News Archives: April, 2012
Federated'​s Donahue Blasts Falsehoods Spread by Regulators, Media
On Friday morning'​s Federated Investors quarterly earnings conference call, President & CEO Chris Donahue added a segment to the normal presentation that addressed "​myths" surrounding the debate over money fund reform. Entitled, "Money-​market fund regulation comments of J. Christopher Donahue," it says, "​During the last few quarters' conference calls I have made comments and answered questions concerning potential SEC proposals for the further regulation of money market funds. I discussed Federated'​s belief that money funds were meaningfully and sufficiently strengthened by the extensive regulatory revisions to Rule 2a-​7 in 2010 and that these enhancements were tested and worked successfully through a series of challenges in 2011 that included the United States debt ceiling crisis and credit downgrade as well as worries over a Greek default and European bank solvency. You know well our position opposing the SEC'​s draconian proposals for floating the NAV and/​or instituting redemption restrictions and capital requirements. We are among a broad group of businesses, state/​local government agencies, trade associations, public interest groups and financial institutions that believe these rules will destroy the functionality, utility, effectiveness and the very essence of money market funds, which are so vital to our economy."
Donahue continues, "I want to take a few minutes on this call to take a look at on some of the myths that continue to be spread by regulators and simply repeated by many in the media. The first one we continually hear is that money market funds were either at the center of or significantly exacerbated the financial crisis of 2007-​2008. This is not true. If one accepts this falsehood, then the arguments in favor of preserving the utility of money funds for 50 million investors and the multitude of municipalities, corporations and other entities who depend on money funds for efficient funding can be ignored."
He explains, "​The facts tell a very different story. The meltdown occurred because certain financial institutions placed enormous leveraged bets on the subprime housing market amplified in many cases by derivatives and by the Fed'​s easy money policy. When those bets went bad, the complex web of counterparty arrangements between different institutions threatened to cause a general collapse of the system. Importantly, only one money market fund lost its $​1 NAV in September 2008 -- and only after an 18-​month period that saw the failure of dozens of banks, mortgage lenders and other financial institutions causing the credit markets to freeze up."
Donahue tells us, "This is often paired with the falsehood that money market funds are "​susceptible to runs" and were bailed out by taxpayers. The Reserve Primary Fund failure in September 2008, followed an unprecedented period that saw the collapse of Lehman Brothers, a number of major financial institutions on the brink and inconsistent responses to these events by the government. As counterparty risk perception increased, institutional investors redeemed 15 percent of their prime money fund shares, followed by large inflows into money funds backed by government debt. For every dollar that left prime funds, 63 cents flowed into government money market funds. The conclusion that should be drawn from this is that investors were not fleeing money market funds but rather were reallocating assets to the most conservative investments in a reeling market beset by the failures and near failures of many leading financial institutions, unpredictable government policies and widespread concerns about whether prime funds could continue to sell assets into the frozen commercial paper market."
He adds, "The steps then taken by the Fed and Treasury were not a "​bailout" of money funds but rather, in the case of the Fed actions, necessary and proper steps to restore liquidity to the financial system as a whole. It is important to remember that when the dust settled, the Reserve Primary Fund investors lost less than a penny on the dollar and no taxpayer funds were needed. In fact, money market fund companies paid $​1.​2 billion to the U.​S. Treasury for insurance that was never used. This is a remarkable contrast to the costs of the bailouts of 2,​840 failed banks and an additional 592 banks that required '​assistance transactions' at a total cost of $​188.​5 billion from 1971 through 2010."
Donahue continues, "​Today money funds hold 30 percent or more of assets in 7-​day available cash and 10 percent in overnight available cash. Money funds are now required by the SEC to have more than double the amount of cash on hand that was needed in September 2008 to pay redeeming shareholders."
