overlooked in a world where the available supply of short-end paper is already relatively constrained. Nowhere is this more acute than in the universe of assets in which Government funds can invest."
A critical piece of the SEC's money market reform rules is a proposal by the U.S. Department Treasury and IRS to allow floating NAV money market fund investors to use a simplified tax accounting method to track gains and losses and provide relief from the "wash sale" rules for any losses on shares of a floating NAV money market fund. In a July 23rd release ("Treasury Guidance on Accounting for Gains and Losses in Certain Money Market Funds") that coincided with the SEC's vote to adopt money fund reform, the Treasury Department wrote, "Today's guidance is proposed rather than final to provide the public an opportunity for comment. Nevertheless, shareholders in floating NAV MMFs can now rely on these proposed regulations to begin to use the simplified method."
The Treasury/IRS proposal sealed the deal for the passage of money market reform as SEC Commissioner Daniel Gallagher, who turned out to be the swing vote, said he would not have voted in favor without this assurance from the Treasury and IRS. "I have consistently, loudly, and publicly stated that my vote for a floating NAV was contingent on the resolution of the tax and accounting-related issues arising from the move away from a constant NAV. As we make abundantly clear in today's release, the accounting issues have been completely addressed: money funds are cash equivalents," stated Gallagher.
We excerpt portions of the Treasury's proposal below. It explains, "This document contains proposed regulations that provide a simplified method of accounting for gains and losses on shares in money market funds (MMFs) that distribute, redeem, and repurchase their shares at prices that reflect market-based valuation of the MMFs' portfolios and more precise rounding than has been required previously (floating net asset value MMFs, or floating-NAV MMFs). The proposed regulations also provide guidance regarding information reporting requirements for shares in MMFs. The proposed regulations respond to Securities and Exchange Commission (SEC) rules that change how certain MMF shares are priced. The proposed regulations affect floating-NAV MMFs and their shareholders."
It continues, "Until the SEC MMF Reform Rules change how certain MMFs price their shares, Rule 2a–7 permits any MMF meeting the other requirements of Rule 2a–7 to compute its price per share for purposes of distribution, redemption, and repurchase by using either or both of (a) the amortized cost method of valuation, and (b) the penny-rounding method of pricing. Under the amortized cost method, an MMF's NAV is determined by valuing the fund's portfolio securities at their acquisition cost, adjusted for amortization of premium or accretion of discount. Under the penny-rounding method, an MMF's NAV is rounded to the nearest one percent in computing the price per share for purposes of distribution, redemption, and repurchase. These methods have enabled MMFs to maintain constant share prices except in situations in which the "deviation [of the current net asset value per share calculated using available market quotations] from the money market fund's amortized cost price per share exceeds 1/2 of 1 percent" (commonly called "breaking the buck")."
Treasury writes, "The SEC MMF Reform Rules generally bar the use of the amortized cost method of valuation and the use of the penny-rounding method of pricing, except by government MMFs and retail MMFs.... An MMF that uses market factors to value its securities and uses basis point rounding to price its shares for purposes of distribution, redemption, and repurchase has a share price that is expected to change regularly, or "float." (This fact explains the origin of the term "floating-NAV MMF".) Floating-NAV MMFs therefore resemble in some respects other mutual funds that are not MMFs, but they remain subject to the risk-limiting conditions in Rule 2a–7 and are expected to continue to fulfill MMFs' unique role. In the absence of the simplified method of accounting proposed in this document, current law would require shareholders to compute gain or loss on every redemption of shares in a floating-NAV MMF."
The proposal also states, "In response to concerns regarding the tax compliance burdens associated with frequent redemptions of shares in floating-NAV MMFs, these proposed regulations describe a permissible, simplified method of accounting for gain or loss on shares in a floating-NAV MMF (the net asset value method, or NAV method). The NAV method, in the opinion of the Commissioner of Internal Revenue, is a method of accounting that clearly reflects income from gain or loss on shares in floating-NAV MMFs. Under this method, gain or loss is based on the change in the aggregate value of the shares in the floating-NAV MMF during a computation period (which may be the taxpayer's taxable year or certain shorter periods) and the net amount of the purchases and redemptions during the period. More specifically, the taxpayer's net gain or loss from shares in a floating-NAV MMF for a computation period generally equals the value of the taxpayer's shares in the MMF at the end of the period, minus the value of the taxpayer's shares in the MMF at the end of the prior period, minus the taxpayer's net investment in the MMF during the period. The NAV method does not change the tax treatment of, or broker reporting requirements for, dividends from floating-NAV MMFs. The proposed method simplifies tax computations by basing them on the aggregate of all transactions in a period and on aggregate fair market values. Every floating-NAV MMF must compute these fair market values for non-tax purposes regardless of how -- or even whether -- the MMF's shareholders are taxed on transactions in the MMF shares. The NAV method takes into account changes in value of floating-NAV MMF shares without regard to realization."
It goes on to say, "Section 1.6045-1(c)(3)(vi) provides an exception to the broker reporting requirement under section 6045 for shares in an MMF "that computes its current price per share for purposes of distributions, redemptions, and purchases so as to stabilize the price per share at a constant amount that approximates its issue price or the price at which it was originally sold to the public...." Comments received by the SEC in response to the SEC MMF Reform Proposal expressed concern that the existing exception would not apply to floating-NAV MMFs and suggested that requiring transaction-by-transaction information reporting would impose significant new costs on floating-NAV MMFs and intermediaries. The Treasury Department and the IRS believe that imposing broker reporting requirements on floating-NAV MMFs would result in administrative burdens that are not justified in light of the expected relative stability of floating-NAV MMF share prices. Therefore, the proposed regulations revise Section 1.6045-1(c)(3)(vi) to clarify that the exceptions under sections 6045, 6045A, and 6045B continue to apply to all MMFs, including floating-NAV MMFs."
On "wash-sale" rules it explains, "A shareholder of a floating-NAV MMF that does not use the NAV method, however, may experience frequent wash sales. For a shareholder with a substantial volume of transactions in floating-NAV MMF shares, tracking wash sales of MMF shares could present significant practical challenges. On July 29, 2013, the IRS published Notice 2013-48 (2013-31 IRB 120) in response to the SEC MMF Reform Proposal. The notice proposed a revenue procedure providing that the IRS would not treat a loss realized upon a redemption of a floating-NAV MMF share as subject to the wash sale rules if the amount of the loss was not more than one half of one percent of the taxpayer's basis in that share. The IRS received comments indicating that the proposed revenue procedure would not significantly reduce the tax compliance burdens associated with applying the wash sale rules to floating-NAV MMFs because shareholders would still have to track all wash sales to determine whether the amount of any particular wash sale exceeds the 0.5% de minimis test. The comments requested that floating-NAV MMFs be exempted entirely from the wash sale rules in section 1091. Concurrently with these proposed regulations, the Treasury Department and the IRS are releasing a final revenue procedure providing that the wash sale rules will not be applied to redemptions of shares in floating-NAV MMFs. This revenue procedure will apply to redemptions of shares in floating-NAV MMFs on or after the effective date of the SEC MMF Reform Rules (expected to be 60 days after their publication in the Federal Register)."
Further, "These regulations concerning the NAV method are proposed to apply to taxable years ending on or after the date of publication in the Federal Register of a Treasury decision adopting these proposed regulations as final regulations. Shareholders of floating-NAV MMFs, however, may rely on the rules in the regulations concerning the NAV method for taxable years ending on or after [date of this document in the Federal Register] and beginning before the date of publication in the Federal Register of a Treasury decision adopting these proposed regulations as final regulations."
Comments on the Treasury's proposal may be mailed to the Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044, hand-delivered to the IRS, or sent electronically via the Federal eRulemaking portal at www.regulations.gov. A public hearing has also been scheduled for November 19 at 10:00 a.m. at the IRS Building in Washington.
While Final Money Market Fund Reform Rules were adopted last week, two SEC Commissioners, Michael Piwowar and Kara Stein, voted in opposition. Here are excerpts from their statements, explaining why they opposed the new rules. First, we look at Piwowar's remarks. "As to the first recommendation, while I support the adoption of all the amendments to the disclosure, reporting, and stress testing requirements, I am not able to support the adoption of the so-called combination approach which would require institutional prime and tax-exempt money market funds to price and transact at a floating net asset value (NAV) calculated to the fourth decimal place (nearest basis point) and also would require liquidity fees and discretionary redemption gates." (For more on the new Reforms, see the SEC's press release here, the SEC's "Speeches" page here, the archived Webcast here, and the full 869-page Final Rule here.)
Piwowar explained, "The combination impedes one of the Commission's stated goals of this reform effort -- "preserving, as much as possible, the benefits of money market funds." Other less onerous alternatives exist that would sufficiently achieve the Commission's goals of lessening money market funds' susceptibility to heavy redemptions, improving their ability to manage and mitigate potential contagion from high levels of redemptions, and increase the transparency of their risks. Most commenters opposed the combination of a floating NAV and liquidity fees and gates because it would not offer either stability of principal or liquidity. Therefore, the continued utility of institutional prime and tax-exempt money market funds as a cash management tool is highly questionable. All of the investors with whom I spoke opposed the combination approach for the same reason. The investors were divided between those that could invest in a fund with a floating NAV calculated to the third decimal place, subject to the tax and operational issues being solved, and those that could invest in a fund subject to a liquidity fee and gate. As a result, I suggested an "investor choice" approach as a possible alternative to consider. The investor choice alternative would allow investors to choose whether to invest in a fund that floats its NAV or one that can impose a liquidity fee and gate. The key feature of this approach is that investors, after receiving complete information as to the benefits and risks of each alternative, could choose which alternative best fits their own unique investment objectives, rather than the Commission choosing which to impose on all investors."
On fees and gates, he said, "After carefully reviewing the possible alternatives for addressing susceptibility to heavy redemptions, I believe that the fees and gates approach would be the most effective at stopping runs on money market funds and would best preserve their benefits. Only the imposition of a gate would stop redemptions, thus ending any run on a money market fund and obviating the need for any future taxpayer bailouts. In addition, the imposition of a liquidity fee increases the cost of redeeming shares, which may mitigate investors' incentives to redeem and would treat remaining investors more equitably by offsetting the costs of liquidity provided to redeeming shareholders. Moreover, the ability to impose fees and gates should not preclude investors from using prime money market funds as effective cash management tools because, in the absence of severe market stress, the day-to-day operations of the funds would not be affected and investors would still have the protection of their principal and the liquidity that they seek in order to cover their expenses as needed."
He added, "I would support giving money market fund boards even more discretion in imposing gates. It is possible that, due to specified triggers for when boards may impose fees and gates, investors may seek to redeem shares as the triggers are approached. Giving the board the power to impose a gate at any time when the board finds it is in the best interests of the fund would make it much more difficult for investors to anticipate exactly when a fund might be subject to a gate, thus mitigating the risk of anticipatory runs. However, even if a run were to commence, the imposition of a gate would stop it. Moreover, in an important change from the proposed reforms, the reforms we are adopting today give the board the power, once the trigger is reached, to impose a gate immediately, rather than wait until the next business day."
On floating NAV he commented, "While fees and gates would stop runs, requiring institutional prime and tax-exempt money market funds to float their NAV would not. The imposition of a floating NAV on these funds is intended to reduce the "first mover advantage" and the chance of unfair investor dilution. The first mover advantage, as described in the adopting release, is the incremental incentive to redeem from a money market fund with a market-based NAV (also known as the "shadow NAV") below $1.00 that is at risk of breaking the buck. Thus, the floating NAV is designed to combat the risks of heavy redemptions during times of stress. However, even putting aside that a floating NAV will not stop runs and will not deter redemptions that constitute rational risk management by shareholders or reflect an incentive to avoid loss, a floating NAV would not stop the first mover advantage during times of stress. During times of stress, when cash on hand is more likely to be insufficient to meet redemptions, a fund may be forced to sell portfolio securities into illiquid secondary markets at discounted prices, and the market-based NAV may not capture the likely increasing illiquidity of a fund's portfolio. Therefore, even if the NAV floats, sophisticated investors with significant money at stake that have a lower risk tolerance, the very investors at which the floating NAV is aimed, will still have incentive to redeem ahead of other investors."
He added, "Today's recommendation requires institutional prime funds to transact at four decimal places (the nearest 1/100th of one penny) instead of rounding to the nearest penny when selling and redeeming shares. All other mutual funds are permitted to transact at three decimal places (the nearest 1/10th of one penny). The stated rationale for transacting at four decimal places is that, as intended by rule 2a-7's investment duration and quality limitations, the floating NAV rarely floats when calculated to the third decimal place and, therefore, some institutional investors may not appreciate the risk associated with money market funds. However, the reason for requiring institutional funds to float their NAVs at all is precisely because institutional investors are sophisticated and well aware of the actual market-based per share value."
Piwowar continued, "The Department of the Treasury is expected to propose today new regulations that would make a simplified aggregate method of accounting available to investors in floating NAV money market funds and would allow taxpayers to rely on the regulations for tax years ending on or after the date the proposed regulations are published in the Federal Register. Treasury believes that this would eliminate any requirement to track individually each share purchase and redemption, and the basis of each share redeemed. However, investors, funds, and outside tax experts have not yet had an opportunity to review and comment on whether this Treasury proposal will solve the tax issues. In fact, a bipartisan group of four members of the Senate Committee on Banking, Housing, and Urban Affairs have requested that the Commission refrain from adopting a floating NAV for any money market funds until the public has had an opportunity to review and comment on the proposed Treasury regulations. While their concerns should not dissuade us from moving forward with the rest of our reforms, I agree with this bipartisan group of Senators that we should wait to adopt the floating NAV until the public has had a chance to comment on Treasury's proposed tax fix."
The actions will lead to a shift in assets. "Due to fund and investor opposition to a floating NAV and the fact that we are also combining it with the fees and gates alternative for institutional prime funds, many institutional money market fund sponsors and many, if not most, institutional investors could decide to abandon prime money market funds. As of July 3, 2014, institutional prime money market funds, held more than $800 billion in assets, constituting about 33% of all money market fund assets. It is estimated that institutional investors hold an additional $76 billion in tax-exempt funds. Therefore, about $880 billion in assets will be subject to both the floating NAV and fees and gates requirements. Nobody knows how these assets will be allocated in the wake of today's reforms or the resulting impact. As of July 3, 2014, government money market funds held about $863 billion in assets (or about 35% of all money market fund assets). If one assumes that stability of principal and liquidity are the paramount concerns for institutional investors, most of these assets could be reinvested in government money market funds. This would result in government funds more than doubling in total assets, while at the same time under our reforms today government funds would be more restricted as to the securities they may invest in. To the extent that these institutional assets are invested in government funds or deposited in banks, they would no longer be available for the short-term funding of state and local governments or businesses."
Commissioner Stein also voted no, but for different reasons than Piwowar. She commented, "While the rules before us today are important, it is critical to remember why we are considering them. We are trying to strengthen a part of our markets that was at the heart of the last financial crisis. We know firsthand the significance of, and risks related to, the wholesale funding markets and money market funds in particular.... Today's rule focuses on money market funds. That focus is appropriate given the sizeable role that these funds play in the wholesale funding markets and the structural features that make them susceptible to runs. But the Commission simply cannot address all of the vulnerabilities in these vibrant and important markets through money market fund rules. It also must strengthen capital, leverage, liquidity, and margin rules for broker-dealers. And it must leverage market forces by empowering investors to better police issuers who may become over-reliant on short-term credit."
Stein added, "Making these markets more resilient to inevitable stresses requires regulators to work together. This means that we at the Commission need to step outside of our jurisdictional silo, and think broadly with our fellow regulators, both domestically and internationally. Collaboration has been promising in the reform of the tri-party repo market, where our staff has been working with staff at the Federal Reserve Bank of New York. This has resulted in the significant accomplishments of reducing intraday credit risk, and minimizing weaknesses in credit risk management. We need to build on these accomplishments to address remaining issues in the tri-party repo market, such as fire-sale risks."
On floating NAV she said, "As for today's main proposal, my primary consideration is whether the reforms will mitigate the risks -- to investors, businesses, municipalities, and our economy -- posed by our wholesale funding markets. When viewed through this lens, several parts of the rule are significant steps forward. For example, requiring institutional prime funds to have a floating net asset value directly addresses a structural feature of money market funds that makes them susceptible to redemption runs. It helps investors understand and experience that these funds are not risk free. And it nudges investors who are unable to tolerate any risk of loss towards other financial products better aligned with their risk-return preferences. I also am pleased that the rule has narrowed the definition of a government fund and tightened its diversification requirements."
On her opposition to gates, she explained, "But while the rule contains improvements, I believe it has a significant shortcoming -- redemption gates. I agree with the staff that a floating net asset value, even when combined with these other improvements and the 2010 amendments, is not a panacea. Money market funds remain vulnerable to runs because investors will still have an incentive to redeem in a crisis. However, after careful study, I am concerned that gates are the wrong tool to address this risk. As the chance that a gate will be imposed increases, investors will have a strong incentive to rush to redeem ahead of others to avoid the uncertainty of losing access to their capital. More importantly, a run in one fund could incite a system-wide run because investors in other funds likely will fear that they also will impose gates."
Stein said, "I share the concerns of many commenters and economists that while a gate may be good for one fund because it stops a run in that fund, it could be very damaging to the financial system as a whole. Even further, while a run by investors in one fund may be halted when the gate for that fund is used, that does not mean the impact on the wholesale funding markets will stop. To the contrary, a fund that drops a gate likely would need to build liquidity to meet redemption requests when the gate is lifted. This means the fund is likely to stop re-investing maturing securities during the gated period, or will invest primarily in government securities, thereby cutting off funding to issuers. This effect could be amplified by investors, who likely will redeem assets from other funds if one fund imposes a gate. And if investors are not able to redeem before the gate comes down, they will be harmed as they are deprived of access to their capital. Ultimately, this contagion could freeze the wholesale funding markets in much the same way as occurred during the recent financial crisis."
She added, "I appreciate that the rule seeks to mitigate some of these concerns by allowing the fund's board to impose gates at a higher liquid assets threshold than was proposed, by shortening the length of the gate, and by requiring daily disclosure of a fund's level of liquid assets. However, I do not believe that these changes adequately address the risk of destabilizing pre-emptive runs for the following reasons. First, adding discretion that makes it easier for a fund to impose a gate could actually increase an investor's incentive to redeem because it makes the use of a gate more likely. This could be especially problematic in a crisis, when an investor's preference to avoid uncertainty could be magnified."
Stein commented, "Second, shortening the gating period to ten business days may only marginally decrease the incentive to redeem since even a ten business day gate is significant, particularly for corporate treasurers or other investors seeking to make payroll or meet other daily demands. Third, while disclosure could help, it also could have the opposite effect by highlighting that a fund could be at or approaching a threshold that would allow it to impose a gate. I also am not sufficiently persuaded by the argument that many investors with a low tolerance for gates will seek alternative financial products that are better aligned with their risk-return preferences. While this could happen, it seems just as likely that those same investors will continue to invest in money market funds because they believe they will be able to redeem before a gate is imposed, or that sponsor support will prevent the gate from ever being used. While the rule requires disclosure of sponsor support, it unfortunately does little to address the moral hazard that is created by it."
In conclusion, she said, "In the end, these are difficult issues with uncertain answers. Ultimately, despite the rule's efforts to mitigate the risks posed by gates, I believe the incentives to avoid them will remain powerful. I fear these incentives may result in a greater chance of fire sales during times of stress, and a spread of the panic to other parts of our financial system, while also denying both investors and issuers access to capital. I am, therefore, in the unfortunate position of not being able to support the rule that the staff recommends adopting today, despite some of its well-considered and thoughtful components."
Much of Federated Investors Q2 earnings conference call (see transcript here) was dominated by discussion of the SEC's July 23rd adoption of new money fund rules, but President and CEO Chris Donahue made it clear that the focus will be on making sure "no client is left behind" as the company prepares for the changes to take effect in two years. Federated's earnings release says, "Money-market assets were $245.2 billion at June 30, 2014, down $23.3 billion or 9 percent from $268.5 billion at June 30, 2013 and down $18.4 billion or 7 percent from $263.6 billion at March 31, 2014. Money-market mutual fund assets were $212.4 billion at June 30, 2014, down $20.5 billion or 9 percent from $232.9 billion at June 30, 2013 and down $15.1 billion or 7 percent from $227.5 billion at March 31, 2014. Revenue decreased by $10.8 million or 5 percent primarily due to an increase in voluntary fee waivers related to certain money market funds in order for those funds to maintain positive or zero net yields and a decrease in revenue due to lower average money-market and fixed-income assets." During Q2 Federated derived 32 percent of its revenues from money-market assets. (Note: The SEC just posted a version of the new rules "Marked to Show Changes from Previous Rule 2a-7" on its "Final Rules" page, but it has yet to post the "Federal Register" version of the rules.)
