FT Alphaville " MMF investors are getting antsy Looks like some investors are getting nervous... Money market mutual funds saw a noticeable reduction of assets under management for the sixth week in a row (third consecutive double-digit decline), with AUM down by $15.2bn for the week ending April 4. Assets of funds targeting institutional investors explained almost all of the decline, dropping $15.1bn. Retail investors" funds closed the week almost unchanged. ... as talk of new regulations for US money market funds has increased in recent weeks. The above is via Credit Suisse. Ben Bernanke seemed to favour new regulations in a speech recently, and on Wednesday the Boston Fed's Eric Rosengren gave a speech arguing in favour of the SEC's proposed reforms. As a quick reminder, the SEC is now considering whether to force MMFs into a floating net asset value and require them to hold more capital against their assets. The regulator might also implement rules that would prevent investors from pulling out some of their money in MMFs during a crisis. Hybrid models are also being considered, and if you want a recap of the proposed reforms and their risk, we've posted an explainer from Barcap in the usual place. Each of these brings risks, and we discussed some of them in our post last week on the issue of deposit insurance and shadow banking. It's also clear why money market funds will protest at these ideas given their thin margins and struggles with finding yield. But whether you agree or disagree with the proposed reforms, Rosengren made several good points in his speech that often go unmentioned in discussions of MMFs, and which are worth highlighting here: 1) Sponsor bailouts of money market funds in the depths of the financial crisis were far more prevalent than is commonly remembered: As Chairman Schapiro of the SEC has recently noted, the "SEC staff provided noactionassurances that allowed more than 100 money market funds to enter into capital support agreements with their [sponsors] in 2007-2008." In addition to many sponsor guarantees, no less than 47 distinct funds received direct support via a cash contribution or an outright purchase of distressed securities at above-market prices - and some funds received direct support more than once. Based on our review of SEC no-action letters and publicly available financial statements, direct support during the time period from 2007 to 2010 was at least $3.2 billion. 2) Such bailouts can't be counted on again: Going forward, one cannot necessarily assume that sponsors will choose to provide financial support; and also, to the extent that the sponsor is a regulated financial institution that requires regulatory approval to provide support, approval of such support is not guaranteed. I would suggest that the ability to assume excessive credit risk under these conditions reflects a potential flaw in the design of money market funds that still needs to be addressed. 3) There was actually a bailout not so long ago: As recently as the fall of 2011, a sponsor provided support to a fund as a result of its holding of downgraded Eksportfinans paper. 4) Money market funds still take quite a lot of credit risk despite the tougher amended 2a-7 standards, and sometimes Tier 1 is loosely defined: One of the challenges in addressing the credit risk of money market funds is that Tier 1 securities that are supposed to reflect relatively low credit risk to money market funds in reality encompass a broad range of credit quality, including some securities with significant credit risk. This is shown in Figure 3, which examines the credit risk of prime funds - classifying their holdings by the credit default swap (CDS) spread of the issuer, sponsor, or liquidity provider of the holdings. As a benchmark, the current five-year CDS spread for U.S. government securities is approximately 30 basis points. As the figure shows, as of September 30 of last year 23 percent of the prime holdings had an issuer, sponsor, or liquidity provider with a CDS quote of between 200 and 300 basis points. Note that the issuers, sponsors, or liquidity providers of 4.5 percent of the holdings had CDS quotes in excess of 400 basis points. This highlights that credit markets are assigning a significant chance that some moneymarket fund investments that current regulation deem permissible could in fact default. And, obviously, that the credit risk embedded in many prime money market mutual funds is substantially greater than the credit risk in U.S. government-only funds. Rosengren makes a good additional point here, which is that it's not enough to simply look at an industry-wide average of risk. It only takes one fund breaking the buck to potentially trigger a run, so this kind of credit risk needs to be examined firm by individual firm. 5) And for all the lessons of 2008, MMFs obviously weren't shy about staying in the market for European bank paper. At the moment they've mostly re-entered the safer European markets, and at short maturities, after being scared off last year - and it's also the case that many European banks are exiting their dollar funding businesses. But surely it says something that more than 60 of these funds, whose business models demand a certain amount of risk aversion, had exposure to Dexia in the first half of last year. Still, something to keep in mind as regulators think of ways to monitor such risk in real-time. Related link: MMFs, deposit insurance, and regulation in the age of the shadow bank run - FT Alphaville This entry was posted by Cardiff Garcia on Thursday, April 12th, 2012 at 21:11 and is filed under Capital markets.