He says, "Another tall tale that is being bandied about concerns the perceived evils of Europe and the view that a significant source of credit risk in money market funds over the past year has been the large exposure to global banks headquartered in Europe. One official even suggested that money market funds could somehow be a conduit for smuggling any unexpected economic problems on the Continent back into the US. Here again the facts paint a much different picture. The majority of U.​S. money market funds' holdings of European-​based institutions are invested in securities of banks that have U.​S. affiliates that serve as "​primary dealers." Primary dealers are financial institutions designated by the Federal Reserve Bank of New York to serve as trading counterparties in the Fed'​s implementation of monetary policy. These dealers are required to participate every time the U.​S. Treasury auctions its securities. They are central players in the U.​S. financial system."
Donahue also says, "Among the instruments of these primary dealers that U.​S. prime money market funds hold, half (​51 percent) are repurchase agreements. Such repos are fully collateralized, usually with U.​S. Treasury and government agency securities that these institutions hold precisely because they are primary dealers. More than half of prime money market funds' European holdings are in banks headquartered in the United Kingdom, Sweden, and Switzerland -- all countries that don'​t use the euro for currency. Total prime money market funds' holdings in the eurozone amount to 15.​5 percent of their portfolios, and virtually all of those holding are in large banks with global diversified operations headquartered in Europe'​s strongest economies -- France, Germany, and the Netherlands."
He continues, "One of my favorite of the fairy tales is the misplaced concern that investors believe that money market funds are guaranteed and there is confusion with banks or checking accounts. Nowhere in any money market fund prospectus or marketing materials is there anything that would convey that money invested is guaranteed. In fact the risks are clearly and repeatedly noted in bold print -- Not FDIC insured -- May Lose Value -- No Bank Guarantee. Institutions hold more than 60 percent of the $​2.​6 trillion invested in money market funds and these professionals certainly know the difference between a fund and a bank account. The loss experienced by Reserve fund shareholders clearly demonstrated the non-​insured status of money market funds. Further a recent survey by Fidelity Investments shows the vast majority of retail investors also knew that money market funds are investments and not guaranteed."
Donahue adds, "Lastly, in promoting the devastating idea of a floating NAV, some folks have been putting forth the fanciful notion that the $​1 NAV, the hallmark of money market funds, is somehow made up or illusory. Far from it. Money fund shares price at a dollar on a daily basis, not because they have promised to repay shares at a dollar, but because the underlying assets are required to meet very stringent credit quality, liquidity and maturity requirements under current SEC regulations. And those regulations were strengthened in 2010 by the SEC based on recommendations from money fund providers."
Finally, he says, "The ability to transact at the $​1 NAV provides a real benefit to corporations, government entities and other money fund users by allowing them to use automated cash management processes, facilitating same day transaction processing, shortening settlement cycles, and reducing float balances and counterparty risk. These are measurable benefits that translate directly into lower costs of capital and higher returns on assets. With so much at stake for the tens of millions of individual investors, corporations, government entities and non-​profits who depend on money market funds for cash management and raising funds, it is important to set the record straight."
ICI'​s March Trends Confirm Asset Declines, Repo Plunge in March
The Investment Company Institute released its latest monthly "Trends in Mutual Fund Investing: March 2012" yesterday. It showed money market mutual fund assets fell by $​70.​7 billion to $​2.​5824 trillion last month. Money fund assets now account for 20.​7% of overall mutual fund assets (​total fund assets moved $​61.​6 billion higher to $​12.​458 trillion. Bond fund assets continued higher. After breaking $​3.​0 trillion last month for the first time, assets grew an additional $​22.​7 billion in March to $​3.​071 trillion, or 24.​6% of assets. Separately, ICI'​s "Month-​End Portfolio Holdings of Taxable Money Market Funds showed that declines in Repo holdings (​down $​65.​6 billion) accounted for practically the entire drop in Taxable MMF assets in March. Funds also continued extending maturities.