On the Friday morning earnings conference call, Donahue said, "Certainly money-market funds are in the news with the SEC's recent release of the new regulations.... Our market share at quarter end was approximately 8.3% down about 1% from a year ago. We continue to see yield-based pressure from bank deposits and other cash vehicles and distribution pressure including certain competitors waiving additional fees in order to produce additional yield."
He explained, "The SEC released on Wednesday new rules for money-market funds, importantly, treasury, government and retail funds as defined were exempted from the floating NAV requirements. However, Federated is disappointed that the SEC has voted to adopt a floating NAV for institutional prime and institutional municipal money market funds. Federated remains committed to providing a variety of liquidity management solutions to our clients, including those that meet the needs of our institutional prime and institutional municipal fund shareholders. We offer a variety of cash management solutions and are developing new products for our customers. We intend to create privately placed funds that will likely mirror existing Federated money market funds to serve the needs of groups of qualified investors as soon as reasonably practicable."
He added, "We will be reviewing the details contained in the Commission's 869-page rulemaking as we consider next steps. The new rules will be subject to a lengthy implementation process including two years for the floating NAVs. We are communicating with our clients to work through the full breadth and scope of the final regulations. The new rules also creates significant new operational burdens. For example, regarding the tax release announced yesterday, the SEC stated that the tax compliance burden has been lifted for investors, in floating NAV money funds. We believe that money market funds sponsors and investors should have had an opportunity to review and comment on the proposed solution to the tax issues caused by floating the NAV in order to provide the SEC and the Treasury with a complete evaluation of the cost and benefits of their proposal and related tax release prior to final adoption. In our view such notice and opportunity to comment is essential if the ultimate goal is good public policy."
On the call, CFO Tom Donahue commented on waivers, "Looking at money funds' minimum yield waivers, the impact to pre-tax income in Q2 was $30 million, based on current assets and assuming overnight repo rates for treasury and mortgage-backed securities run at roughly 5 to 7 basis points over the quarter and T-bills stay in the 2 to 5 basis point range. The impact of these waivers to pre-tax income in Q3 would be about $31 million. `Looking forward and holding all other variables constant, we estimate that gaining 10 basis points in gross yields would likely reduce the impact of minimum yield waivers by about 45%. And a 25 basis point increase would reduce the impact by about 70%."
Money funds also came up several times in the Q&A portion of the earnings call. On costs and new products, Chris Donahue said, "Well, we're not in a position to put any kind of a number on that yet. We're in the process of going through the kinds of products that we might want to come up with in order to respond to capture clients that don't fall into a group that would qualify for a private fund and a retail exemption. And when you have a lot of clients that are on omnibus accounts where you have both types of clients inside that omnibus it is very difficult for us to figure out what has to happen in the day and a half since the regs came out. So I am not in a position to give you a number on our costs. I would say the costs will be substantial in terms of industry because you have got a lot of products to change around. And if you are going to maintain a floating net asset value product you're going to have to go to four decimal places and we have commented extensively on those kinds of costs. Whether those products remain viable remains to be seen, so it's pretty much up in the air right now as to what those costs will be."
Later in the call he elaborated further on potential new products. "There's another idea floating around -- although it doesn't look all that viable now because of the rate environment -- which is the all 60-day and under [maturity] prime fund... In a different rate environment, that would work. And its economics would be very comparable to the current fund. There are other ideas that you could come up with, for example, a collective fund that would only be for retirement accounts." Later he added, "We were already underway with an an internal review of the entire money market fund lineup -- just to take a look at it and see what should be done and what should be changed in any event. So right now, [money market reform] just accelerates it and focuses it on taking care of the clients so that we do the best we can to leave no client behind."
Donahue went on, "We had a call with 600-700 clients yesterday, the theme of what we presented was, basically, 'Look, you've got a 2 year implementation. Nothing changes right now; digest what is in the rule, give us a shot at figuring out what kind of products can work.' I have not had a client talking about shifting assets from this column to that column as of yet."
On the long term viability of the cash management business he said, "With $2.6 trillion in money funds with very low yields for a very extended period, it tells you that there is a certain love for a cash management product as a cash management service so the underlying customer demand is certainly there." He adds, "I think you're going to see a little more consolidation in the business as others take a look at this and throw in the towel. I think that the focus of this firm [on money market funds], as one of our key businesses, will enable us to be very competitive.... The cash management business is very viable and we think that our earnings power will be excellent."
In other news, Barclays strategist Joseph Abate released a report Friday, "Reform and the Shortage of Short-Term Supply." Writes Abate, "This week, the SEC voted to require institutional money funds to adopt floating NAVs. But by significantly increasing the demand for government safe assets, the reform will likely exacerbate the logjam created by the shortage of short-term market supply. The regulatory effect on short rates of money fund reform depends on three key unknowns: how much capital leaves money funds, where it will go, and how quickly it will shift."
Adds Abate, "We expect balances leaving prime funds to shift primarily into government-only funds, increasing the demand for bills, agencies, and repo by 10-25%. But limited dealer balance sheets and potentially capped allotments at the Fed's RRP program may cause a logjam in short-term markets, pushing rates on these instruments to the RRP floor. As long as banks are long short-term liquidity and can offset some of the decline in wholesale unsecured funding with deposits, we do not expect CP and CD spreads to widen. The outlook for short-term rates depends critically on how quickly investors in soon-to-float prime funds shift their balances to alternative products. In a rising rate environment and with a 2-year SEC adjustment window, the departure rate might be slower than feared."
Following Wednesday's Open Meeting, where Final Money Market Fund Reforms were adopted by a vote of 3-2, the SEC released the text of statements from all five Commissioners. We published Chair Mary Jo White's speech yesterday ("SEC Adopts MMF Reforms; Chair White on Rule's Fundamental Changes"), and today we post excerpts from the two Commissioners who joined her in favor of the rule -- Luis Aguilar and Daniel Gallagher. (For more on the new Reforms, see the SEC's press release here, the SEC's "Speeches" page here, the archived Webcast here, and the full 869-page Final Rule here.) Here's what Aguilar had to say. "It is well known that the journey to arrive at the amendments considered today was a difficult one, and I can confidently say that this has been, at times, perhaps one of the most flawed and controversial rulemaking processes the Commission has undertaken. He added, "The quality of the June 2013 release resulted in the Commission receiving thoughtful input and a considerable amount of data and detailed analysis, which, in turn, has significantly improved today's proposal. In total, the Commission received over 1,400 comment letters from a variety of commenters, including individuals, academics, investment companies, investment advisers, banks, operating companies, professional and trade associations, and government entities. The comment letters commented on all aspects of the June 2013 proposal from a variety of perspectives, including, expressing support, or opposition, to the floating NAV proposal, indicating varying degrees of support, or opposition, for liquidity fees and/or redemption gates (or the combination thereof), and mostly support of the enhanced disclosure requirements in the proposed reforms."
Aguilar continued, "These comments make it clear that many will believe that today's reforms may go too far; while conversely, others will believe that we have not gone far enough. Today's rulemaking, however, is a result of extensive data and in-depth analysis, much of which is the product of work conducted in-house by staff economists in the Division of Economic and Risk Analysis. For example, just to name a few: DERA analyzed the liquidity costs during market stress and non-market stress periods, and its study supports the appropriateness of the 1% default liquidity fee being adopted in today's reforms; DERA analyzed government funds' exposure to non-government securities, and the findings provides support for the significant reduction in the non-government securities basket in today's reforms; DERA measured the extent to which municipal money market funds may be exposed to guarantees or demand features from a single guarantor, and its study supports the staff's recommendation for reducing the 25% basket for guarantees and demand features from a single institution; and (iv) lastly, DERA analyzed the overall availability of domestic and global safe assets, and concluded that, given the size of the global market for safe assets, DERA does not anticipate that the proposed reforms will result in a large impact to the domestic and global markets for safe assets."
He added, "There are several aspects of today's amendments that warrant special mention. First, today the Commission adopts a floating NAV for those money market funds that have tended to exhibit greater volatility. As the release states, for such funds, it is expected that the floating NAV will reduce the chance of unfair investor dilution by weakening the incentive for certain investors to take a "first mover advantage" by redeeming in times of market stress or when there is a price discrepancy between the market-based NAV and the stable share price. Additionally, it will make it even more transparent that money market fund investors bear the risk of loss on their investment, as is always the case. Nevertheless, many have expressed concerns about requiring money market funds to have a floating NAV. In particular, concerns have been raised as to accounting and federal income tax considerations that would make such funds virtually unworkable. However, as today's release discusses, the Treasury Department and the Internal Revenue Service will announce today proposed regulations and a revenue procedure to address these issues. As a result, it is expected that money market funds, even with a floating NAV, will continue to be viable and efficient products. In that regard, I would like to thank the respective staff at the Treasury and the IRS for helping to address the difficult issues raised by the implementation of today's floating NAV amendments."
Aguilar continued, "However, as is noted in the Commission's release, the floating NAV requirement will not by itself stop runs on money market funds in times of market stress. For that reason, the Commission is also authorizing the use of "fees and gates," as a necessary aid in the reduction of the systemic risks that today's reforms are designed to address. Some observers, including staff at the Federal Reserve Bank of New York, have suggested the possibility that fees and gates may themselves cause pre-emptive runs, by encouraging investors to redeem their shares before fees and gates are imposed. However, as discussed at length in today's release, the Federal Reserve staff's conclusion that fees and gates may cause pre-emptive runs is based on a model whose assumptions and features are different than the reforms we are adopting today. Accordingly, as noted in the release, the Federal Reserve paper's findings regarding the risks of pre-emptive redemptions are not likely to apply. In addition, there are several aspects of today's amendments that are designed to mitigate the risk of pre-emptive runs as the result of "fees and gates," and to reduce the effects of such runs should they occur. These include a maximum time period for the imposition of gates that is shorter than what was proposed and a significantly smaller default liquidity fee than initially proposed."
More on fees and gates: "The use of fees and gates, like other provisions recommended today, has required particularly close and thoughtful deliberation. I struggled with a change that allows fund boards to temporarily prevent investors from redeeming their own cash, even when it is limited to a severe market stress scenario. This amendment is in direct conflict with the foundations of the Investment Company Act of 1940, which require that investors be able to redeem their money. It seems equally concerning to me to support the imposition of a fee on redeeming investors in a time of such high market volatility and investor stress, even when the fee provides additional liquidity to other non-redeeming investors in the same fund. Investors may be required to pay fees when they are least able to do so. I ultimately conclude, however, that the combination of providing investors with full disclosure concerning the possibility that gates and fees will be imposed in certain limited circumstances, and the benefits to investors and the country as a whole of reducing systemic risk and lessening the risk of a future economic collapse, justifies the Commission taking these extraordinary steps."
He concluded, "Today's amendments also address, in part, the possible migration of assets from registered money market funds to private investment funds. In particular, the amendments to Form PF will require large liquidity fund advisers to provide the SEC, on a monthly basis, with basically the same information in respect to their funds' portfolio holdings as is provided by registered money market funds. While Form PF does not cover all unregulated funds or vehicles the additional information will provide important information and transparency to the Commission. I expect the Commission staff to closely monitor these developments and to recommend to the Commission and, if necessary, to Congress, any possible amendments or legislative reforms needed to address the operations of these dark, less regulated markets. More generally, while I support the adoption of today's amendments, I expect the staff to monitor the impact and effects of these amendments and to provide regular and frequent reports to the Commission."
In his comments, Gallagher said, "The process has illustrated that it is incumbent on us as Commissioners to set aside any preconceptions we may have and approach each issue dispassionately and with an open mind. It is our duty to strive to understand the substance of those issues as well as the potential impacts of any regulatory approaches we consider -- and then to make the difficult decisions that often follow. Despite an inauspicious start, this rulemaking process has demonstrated the Commission's ability to make those difficult decisions, and I'm pleased that a majority of the Commission has joined together to successfully conclude our long and arduous path to implement commonsense, reasonable reforms to our rules governing money market mutual funds."
He added, "As for my own path to today's rulemaking, I consistently have been a proponent of requiring money market mutual funds to adopt market-based pricing -- that is, a floating net asset value -- but not at any cost, and only in the context of a reform package that effectively mitigates risks to investors without forcing money funds to masquerade as federally insured bank deposits. I was not able to support an earlier reform proposal that included a proposal for so-called "capital buffer" requirements. That proposal made no economic sense, as proven by `Craig Lewis, and did not fit either the definition of regulatory capital or the structure of money market funds <b:>`_ The paltry so-called "buffer" would have offered only an illusion of protection to investors and the markets."
He explained, "And I would note that the infirmities of the unsuccessful SEC capital buffer proposal of 2012 also feature in pending international proposals, and foreign policymakers should be loath to follow that rabbit down the hole. Like other mutual funds, money market funds should be risk-taking ventures borne of the capital markets, where we want investors, whether retail or institutional, to take risks -- informed risks that they freely choose in pursuit of a return on their investments. Today's reforms squarely address and put investors on notice of this distinction, and I applaud the Commission and staff for resisting outside pressure to apply a bank regulatory paradigm to a product that is so integral to the functioning of the capital markets. Many forget, sometimes all too conveniently, that this agency came very close to imposing a capital buffer on money funds. This was a big-government, bank-regulator preferred proposal that would have crippled the industry. I take great pride in my successful efforts to kill that misguided proposal."
Gallagher continued, "The Commission does not have oversight authority over banks or bank products, and we do not have access to the tools available to the prudential regulators who do. There should be no confusion about that, now or ever, and the agency learned no tougher lesson from the events of 2008. The Commission is an appropriated independent agency without a Treasury line of credit or a balance sheet. We cannot bail out any firm or product, and that is the proper order of things. Our oversight should be focused on market-based valuations and strict capital standards employing those valuations, and in the case of failure, we should be expert in the wind-down process. As I have said so many times recently, we should be the morticians, not the ER doctors."
He added, "The tailored floating NAV requirement we are adopting today directly addresses concerns that arose during the financial crisis. Most notably, as has been discussed, it eliminates the first-mover "put" advantage that favors sophisticated institutional investors at the expense of retail investors, leaving the latter holding the proverbial bag. Just as importantly, in my view, today's floating NAV reforms clarify for investors the risks associated with investing in money market mutual funds while making it clear to the markets and to policymakers that these financial instruments are not bank products to be overseen by prudential regulators, but rather investment products properly regulated by the SEC. However, as I have consistently stated, requiring money market funds to float their net asset values should help stem a run, but does not fully solve the problem of run risk."
He told the Open Meeting, "Unlike in the banking sector, there is no federal insurance program, and no taxpayer dollars, to help stop runs. Accordingly, it is critical for fund boards to have discretionary tools at their disposal to limit or suspend redemptions temporarily in appropriate circumstances. The fees and gates allowed in today's rule give fund boards a mechanism to stem the tidal wave of redemptions that can materialize in the midst of a market crisis -- and that cannot be stopped by floating the NAV alone. And the gating component of today's rule is actually just a codification of the status quo with mandated disclosure so investors can better understand the potential of a liquidity event. Neither reform on its own would have meaningfully achieved all of the objectives we set out to accomplish. But together, as demonstrated by DERA's comprehensive analysis, today's floating NAV and fees and gates reforms are a targeted and measured regulatory response and the best path forward for our regulatory oversight of money market mutual funds in the future."
Gallagher went on, "All that said, I have consistently, loudly, and publicly stated that my vote for a floating NAV was contingent on the resolution of the tax and accounting-related issues arising from the move away from a constant NAV. As we make abundantly clear in today's release, the accounting issues have been completely addressed: money funds are cash equivalents. And, as Chair White noted, concurrently with today's rulemaking, the Department of the Treasury and the IRS have issued a revenue procedure, that is, an official IRS statement of procedure that may be relied on by taxpayers under the Internal Revenue Code, and a proposed rulemaking that squarely addresses each of the principal concerns that were raised by commenters, and that may be relied upon by taxpayers beginning on the same date that today's rule becomes effective."
He said, "First, Treasury and the IRS have issued a proposed rulemaking that allows taxpayers to use the simplified aggregate accounting method for funds subject to a floating NAV. Under this method, investors will not be required to track and report the cost or tax basis and redemption price of all shares they purchase and redeem. Rather, they will calculate their taxable gain or loss on an aggregate basis at the end of the tax year, based on information already provided in their year-end statements. Second, Treasury and the IRS have issued a revenue procedure that exempts taxpayers invested in funds subject to a floating NAV from the "wash sale" rules, which prohibit taxpayers from recognizing a loss on the sale of a security if the investor buys a substantially identical security within 30 days -- a common occurrence with short term cash management securities such as money market funds. This revenue procedure will become effective on the same day as our amendments, providing full and immediate relief to taxpayers who otherwise would have had to track the timing of individual purchases and redemptions for compliance with the wash sale rules."
In conclusion, Gallagher said, "I have also insisted that we provide a long compliance period to give the industry and investors the time needed to implement and understand the intricacies of today's rule, and so I am pleased that there will be a two-year compliance period. Today's amendments introduce substantial changes to the regulatory framework governing money market funds, and it is imperative that we afford money funds and their investors ample time to make business and investment decisions."
At the Open Meeting of the Securities and Exchange Commission on July 23, the SEC voted to pass Final Money Market Fund Reforms by a vote of 3-2, adopting the floating NAV for institutional prime funds, fees and gates for all non-government funds, and additional disclosures and other measures which were proposed in June 2013. (See yesterday's Crane Data News, "SEC Final Rule on MMF Reform Just Like Proposal," and see the SEC's press release here, the archived Webcast here and the full 869-page Final Rule here. Also, see the Treasury's "Guidance on Accounting for Gains and Losses in Certain Money Market Funds".) Chair Mary Jo White along with Commissioners Daniel Gallagher and Luis Aguilar voted in favor, while Commissioners Kara Stein and Michael Piwowar voted against. Below are excerpts from White's statement; look for comments from the other commissioners in the coming days. See the SEC's "Speeches" page here, Chair White's Opening Statement here, Commissioner Aguilar's Comments here, Commissioner Gallagher's Comments here, Commissioner Piwowar's (dissenting) Comments here, and Commissioner Stein's (dissenting) Comments here.
In her opening remarks, White said: "Today's reforms will fundamentally change the way that most money market funds operate. They will reduce the risk of runs in money market funds and provide important new tools that will help further protect investors and the financial system in a crisis. Together, this strong reform package will make our financial system more resilient and enhance the transparency and fairness of these products for America's investors. Over the last several decades, money market funds have become a critical part of the American economy, providing an important source of short-term financing for issuers, including American businesses, state and local governments, and other market participants. Today, nearly $3 trillion is invested in money market funds, much of it in institutional prime funds held by investors such as pension funds and corporations. Issuers and investors now rely daily on money market funds, and the benefits of such funds are significant. But the widespread use of money market funds can also create risks through investor runs and the contagion that can follow."
Explaining what precipitated reforms, White added: "During the last financial crisis, institutional prime money market funds experienced an unprecedented run when the Reserve Primary Fund "broke the buck" and declared it would no longer redeem investors' shares dollar-for-dollar. In one week, investors pulled approximately $300 billion from prime money market funds, or 14 percent of the assets in those funds. This phenomenon, together with other events in the fall of 2008, caused the short term financing markets to dry up, severely limiting the ability of companies to borrow funds, manage cash, and continue fueling the American economy. As part of a program of extraordinary support across the financial system, a temporary guarantee program was provided through Treasury to stop the run on institutional prime funds, and the Federal Reserve established liquidity facilities. The financial crisis was devastating, with severe and lasting losses for American households and the U.S. economy. In the years since, the Commission has advanced a full program of rulemaking and enforcement actions to promote financial system stability and protect American investors."
She also said, "In 2010, the Commission adopted new requirements that demonstrably and significantly increased the resilience of money market funds. But as the Commission noted then, those measures were only a first step. Since then, there has been no shortage of opinions and proposals to address the remaining risks associated with money market funds. The Commission has taken up and evaluated, among other measures, a floating NAV, capital buffers, minimum balances at risk, and fees and gates. As is known, the discussion within the Commission has been robust, as should be expected -- indeed, welcomed -- in an agency that is required to be independent and composed of five members of different backgrounds and perspectives."
White said, "And our discussions did not occur in a vacuum. The Commission was built on transparency and disclosure, and we embrace those principles. The Commission and its staff reviewed thousands of comment letters, met with hundreds of market participants, and directly engaged our fellow regulators on the full range of possible options. Our economists conducted extensive analyses of the available data, built and applied their own models, and shared their work with the public and other regulators. Today's reforms are the culmination of this process. The proposal made last June was unanimously approved by the Commission, drawing on the experience and expert advice of a staff dedicated to this agency's mission to protect investors and our markets. But, as Congress anticipated in 1934 when it established the Commission, unanimity is not itself a goal. Choices must be made and differences will be expressed. That is entirely appropriate."
Continued the SEC chair, "The recommendation before us today creates a very strong reform package that significantly mitigates the risks of a run in money markets funds and that will limit further contagion should a run occur. The individual policy choices embodied in this recommendation have not been undertaken in isolation, but rather with a clear-eyed awareness of their assembly into a single coherent reform. Some elements of the recommendation have attracted more attention than others. The first is the decision to recommend combining both of the principal reforms advanced in the proposal: a floating NAV for institutional prime funds and discretionary liquidity fees and gates for non government funds. As any cursory glance at the comment file will reveal, this combination is not without debate. But, proceeding with only one of these reforms would leave our work here today incomplete."
She states, "The debate and analysis of the last several years have identified two distinct risks: One is the "first mover advantage" that incentivizes investors to be the first to redeem so that they receive the fixed price of their shares even if the market value of the fund's holdings is less per share. The floating NAV addresses this risk, as well as enhancing transparency and highlighting investment risk for shareholders. The second risk is widespread runs and the potential for contagion from one fund experiencing heavy shareholder redemptions. Fees and gates mitigate this risk and the potential impact for investors and markets."
White explained, "Bottom line: these reforms address risks in different ways and together provide protections greater than either would alone. This combination could diminish the attractiveness of institutional prime funds for some investors, and consequently reduce demand for some corporate issuances. But we cannot shrink from requiring a needed change in the marketplace. The goal is to strike a balance that preserves, where possible, the advantages that money market funds provide, while putting in place the measures necessary to better protect investors and promote market stability. This balance is now possible because of key tax guidance that the Department of Treasury and the Internal Revenue Service have advised us they will release later today, which will eliminate significant costs of the floating NAV reform. They will propose new regulations to allow money market fund investors to use a simplified tax accounting method for determining gains and losses, which will eliminate the need to track individual purchase and sale transactions for tax reporting purposes. And, they will release a new revenue procedure that provides relief from the "wash sale" rules for any losses on shares of a floating NAV money market fund."
She went on, "Another significant element of the recommendation is to require a floating NAV for institutional prime money market funds, but not for other money market funds. Some have argued that the floating NAV should be applied to all funds, regardless of their characteristics. But all money market funds are not alike, and neither is the balance of our key objectives. In particular, the balance between preserving the benefits of money market funds and addressing their potential risks must be closely evaluated in light of a fund's characteristics. Institutional prime money market funds experienced the precipitous run during the financial crisis, and our analysis has shown that they continue to be the most susceptible to runs. Retail and government money market funds have not to date faced significant runs even in the worst of times; in fact, investors ran to government money market funds in 2008 and the value of their portfolios appreciated. At the same time, retail investors in particular have come to rely on the liquidity and stability of money market funds, and they lack investment substitutes with similar characteristics, including those that may be available to institutional investors."
White added, "Strong action does not mean blunt action, and -- as the Commission has repeatedly said -- reform must be tailored to preserve benefits like these for retail investors when the risks do not dictate otherwise. While the costs of a floating NAV can be justified against the demonstrable run risk in institutional prime funds, a different balance must be struck for retail and government funds."
On fees and gates she said, "A third element of the recommendation that has attracted significant attention is how we address the potential for "pre-emptive" runs sparked in the market by one fund implementing a fee or gate that raises questions for investors in other funds. It is important to remember first and foremost how important fees and gates can be in a crisis situation. Quite simply, they are how a fund board can stop a potential run and prevent the spread of a disruption to the broader market in situations where a floating NAV alone will be ineffective. Fees more equitably allocate liquidity risk by making redeeming investors pay their share of the costs of the liquidity they receive in times of stress when liquidity is expensive. If a large number of redemptions do occur, gating will stop redemptions altogether for a period of time, ensuring they do not trigger fire sales of money market fund assets and risk spiraling into a crisis beyond the immediate fund."
Further, she added, "While many strongly favor this reform, others have expressed a concern that it could do harm by potentially triggering destructive "pre-emptive" runs. This concern is important, but addressing it need not -- and should not -- mean foregoing an important reform. What we have done in response to this concern is to make significant modifications to the original proposal that, while preserving the fundamental utility of fees and gates, mitigate the pre-emptive run risk and dampen the effects if they were to occur. The recommendation, among other measures, increases the thresholds for imposing a fee or gate to a higher level of remaining liquid assets. A money market fund that imposes a fee or gate with substantial remaining internal liquidity is in a better position to bear those redemptions without a broader market impact because it can satisfy those redemption requests with cash, without selling assets, and this is less likely to generate a run in other funds. The recommendation makes the imposition of a fee or gate more discretionary, rather than the result of strict triggers. The absence of such triggers make it less likely that informed investors will be able to "front run" the exercise of a fee or gate, thereby precipitating a run. And the recommendation lessens the liquidity impact for investors of a fee or gate by, among other things, permitting only a short maximum gate. This change will also diminish the incentive of an investor to run in order to preserve liquidity."
In conclusion, White stated, "Beyond the principal reforms of a floating NAV and fees and gates, today's reform also establishes enhanced disclosure, diversification, and reporting requirements for money market funds. With this strong package of reforms, we have taken another significant step toward promoting financial stability and protecting the interests of investors. It is a multi faceted reform that warrants close monitoring as we proceed with implementation, and I have directed the staff to conduct an ongoing, comprehensive review of the impact of today’s measures. More broadly, looking ahead, market-based financing remains -- quite appropriately -- an area of intense focus after the financial crisis, and the SEC and our fellow regulators must ensure that our efforts work in tandem. The risks of short-term financing must continue to be identified and addressed, but so too must the benefits. And I am committed to strengthening the regulatory framework for these activities, whether conducted by bank or non-bank institutions."
The U.S. Securities & Exchange Commission (SEC), which discussed and passed its Final Money Market Fund Reforms Wednesday morning (July 23 10am) with a 3-2 vote, released the following press release and "Fact Sheet" outlining the new rules. (The SEC's full 869-page Final MMF Reform Rules are now available here. Visitors may also view the archived Webcast of the Sunshine Meeting here.) The SEC's "Fact Sheet" on Money Market Fund Reform says, "The Commission will consider whether to adopt final rules that reform the way money market funds are structured and operate in order to better equip them to address run risks, while preserving the benefits of money market funds. The money market fund reforms would: Floating NAV - Require certain money market funds to maintain a floating net asset value (NAV) for sales and redemptions based on the current market value of the securities in their portfolios rounded to the fourth decimal place (e.g., $1.0000). The requirement, which would apply to institutional prime money market funds (including institutional municipal money market funds), would result in the daily share prices of the money market funds fluctuating along with changes in the market-based value of the funds' investments. Fees and Gates - Provide new tools to money market fund boards of directors to directly address a run on a fund. The new tools -- fees and gates -- would give fund boards the ability to impose liquidity fees or to suspend redemptions temporarily, also known as "gate," if a fund's level of weekly liquid assets falls below a certain threshold." (Note: See Chair Mary Jo White's Opening Statement here, Commissioner Aguilar's Comments here, Commissioner Gallagher's Comments here, Commissioner Piwowar's (dissenting) Comments here, and Commissioner Stein's (dissenting) Comments here. You can see the SEC's "Speeches" page here.)
The release continues, "Portfolio Diversification, Disclosure and Stress Testing - Enhance diversification, disclosure and stress testing requirements as well as provide updated reporting by money market funds and private funds that operate like money market funds. Tax and Accounting - The SEC was informed that should these rules be adopted, the U.S. Department of the Treasury and the Internal Revenue Service today will release two types of tax guidance. They will propose new regulations to allow floating NAV money market fund investors to use a simplified tax accounting method to track gains and losses that could be used beginning today. The proposed regulation will eliminate the need to track individual purchase and sale transactions for tax reporting purposes. And, they will release a new revenue procedure that provides relief from the "wash sale" rules for any losses on shares of a floating NAV money market fund. Other Measures - In addition, the Commission will consider whether to re-propose amendments to the Commission's money market fund rules and Form N-MFP to address provisions that reference credit ratings, and propose an additional amendment to the issuer diversification provisions in the rule."
The "Fact Sheet" says on "Background," "Money market funds are a type of mutual fund registered under the Investment Company Act of 1940 and regulated under rule 2a-7 of the Act. Money market funds pay dividends that reflect prevailing short-term interest rates, are redeemable on demand, and, unlike other investment companies, seek to maintain a stable NAV, typically $1.00. This combination of principal stability, liquidity and payment of short-term yields has made money market funds popular cash management vehicles for both retail and institutional investors. There are many kinds of money market funds, including ones that invest primarily in government securities, tax-exempt municipal securities, or corporate debt securities. Money market funds that primarily invest in corporate debt securities are referred to as prime funds. In addition, money market funds are often structured to cater to different types of investors. Some funds are marketed to individuals and intended for retail investors, while other funds that typically require high minimum investments are intended for institutional investors."
It continues, "After the events of the 2008 financial crisis, in March 2010, the SEC adopted a number of amendments to rule 2a-7. These amendments were designed to make money market funds more resilient by reducing the interest rate, credit and liquidity risks of fund portfolios. When the SEC adopted the 2010 amendments, the SEC stated that money market funds’ experience during the 2008 financial crisis raised questions of whether more fundamental changes to money market funds might be warranted. Several significant market events since the 2010 reforms have allowed the SEC to evaluate the efficacy of those reforms. Specifically, in the summer of 2011, the Eurozone sovereign debt crisis and an impasse over the U.S. government's debt ceiling unfolded, and during the fall of 2013 another U.S. government debt ceiling impasse occurred."
The SEC's statement tells us, "Although the 2010 reforms were an important step in making money market funds better able to withstand heavy redemptions, analysis and data from the SEC's Division of Economic and Risk Analysis (DERA) suggested that additional reforms would assist in addressing potential future situations when credit losses may cause a fund's portfolio to lose value or when the short-term financing markets more generally come under stress. In response, in 2013, the SEC proposed alternative reforms that could also be adopted in combination. Those reforms were a floating NAV for institutional prime funds and permissible liquidity fees and redemption gates. After consideration of the approximately 1,400 comments received on the proposal, the SEC is now considering whether to adopt final rules that further amend the rules that govern money market funds."
It says of the "Money Market Fund Reform Package," "Floating NAV – Under the floating NAV amendments, institutional prime money market funds would be required to transact at a floating NAV, instead of at a $1.00 stable share price. The floating NAV amendments are designed to reduce the first mover advantage inherent in a stable NAV fund, by dis-incentivizing redemption activity that can result from investors attempting to exploit the possibility of redeeming shares at the stable share price even if the portfolio has suffered a loss. They are also intended to reduce the chance of unfair investor dilution and make it more transparent to certain of the impacted investors that they, and not the fund sponsors or the Federal government, bear the risk of loss. Floating the NAV – Institutional prime money market funds would no longer be able to use amortized cost to value their portfolio securities. Daily share prices of these money market funds would fluctuate along with changes in the market-based value of their portfolio securities."
The release continues, "Showing Fluctuations in Price – Institutional prime money market funds would be required to price their shares using a more precise method so that investors are more likely to see fluctuations in value. Currently, money market funds "penny round" their share prices to the nearest one percent (to the nearest penny in the case of a fund with a $1.00 share price). Under the floating NAV amendments, institutional prime money market funds instead would be required to "basis point round" their share price to the nearest 1/100th of one percent (the fourth decimal place in the case of a fund with a $1.0000 share price)."
It adds, "Government and Retail Money Market Funds – Government and retail money market funds would be allowed to continue using the amortized cost method and/or penny rounding method of pricing to seek to maintain a stable share price. A government money market fund would be defined as any money market fund that invests 99.5 percent (formerly 80 percent) or more of its total assets in cash, government securities and/or repurchase agreements that are collateralized solely by government securities or cash. A retail money market fund would be defined as a money market fund that has policies and procedures reasonably designed to limit all beneficial owners of the money market fund to natural persons. A municipal (or tax-exempt) fund would be required to transact at a floating NAV unless the fund meets the definition of a retail money market fund, in which case it would be allowed to use the amortized cost method and/or penny rounding method of pricing to seek to maintain a stable share price."
The release also states, "Notice of Proposed Rule 10b-10 Exemptive Relief – The SEC today would issue a Notice of Proposed Rule 10b-10 Exemptive Relief, soliciting comment on a proposal to exempt broker-dealers from the written notification requirement under Rule 10b-10(a) of the Securities Exchange Act of 1934 for transactions effected in shares of floating NAV money market funds. The proposed order would, subject to certain conditions, grant exemptive relief from the immediate confirmation delivery requirements of Rule 10b-10 for such floating NAV transactions."
On "Liquidity Fees and Redemption Gates," it says, "The SEC would adopt a new liquidity fees and gates regime to give fund boards a new tool to directly address runs. Liquidity Fees – Under the rules, if a money market fund's level of "weekly liquid assets" falls below 30 percent of its total assets (the regulatory minimum), the money market fund's board would be allowed to impose a liquidity fee of up to two percent on all redemptions. Such a fee could be imposed only if the money market fund's board of directors determines that such a fee is in the best interests of the fund. If a money market fund's level of weekly liquid assets falls below 10 percent, the money market fund would be required to impose a liquidity fee of one percent on all redemptions. However, such a fee would not be imposed if the fund's board of directors determines that such a fee is not in the best interests of the fund or that a lower or higher (up to two percent) liquidity fee is in the best interests of the fund. Weekly liquid assets generally include cash, U.S. Treasury securities, certain other government securities with remaining maturities of 60 days or less, and securities that convert into cash within one week."
The SEC's "Fact Sheet" continues, "Redemption Gates – Under the rules, if a money market fund's level of weekly liquid assets falls below 30 percent, a money market fund's board could in its discretion temporarily suspend redemptions (gate). To impose a gate, the board of directors would find that imposing a gate is in the money market fund's best interests. A money market fund that imposes a gate would be required to lift that gate within 10 business days, although the board of directors could determine to lift the gate earlier. Money market funds would not be able to impose a gate for more than 10 business days in any 90-day period. Prompt Public Disclosure - Money market funds would be required to promptly and publicly disclose instances in which the fund's level of weekly liquid assets falls below the 10 percent threshold and the imposition and removal of any liquidity fee or gate."
It says of "Government Money Market Funds – Government money market funds would not be subject to the new fees and gates provisions. However, under the proposed rules, these funds could voluntarily opt into them, if previously disclosed to investors. Enhanced Disclosure Requirements – The final rules would seek to improve the transparency of money market fund operations and risks by, among other things: Website Disclosure – Money market funds would be required to disclose on their website, on a daily basis, their levels of daily and weekly liquid assets, net shareholder inflows or outflows, market-based NAVs per share, imposition of fees and gates, and any use of affiliate sponsor support. New Material Event Disclosure – Money market funds would be required to promptly disclose certain events on a new Form N-CR. These events would include the imposition or removal of fees or gates and the primary considerations or factors taken into account by a board of directors in its decision related to fees and gates; portfolio security defaults; sponsor or fund affiliate support, including the amount of support and a brief description of the reason for support; and–for retail and government funds–a fall in the fund’s market-based NAV per share below $0.9975."
It also says, "Disclosure of Sponsor Support – Money market funds would be required to provide in their statements-of-additional-information (SAIs) disclosure regarding any occasion during the last 10 years (but not for occasions that occurred before the compliance date) in which the money market fund received sponsor or fund affiliate support. This disclosure would be in addition to the current-event disclosures required on Form N-CR. Immediate Reporting of Fund Portfolio Holdings – Money market funds currently report detailed information about their portfolio holdings to the SEC each month on Form N-MFP. The final rules would amend Form N-MFP to clarify existing requirements and require reporting of additional information relevant to assessing money market fund risk. In addition, the final rules would eliminate the current 60-day delay on public availability of the information filed on the form and make it public immediately upon filing. Improved Private Liquidity Fund Reporting – To better monitor whether substantial assets migrate to private "liquidity funds" in response to money market fund reforms, the final rules would amend Form PF, which private fund advisers use to report information about certain private funds they advise. The final rules would require a large liquidity fund adviser (a liquidity fund adviser managing at least $1 billion in combined money market fund and liquidity fund assets) to report substantially the same portfolio information on Form PF as registered money market funds are required to report on Form N-MFP. A liquidity fund is essentially an unregistered money market fund."
The Fact Sheet adds, "Stronger Diversification Requirements – The final rules would also include the following changes to the diversification requirements for money market funds' portfolios: Aggregation of Affiliates – Money market funds would be required to treat certain entities that are affiliated with each other as single issuers for purposes of determining whether they are complying with money market funds' five percent issuer diversification limit. Under this limitation, a fund generally could not invest more than five percent of its assets in any one issuer, or group of affiliated issuers. Removal of the 25 Percent Basket – For money market funds other than tax-exempt money market funds, the final rules would require that all of a money market fund's assets meet the 10 percent diversification limit for guarantors and demand feature providers, thereby removing the so-called 25 percent basket that permitted as much as 25 percent of the value of securities held in a money market fund's portfolio to be subject to guarantees or demand features from a single institution. For tax-exempt money market funds (also referred to as municipal money market funds), the 25 percent guarantor basket would be reduced to 15 percent so that no more than 15 percent of the value of securities held in a tax-exempt money market fund's portfolio could be subject to guarantees or demand features from a single institution."
It continues, "Asset-Backed Securities – Money market funds would be required to treat the sponsors of asset-backed securities as guarantors subject to the 10 percent diversification limit applicable to guarantees and demand features, unless the money market fund's board of directors (or its delegate) determines that the fund is not relying on the sponsor's financial strength or its ability or willingness to provide liquidity, credit or other support to determine the asset-backed security’s quality or liquidity. Enhanced Stress Testing – The final rules would further enhance the stress testing requirements adopted by the SEC in 2010. In particular, a money market fund would be required to test its ability to maintain weekly liquid assets of at least 10 percent and to minimize principal volatility in response to certain specified hypothetical stress scenarios. In addition, the SEC would be adopting modifications to the current reporting requirements to boards of directors regarding stress testing aimed at improving the quality of reports the boards receive."
The statement comments, "Removal of References to Credit Ratings and Amendment to Issuer Diversification Provisions - In addition to the broad reforms to money market fund regulation discussed above, the SEC today would re-propose amendments to rule 2a-7 and Form N-MFP to address provisions that reference credit ratings. The SEC would also propose an amendment to the issuer diversification provisions of rule 2a-7. Re-proposed Ratings Removal – The re-proposed amendments would implement section 939A of the Dodd-Frank Act, which requires the SEC to remove any reference to or requirement of reliance on credit ratings in its regulations and to establish appropriate standards of creditworthiness in place of certain references to credit ratings in SEC rules. Currently, to ensure that these funds are invested in high quality short-term securities, rule 2a-7 requires that money market funds invest only in securities that have received one of the two highest short-term ratings (that is, are rated either "first tier" or "second tier") or if they are not rated, are of comparable quality. It also currently requires that a money market fund invest at least 97 percent of its assets in first tier securities. In addition, rule 2a-7 requires that a fund's board of directors (or its delegate) determine that the security presents minimal credit risks. This determination must be based on factors pertaining to credit quality in addition to any rating assigned to the security."
It adds, "Credit Quality Determinations for Money Market Fund Portfolio Securities – The re-proposed amendments to rule 2a-7 would eliminate the credit ratings requirements for money market funds. Instead, a money market fund could invest in a security only if the fund's board of directors (or its delegate) determines that it presents minimal credit risks, and that determination would require the board of directors to find that the security's issuer has an exceptionally strong capacity to meet its short-term obligations. Amendments to Form N-MFP – Currently money market funds report their portfolio holdings and other information to the Commission each month on Form N-MFP, including certain credit ratings assigned to each portfolio security. The re-proposed amendments to Form N-MFP would require that a money market fund disclose any credit rating that the fund's board considered in determining that a portfolio security presents minimal credit risk. Proposed Issuer Diversification Exclusion – The proposed amendment to rule 2a-7 would eliminate an exclusion from the issuer diversification provisions for securities with certain guarantees."
Finally, the release says, "Compliance Dates for Money Market Fund Reform The amendments would become effective 60 days after the date of publication of the rules in the Federal Register. The compliance dates would be as follows: The compliance date for the floating NAV amendments and fees and gates amendments would be two years after the date of publication of the release in the Federal Register. The compliance date for a new Form N-CR would be nine months after the date of publication of the rules in the Federal Register. The compliance date for the amendments to diversification, stress testing, disclosure, Form PF, Form N-MFP and clarifying amendments would be 18 months after the date of publication of the rules in the Federal Register."