ICI'​s "​Trends" says, "The combined assets of the nation'​s mutual funds increased by $​61.​6 billion, or 0.​5 percent, to $​12.​458 trillion in March, according to the Investment Company Institute'​s official survey of the mutual fund industry. In the survey, mutual fund companies report actual assets, sales, and redemptions to ICI..... Money market funds had an outflow of $​70.​63 billion in March, compared with an outflow of $​3.​01 billion in February. Funds offered primarily to institutions had an outflow of $​57.​58 billion. Funds offered primarily to individuals had an outflow of $​13.​05 billion."
In April month-​to-​date, Crane Data'​s Money Fund Intelligence Daily shows money fund assets virtually flat. They'​ve declined by $​782 million (​down 0.​0%) through 4/​25/​12). YTD, we show an overall asset decline of $​110.​8 billion, or 4.​3%. Our daily series shows increases in Institutional and Prime Institutional funds in April; they'​ve gained $​15.​9 billion and $​20.​0 billion, respectively. Taxable Retail funds have lost $​9.​9 billion MTD while Tax-​Exempt funds have lost $​6.​8 billion.
ICI'​s Portfolio Holdings series shows Repurchase Agreements plunged in March (​down $​65.​2 billion to $​501.​6 billion) after jumping $​37.​3 billion in February. Repos remain the largest portfolio holding among taxable money funds with 21.​8% of assets, though Treasury Bills & Securities at 21.​0% ($​483.​7 billion) were a close second. Holdings of Certificates of Deposits, which rank third among portfolio holdings, inched higher, rising $​1.​7 billion to $​403.​5 billion (​17.​5%).
Commercial Paper fell by $​7.​8 billion to $​362.​9 billion, but CP remained the fourth largest composition sector with 15.​8% of taxable asset composition. U.​S. Government Agency Securities saw holdings continue to fall, dropping $​16.​7 billion to $​334.​2 billion, or 14.​5% of assets. Notes (​including Corporate and Bank) accounted for 5.​6% of assets ($​128.​9 billion), while Other holdings accounted for 3.​5% ($​81.​5 billion).
The Number of Accounts Outstanding in ICI'​s Holdings series for taxable money funds dropped to 25.​67 million from 25.​71 million the month before, while the Number of Funds declined by 6 to 424. The Average Maturity of Portfolios lengthened to 46 days in March from 45 days in February and 42 days in December. Finally, note that the archived version of our Money Fund Intelligence XLS monthly spreadsheet (​see our Content Page to download) now has its Portfolio Composition and Maturity Distribution totals updated as of March 31, 2012. (​We revise these following the monthly publication of our Money Fund Portfolio Holdings data.)
In other news, Federated Investors announced its First Quarter 2012 Earnings late yesterday. The company hosts its quarterly earnings call Friday morning at 9am. Watch for coverage of the call in Monday'​s "​News".
April MFI Profile: Talking Tax Exempts With Western Asset'​s Amodeo
The following is excerpted from the latest Crane Data'​s Money Fund Intelligence newsletter. This month MFI interviews managers of Western Asset Management'​s Municipal Money Market Funds. We speak with Robert Amodeo, Portfolio Manager and Head of the Municipal Group, and Charles Bardes, a Portfolio Manager on the Tax-​Exempt Money Market Mutual Funds. The two have been running money funds with the unit since its days as Salomon Brothers Asset Management (​in the late '​80'​s/​early '​90'​s), which then became Citigroup Asset Management and eventually was acquired by Western parent Legg Mason. Our Q&​A involving tax-​exempt money fund issues follows.
MFI: What has been the biggest challenge recently vs. historically? Amodeo: Our investment philosophy and process are unchanged as they served our shareholders well during the most volatile markets yet everything around us has changed.... Historically, money market funds were a product that didn'​t concern too many people. But today investors ask you to be an active manager, you have to have good credit, you need to be proactive in your positioning. You need to anticipate rating actions, which seems to be coming through the pipeline a little faster than they have in years prior. So, an active manager will be able to perform well in this marketplace. But if you subscribe to the old "​gut feel" rules, say 10 years ago, the industry won'​t allow you to survive.