The U.S. Securities & Exchange Commission (SEC), which is scheduled to discuss and vote on Final Money Market Fund Reforms Wednesday morning, July 23, at 10am Eastern, has posted an Agenda for the meeting. (We'll excerpt from the expected press release as soon as it's available tomorrow morning, and we'll forward this to subscribers. Visitors should also be able to view the Webcast of the Sunshine Meeting here.) We quote from the Meeting Agenda, and include comments from some analysts that have been weighing in with their expectations and the ramifications of money fund reform below. Wednesday's "Open Meeting Agenda" (July 23, 2014) lists, "Item 1: Money Market Fund Reform; Amendments to Form PF, Office: Division of Investment Management, Staff: Norm Champ, Diane Blizzard, Sarah ten Siethoff, Thoreau Bartmann, Sara Cortes, Adam Bolter, Erin Loomis, Andrea Ottomanelli Magovern, Kay Mario Vobis, Amanda Wagner." It says, "The Commission will consider whether to adopt amendments to certain rules under the Investment Company Act of 1940 that govern the operation of money market funds and related amendments to Form PF under the Investment Advisers Act of 1940. For further information, please contact Thoreau Bartmann, Division of Investment Management, at (202) 551-6745."
The agenda continues, "Item 2: Notice of Proposed Exemptive Relief, Office: Division of Trading and Markets, Staff: Steve Luparello, Haimera Workie, Natasha Vij Greiner, Jonathan Shapiro, George Makris." It says, "The Commission will consider whether to issue a notice of proposed exemptive relief. For further information, please contact Natasha Greiner, Division of Trading and Markets, at (202) 551-4563."
Finally, it lists, "Item 3: Removal of Certain References to Credit Ratings and Amendment to the Issuer Diversification Requirement in the Money Market Fund Rule, Office: Division of Investment Management, Staff: Norm Champ, Diane Blizzard, Penelope Saltzman, Amanda Wagner." It explains, "The Commission will consider whether to (i) re-propose amendments to the principal rule under the Investment Company Act of 1940 that governs the operation of money market funds to address provisions that reference credit ratings and (ii) propose an amendment to the diversification provisions in that rule. For further information, please contact Amanda Wagner, Division of Investment Management, at (202) 551-6762." Watch for more coverage Wednesday morning as it becomes available.
On Friday, JP Morgan Securities' US Fixed Income Strategy projected what reform could look like. "For years the regulators have indicated their intent to structurally reform MMFs to prevent another run in the event of a severe liquidity or credit crisis. However, in doing so, they have the potential to significantly impact the money markets. Worst case scenario, the reforms could cause a huge structural shift in money permanently moving away from prime MMFs and into government MMFs and bank deposits. All else equal, this could cause short borrowing rates for banks and corporations to materially increase while those of sovereigns and agencies to decrease, which would have ramifications on any financial contract that is tied to Libor. Based on recent public comments, the Commissioners still seem to be divided on what the appropriate path should be going forward. Regardless, MMFs are likely going to be shoring up their liquidity as we head into next week in anticipation of potential outflows post-meeting. We wouldn't be surprised if prime funds' 7d liquidity moves above the current 42% level in the near-term."
The update from Alex Roever, Teresa Ho, and John Iborg, outlined their expectations for what reform will look like. Variable NAV: "Most likely, reforms will require targeted MMFs to transition from a constant NAV model to one of a variable NAV <b:>`_. MMFs will have at least two years to implement the change. Of course, this is predicated on Treasury providing some sort of relief on the tax consequences that would be created by buying and selling fund shares on a daily basis. We are less certain on the imposition of liquidity fees and redemptions gates on targeted funds given the resistance from the Fed. However, as this is the only method that addresses run risk and would only be applied in times of stress, we would not be surprised if the SEC decides to combine this with the variable NAV alternative."
The piece adds, "Prime institutional funds are likely going to be the bulls-eye that the SEC targets. They will be subject to the most stringent reforms relative to other types of MMFs. As prior crises have shown, institutional shareholders of prime funds are most prone to run risk. In 2008 post Lehman's bankruptcy, they withdrew $428bn over the course of two weeks. In 2011 during the European crisis and the US debt ceiling debacle, they withdrew $192bn over the course of two months." On the other hand, on "Prime retail funds, government funds, and municipal funds," "We think these types of funds will most likely be exempt from structural reforms.... Retail funds will most likely be defined as MMFs that limit their share ownership to natural persons.... This definition will include individuals that invest in MMFs through individual accounts, retirement accounts, college savings plans, health savings plans and ordinary trusts."
On "Disclosures:," they say, "We're fairly certain that the SEC will require MMFs to provide additional disclosures and/or more frequent disclosure of holdings either to the SEC, the public, or both. The idea is that these disclosures would provide greater transparency regarding MMFs such that investors have an opportunity to better evaluate risks of investing in a particular fund and the SEC and other financial regulators can obtain important information needed to monitor financial stability risks. How frequent or in what form remains to be seen. At a minimum, we suspect the SEC would require funds to disclose their overnight and weekly liquidity levels as well as their market-based NAVs on a daily basis."
Finally, Roever and his team went into more depth about the impact of potential reforms on institutional prime funds. "It remains unclear how institutional prime fund shareholders will react. While the transition period will give prime fund sponsors time to create VNAV funds, there's no guarantee the affected shareholders are going to stick around while this transition happens. Corporate treasurers and other institutional shareholders may be willing to evaluate the suitability of VNAV prime funds, but some may be wary of leaving cash in orphaned CNAV prime funds in the interim. As this regulatory transition takes place, these institutional class shareholders may prefer to shift holdings someplace else, particularly if they get concerned other shareholders might pull out. Just where these shareholders would take their money is an interesting question. For reasons we discussed already, large banks may be resistant to taking on more deposits. A more likely destination would be treasury and government MMFs that will likely be allowed by regulators to remain CNAV."
In related news, "Marketwatch's "The Tell" blog ran a piece Tuesday, "SEC Rule Could Shift $500 Billion of Money Fund Assets, Analyst Says," citing analysis from Bank of America Merrill Lynch U.S. Rates Analyst Brian Smedley. Blog author Ben Eisen writes, "During the darkest days of the financial crisis in September 2008, a giant money-market fund called the Reserve Primary Fund saw its net asset value drop below $1 per share, a rare event called breaking the buck. Nearly six years later, the scars that event left on the money-market industry haven't fully healed. That's the backdrop for a slew of new reforms that are due for a vote before the Securities and Exchange Commission Wednesday morning. If the SEC adopts changes to Rule 2a-7 -- which have been a long time in the making -- it could dramatically reshape where investors park their cash within the money-funds industry, according to Brian Smedley, rates strategist at Bank of America Merrill Lynch. He believes $500 billion could flow out of prime funds (which invest in commercial paper as well as government securities) and into government funds (just government securities)."
The piece continues, "But let's back up a second. There are a number of key measures within the reforms, including potential redemption fees, new definitions for fund types, and new treatments for municipal bond funds. But the most important would be a measure to let the net asset value of prime funds float, rather than stay fixed. Currently, the NAVs are fixed at $1, which is why it was so consequential that a fund broke the buck. But the institutional non-government funds that were most susceptible during the financial crisis are now thought by many to be more stable if their NAVs are allowed to float. Government money-market funds may stay fixed. If those regulations pass, Smedley thinks investors would thus leave the floating-NAV funds for the fixed-NAV funds."
MarketWatch adds, "He writes in a Tuesday note: 'Funds that designate themselves as institutional prime fund have assets of roughly $900bn, equal to 35% of total money fund AUMs. We expect the SEC to move ahead with the proposed requirement. This will likely spur fund investors to reallocate a material portion (perhaps half a trillion dollars over time) of prime fund assets into government-only funds, which will likely retain a fixed NAV. Note that institutional MMF investors have not altered their allocation between prime and government money funds since the SEC's proposal was released.'" It goes on, "An exodus from some funds in favor of others could noticeably impact prices of short-term rates, Smedley believes: 'This should result in upward pressure on Libor over time and cause short-dated Treasuries and agencies to richen even further, especially given the negative supply outlook for bills and repo.'"
The Investment Company Institute released its latest "Money Market Funding Holdings" report, which tracks the aggregate daily and weekly liquid assets, regional exposure, and maturities (WAM and WAL) for Prime and Government money market funds (as of June 30, 2014). ICI's "Prime and Government Money Market Funds' Daily and Weekly Liquid Assets table shows Prime Money Market Funds' Daily liquid assets at 24.2% as of June 30, up from 22.8% on May 31. "Daily liquid assets" were made up of: "All securities maturing within 1 day," which totaled 19.7% (vs. 18.7% last month) and "Other treasury securities," which added 4.5% (vs. 4.2% last month). Prime funds' Weekly liquid assets totaled 36.1% (vs. 36.6% last month), which was made up of "All securities maturing within 5 days" (30.0% vs. 31.5% in May), Other treasury securities (4.4% vs. 4.0% in May), and Other agency securities (1.7% vs. 1.1% a month ago).
Government Money Market Funds' Daily liquid assets total 62.8% in June vs. 62.3% in May. All securities maturing within 1 day totaled 27.8% vs. 27.3% last month. Other treasury securities added 35.0% (vs. 35.0% in May). Weekly liquid assets totaled 81.6% (vs. 79.9%), which was comprised of All securities maturing within 5 days (39.0% vs. 37.9%), Other treasury securities (32.5% vs. 32.9%), and Other agency securities (10.1% vs. 9.1%).
ICI's "Prime and Government Money Market Funds' Holdings, by Region of Issuer" table shows Prime Money Market Funds with 47.9% in the Americas (vs. 40.6% last month), 20.0% in Asia Pacific (vs. 19.1%), 32.0% in Europe (vs. 40.0%), and 0.2% in Other and Supranational (vs. 0.3%). Government Money Market Funds held 89.9% in the Americas (vs. 84.6% last month), 0.5% in Asia Pacific (vs. 0.6%), 9.6% in Europe (vs. 14.8%), and 0.0% in Supranational (vs. 0.1%).
The table, "Prime and Government Money Market Funds' WAMs and WALs shows Prime MMFs WAMs and WALs remained the same from last month (at 45 and 80 days, respectively) and Government MMFs' WAMs shortened by one day to 42 days and their WALs remained the same at 71 days. ICI's release explains, "Each month, ICI reports numbers based on the Securities and Exchange Commission's Form N-MFP data, which many fund sponsors provide directly to the Institute. ICI's data report for May covers funds holding 94 percent of taxable money market fund assets." Note: ICI doesn't publish individual fund holdings.
ICI Senior Economist Chris Plantier added additional commentary in "ViewPoint" ntitled, "European Banks Significantly Reduced Borrowing from U.S. Money Market Funds in June". "European banks have generally become less willing to borrow from U.S. money market funds due to regulatory pressures, especially at the end of the quarter. Specifically, the new Basel III requirements seek to increase capital ratios of banks and explicitly limit how much banks fund their operations through short-term borrowing (which includes short-term securities banks issue that money market funds invest in). This quarter-end effect was particularly strong at the end of June as European bank regulators continued to monitor bank progress toward meeting the new Basel III requirements, which will be fully phased in over the next few years," writes Plantier.
Adds Plantier, "The June drop in the share of prime money market fund portfolios allocated to European counterparties was the largest decline since Form N-MFP data have been collected, topping even the tumultuous summer of 2011. The large monthly decline indicates that European banks can shrink their balance sheets quickly and/or have the ability to find other sources of funding quickly. We suspect it is a fair amount of the former. The increase in lending to U.S. counterparties is almost entirely due to the large increase in money market fund lending to the Federal Reserve via the Fed's overnight reverse-repo facility."
He also says, "The money market fund use of the Federal Reserve facility could increase further as major bank regulatory changes are implemented, and as the structural changes likely to be imposed on money market funds are phased in over the next few years. Under this facility, 93 money market funds have been designated by the Fed as eligible counterparties for its reverse-repo facility; each of these 93 funds can execute up to $10 billion in repo agreements. It is difficult to know exactly how large the Fed's overnight reverse-repo facility will be going forward, but we know that money market funds collectively are currently using less than one-third of their maximum $930 billion allotment (93 funds x $10 billion each). This facility will improve the Federal Reserve's ability to control short-term interest rates and will likely be an important safety value as Basel III and other regulatory changes are applied."
JP Morgan Securities' latest "Prime Money Market Funds Holdings Update" for June says, "Given upcoming leverage ratio disclosures, many banks significantly shrunk their balance sheets at the end of June, triggering a sharp spike in RRP usage among money funds. While this was only a temporary phenomenon (as banks returned to scaling their balance sheets post quarter-end), these acute spikes in RRP holdings are significant in that they highlight the ease to which funds can move en masse into the RRP facility. As bank regulations continue to be implemented, this pattern of increased RRP usage at quarter-ends could become a regular feature."
Money market funds saw a large surge in the use of the RRP program. The piece, by Alex Roever, Teresa Ho, and John Iborg, tells us, "Both prime and government MMFs saw record participation into the RRP facility, totaling $147bn and $148bn respectively. There were four prime MMFs and zero government MMFs that went in for the full $10bn allotment. Comparatively, there were three prime MMFs and two government MMFs that went in for the full $7bn allotment at March quarter-end. The surge in RRP was prompted by a sharp pullback in bank balance sheets at quarter-end. Due to the way leverage ratios are calculated by European bank regulators, European banks exhibited the greatest contraction in bank balance sheets."
They also note a reduction in exposures to Yankee banks. "The decline in Yankee bank holdings was primarily concentrated in time deposits. By jurisdiction, the decrease was driven by reductions in holdings of French banks (-$18bn), Swedish banks (-$17bn), Norwegian banks (-$14bn), and UK banks (-$13bn). Notably, prime MMFs’ holdings of Japanese banks were the only banking sector that materially increased month-over-month. As of June month-end, Japanese bank exposures increased by $12bn, mostly via growth in unsecured CDs."
Treasury floaters continued to increase in June. "At the end of June, MMFs held a total of $15.9bn in Treasury floaters, an increase of $2.46bn from May. The pace at which MMFs have added Treasury FRNs has slowed somewhat in the second quarter ($6.44bn) versus first quarter ($9.46bn). At current levels, MMFs hold about 19% of the $82bn currently outstanding, a decrease from 23% in March. This seems to suggest that non-MMF investors are participating in a greater portion of the market and finding this product relatively more attractive. Treasury MMFs continue to be the largest holders of Treasury FRNs with $10.5bn in their portfolios as of May month end, followed by prime MMFs with $4.1bn, and Government Agency MMFs with $1.3bn." Finally, they say, "forthcoming details about money fund reform and the Fed's exit strategy will dominate investors' focus the second half of this year."
On behalf of Federated Investors, David Freeman, partner at Arnold & Porter LLP law firm, issued yet another comment letter to the SEC on money fund reform. The letter, which may be setting the stage for a legal challenge to pending SEC rules, is addressed to Chair Mary Jo White and was posted to the SEC's web site on July 16. It was prompted by the news that the SEC will meet to discuss and potentially adopt new money fund rules on July 23. (See our July 17 News "SEC Posts Notice Confirming MMF Reform Vote on July 23".) Note that the SEC's "Comments on Proposed Rule: Money Market Fund Reform" page also now shows July 15 letters from Senator Mike Crapo and Senator Pat Toomey to Treasury Secretary Lew on the tax issues associated with a floating NAV. (See our "Link of the Day" from July 17, "Reuters writes "U.S. Senators Urge Treasury to Fix Money Fund Tax Concerns".)
Citing a recent piece in the Wall Street Journal, Freeman writes, "The Commission soon may adopt new MMF rules that would impose on MMF investors and MMFs an onerous regulatory alternative that would destroy the utility of MMFs for a large segment of investors, with further adverse consequences for issuers who rely upon MMFs as an important alternative to bank financing. This is particularly troubling when the Commission has before it less burdensome alternatives that would achieve its regulatory goals of reducing run risk and potential first movers, as well as enhancing the transparency of MMFs for investors." The missive supplements earlier letters posted on behalf of Federated on April 4, April 23, April 25, and May 14.
He writes, "In the current rulemaking, the Commission must address the overwhelming rejection by commenters of Alternative One (because a floating net asset value (NAV) will impose enormous costs on investors and affected issuers with no benefit in terms of curbing run risk) and further rejection of the combination of Alternatives One and Two (because the resulting product will not be viable for investors and the alternative of gates/fees can address potential run risk and potential first movers). The Commission must address, as well, comments on its current formulation of Alternative Two, which Federated and other commenters have suggested can and should be strengthened to give MMF boards additional authorities and flexibility to protect shareholders from potential first movers and enhance investor acceptance. The Commission must, under the APA (Administrative Procedure Act) and under the Investment Company Act of 1940, consider whether its rules 'promote efficiency, competition, and capital formation.' This requires more than simply checking the box on economic studies but mandates a real weighing of the economic impact of rules. In the current rulemaking, this requires the Commission to choose a regulatory alternative that best 'preserve[s] the ability of money market funds to function as an effective and efficient cash management tool for investors,' as the Release states, while furthering the Commission's goal of preventing or mitigating large-scale redemptions during market stress. As the Commission itself has acknowledged, the gates and fees alternative maintains the day-to-day utility of MMFs; the floating NAV alternative does not."
Freeman continues, "The Commission also must act consistent with its published Guidance on Economic Analysis in Commission Rulemakings, which requires, among other things, consideration of whether alternatives to a proposed rule are 'better or worse ... in terms of achieving the regulatory purpose in a cost-effective manner' when measured against the proposed rule. As the record demonstrates, an enhanced gates and fees proposal (modified as Federated and others have proposed), together with enhanced disclosures of MMF 'market-based' NAVs, best achieves the Commission's objectives of curbing run risk and enhancing transparency in the most cost-effective manner. The Commission must, under the Administrative Procedure Act, articulate a 'rational connection' between the facts found and the regulatory choice made. A final rule cannot rest merely on the Commission's 'predictive judgments,' but must be supported by the rulemaking record. In particular, speculation that a floating NAV for MMFs 'could alter investor expectations' and therefore investors 'should become more accustomed' to MMF NAV fluctuations and investors 'thus may be less likely to redeem shares in times of stress,' without credible support for this proposition in the record (of which there is none) cannot possibly support the Commission's floating NAV proposal."
He comments, "We reiterate, as we did in our May 14th letter, that there is no justification in the Commission's extensive rulemaking record for requiring a large segment of MMFs to convert to floating NAV, where the Commission has the alternative of fully informing investors of minute fluctuations in MMF valuations through enhanced disclosure, and where the Commission has a further alternative -- gates and fees -- that best addresses run risk." He adds, "Indeed, if the Commission were to choose a regulatory option that would destroy a product for a large segment of investors, when a far less disruptive alternative is available that better achieves its regulatory goals, better protects investors, and preserves the product, the Commission would violate its obligations under the Administrative Procedure Act and the Investment Company Act."
The letter goes on, "The Commission has described its own proposal in terms of alternatives: 'Alternative One,' a floating NAV for MMFs that are not 'retail' or 'government' MMFs; 'Alternative Two,' liquidity fees and gates applicable to all MMFs except government MMFs; and a third alternative, which would combine the first two alternatives. In weighing the costs and benefits of the Commission's rulemaking, these alternatives must be measured against each other as well as against various alternatives proposed by commenters. The Commission must consider that commenters, as well as the Commission itself, nearly uniformly state that a floating NAV would not prevent or mitigate large-scale redemptions in a crisis and that gates are the 'one regulatory reform discussed' that will."
Freeman continues, "Similarly, the Commission's statements in the Release that a floating NAV for MMFs 'could alter investor expectations' and therefore investors 'should become more accustomed' to MMF NAV fluctuations and investors 'thus may be less likely to redeem shares in times of stress' remain pure speculation, unsupported by the record or any other data. In any event, the Commission, if it chooses to impose a floating NAV on a large segment of MMFs, will need to explain why it believes investors, intermediaries, and issuers to affected funds should bear the enormous costs of a floating NAV (restructuring, retooling and accounting for a floating NAV in the case of investors and intermediaries; higher financing costs for affected issuers) when disclosure of underlying NAV fluctuations, particularly for institutional investors, could achieve the same informational result, and gates/fees could achieve a better result in terms of curbing run risk. If the Commission, as proposed, adopts a floating NAV for institutional, but not retail, prime MMFs, it also will need to explain why institutions need the informational benefit of a floating NAV, while retail investors do not -- which is a ridiculous proposition."
Freeman adds, "The Commission is obligated to consider whether the gates and fees proposal as compared to the floating NAV proposal (or any proposed modification thereto) is more effective in achieving the proposed rule's goal of deterring runs and protecting investors against first movers with lower costs than the floating NAV approach. The Commission itself acknowledged that 'gates are the one regulatory reform in this Release ... that definitely stops a run on a fund (by blocking all redemptions),' a position strongly supported by the record. The Commission also has acknowledged that gates and fees would be less detrimental to MMF investors because they would preserve the day to day utility of the product. Thus, the gates and fees proposal is better in achieving the Commission's regulatory purpose in a cost-effective manner, when measured against the floating NAV. Only a small number of commenters raised concerns about the effectiveness of the gates/fee proposal, suggesting that it could lead to preemptive runs by investors who closely monitored a MMF as it approached a gate or fee trigger. As the Commission is aware, this concern can be addressed through modifying the proposal, as Federated and other commenters have suggested, to give MMF boards greater flexibility to intervene to protect shareholders and avoid the potential adverse effects of a hard 'trigger' for gates and fees."
He further states, "The record does not justify the Commission's third alternative -- the imposition of both a floating NAV and gates and fees on a large segment of MMFs. There is substantial evidence in the record that a floating NAV MMF with gates and fees simply will not be viable -- creating 'a uniquely undesirable product that no rational investor would select.' This will completely deprive affected investors of the use of prime MMFs, and prime MMFs' shrinking capacity will, in tum, diminish the market for commercial paper issuers."
In conclusion, Freeman writes, "As we previously wrote the Commission, 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. 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. The Commission's gates and fees proposal, modified as Federated and others have recommended and coupled with enhanced disclosure, will fully address the Commission's regulatory goals. Adding a floating NAV requirement for prime institutional funds serves no purpose, other than to destroy the utility of those fuds for affected investors."
In their latest Quarterly Corporate Cash Briefing webinar, principals from Treasury Strategies talked about trends in corporate cash and led a panel discussion on the ramifications of next Wednesday's meeting of the SEC Commissioners to address money fund reform. (See our "Crane Data News" from yesterday "SEC Posts Notice Confirming MMF Reform Vote on July 23; Market Share.") The 45-minute webinar featured commentary from Tony Carfang, partner, Treasury Strategies; Edmonia Lindsey, managing director, Treasury Strategies; Debbie Cunningham, chief investment officer, global money markets, Federated Investors; and Roger Merritt, managing director, Fitch Ratings.
On the SEC's meeting July 23rd to discuss money fund reform, Cunningham said the rumor mill has been churning with regard to what the SEC staff will recommend to the commissioners. "We've heard, from a rumor mill perspective with no confirmation, the staff recommendations are as follows: one, floating NAV plus gates and fees for institutional prime funds; two, gates and fees for retail prime funds; and three, the exemption of government money market funds away from these requirements, which will also be extended to municipal money funds."
However, added Cunningham, the commissioners themselves have expressed, very publicly in many instances, differing viewpoints on the most appropriate path forward. So it's hard to say what the outcome will be. "The meeting will be held, the discussions will take place, and we'll see if there's a vote. If there is a vote, we'll see what the outcome of that vote is."
There is also speculation that the U.S. Treasury is in conversations with the SEC about how to meet Commissioners Gallagher and Aguilar's concerns about the tax treatment of the daily transactions in and out of money funds, said Carfang. "That would then pave the way for them to vote in favor of the fluctuating NAV; otherwise they might not vote for it," he said.
The panelists also discussed the impact of other regulations, including Basel III. "The simple takeaway is, it means that banks are going to have to hold more capital and more liquidity, which in turn has knock-on effects for both corporate treasurers and money funds," said Merritt. "We're starting to see new capital instruments in the market that are specifically designed to be Basel III compliant." Added Cunningham, "One of the types of structures more recently that has evolved that addresses some of these concerns is what I'll call the partial non-call structure. That's a structure that has become quite popular."
On adjusting portfolios in a rising interest rate environment, Cunningham said, "We certainly don't want to take large bets in the context of that changing rate outlook. But I think modifications as we go into that time period -- which would include maybe shortening your duration a little bit, maybe taking on a little more in floating rate issuers that would be responsive to that rising rate environment -- might be more prudent in that rising rate environment."
Also, Carfang provided an update on corporate cash levels for Q1 2014. U.S. corporate cash was at $1.85 trillion as of March 31, a $90 billion drop, the largest quarter-over-quarter drop on record, he said. "We're not quite sure if this is the beginning of a reversal. We'll know more when we see next quarter's statistics," he said. However, he added, there's been a lot of activity this year in cross-border mergers, particularly where U.S. companies are moving their headquarters overseas. "Perhaps some of that activity is reflected in the drop in US cash." To that point, while corporate cash is decreasing in the U.S., it is rising in the U.K., the Eurozone, and Japan. Corporate cash levels increased slightly to 0.54 trillion GBP in the UK, rose to an all-time high of over 2 trillion euro in the Eurozone, and spiked to 243 trillion yen in Japan.
Federated's Cunningham also commented on a variety of subjects, including regulations, interest rates, and portfolio strategies in her quarterly Money Market Update, delivered Wednesday afternoon. She said Federated had no exposure to the Portuguese bank, Banco Espirito Santo, which missed a payment and roiled the markets earlier this month. "There was no exposure to that from a money market fund perspective, not from a Federated or [from an] industry standpoint. That issuer was nowhere close to being money market eligible. Its long-term rating, depending on whether you look at the bank or the bank holding co, was either 'B' or triple-C, which are obviously in junk land and is not something that would be eligible or would ever be considered in the context of a high quality money market fund." [Crane Data verified that no money market funds hold this name nor any Portugese-related debt.]
In other news, SEC Chair Mary Jo White released a statement on the fourth anniversary of the Dodd-Frank Act. "I expect the Commission will soon implement critical Dodd-Frank Act rules for credit ratings agencies and securitization, in addition to finalizing important new rules for money market funds," she wrote. Also, another comment letter from Arnold & Porter's David Freeman on behalf of Federated Investors was posted to the SEC's "Comments on Proposed Rule: Money Fund Reform" website. Watch for excerpts and coverage of this on Monday.
The SEC posted a "Sunshine Act Meeting" notice late Wednesday, officially confirming its meeting on Money Market Fund Reform next Wednesday (July 23). In addition to voting on the reform alternatives of floating NAV for prime institutional funds, emergency gates and fees, or a combination of these, it appears that the Commission will provide exemptive relief from 'de minimus' taxes and propose rules on ratings. The statement says, "Notice is hereby given, pursuant to the provisions of the Government in the Sunshine Act, Pub. L. 94-409, that the Securities and Exchange Commission will hold an Open Meeting on Wednesday, July 23, 2014 at 10:00 a.m., in the Auditorium, Room L-002. The subject matters of the Open Meeting will be: The Commission will consider whether to adopt amendments to certain rules under the Investment Company Act of 1940 that govern the operation of money market funds and related amendments to Form PF under the Investment Advisers Act of 1940. The Commission will also consider whether to issue a related notice of proposed exemptive relief. The Commission will consider whether to (i) re-propose amendments to the principal rule under the Investment Company Act of 1940 that governs the operation of money market funds to address provisions that reference credit ratings and (ii) propose an amendment to the diversification provisions in that rule. At times, changes in Commission priorities require alterations in the scheduling of meeting items. For further information and to ascertain what, if any, matters have been added, deleted or postponed, please contact: The Office of the Secretary at (202) 551-5400. Kevin M. O'Neill, Deputy Secretary."
In other news, Crane Data's most recent monthly Money Fund Intelligence Family & Global Rankings, which ranks the asset totals and market share of managers of money funds in the U.S. and globally, shows moderate asset decreases for over half of the major money fund complexes in May, and bigger decreases for the majority over the past three months ended June 30. (These "Family" rankings are available to our Money Fund Wisdom subscribers.) Goldman Sachs, UBS, Morgan Stanley, Western Asset Management, and SSgA showed solid gains in June, rising by $5.6 billion, $3.4 billion, $2.3 billion, $1.4 billion, and $1.3 billion respectively, while Morgan Stanley, Goldman Sachs, SSgA, and First American led the increases over the 3 months through June 30, 2014, rising by $4.1B, $3.0B, $1.2B, and $1.1B, respectively. Money fund assets overall decreased by $7.1 billion in June and fell by $62.7 billion over the last three months (according to our Money Fund Intelligence XLS).
Our latest domestic U.S. money fund Family Rankings show that Fidelity Investments remained the largest money fund manager with $405.1 billion, or 16.3% of all assets (down $3.3B in June, down $10.3B over 3 mos. and down $13.9B over 12 months), followed by JPMorgan's $238.3 billion, or 9.6% (down $524M, down $5.4B, and up $13.0B for 1-month, 3-months and 12-months, respectively). Federated Investors ranks third with $201.9 billion, or 8.1% of assets (down $2.3B, down $14.4B, and down $19.2B), BlackRock ranks fourth with $184.3 billion, or 7.4% of assets (down $5.5B, down $12.9B, and up $41.4B), and Vanguard ranks fifth with $170.8 billion, or 6.9% (down $962M, down $3.1B, and up $565M).
The sixth through tenth largest U.S. managers include: Schwab ($158.2B, 6.4%), Dreyfus ($154.2B, or 6.2%), Goldman Sachs ($138.7B, or 5.6%), Wells Fargo ($108.3B, or 4.4%), and Morgan Stanley ($104.2B, or 4.2%). The eleventh through twentieth largest U.S. money fund managers (in order) include: SSgA ($83.9B, or 3.4%), Northern ($74.5B, or 3.0%), Invesco ($59.5B, or 2.4%), BofA ($47.0B, or 1.9%), Western Asset ($41.9B, or 1.7%), First American ($38.9B, or 1.6%), UBS ($36.9B, or 1.7%), Deutsche ($34.5B, or 1.4%), Franklin ($18.4B, or 0.7%), and RBC ($18.4B, or 0.7%). Crane Data currently tracks 75 managers, unchanged from last month and up one from last quarter.
Over the past year, BlackRock showed the largest asset increase (up $41.4B, or 27.5%; note that most of this is due to the addition of securities lending shares to our collections), followed by Goldman Sachs (up $14.2B, or 10.7%), JP Morgan (up $13.0B, or 5.6%), and Morgan Stanley (up $11.2B, or 12.1%). Other big gainers since June 30, 2013, include: SSgA (up $9.0B, or 12.3%), BofA (up $4.1B, or 9.5%), Dreyfus (up $3.8B, or 2.5%), American Funds (up $3.3B, or 18.1%), and Reich & Tang (up $3.3B, or 41.4%). The biggest declines over 12 months include: Federated (down $19.2B, or 8.6%), Fidelity (down $13.9B, or 3.3%) and UBS (down $9.5B, or 18.9%). (Note that money fund assets are very volatile month to month.)
When "offshore" money fund assets -- those domiciled in places like Dublin, Luxembourg, and the Cayman Islands -- are included, the top 10 managers match the U.S. list, except for BlackRock moving up to No. 3, Goldman moving up to No. 4, and Western Asset appearing on the list at No. 9. (displacing Wells Fargo from the Top 10). Looking at these largest Global Money Fund Manager Rankings, the combined market share assets of our MFI XLS (domestic U.S.) and our MFI International ("offshore), we show these largest families: Fidelity ($411.4 billion), JPMorgan ($363.1 billion), BlackRock ($299.5 billion), Goldman Sachs ($220.6 billion), and Federated ($211.4 billion). Dreyfus ($178.5B), Vanguard ($170.8B), Schwab ($158.2B), Western ($134.0B), and Morgan Stanley ($122.4B) round out the top 10. These totals include offshore US dollar funds, as well as Euro and Sterling funds converted into US dollar totals.
In other news, our July 2014 MFI and MFI XLS show that both net and gross yields remained at record lows for the month ended June 30, 2014. Our Crane Money Fund Average, which includes all taxable funds covered by Crane Data (currently 849), remained at a record low of 0.01% for both the 7-Day and 30-Day Yield (annualized, net) averages. (The Gross 7-Day Yield was also unchanged at 0.13%.) Our Crane 100 Money Fund Index shows an average yield (7-Day and 30-Day) of 0.02%, also a record low, down from 0.03% a year ago. (The Gross 7- and 30-Day Yields for the Crane 100 remained unchanged at 0.16%.) For the 12 month return through 6/30/14, our Crane MF Average returned a record low of 0.01% and our Crane 100 returned 0.02%.
Our Prime Institutional MF Index yielded 0.02% (7-day), the Crane Govt Inst Index yielded 0.01%, and the Crane Treasury Inst, Treasury Retail, Govt Retail and Prime Retail Indexes all yielded 0.01%. The Crane Tax Exempt MF Index also yielded 0.01%. (The Gross Yields for these indexes were: Prime 0.19%, Govt 0.10%, Treasury 0.07%, and Tax Exempt 0.14% in June.) The Crane 100 MF Index returned on average 0.00% for 1-month, 0.00% for 3-month, 0.01% for YTD, 0.02% for 1-year, 0.04% for 3-years (annualized), 0.06% for 5-year, and 1.63% for 10-years.
The Investment Company Institute released its latest data on "Worldwide Mutual Fund Assets and Flows (First Quarter 2014)," which shows that global money market mutual fund assets grew slightly overall in Q1 '14. The latest data show worldwide money market mutual fund assets rising by $35 billion to $4.795 trillion, led by a large increase in Chinese MMFs (which overcame a large drop in U.S. MMFs). Globally, MMF assets increased by $135.8 billion over the past year (through 03/31/14). Crane Data excerpts from ICI's latest release and analyzes the money fund portion of the ICI's latest global statistics, below.
ICI's latest Worldwide Mutual Funds release says, "Mutual fund assets worldwide increased 2.7 percent to $30.84 trillion, an all-time high, at the end of the first quarter of 2014. Worldwide net cash flow to all funds was $350 billion in the first quarter, compared to $252 billion of net inflows in the fourth quarter of 2013.... Inflows into bond funds totaled $95 billion in the first quarter, reversing the net outflows of $8 billion in the fourth quarter. Inflows into money market funds were $28 billion in the first quarter of 2014, somewhat lower than the $49 billion inflow recorded in the fourth quarter of 2013."
The quarterly statement explains, "The Investment Company Institute compiles worldwide statistics on behalf of the International Investment Funds Association, an organization of national mutual fund associations. The collection for the first quarter of 2014 contains statistics from 45 countries.... The growth rate of total mutual fund assets reported in U.S. dollars was made slightly larger by U.S. dollar depreciation."
ICI continues, "Money market funds worldwide experienced a net inflow of $28 billion in the first quarter of 2014 after registering a net inflow of $49 billion in the fourth quarter of 2013. The global inflow from money market funds in the first quarter was driven by inflows of $19 billion in Europe and $91 billion in the Asia and Pacific region. Money market funds in the Americas posted outflows of $81 billion in the first quarter."
According to Crane Data's analysis of ICI's worldwide funds data, the U.S. maintained its position as the largest money fund market in Q1'14 with $2.631 trillion (down to 54.9% of all worldwide MMF assets); assets decreased by $86.9 billion in Q1'14 (they were up by $35.5B in the past year). France remained a distant No. 2 to the U.S. with $448.8 billion (9.3% of worldwide assets, up $8.2 billion in Q1 but down $30.6B over 1 year (and down a shocking $248.4 billion since the end of 2009). This was followed by Ireland ($384.9 billion, or 8.0% of total assets), where money fund assets were up $17.5B in Q1 and up $21.9B over 12 months. Australia remained in 4th place in the latest quarter, though it saw a drop of $16.5 billion in the quarter and $32.4B over the past year to $332.1B (6.7%), and Luxembourg remained in 5th place with $321.4B, or 6.7% of the total (up $690 million in Q1 and down $4.4B for 1 year).
China continued its dramatic money fund growth in Q1 of 2014. The 6th largest money fund country saw assets jump again; China now reports $234.5B in total, up a massive $111.0 (89.8%) in Q1 (after rising $43.6B in Q4) and up $150.9 billion (180.7%) over the last 12 months. See our July 9 "Link of the Day", "Chinese Money Fund Growth." (The Asia Asset Management article said, "Money market funds (MMFs) continued to play a key role in the growth of mainland China's asset management industry.... Beijing-based Tianhong Asset Management, which paired up with e-commerce giant Alibaba Group to launch the online fund platform Yu'e Bao, trumped conventional asset managers with total AUM of 586.1 billion RMB (US$93.88 billion) as of the end of June. Tianhong's ballooning AUM has mainly been driven by its partnership with Alibaba, through which it launched its first online MMF, the Tianhong Zenglibao Monetary Fund, in June 2013."
Alibaba launched an online money-market fund called Yu'e Bao last June, and the fund had 554 billion RMB in assets as of March 31, 2014, which equates to around $90 billion US, explained Jonathan Curry, chairman, `Institutional Money Market Fund Association, speaking last month at the 6th annual Crane Money Fund Symposium in Boston. (Watch for excepts from Curry's Symposium comments in coming days.)
The latest ICI Worldwide statistics also show Korea ($70.4B, up $6.5B and up $2.1B on the quarter and year, respectively), Brazil ($55.0B, up $8.4B and down $837M), and Mexico ($54.4B, up $1.4B and down $3.4B) remaining in the 7th through 9th largest money fund market spots. Taiwan moved into 10th place with a jump of $90M (to $27.7B), moving ahead of India ($22.2B), which saw assets drop $7.1B. Canada, South Africa, Japan, Switzerland, Sweden, Finland, Chile, Norway, and Italy also ranked among the 20 largest countries that have money market mutual funds.
Note that Ireland and Luxembourg's totals are primarily "offshore" money funds marketed to global multinationals, while most of the other countries in the survey have primarily domestic money fund offerings. (Crane Data believes that some of these countries, like France and Italy, do not have true "money market funds" due to their lack of strict guidelines and "accumulating" NAVs instead of stable NAVs.)
Contact us if you'd like our latest "Largest Money Market Funds Markets Worldwide" spreadsheet, based on ICI's data. Finally, for those interested in global money funds, consider attending the 2nd annual Crane's European Money Fund Symposium, which will take place Sept. 22-23, 2014, at the London Tower Bridge Hilton in London, England.
Corporate treasurers and CFOs continue to build their organizations' cash, but some are wary of investing that cash in money market funds due to low yields and the threat of reforms, according to the Association for Financial Professionals' "2014 AFP Liquidity Survey," which was released yesterday. The survey said 36 percent of companies reported rising cash reserves in the last year and among those that increased cash holdings, a full 73 percent indicated that bigger reserves were the result of better operating cash flows. Fewer than a quarter reduced reserves over the period. As far as respondents' driving principles for cash investment, "Slightly more than two-third of respondents (68 percent) indicate that safety is the most important short-term investment for their organization, while 28 percent of respondents report their organizations' most important cash investment policy objective is liquidity." These numbers are virtually unchanged from 2013.
Companies are sticking to ultra-conservative investment strategies with their short-term holdings, with 75 percent of all short-term investments maintained within three vehicles: bank deposits, money market funds, or U.S. Treasury securities. A full 52 percent of corporate cash holdings are maintained in bank deposits, the largest percentage reported since AFP began its Liquidity Survey series in 2006. Just 16 percent was invested in money market funds, the same as 2013, but down from 19 percent in 2012 and 30 percent in 2011. Larger organizations with at least $1 billion in revenues continue to allocate more of their short-term investments to money market funds than do smaller organizations (20 percent of the portfolio versus 11 percent).
One reason bank deposits have been more attractive is because of the lack of strong investment alternatives that generate yield. "Still another factor is the continued regulatory uncertainty surrounding money market funds (MMFs). It has been a year since the U.S. Securities and Exchange Commission (SEC) proposed reforms for these investment vehicles. Among those proposals was one that would allow floating of the net asset value (NAV) for prime institutional funds, an approach that ultimately could temper the perceived safety of the investment vehicle that had made these MMFs attractive as repositories for corporate short-term cash. In recent years, as proposals for regulating MMFs have been discussed, some organizations have moved significant proportions of their cash holdings away from MMFs and back into banks. Several questions arise from this. What, if anything, will occur should the SEC finally move ahead on its proposed regulatory changes? If companies move to liquidate some or all of their cash holdings, where then would these funds go?"
The floating NAV proposals are of particular concern. "From the perspective of many treasurers, a floating NAV would undermine the safety of principal that has made money market funds attractive investment vehicles. Should the SEC enact a floating NAV rule, many organizations will have to revise their investment policies and look for alternative investments that offer comparable safety, liquidity and yield."