MFI: Do potential bank downgrades impact the tax-​exempt market? Amodeo: Absolutely, it is in particular the letters of credit, or the standby purchase agreements [​that are impacted]. It'​s the liquidity within the marketplace that'​s backed by those large banks which are now moving toward Tier 2. So, whereas in the past you may have been able to diversify the portfolios to twelve names, now there will be less names in that top tier. Or you would have to move to just names that perhaps you have overlooked in years prior.
MFI: Is the majority of the municipal supply dependent on those types of [​demand and liquidity] features? Bardes: Yes, in fact one of the concerns we had prior to the recent Moody'​s action was the Basel III recommendations, which essentially wouldn'​t be going fully into effect until 2015. But there was a lot of concern about whether banks would be averse to capital requirements and whether they would be willing to write more letter of credit business renewals especially. For 2010 and 2011, we really didn'​t see that much of a drop off in renewals and such. There were some issuers that did take advantage of either bonding out or issuing SIFMA index notes or other types of instruments, as opposed to variable rate demand notes, but we didn'​t see it affecting supply as much. Now the landscape has changed a little bit, once again. A couple of banks that were counted on to be there now are facing potential downgrades.
Amodeo: The challenge for tax-​exempt investors is to be able to differentiate the liquidity aspect of the variable rate demand note from the mechanics of the note itself. VRDNs seem to be under attack on a regular basis but the mechanics of the instrument work very well when backed by strong liquidity provider.
MFI: Is the Moody'​s threat a big deal? How much of an impact could it have on the market? Amodeo: Well for us we'​ve remained proactive. We moved our portfolios away from these potential downgrades into other names [​to] get ahead of it. Like we have in prior cycles and prior years of potential downgrades, we don'​t want to sit there and wait for it to take place. We really want to be proactive. For us, it won'​t have much of an impact at all.
MFI: Is it similar to when the municipal bonds insurers all got downgraded? Amodeo: Yes, and in many ways we were ahead of that as well. We know from experience that [​you'​ve got to] be proactive in this marketplace, so that when you are looking for replacement parts you want to be ahead of the crowd. The landscape you just described is very similar to the one we are confronting now.
MFI: Is the lack of supply a major problem in this market? Bardes: No, not today. It'​s fine. We are able to, kind of move pieces around in the last month or so.... We'​ve been finding ample replacement parts for those securities we'​ve divesting of.
MFI: Are crossover [​taxable] buyers impacting the market? Amodeo: Yes, they drove municipal yields lower. Municipal bonds or variable rate demand notes appeared cheap, not only on a tax-​adjusted basis but in a nominal sense. That drew the attention of these institutions that normally would avoid the tax-​exempt securities because they cannot benefit from the tax-​exempt income. So, they came marching in with their large balance sheets and really soaked up a great deal of supply ... and drove yields to lower levels, levels comparable to the taxable arena.... The taxable arena cheapened up a little bit recently, so they put back some VRDNs as their traditional securities appeared more attractive. (​Look for more excerpts in coming days or see our April MFI for the full interview.)
Financial Stability Board Progress Report on Shadow Banking Oversight
A statement and report issued Friday by the Financial Stability Board entitled, "FSB publishes progress reports to the G20 on the financial regulatory reform programme" says, "The FSB published on 20 April a letter from the Chairman to the G20 Finance Ministers and Central Bank Governors describing progress on the financial regulatory reform programme, and three progress reports on specific aspects of the programme: extending the G-​SIFI framework to domestic systemically important banks; strengthening the oversight and regulation of the shadow banking system and a joint report from the International Accounting Standards Board (​IASB) and the Financial Accounting Standards Board on their progress in converging their standards."
The FSB'​s second report, "Strengthening the Oversight and Regulation of Shadow Banking: Progress Report to G20 Ministers and Governors," comments, "​At the Cannes Summit in November 2011, the G20 Leaders agreed to strengthen the oversight and regulation of the shadow banking system, and endorsed the Financial Stability Board (​FSB)'​s initial recommendations with a work plan to further develop them in the course of 2012.... The "​shadow banking system" can broadly be described as "​credit intermediation involving entities and activities outside the regular banking system". It has become an integral part of the modern financial system that has an important role in supporting the real economy. For example, the shadow banking system provides market participants and firms with an alternative source of funding and liquidity. Furthermore, some non-​bank entities may have specialised expertise to assess risks of borrowers and hence can spur competition in the allocation of credit in the economy."