When selecting money market funds, 73 percent of respondents cited yield as a primary consideration, up sharply from the 54 percent in the 2013 survey. "Fund ratings are the second most common driver in the selection of funds, cited by 69 percent of financial professionals, followed by both fund sponsorship status as part of a bank relationship and counterparty risk, each cited by 51 percent of survey respondents. Even as allocations to money market funds declined during the survey period, yield is the primary driver behind fund selection. On par with fund ratings, the popularity of yield likely reflects the transparency in reporting requirements and regulations enacted several years ago, along with a more positive outlook on credit expectations and counterparty risk of underlying investments. Also notable is the third-place ranking of fund sponsor (as part of the bank relationship) as the primary factor in selecting a fund. With many companies allocating over half of their balances to bank deposits and almost half of the money market funds selected as part of a bank relationship mix, one might infer there is an even greater focus in incorporating money market funds in the bank relationship process."
Regarding offshore cash management trends, the report says: "Three in five organizations hold some amount of their cash outside of the U.S. The share increases to three-quarters for publicly owned organizations; one in three of these companies hold at least half of their cash outside of the U.S. Large organizations are also more likely than smaller ones to maintain cash in international investments. Two-thirds of large organizations -- those with at least $1 billion in annual revenues -- hold cash outside the U.S. versus just under half of organizations with annual revenues under $1 billion that do so." Approximately 56% of non-U.S. cash holdings are maintained in bank-type investments (including CDs, time deposits, etc.), while 15 percent are held in money market mutual funds and 8 percent are in government securities.
On average, organizations allow 4.4 investment vehicles beyond bank deposits for their short-term investment portfolio, a slight decrease from the average 4.6 vehicles reported in the 2013 survey. The most permissible are Treasury securities (63% say they are permissible), "pure" Treasury money market funds (47%), commercial paper (45%), and diversified money market funds (41%). Organizations actually invest in an average of 2.7 vehicles for their cash and short-term investment balances -- same as 2013. Also, "70 percent of short-term investment portfolios are maintained in investments with maturities of 30 days or less, while 80 percent of financial professional do not anticipate any change in the tenor of their organizations' investment portfolios over the next year."
The report adds, "More than half of financial professionals whose organizations have non-U.S. cash holdings report significant changes to their companies' average balances over the past year. More organizations increased their average balances of both U.S. and non-U.S. cash holdings than decreased them, a pattern consistent with their overall shifts in balances."
The report adds, "Another important factor for many organizations is the ability to generate earning credit rates (ECRs) from their deposits (41 percent). For the past couple of years, ECRs have been enticing vehicles in which to place excess bank balances that would normally be placed in money market funds and/or Treasury securities. In recent times, ECRs have offered above-market rates of return compared to similar investment options that offer safety, liquidity and yield, in that order. Banks will continue to have a need for more stable longer term balances -- especially with pending impacts from Basel III. But this will come with more scrutiny and stable deposit availability from the company being worth more to the bank." It goes on to say, "Generally ECRs are used to defray only traditional cash management fees. An example is organizations may generate monthly bank fees that are defrayed by earning credits generated by holding excess cash balances."
The study also says the vast majority of financial professionals cite banks as resources their organizations use to access opening cash and short-term investment holdings information. "Larger companies typically have more cash and also have more resources to help them manage that cash and often use outside data providers that feed information to treasury workstations and/or money fund portals. More than five in six survey respondents indicate banks are an important information resource, with little variation by organization type. Other information resources used include: data feeds from information sources (cited by 29 percent of survey respondents); money market portals (29 percent); money market funds (28 percent); and custodians (24 percent)."
The survey was underwritten by RBS Citizens and conducted in May 2014, generating 740 responses. Respondents were senior finance and treasury executives from a broad range of companies -- typically U.S.-based multinationals with a median of $2 billion in revenue. AFP will take a deeper dive into the findings during a one-hour webinar on August 26 at 3:00 pm called the 2014 Liquidity Survey Companion Webinar. Our own Pete Crane, president, Crane Data, will be on the panel along with Tom Hunt, Director of Treasury Services, AFP, and Matthew Richardson, Head of Product Solutions, RBS Citizens.
Crane Data released its July Money Fund Portfolio Holdings Friday, and our latest collection of taxable money market securities, with data as of June 30, 2014, shows a big jump in Repos, and a big drop in Other (Time Deposits), CP and CDs. Money market securities held by Taxable U.S. money funds overall (those tracked by Crane Data) decreased by $18.0 billion in June to $2.370 trillion. Portfolio assets also decreased by $3.7 billion in May, $39.1 billion in April, and $43.0 billion in March. Repos again surpassed CDs as the largest portfolio composition segment among taxable money funds, followed by Treasuries, then by CP, Agencies, Other, and VRDNs. Money funds' European-affiliated holdings plunged to 23.5% of holdings (down sharply from 30.8% last month), primarily due to a record spike in holdings of the NY Fed's RRP (repo) program. Below, we review our latest Money Fund Portfolio Holdings statistics.
Among all taxable money funds, Repurchase agreement (repo) holdings jumped by $76.1 billion to $591.5 billion, or 25.0% of fund assets, after rising $32.9 billion in May. (Holdings of Federal Reserve Bank of New York repo rose $148.3 billion to a record $274.5 billion.) Certificates of Deposit (CDs) dropped in June, decreasing $17.4 billion to $550.7 billion, or 23.2% of holdings. Treasury holdings, now the third largest segment, increased by $4.8 billion to $390.6 billion (16.5% of holdings). Commercial Paper (CP), which dropped to the fourth largest segment, decreased by $30.9 billion to $363.0 billion (15.3% of holdings). Government Agency Debt was up $8.5 billion. Agencies now total $322.1 billion (13.6% of assets). Other holdings, which include primarily Time Deposits, dropped sharply (down $55.7 billion) to $120.2 billion (5.1% of assets). VRDNs held by taxable funds decreased by $3.3 billion to $32.3 billion (1.4% of assets).
Among Prime money funds, CDs still represent over one-third of holdings with 37.2% (down from 36.5% a month ago), followed by Commercial Paper (24.5%, down from 27.2%). The CP totals are primarily Financial Company CP (14.5% of holdings) with Asset-Backed CP making up 6.0% and Other CP (non-financial) making up 4.0%. Prime funds also hold 5.4% in Agencies (up from 4.9%), 4.2% in Treasury Debt (up from 4.0%), 2.0% in Other Instruments, and 4.8% in Other Notes. Prime money fund holdings tracked by Crane Data total $1.481 trillion (down from $1.505), or 62.5% of taxable money fund holdings' total of $2.370 trillion.
Government fund portfolio assets totaled $431.6 billion, down from $436.8 billion last month, while Treasury money fund assets totaled $457.7 billion, up from from $444.5 billion at the end of May. Government money fund portfolios were made up of 55.4% Agency securities, 20.9% Government Agency Repo, 4.5% Treasury debt, and 18.5% Treasury Repo. Treasury money funds were comprised of 67.7% Treasury debt and 31.4% Treasury Repo.
European-affiliated holdings decreased $175.8 billion in June to $558.0 billion (among all taxable funds and including repos); their share of holdings is now 23.5%. Eurozone-affiliated holdings also fell (down $93.3 billion) to $324.0 billion in June; they now account for 13.7% of overall taxable money fund holdings. Asia & Pacific related holdings rose by $7.5 billion to $291.5 billion (12.3% of the total), while Americas related holdings increased $153.0 billion to $1.520 trillion (64.1% of holdings).
The overall taxable fund Repo totals were made up of: Treasury Repurchase Agreements (up $93.1 billion to $353.6 billion, or 14.9% of assets), Government Agency Repurchase Agreements (down $16.9 billion to $154.2 billion, or 6.5% of total holdings), and Other Repurchase Agreements (down $142 million to $83.7 billion, or 3.5% of holdings). The Commercial Paper totals were comprised of Financial Company Commercial Paper (down $26.4 billion to $214.4 billion, or 9.0% of assets), Asset Backed Commercial Paper (down $683 million to $89.4 billion, or 3.8%), and Other Commercial Paper (down $3.9 billion to $59.2 billion, or 2.5%).
The 20 largest Issuers to taxable money market funds as of June 30, 2014, include: the US Treasury ($390.6 billion, or 16.5%), Federal Reserve Bank of New York ($274.5B, 11.6%), Federal Home Loan Bank ($196.1B, 8.3%), BNP Paribas ($60.1B, 2.5%), Bank of Tokyo-Mitsubishi UFJ Ltd ($59.5B, 2.5%), Bank of Nova Scotia ($57.4B, 2.4%), RBC ($53.0B, 2.2%), JP Morgan ($51.9B, 2.2%), Wells Fargo ($51.3, 2.2%), Sumitomo Mitsui Banking Co ($47.6B, 2.0%), Citi ($46.5B, 2.0%), Credit Agricole ($45.1B, 1.9%), Federal Home Loan Mortgage Co ($44.8B, 1.9%), Credit Suisse ($42.4B, 1.8%), Federal National Mortgage Association ($41.5B, 1.8%), Bank of America ($40.0B, 1.7%), Toronto-Dominion ($39.7B, 1.7%), Federal Farm Credit Bank ($36.7B, 1.6%), Natixis ($35.3B, 1.5%) and Mizuho Corporate Bank Ltd. ($32.9B, 1.4%).
In the repo space, Federal Reserve Bank of New York's RPP program issuance (held by MMFs) remained the largest program by far with 46.4% 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 ($274.5B, 46.4%), BNP Paribas ($32.7B, 5.5%), Bank of America ($30.1B, 5.1%), RBC ($23.6B, 4.0%), Wells Fargo ($20.2B, 3.4%), JP Morgan ($19.7B, 3.3%), Credit Suisse ($19.6B, 3.3%), Barclays ($19.6B, 3.3%), Citi ($18.3B, 3.1%), and Credit Agricole ($16.9B, 2.9%). Crane Data shows 82 funds participating in the NY Fed repo program with 2 money funds maxing out the Fed program with $10 billion, and 8 more holdings over $7 billion (the previous cap). The largest Fed repo holders include: State Street Inst Lq Res, Western Asset Inst Lq Res, Federated Trs Oblg, Goldman Sachs FS Trs Obl Inst, Dreyfus Tr&Ag Cash Mgmt Inst, Morgan Stanley Inst Liq Trs, JP Morgan Prime MM, Morgan Stanley Inst Lq Gvt, Northern Trust Trs MMkt, and BlackRock Lq T-Fund.
The 10 largest CD issuers include: Bank of Tokyo-Mitsubishi UFJ Ltd ($41.3B, 7.5%), Sumitomo Mitsui Banking Co ($39.6B, 7.2%), Bank of Nova Scotia ($36.4B, 6.7%), Toronto-Dominion Bank ($33.4B, 6.1%), Mizuho Corporate Bank Ltd ($26.9B, 4.9%), Bank of Montreal ($23.2B, 4.2%), Rabobank ($22.9B, 4.2%), Wells Fargo ($22.6B, 4.1%), Citi ($20.9B, 3.8%), and Natixis ($20.5B, 3.7%).
The 10 largest CP issuers (we include affiliated ABCP programs) include: JP Morgan ($22.1B, 7.1%), Westpac Banking Co ($16.0B, 5.1%), Commonwealth Bank of Australia ($15.6B, 5.0%), RBC ($11.6B, 3.7%), Skandinaviska Enskilda Banken AB ($10.6B, 3.4%), BNP Paribas ($10.4B, 3.3%), HSBC ($9.8B, 3.2%), FMS Wertmanagement ($9.5B, 3.1%), Australia & New Zealand Banking Group ($9.5B, 3.0%), and National Australia Bank Ltd. ($8.6B, 2.8%).
The largest increases among Issuers include: Federal Reserve Bank of New York (up $148.3B to $274.5B), Federal Home Loan Bank (up $10.6B to $196.1B), State Street (up $4.6B to $11.3B), US Treasury (up $4.1B to $390.6B), Toronto-Dominion Bank (up $3.9B to $39.7B), and Mizuho Corporate Bank Ltd. (up $2.7B to $47.6B). The largest decreases among Issuers of money market securities (including Repo) in June were shown by: Deutsche Bank AG (down $25.1B to $27.0B), Barclays PLC (down $22.3B to $29.8B), Societe Generale (down $16.5B to $23.9B), DnB NOR Bank ASA (down $16.4B to $12.3B), Credit Agricole (down $13.7B to $45.7B), and BNP Paribas (down $12.1B to $60.1B).
The United States remained the largest segment of country-affiliations; it now represents 54.9% of holdings, or $1.302 trillion. Canada (9.1%, $216.5B) moved into second place ahead of France (7.7%, $183.5B). Japan (7.6%, $180.4B) remained the fourth largest country affiliated with money fund securities. Sweden (3.7%, $87.9B) moved up to fifth place, ahead of Australia (3.5%, $83.7B) and the U.K. (3.2%, $76.1B). The Netherlands (3.1%, $74.9B) ranked 8th while Germany (2.5%, $59.7B) dropped to 9th place. Switzerland (2.4%, $57.4B) 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 June 30, 2014, Taxable money funds held 25.2% of their assets in securities maturing Overnight, and another 12.1% maturing in 2-7 days (37.3% total in 1-7 days). Another 19.7% matures in 8-30 days, while 25.8% matures in the 31-90 day period. The next bucket, 91-180 days, holds 13.6% 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 late Monday). 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 in yesterday's "Link of the Day," the Securities & Exchange Commission is planning to adopt money market reforms in as soon as two weeks. This is according to two news reports, including one from Bloomberg News, which published the article, "Prime Money Funds Said to Float $1 Price," on July 10. "The riskiest money-market mutual funds will have to let their share prices fluctuate and charge investors withdrawal fees during times of stress under tougher U.S. rules set for adoption this month. The Securities and Exchange Commission is poised to impose both requirements on some money-market mutual funds, which required a federal backstop during the 2008 financial crisis, according to a person familiar with the matter who asked to not be named because terms of the final rule haven't been made public," wrote Dave Michaels at Bloomberg. "The final rule, which began as a proposal issued last year, is likely to be voted on by the five-member commission on July 23, the person said." (Note: Crane Data's July Money Fund Portfolio Holdings, with data as of June 30, were released on Friday. Watch for our Holdings story on Monday.)
Bloomberg quoted SEC Chair Mary Jo White at today's meeting of the SEC's Investor Advisory Committee as saying, "`The commission is actively engaged with the staff in proceeding to finalize rules in the near-term and I am confident we will adopt very robust rules." Continues the article, "The plan would require prime institutional funds to float the value of their share price, traditionally set at a stable $1, which makes them a popular place to park cash. It also would require funds to impose a 1 percent fee on redemptions and permit them to temporarily suspend withdrawals when liquidity drops below required levels." (Note: the original proposal had a 2% redemption fee, so this is a big concession if true.)
The Bloomberg piece adds, "White is pushing to hold the vote on July 23, the person said. The SEC has been under growing pressure from the Federal Reserve and other U.S. and global regulators to finish the rule. Federal Reserve Chair Janet Yellen said July 2 that progress on new rules for money funds has "been frustratingly slow." Details of the rule could still change before the vote, with at least two commissioners having voiced objections to parts of the plan. Commissioner Kara M. Stein, a Democrat, has questioned whether allowing funds to suspend redemptions could exacerbate, instead of reduce, the risk of runs on a fund. Stein's concerns are consistent with a paper published in April by Fed economists. They wrote that well-informed investors would preemptively pull out money when they believed a money fund might suspend redemptions after suffering a loss."
The Wall Street Journal's article, which broke the news Wednesday evening (July 9), was written by Andrew Ackerman. It said, "Ms. White's plan is expected to gain support from a majority of the agency's five commissioners, overcoming years of internal debate about how best to address money-fund vulnerabilities. Ms. White, Democrat Luis Aguilar and Republican Daniel Gallagher are expected to support the plan, these people said."
The Ackerman piece goes on, "Ms. White still is seeking support from a fourth commissioner, Democrat Kara Stein, who has expressed reservations about redemption limits but is developing her views, these people said. Commissioner Michael Piwowar, a Republican, doesn't support a combined approach, and isn't expected to support the plan, according to people familiar with the matter."
The Journal adds, "Ms. White's approach would combine two options the agency presented last summer when it voted to propose tighter rules: a floating share price for prime institutional funds, which are considered riskier than other money funds and invest in short-term corporate debt, coupled with redemption "gates" and fees. Because floating share prices would apply only to prime institutional funds -- which comprise about 37% of the industry -- mom-and-pop retail investors aren't expected to be directly affected."
Ackerman writes, "A deal is partly contingent on the Treasury Department agreeing to ease tax rules on the small gains and losses for investors in floating-rate funds, requirements that funds say would be too burdensome. A person familiar with the matter said Treasury is close to an agreement with the SEC on the issue. A Treasury spokeswoman declined to comment. Ms. White's inclusion of redemption restrictions comes despite the concerns of other regulators who have said limits would encourage investors to bolt over fears they wouldn't be able to withdraw money." (The Journal writer also comments in a video posted on WSJ.com.)
Finally, Time columnist Jacob Davison also wrote about the pending reforms in a piece called "Does Anybody Need a Money Market Fund Anymore?," published July 10. Writes Davidson, "Fund companies are really, really unhappy about the SEC's proposed regulations. They've been fighting the rules for years, and until there's an official announcement, you shouldn't be sure anything is actually going to happen. Others are worried the new regulations, specifically redemption restrictions, might actually cause runs on the market as investors fear they could be prevented from pulling money out if things get worse."
Note that there has been no public or official word from the SEC on these articles or issues, and it's unclear whether the leaks and "sources" cited are from within the SEC or from outside. If the SEC does schedule a vote and meeting on Money Fund Reform, it likely will appear first in the form of a Sunshine Act Notice and will be listed on the SEC's "Upcoming Events" page. (The SEC met July 10, but there is no agenda yet for an expected July 23 meeting.)
The Federal Reserve Board of Governors released its "Minutes of the Federal Open Market Committee, June 17-18, 2014" yesterday, detailing discussions on several money fund-related issues, including the reverse repo facility, interest rate hikes, and the ECB. (For more on this meeting, read our June 19 "News," "Fed Slouches Toward '15 Rate Hike; No Formula for Considerable Period.") Regarding "Developments in Financial Markets and the Federal Reserves' Balance Sheet," the FOMC minutes state: "The SOMA (System Open Market Account) manager reported on the System open market operations during the period since the Committee met on April 29-30, 2014, outlined the testing of the Term Deposit Facility, described the results from the fixed-rate overnight reverse repurchase agreement (ON RRP) operational exercise, and provided some possible options for adjusting the list of counterparties eligible to participate in ON RRP operations. The manager also noted the effects of recent foreign central bank policy actions on the yields on the international portion of the SOMA portfolio and discussed ongoing staff work on improving data collections regarding bank funding markets." (Note: See also today's "Link of the Day" with news about the SEC's pending Money Market Fund Reforms.)
The committee members also discussed monetary policy normalization. "A staff presentation included some possible strategies for implementing and communicating monetary policy during a period when the Federal Reserve will have a very large balance sheet. In addition, the presentation outlined design features of a potential ON RRP facility and discussed options for the Committee's policy of rolling over maturing Treasury securities at auction and reinvesting principal payments on all agency debt and agency mortgage-backed securities (MBS) in agency MBS."
Much was said about the effects of the reverse repo facility, "Most participants agreed that adjustments in the rate of interest on excess reserves (IOER) should play a central role during the normalization process. It was generally agreed that an ON RRP facility with an interest rate set below the IOER rate could play a useful supporting role by helping to firm the floor under money market interest rates. One participant thought that the ON RRP rate would be the more effective policy tool during normalization in light of the wider variety of counterparties eligible to participate in ON RRP operations. The appropriate size of the spread between the IOER and ON RRP rates was discussed, with many participants judging that a relatively wide spread -- perhaps near or above the current level of 20 basis points -- would support trading in the federal funds market and provide adequate control over market interest rates. Several participants noted that the spread might be adjusted during the normalization process."
The minutes continued, "A couple of participants suggested that adequate control of short-term rates might be accomplished with a very wide spread or even without an ON RRP facility. A few participants commented that the Committee should also be prepared to use its other policy tools, including term deposits and term reverse repurchase agreements, if necessary. Most participants thought that the federal funds rate should continue to play a role in the Committee's operating framework and communications during normalization, with many of them indicating a preference for continuing to announce a target range. However, a few participants thought that, given the degree of uncertainty about the effects of the Committee's tools on market rates, it might be preferable to focus on an administered rate in communicating the stance of policy during the normalization period. In addition, participants examined possibilities for changing the calculation of the effective federal funds rate in order to obtain a more robust measure of overnight bank funding rates and to apply lessons from international efforts to develop improved standards for benchmark interest rates."
There was also some discussion of unintended consequences of RRP. "While generally agreeing that an ON RRP facility could play an important role in the policy normalization process, participants discussed several potential unintended consequences of using such a facility and design features that could help to mitigate these consequences. Most participants expressed concerns that in times of financial stress, the facility's counterparties could shift investments toward the facility and away from financial and nonfinancial corporations, possibly causing disruptions in funding that could magnify the stress. In addition, a number of participants noted that a relatively large ON RRP facility had the potential to expand the Federal Reserve's role in financial intermediation and reshape the financial industry in ways that were difficult to anticipate. Participants discussed design features that could address these concerns, including constraints on usage either in the aggregate or by counterparty and a relatively wide spread between the ON RRP rate and the IOER rate that would help limit the facility's size. Several participants emphasized that, although the ON RRP rate would be useful in controlling short-term interest rates during normalization, they did not anticipate that such a facility would be a permanent part of the Committee's longer-run operating framework. Finally, a number of participants expressed concern about conducting monetary policy operations with nontraditional counterparties."
There was further RRP related discussion. "Conditions in unsecured short-term dollar funding markets remained stable over the intermeeting period. The Federal Reserve continued its ON RRP exercise. Total take-up in the ON RRP exercise rose in April and May before falling back in June. Much of the transitory increase in take-up occurred in response to a large seasonal reduction in outstanding Treasury debt and an associated drop in the rates on Treasury repurchase agreements during the first half of the second quarter that were reversed during the second half. In May, the Federal Reserve began an eight-week series of test auctions of seven-day term deposits. The number of participants and the total amount awarded increased over the course of the first five operations." (Note: Crane Data will be releasing its June 30 Money Fund Portfolio Holdings data late Thursday, which will show which funds owned the record amounts of Fed repo at the latest month-end.)
The FOMC also talked about the European Central Bank's June 5 rate cut. "The expected path of ECB policy rates implied by market quotes for short-term interest rates fell over the intermeeting period, as investors anticipated the easing of policy announced by the ECB at its June meeting. By contrast, late in the period, market participants interpreted statements by Bank of England Governor Carney as signaling an earlier tightening of policy than had been anticipated, and near-term policy rate expectations moved higher in response."
Related to raising the federal funds rate, "Results from the Desk's June Survey of Primary Dealers indicated no change in the dealers' consensus expectation about the most likely timing of the first increase in the federal funds rate target but showed a lower median longer-run level of the federal funds rate relative to the April survey.... The Committee agreed to maintain its target range for the federal funds rate and to reiterate its forward guidance about how it would assess the appropriate timing of the first increase in the target rate and the anticipated behavior of the federal funds rate after it is raised. The guidance continued to emphasize that the Committee's decisions about how long to maintain the current target range for the federal funds rate would depend on its assessment of actual and expected progress toward its objectives of maximum employment and 2 percent inflation."
Finally, in its "Summary of Economic Projections," there was commentary related to rate hike projections. "Nearly all participants judged that economic conditions would warrant maintaining the current exceptionally low level of the federal funds rate at least until 2015. Relative to their projections in March, the median values of the federal funds rate at the end of 2015 and 2016 increased 13 basis points and 25 basis points to 1.13 percent and 2.50 percent, respectively, while the mean values rose 7 basis points and 11 basis points to 1.18 percent and 2.53 percent, respectively."
At Crane's 6th annual Money Fund Symposium in Boston, an expert panel explored trends in the money funds alternatives space during a session called "Enhanced Cash, SMAs, and Ultra Short Options," moderated by Alex Roever, MD, J.P. Morgan Securities. The panelists were David Fishman, MD, co-head of liquidity, Goldman Sachs Asset Management, Jonathan Carlson, MD, Bank of America Global Capital Management, and Peter Yi, director, short duration fixed income, Northern Trust. "What's confusing about this space is there's so much different nomenclature," said Roever, kicking off the session. There are short duration bonds funds, enhanced cash, some 3 or 4 different categories within this space between traditional money funds and the core bond fund.
"When you are talking to a client, how do you explain which strategy you are trying to sell them?" asked Roever. "Typically, you tell them whatever they are looking for is the exact sweet spot on the curve for them," quipped Carlson. "But there is a wide gamut so salespeople have to know who they are talking to, how much cash they have, how much risk they want to take with their cash, where the cash in domiciled -- all of those things go into the risk appetite. Depending on how opportunistic they want to be with a sleeve, or multiple sleeves, or even all of their cash, will define what space they're in. The more risk tolerant they are, the more that risk tolerance will find its way into the guidelines and the portfolios will get longer, go lower in quality, and make greater use of the securitized asset classes, those kinds of things. When we talk to clients, we talk to them about these sleeves and we work to supply a solution."
Yi said this enhanced cash space/short duration space started to gain traction after the financial crisis of 2008. "The first wave of general interest came from money market investors that ultimately got sick of the zero [yield] interest rate environment. But 5 years later, when the markets have healed and the economy has healed, they are asking the question, 'Why am I still getting 0?' So with this global search for yield, they are looking for new alternatives. When you offer them a more holistic cash management solution like segmenting your cash, allocating a certain percentage into your operational cash needs, a little bit to your reserve, then having your strategic bucket, it makes a little more sense for them."
So what are clients looking for in this space? Said Carlson, "Every client that comes to us says the same three things in the same order: One, it is our cash don't lose it; two, I want to make sure it liquid so I have it when I need it, not when you tell me I can have it; and three, give me some added yield in compensation for the risk that I'll let you take."
Fishman talked about portfolio construction. "When we look at a typical short duration benchmark, you are going to include Treasuries, government agencies, and high grade corporates -- those are the three basics in almost every short duration portfolios that we manage. What we've seen is, when rates were higher, sometimes that was enough. But as rates have been driven lower, people have started to add tools to their tool belt -- they've added asset-backed, then mortgage-backed paper, and as spreads have been tighter in each one, we've seen corporates expand out to high yield, usually triple-B. We don't see too many corporates going down into double-B, but you get into high yield, EM, bank loans, CLOs. What happens is, we keep adding categories as yields go lower."
He adds, "In the search for yield, people will start to explore other asset classes. There are asset classes that a short duration would have never have looked at before that they are now looking at -- high yield paper for one. Very short-time to maturity high yield paper was taboo in these types of products historically; now we have conversations with clients almost every day about adding that."
Yi says his firm spends a lot of time focusing on the new issue market. "Right now the dynamics in the new issue market are so robust, there are deals every week. It's really a healthy market and we view that to be a sign of really good dynamics for the fixed income space." He adds, "Most of the activity now is definitely in the new issue market. If you have the access to it, that's where you get most of your supply."
On the prospect of negative returns in a rising rate environment, Carlson said, "I think it's important to define what performance is. Total return is what we all live and die by, but it's not necessarily what our clients look at and its not necessarily, in our case, even what are clients are sometimes even remotely interested in." He continues, "Some clients don't even look at the page that shows the total return -- they want to know what is the book yield on their portfolio, what's the income that they are making. It matters internally, you want your composites to look good, you want to market yourself, but to a lot of clients, total return doesn't really mean all that much."
Also, the panelists spoke about the lack of an adequate benchmark in this space. "You can't find a great benchmark in this space," said Carlson. "There is not one that matches a mandate, so we have found, at least in the SMA space, the best benchmarks are other managers for that same client."
Finally, the panelists were asked if money market reform pushes money into the enhanced cash area. Said Fishman, "Reform is going to put money in motion, and money in motion has to land somewhere. The nice part is, there are a lot of landing spots for it. It's going to cause people to examine things they haven't thought about before. The world was very orderly before. We're going to go into a period of disorderliness when money fund reform gets announced. The first thing to do is take a deep breath and exhale -- there's nothing we need to do ... yet. But now is the time to start getting educated on what those options are. And yes, money is going to end up in this space by pure action of reform."
Added Carlson, "The Fed took rates to zero in the 4th quarter of 2008, and the size of the money fund industry is [still] $2.6 trillion. So there's got to be something that money funds offer that is over and above the zero rates.... Maybe I'm being way too simplistic, but dollar in, dollar out NAV has got to be a big one of those things. If that goes away, I think money almost automatically has to migrate into this space."
The July issue of Crane Data's Money Fund Intelligence was sent out to subscribers on Tuesday morning. The latest edition of our flagship monthly newsletter features the articles: MMF Reform Regulations Delayed; Stalemate Part II?," which discusses the delay and possible stalemate of money market reform; "Fidelity's Nancy Prior Says Black Clouds Parting," which summarizes the keynote speech from Fidelity's top money fund leader; and, "State of Money Funds: Highlights of Symposium," which reviews a number of sessions from our recent Money Fund Symposium conference. We also updated our Money Fund Wisdom database query system with June 30, 2014, performance statistics and rankings late Monday night, and will send out our MFI XLS spreadsheet Tuesday a.m. (MFI, MFI XLS and our Crane Index products are available to subscribers at our Content center.) Our June 30 Money Fund Portfolio Holdings data are scheduled to go out on Thursday, July 10.
The latest MFI newsletter's lead article comments, "Though SEC Chair Mary Jo White has repeatedly said Money Market Fund Reforms are coming in the "very near term," recent press reports and discussions among money fund managers and lawyers indicate that it could be months more before we see any final rules. Some are even predicting an indefinite stalemate. We still believe that dropping the floating NAV, or using it only after a threshold is broken, is the only path forward, given the lack of progress with the IRS over 'de minimis' gains issues."
The article explains, "Last month, The Wall Street Journal wrote in "SEC Divided on Money-Market Fund Rules," broke the news that it may be some time before we see money market fund reforms. The Journal article commented, "Six years after money-market mutual funds became a source of vulnerability in the financial crisis, U.S. securities regulators are still hashing out how to limit the risks they pose to the financial system. Tighter rules might not be finalized for several months, according to people familiar with the process.""
Our monthly "profile" piece says, "Nancy Prior, President of Fidelity Investments' Fixed-Income unit, gave the keynote address, entitled, "Money Market Funds: Past and Future," at Crane's Money Fund Symposium, late last month. We excerpt from the text of the speech below. Prior comments, "At long last, it appears we're getting close to the much-anticipated, long-awaited announcement of new money market fund rules from the Securities & Exchange Commission."
She continues, "The skies appear finally to be brightening after what seems like one long, gloomy winter. For the past 5 1/2 years, the money market mutual fund industry has been ... you can pick your metaphor here: Embattled, Under siege, Under a cloud.... Suffice it to say, the past few years have just not been a whole lot of fun. In addition to a very challenging, uncertain regulatory environment, we have had to manage through a prolonged and unprecedented period of extraordinarily low interest rates. Given all of this, it's not surprising that some financial writers predicted that money market mutual funds would not make it through this gauntlet."
The July MFI article on State of Money Funds: Highlights of Symposium explains, "Crane's Money Fund Symposium, held June 23-25 at the Renaissance Boston Waterfront Hotel, featured record attendance with approximately 500 attendees, speakers, and sponsors. It also earned rave reviews for its content, which delved into the major issues on the money fund landscape. Here are some of the highlights."
Crane Data's July MFI with June 30, 2014, data shows total assets decreasing by $13.4 billion (after rising $10.9 billion in May, falling by $59.5 billion in April and $25.9 billion in March) to $2.479 trillion (1,248 funds, down from 1,255 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 41 and 43 days, respectively, unchanged from the prior month. (See our Crane Index or craneindexes.xlsx history file for more on our averages.)
The Wells Fargo Advantage Funds Money Market Funds team did such a spot-on recap of the 6th Annual Crane Money Fund Symposium in its June 30 "Portfolio Manager Commentary" that we thought we'd share it with you. "Last month we attended the Money Fund Symposium sponsored by Crane Data. With nearly 500 attendees, this is the largest conference aimed at money market fund portfolio managers, credit analysts, investors, servicers, issuers of money market securities, and others involved in the money market fund industry. There were a number of good panels and many enlightening side conversations, but those of us here who attended had a common takeaway: an underlying current of frustration," writes the team, led by Dave Sylvester, head of money funds at Wells Fargo. (Sylvester moderated a dealer panel that talked about supply -- see our previous story here. Another member of the team, Mike Bird, senior fund manager, taxable money funds, spoke at a session called "Government Money Fund Issues & Repo Update." Note: To subscribe to Wells' free monthly Money Fund "Portfolio Manager" Commentary, click here.)
The Wells commentary continues: "Many participants expressed frustration with the glacial pace of so-called money market fund reform measures. After having the floating net asset value (NAV) of Damocles hanging over their heads for more than a year now, we understand the desire of some to move on. But we'll not join one participant who voiced the view that it almost doesn't matter what the Securities and Exchange Commission does, so long as we get something soon! While we don't generally comment in this forum on the proposed amendments to Rule 2a-7, we would counsel patience and are thankful that the regulators are taking a measured and thoughtful approach to what might prove to be deeply significant and long-lasting changes."
It says, "There was also a general undertone of frustration with how long we have had to endure the Federal Reserve's (Fed's) zero-interest-rate policy. It is staggering to think that the federal funds target rate has been set between 0 and 25 basis points (bps; 100 bps equals 1.00%) for five and a half years now! Conference participants shared an almost universal belief that short-term rates will rise in 2015, prompted most certainly by the Fed's own forecasts, colloquially known as the dots. What surprised us somewhat was that everyone seemed to accept that any rise in rates would be clearly signaled well in advance in clear and universally understood terms and that the Fed would hike rates in a slow and deliberate manner. The Fed's own forecasts, along with speeches by some of the Federal Open Market Committee (FOMC) members, reflect considerably more diversity of opinion than we encountered at the conference. What's more, if conference participants are heeding the FOMC's warnings that changes in current interest rate policy are dependent on the strength of the economy, they must share a universally rosy view of those prospects."
Wells continues, "There also seemed to be an almost unquestioning faith in the Fed's ability to manage the next phase of monetary policy through the dual mechanisms of interest on excess reserves (IOER) and its reverse repurchase agreement (RRP) program despite the fact that both are brand new tools that have never been used to manage monetary policy, let alone in an environment where the Fed has a $4 trillion balance sheet. While RRP seems to be successful so far in its role as the new rate floor, few people seemed to recall that IOER, which now acts as a ceiling on money market rates, was actually designed to put a floor under them and now has to be supplemented by the RRP. Even without this misstep, the complexity of the markets alone makes us think that somehow, some way, things will not go as smoothly as our colleagues seem to expect."
Wells Fargo also summarized a session on supply, "Conference attendees also expressed frustration with the continued lack of supply of eligible money market investments, especially in the shorter maturities. One particularly engaging presenter noted that the total money market supply is down almost $2.5 trillion since its peak in 2008, whereas money market fund assets have fallen only about $435 billion during the same period. This has created a real shortage of investable assets and is one factor enabling money market yields to regularly trade below IOER. We noted that banks are curtailing their issuance of shorter maturities as they move into compliance with the Basel liquidity coverage ratio, while others are trimming the size of their repurchase agreement (repo) books to fit the requirements of the supplementary leverage ratio. Cocktail party talk sometimes seemed like a competition between the different banks to see which had the longest minimum maturity it would write or which had cut the size of its repo book the most. There were, however, a couple of faint rays of hope on the supply front as some of the dealer panelists looked for a modest increase in the amount of asset-backed commercial paper outstanding, while others thought that nonfinancial commercial paper would continue to grow. Both of these are relatively small segments of the market, though, and any increase there will not make up for cutbacks in the certificate of deposits, Treasury, and repo markets."
"Generally it was felt that once the Fed's RRP program started up in earnest, money market funds could use it to fill their daily and weekly liquid-asset buckets. But several participants expressed a reluctance to completely embrace the Fed's program. Some expressed a reluctance to tie their portfolios to an investment with an administered rate and preferred the market-based rates in the repo and time deposit markets, while others questioned whether RRP could really be counted on as a permanent feature of the market. Still others questioned whether a portfolio that only had one repo counterparty was consistent with the concept of diversification."
It concludes: "Overall, the conference had an optimistic tone with respect to the outlook for money market fund assets. Many panelists and participants expressed the view that should assets eventually leave prime funds because of a floating NAV, most of that money would end up in government money market funds. One panelist expressed the view that the increased cost of wholesale deposits would cause banks to turn away institutional depositors who would then turn to government money market funds. While it is hard for us to envision banks actually turning away creditworthy institutional depositors, we did talk to one hedge fund representative who was doing due diligence on money market funds specifically because the banks they work with had capped the amount of deposits they would take. Whether or not this becomes a theme remains to be seen. Overall, it was once again an excellent conference and one that we would recommend to anyone interested in an in-depth look at the world of money market funds. Despite the frustrations expressed by the participants, the overall mood remained upbeat, and the industry seemed well positioned to meet the challenges of the future."
For more coverage of the conference, check out the following links: Fidelity's Nancy Prior Gives Symposium Keynote: Black Clouds Parting; State of the MF Industry: Nowhere to Go But Up; Feeling Good in Boston; Senior PMs Talk Ratings, Regulations, Trends at Money Fund Symposium; More Money Fund Symposium Highlights: Major Money Fund Issues 2014; and Yet More MF Symposium: Dealer Panel on Supply Outlook, New Products. Attendees and subscribers can also hear the recordings and see the final Powerpoints and binder in our "Money Fund Symposium 2014 Download Center" here.
A press release sent out yesterday says, "The Institutional Money Market Funds Association (IMMFA) has today published an updated set of Position Papers on the European Commission's proposal for a new Regulation for money market funds: "Regulation of the European Parliament and of the Council on Money Market Funds ('MMFR')". IMMFA supports many of the provisions in the MMFR. The introduction of minimum liquidity and diversification requirements, "know your client" policies and enhanced transparency will make money market funds (MMF) even stronger and improve their resilience in stressed market conditions. IMMFA also proposes additional measures such as the use of trigger-based liquidity fees and gates to meet regulators' desire to reduce run risk in MMF whilst maintaining them as an effective product for investors." (Note: Crane Data will be hosting its second annual European Money Fund Symposium September 22-23, 2014, in London, where these issues will be discussed in detail.)
The London-based IMMFA explains, "The position papers address in addition many of the fundamental questions raised in the policy debate on MMF debate including: Why accounting funds as variable NAV (VNAV) rather than constant or stable NAV (CNAV) has no impact on the degree of risk in the financial system; What might become of the E480bn invested in European CNAV MMFs if key aspects of the proposal are implemented; Why investors find CNAV MMF so useful; and The role CNAV MMF play in funding SMEs and other businesses across Europe."
Susan Hindle Barone, Secretary General of IMMFA, comments, "Money market funds are a key component of the capital markets and an invaluable tool for many of the enterprises which are the engine-room of recovery and growth in Europe. We are keen to work with regulators to ensure that we address the real issues at the heart of the MMF debate. The key to reliable, robust funds lies in liquidity and transparency. Liquidity fees and redemption gates are the most direct and effective measure to dampen volatility in stressed market conditions. We hope that these position papers assist in a fuller understanding of this important sector."
The release adds, "IMMFA also announced changes to its Board composition following its AGM last week. Jonathan Curry of HSBC Global AM was confirmed as Chair of IMMFA for a further year. Kathleen Hughes of Goldman Sachs was re-elected and James Finch of UBS Global AM elected as Board Directors of IMMFA. Susan Dargan of State Street Global Services was re-elected as Board Director representing Associate Members."
The full set of "IMMFA Position Papers" subtitled, "Regarding the European Commission Proposal for a Regulation on Money Market Funds," explains, "The following documents comprise an industry response to the European Commission's Proposal." The "IMMFA Summary Position on Money Market Fund Reform," says about "Money Market Funds," "Money Market Funds (MMFs) form a large and important sector of the European mutual fund industry, with just under E1 trillion assets under management. They are used by both retail and institutional investors, across many European countries. They are cash management vehicles, which provide investors with access to professional credit and operational risk management skills, in a transparent, low-cost and easy-to-use format. As well as being a useful tool for investors, MMFs are important for the wider European economy. By aggregating the cash holdings of a wide range of investors, they are able to provide scale funding for banks, financial institutions, corporations and businesses. They are also the leading investors in the short-term securitised asset market, which has been identified by both the European Central Bank and the Bank of England as a key market to improve the credit flow from the financial sector to the wider economy."
It continues, "The Institutional Money Market Funds Association (IMMFA) represents MMF managers and sponsors, who offer MMFs to institutional investors. In addition to "short term MMF" regulations and UCITS regulations, all IMMFA members abide by a Code of Practice that sets out the best standards of investment risk management for MMFs. IMMFA works with policy makers and regulators to provide information and advice about the European money markets, and to represent the views of MMF managers and investors in discussions about the future regulation. IMMFA welcomes the European Commission's desire to establish more consistent and more transparent regulation of the MMF sector in Europe. IMMFA shares the Commission's aim to ensure that the MMF sector is well prepared for the possibility of distressed financial markets in the future; and to ensure that the MMF sector does not become a conduit through which market contagion passes on to the banking sector."
Regarding the "European Commission Reform Proposals," the paper comments, "Nonetheless, IMMFA believes that some of the Commission's draft reform proposals will not achieve these shared aims. Indeed, some of the proposals are likely to make the European money markets less effective. If implemented in full, these new regulations will make it more expensive for European businesses to raise funds for new investment and more expensive for individuals and institutions to manage their cash holdings. Yet, the money markets will remain vulnerable to systemic risks. IMMFA has produced a series of papers which explain in more detail what MMFs are and why they are important to the European economy. They also describe, in some detail, why some of the European Commission's proposals should be amended or withdrawn. These papers make the case for a MMF sector that is safer and more transparent, and which continues to provide services to investors and borrowers in a cost-effective manner."
IMMFA writes of "The Major Risks," "MMFs lend money to a range of borrowers, including governments and government agencies, banks and other financial institutions, corporations and businesses. The main risk to the investors in a MMF is that one of these borrowers fails to repay their loan. A second risk is that market participants judge it unlikely that a borrower will be able to repay, and the price of this borrower's debt falls in value in the secondary market. The best defence against these risks is to diversify the portfolio, with a wide range of high-credit quality assets of short-duration."
They explain, "Well-run MMFs employ a range of risk mitigation strategies and are very unlikely to suffer defaults or significant falls in value. However, if other mutual funds or money market investors encounter problems with their asset holdings, and sell significant volumes of assets into the secondary markets to liquidate their positions, these credit problems can be quickly transmitted to MMFs, a process known as "contagion". Falling prices of bad assets drag down the prices of good assets. In such circumstances, MMF investors might decide to switch from bank and corporate credit to government credit, and a run on MMFs might result."
IMMFA says about "How to Reduce these Risks," "In a distressed market, where prices of both good and bad assets are falling, and where investors embark on a flight to quality, even well-run MMFs are vulnerable. Regardless of the amount of liquid assets in the fund, and the credit quality of these assets, when there is a sudden and significant demand from investors to redeem their holdings, all MMFs face major challenges. The manager has to decide whether to liquidate their asset holdings to meet redemption requests, probably incurring losses and possibly amplifying the rate of falling prices. Or, the manager could shut the fund temporarily, imposing a fee on investors who need to redeem, thereby stemming the flow of cash out of the money markets while ensuring that all investors are treated fairly."
The paper continues, "IMMFA strongly supports this second course of action, namely introducing redemption gates and liquidity fees. These mechanisms make it impossible for investors to run from their MMFs unless they pay a premium for liquidity during a distressed market. These mechanisms are the equivalent for the mutual fund industry of bank holidays in the banking industry. Whereas asset sales by MMFs into falling markets would be likely to accelerate investor flight, the introduction of redemption gates and liquidity fees would help to decelerate the spread of contagion."
It adds, "A number of other solutions have been proposed, with the aim of dissuading investors from running from their MMF during distressed market conditions. These include requiring MMFs to hold a capital buffer of 3% of the net asset value of the fund, or requiring MMFs to change their pricing structure -- both for the assets in the fund and the fund itself. The European Commission has supported the use of a capital buffer, the move to variable pricing for MMFs and the move to mark-to-market pricing of assets within a MMF."
The paper explains, "IMMFA believes that these changes would be highly disruptive of the MMF sector, raising costs for investors and borrowers, without in any way reducing the risks that are inherent in the wider money markets. IMMFA believes that regulatory reforms should focus on the actual causes of risk -- the quality of the assets and the ability of investors to redeem their holdings -- rather than superficial issues concerning fund structures and prices."
Finally, IMMFA's "Conclusion" says, "There is no evidence to suggest that changes to accounting and pricing structures within MMF would stop investors from running when markets become distressed. By contrast, imposing redemption gates and liquidity fees would be a cheap and effective solution. IMMFA supports the introduction of smart regulatory reform, which will preserve the benefits of the MMF sector -- for investors and borrowers -- while reducing systemic risk."
Supply, or lack thereof, has been one of the biggest challenges in the money fund industry in recent years. An expert panel of dealers at the 6th annual Crane's Money Fund Symposium took a closer look at supply and new products found a few rays of hope in an otherwise dreary environment. "Since 2008, supply is down $2.5 trillion. I think we know that supply is an issue in this market, but there can be some bright spots and changing in complexion," said Dave Sylvester, head of money funds at Wells Fargo Advantage Funds and moderator of the session, called "Dealer Panel: Supply Outlook, New Products." Sitting on the panel was Stewart Cutler, head of originations at Barclays, Ron Flynn, executive director, J.P. Morgan Securities, and Jean-Luc Sinniger, director, Citi Global Markets. (Attendees of Money Fund Symposium and Crane Data Subscribers may access the Conference Downloads -- the full binder, recordings and Powerpoints here.)
One of the potential bright spots discussed was a new commercial paper program issued by Apple that had no backstop facility. Is this a growing trend? "That is a corporate program where the issuer did not have to seek a backstop liquidity from a bank, essentially, the liquidity is provided through the cash sitting on the balance sheet of the issuer," said Sinniger. "That is quite exceptional, but it is not unique. Usually, there needs to be 100% backup liquidity of some sort for CP outstanding. In most cases, for corporate issuers, that liquidity is provided by bank lines. I don't necessarily think that program is announcing any kind of new trend although it would be nice because that would provide some relief for banks which liquidity is scarce and sometimes it will be difficult to get the backup client."
Added Flynn: "I think it's helpful on the margin, but is that enough to drive more corporate issuers into our market? I think the answer to that is no. The Apple situation is not unique, but it's still interesting when a client can come without any committed bank backstop. We do think corporate CP outstandings are going higher. We certainly expect to see continued growth in that space."
Sylvester asked the panelists to talk about the advantages and disadvantages of direct issues. "Over the last 12 month we've seen two large issuers who have elected to stop issuing directly and to distribute their paper through dealers," said Cutler. "From their perspective, the dealer service distribution capability, low fees, and value added was really a better strategy than supporting a direct issuer desk. It wouldn't surprise me over the next 12 months if we see others abandon the direct issue format in favor of dealer distribution. That's more for the non-financials. As for the advantages there may be an opportunity to eliminate the dealer fee and then get a slightly higher yield in terms a direct transaction." He added: "The benefit of going through the dealer community is the ability to obtain price guidance and other market intelligence as to where other issuers are getting priced and volume executed on a daily basis. To some degree, going directly to investors inhibits that free flow of information."
Flynn discussed growth in other areas. "The callable puttable market has grown quite substantially in its popularity. The numbers are modest at this point, but we certainly do expect this to be an area for growth." In the callable market, there has been $46 billion issued by 7 banks and 2 conduits year to date, he said. Deutsche Bank, Credit Suisse, and UBS are the top three banks. In the puttable market there has been $15 billion issued by 8 banks and 4 conduits, Flynn added. The three largest issuers are Societe Generale, Deutsche Bank, and UBS.
Sylvester asked the panel about products that might help money market funds maintain a stable yet variable NAV in a rising rate environment, given that rate increases appear to be on the horizon. "Floaters may come back into mode as we go forward into a rising rate environment," said Cutler. "Many of our issuers are right now checking to make sure they have the flexibility to issue floating rate notes should we get into that rising rate environment. They are more likely to maintain a stable price during a rising rate scenario then straight fixed rate paper especially if its 90 or 180 days. The second might be the puttable product. The final product I would point to is the new 2 year floater," he said. That is a product designed to maintain par value as rates are increasing, he added.
There was also some discussion of the Federal Reserve's reverse repo facility. Said Flynn: "I think it's fair to step back and to talk about the different levers the Fed can pull to change the complexion of that facility -- first and foremost is price, second is the approved counterparty list, three is the counterparty limits, how much can each fund or counterparty take out of the facility, and then the aggregate limit to the facility. Clearly what the fed will do will be dictated by the market or conditions at the time and their ultimate objectives."
"The Fed looks to this facility very much as a stabilizing force. It's not viewed to be a destabilizing force and they've got plenty of time and they are being very thoughtful and deliberate and I think that's exactly how they'll proceed. If they look to pull or change any of these levers, it'll be meaningful and I do think some of the supply will be ultimately pushed out of the market. But ultimately it'll be more periods of adjustment that markets will have to rebalance around."
Also, the on asset-backed commercial paper market, Sinniger is hopeful about its prospects. "I'm actually fairly optimistic about the asset backed commercial paper market. In Europe, the head of the ECB has given some very positive feedback on what he thought about securitization and I think regulators are starting to realize it is a very good engine of growth for funding the real economy. Other good news, when you talk to issuers of ABCP, they say that their pipeline is very healthy. There is definitely assets that need to be securitized and on the buy side there are also a lot of investors that are looking for the product. It's actually a great product from a credit standpoint. All the ingredients are there to see ABCP coming back."
Finally, the panel talked about growing or emerging new markets. "We've seen issuance come out of Chile and China, Singapore, a handful of new geographies in the past 4 or 5 years," said Flynn. "We would expect this trend to continue. It's modest by comparison with Europe, the U.S., and Australia, but meaningful nonetheless and the most likely avenue for growth."
What are the major money fund issues of 2014? A panel of experts explored this question in detail at Crane's 6th Annual Money Fund Symposium and some themes emerged -- uncertainty, perseverance, and optimism. "If you had told me 6 years ago that we'd still have $2.6 trillion sitting in money market funds in 2014 at the rates that we've had, I would certainly not have predicted that," said panelist Charlie Cardona, president of Dreyfus Corp. and CEO of BNY Mellon Cash Investment Strategies. "I think it's an immensely strong testament to all the things that people like about money market funds." Cardona sat on the panel alongside Andrew Linton, executive director, J.P. Morgan Asset Management, and Matt Steinaway, senior managing director, State Street Global Advisors. The session, called "Major Money Fund Issues 2014" was moderated by Roger Merritt, managing director, Fitch Ratings.
One of the big issues discussed was the yield environment. "It goes without saying that the environment remains challenging for yield," said Steinaway. "We have seen a broad range of regulations that have impacted our markets, everything from Basel III to Dodd-Frank to the pending 2a-7 regulations. There has clearly been a storm of regulations that have come into play and impacted our ability to access collateral. It is more on the issuer side where we are seeing most of our challenges. As we look across the landscape at opportunities to invest on our clients behalf, we are increasingly restrained as all of our counterparties one by one start to comply with some of the new rules that are in place. What we were hoping perhaps was more of a '15 or '16 event, has clearly become more of a '14 event. We're starting to see significant impact on our ability to access supply on the front end."
"On the repo side, we are also seeing the same impact with tri-party reform. Tri-party reform, the Federal Reserve initiative to reduce risk in that system, has also had the effect of lowering the amount of repo outstanding and changed the mix of repo outstanding. What was largely a liquidity product is evolving slowly to become more of a yield product where we are seeing more unique structures and more unique collateral types. We do think that is a good opportunity set, however it does detract from our ability to source liquidity product for our clients."
On the topic of fee waivers, Cardona said: "We all define our time in the business as pre-2008 and post-2008 and I look back fondly on pre-2008 because clearly we have all been under significant stress due to interest rates and regulatory assault. Fee waivers are a fact of life that we've all lived with for 6 years now. It's painful for us as an advisor, it's painful for our distribution partners to share in the waivers, and it's very painful for savers, those that save and manage finances prudently who can earn nothing on their cash and are forced to take on risk to earn any yield."
"We certainly waive as much if not more in fees than we keep today. But the business remains profitable, everybody is sharing in the pain. But we have a long-term commitment, as does many of my colleagues in the industry. The longer it goes on, the more determined we are to ride it out and see it through. Hopefully, a year from now we're in a better space. I don't think the model is broken -- it is severely challenged, but it is not broken. There is always going to be cash to manage, the way we do it today may look different from the way we do it tomorrow, depending upon the outcome of reform. But we certainly are committed to riding out the environment. The worst days are hopefully behind us and the better days are coming."
Linton shared his thoughts on the growing interest in separate accounts. "We have a separate account business that has seen over the past 5 years significant inflows. It is very customizable to clients guidelines where we can look at their liquidity needs, their credit requirements, how much risk they are willing to accept and customize a portfolio for them." Linton added: "Clients are really getting more focused on how much liquidity they actually have to have and how to segment out their cash into what needs to be liquid and what needs to go to a separate account where they can customize the guidelines, get as much yield out of that money that needs to be less liquid. That's the big trend we have seen from our clients over the past couple of years."
Steinaway talked about risk clients appetite for risk. "I don't think that many of our clients are looking for us to take inordinate risk to generate yield in portfolios. We live in this very weird world where there are clients who are very happy generating zero percent returns in their funds, so we have had inflows in a range of products and continue to take inflows. As one of our clients said, I wouldn't be in cash if I didn't need to be. So the balances that we see are stable balances. Not necessarily strategic allocations, but a core fundamental balance of cash."
Cardona added: "With respect to portfolios, we've all been homogenized a bit more under the 2010 reforms, which I think have been good and meaningful for the industry as far as mandating liquidity levels, weighted average life, and shorter weighted average maturities. There really isn't much of a premium that we see at this point to go out very long in our funds."
On pending reforms, Linton said: "I can't wait for them to come out -- let's get it over with. The SEC itself said it’s like being 10 months pregnant and I kind of agree with them." Regarding reforms, Cardona said, "We're an advocate of choice among those options. Let the buyer decide if they want a fluctuating NAV product. We can certainly structure it, but it would need to be accompanied with tax relief. We do believe there is a portion of our client base that would use a product like that. There are others that would not and would be more a proponent of a stable NAV product and, with a better understanding of how fees and gates might work, would probably be more amendable to using that type of product. But clients are just plain weary of the conversations, and it's been going on so long that we're all just anxious to get closure to it."
Finally, the panelists were asked to take out their crystal balls and predict what the money fund industry will look like in 5 or 10 years. "I'm an optimist by nature," said Steinaway. "I think the industry is healthy and is growing. We've proved over the last several years with low rates that there is a fundamental need for the services that money markets provide. There may be fundamental challenges in how we meet our investors demand and they may have to think about the risk they take and how they structure portfolios, how they use guidelines, how they use ratings, and how much liquidity they need. But fundamentally, the service that they need, we provide. As rates rise, innovation re-enters the marketplace. When we get some yield, I can assure you there will be a lot more innovation from the street."
Added Linton: "This industry is full of very intelligent, innovative people. No matter what the regulations throw at us, we will find a way to serve our clients." Concluded Cardona: "I'm very proud of to be part of an industry that has always approached this business with a tremendous degree of integrity and fiduciary capacity. There is going to be cash to manage -- whether it's for retail individuals or institutions, and having lived through and survived what we've been through, I too am an optimist. Regardless of how we may need to restructure and retool it, it may look a little different. But you will be here for Peter Crane's 10th, 15th and 20th annual conference."
A trio of money market fund portfolio managers shared their thoughts on what they're buying (and not buying), the impact of pending regulations, and the effect of rating agency rules during a lively and informative panel discussion at the 6th Annual Crane Money Fund Symposium in Boston (June 23-25). "Senior Portfolio Managers Perspectives," moderated by Joel Friedman of Standard & Poor's Ratings, featured comments from Rich Mejzak, co-head of portfolio management at BlackRock, Rob Sabatino, MD at UBS Global Asset Management, and John Tobin, MD at J.P. Morgan Asset Management. (Note: The full conference binder, session recordings and Powerpoints from last week's Money Fund Symposium are available to Attendees and Subscribers here and via our "Content" center.)
One hot topic during the 50-minute session was on how pending money market reforms impact the job of portfolio manager. "We've all become experts in the regulatory environment, spending a lot of time talking to different officials, discussing it within our organization and ultimately, where the product is going to migrate towards," said Sabatino. "It seems like clients as well as us in the industry just want to get it over with. We've been talking about this for so many years, we just want to know what our fate is going to look like. Several months ago we thought we were getting closer to a resolution, but now it seems there is really no magic bullet. Unfortunately we're not going to have an answer in the next several months, it seems."
Added Mejzak: "Regarding the increase in the reporting requirements and the increased transparency, while many of the reports that are required now are automated internally via our systems, they still need to get reviewed. Our entire team spends a lot off time reviewing the reports that go out."
Sabatino said the reforms will likely be different from the 2010 regulations. "It's not just about safeguarding the industry as it was in 2010. Now they are really looking at changing the product, and with that comes a lot of spillover impact, not only for us managing the products, but for the investors and the issuers in the space. There's really no silver bullet. If you really want to strengthen the product, it needs to be a process that safeguards the products and looks out for the investors rather than just takes away the options for investors -- that's really where it seems like regulations are headed."
When reforms do occur, Mejzak expects to see money move from prime funds to government funds. "Initially, I think they are waiting until: one, the Fed repo facility gets to the capacity they want it to get to; and, two, short term rates are at least stabilized or trending higher so the market can absorb the demand for the government product that would be anticipated by such a shift. They don't want this to be disruptive. Until the market demonstrates that it's able to absorb that shift, I don't expect them to do anything as far as the regulations goes."
Another discussion centered on what the portfolio managers are buying and avoiding. "One of the things that been a good story is the improvement in bank quality over the last 6 months to a year," said Tobin. "That's had an impact on our approved list. Names that we were only buying out to 3 [months], we're now buying out to 6 [months] and 1 year. That allows us to buy floating rate product. We like to have 25% of our fund in floating. It was virtually impossible to do when we had names approved after 3 months. So given the improvement in our approved list, we've been adding 1 year. In terms of what we haven't bought, we haven't played in the Treasury floater yet. It looked expensive in the last two go-rounds."
Tobin added: "Certainly, the Fed having the reverse repo facility has helped a lot, and you can see that given the utilization. The Treasury and agency funds are super-reliant on it. It's also a key strategy for us -- we're big players in the space."
Mejzak offered his thoughts on repos. "Clearly, the market is migrating towards more alternative collateral and longer term structures, away from the GC and the overnight structure. We're a big player in alternative repo, specifically in our securities lending portfolio, where we're finding it one of the few places we can generate any alpha right now. We deem it to be one of the best opportunities in the marketplace right now. We recognize where the market is going -- it's going longer in structure and certainly much more towards the alternative collateral. It's a place where we intend to remain very active."
The panelists also commented on challenges related to credit ratings. "The banks have done a phenomenal job of terming out their liabilities. But I think there's another stress that's lying on top of that -- it relates to rated funds," said Tobin. "If you think about how each of the agencies approaches their ratings -- two use more of a threshold approach, and one uses more of an analytical framework, where they are assessing the credit piece and the liquidity piece in a stress scenario. That particular one [Moody's] becomes very painful as you try and add mid- to high-single A names at 3 months or longer. I think issuers are probably hearing push-back that we're full to your name because you're a mid- to high- single-A, and we really need double-A names in order to hold the triple-A rating. That's been an added stress on top of the limited supply that we find in the marketplace."
Added Sabatino: "That's going to be a huge challenge for our industry. The rating agencies as a whole need to look at their practices, reassess some of the criteria, and hopefully we'll have an active dialogue with them to ensure that we can continue to hold these ratings. The fact is, we feel from a research perspective that many of these credits have improved dramatically. Their balance sheets look better, [and] profitability, while stressed in some areas, continues to remain robust. From a credit standpoint, we're more confident. Yet from a rating agency standpoint they are lower rated. We're at a point where it's going to be hard to find the double-A bank credits, and the space is going to migrate to triple-B plus. `That's going to be an issue for money market funds in general."
Mejzak commented on new products, "Over the last 12 to 18 months, anticipating money fund reform at some point, we have launched 3 short duration floating NAV products to fill out our entire product set in the cash space and at the same time, [and to] offer an opportunity for additional yield in this environment. Then last December we launched the cash ETF. We just realized that cash as an asset class is going to be different -- how different and what it will look like we can guess. But we don't know, and we think it's important to have a full array of products that can satisfy our investor base."
Sabatino added: We really don't know which product is going to be the one that's going to take off because we don't know what the environment is going to look like. Many investors want to know what their options are. They like money market funds, they still like the stable NAV. Regardless of the low rate environment, you see the assets continue to stay in stable NAV money market funds. The fact is, money funds will still be around for quite some time as we know them currently, and there will be a transition period for all of us to figure out what the mousetrap will look like."