It continues, "However, the shadow banking system can also pose risks to the financial system, on its own and through its links with the regular banking system. These risks can become acute especially when it transforms maturity/​liquidity and creates leverage like banks. For example, short-​term deposit-​like funding of non-​bank entities can easily lead to "​runs" in the market if confidence is lost. The use of collateralised funding (​secured financing) techniques such as repos (​repurchase agreements) and securities lending can exacerbate such "​runs" and boost leverage, especially when asset prices are buoyant and margins/​haircuts on secured financing are low. Moreover, the risks in the shadow banking system can easily spill over into the regular banking system as banks often comprise part of the shadow banking credit intermediation chain or provide support to non-​bank entities."
The report explains, "​The FSB issued initial recommendations in its report "Shadow Banking: Strengthening Oversight and Regulation" (​hereafter October 2011 Report) 3 to address such risks posed by the shadow banking system. It has adopted a two-​pronged approach. First, the FSB will enhance the monitoring framework through continuing its annual monitoring exercise to assess global trends and risks, with more jurisdictions participating in the exercise. Second, the FSB will develop recommendations to strengthen the regulation of the shadow banking system, where necessary, to mitigate the potential systemic risks with specific focus on five areas: (​i) to mitigate the spill-​over effect between the regular banking system and the shadow banking system; (​ii) to reduce the susceptibility of money market funds to "​runs"; (​iii) to assess and mitigate systemic risks posed by other shadow banking entities; (​iv) to assess and align the incentives associated with securitisation to prevent a repeat of the creation of excessive leverage in the financial system; and (​v) to dampen risks and pro-​cyclical incentives associated with secured financing contracts such as repos, and securities lending that may exacerbate funding strains in times of "​runs". The proposed policy recommendations in all five areas will be developed by the end of 2012. The rest of this report details the FSB'​s progress to-​date in response to the request from the G20."
The section on "Money Market Funds" says, "The International Organization of Securities Commissions (​IOSCO) is developing policy recommendations related to money market funds (​MMFs) by July 2012 through its Standing Committee on Investment Management (​SC5). IOSCO aims to publish a consultation report shortly. The consultation report provides an analysis of the systemic importance of MMFs and their key vulnerabilities, including their susceptibility to runs. It also highlights some of the issues which have to be considered, such as the impact on short-​term funding and effects on investor behaviour, implementation challenges as well as other potential disruptive effects. It also clarifies the role of MMFs during the crisis and describes the changes introduced in MMF regulation following the crisis. The report then analyses the characteristics and benefits of MMFs in various jurisdictions (​with a focus on Europe and the US, but also including Australia, Brazil, Canada, China, India and Japan) and the particular regulatory arrangements which have influenced their role and risks."
The FSB adds, "Based on such analysis, the draft consultation report sets out possible policy options that could reinforce the soundness of money market funds and address the identified systemic vulnerabilities such as the following: (​i) Mandatory move from constant to variable net asset value (​NAV) -- this may include other structural arrangements that may reduce susceptibility to runs caused by sudden fluctuations in the "​true" price of MMFs, such as introduction of "​NAV buffer" if constant NAV is maintained. (​ii) Enhancement of MMF valuation and pricing framework -- this may include restricting the use of amortised cost accounting by MMFs. (​iii) Enhancement of liquidity risk management -- policy measures such as liquidity buffer, redemption restrictions and establishment of private liquidity facilities will be considered as tools to improve MMFs' management of redemption pressures. (​iv) Reduction in the importance of ratings in the MMF industry -- policy measures such as removal of references to ratings from MMF regulations and improvement of MMF ratings would be considered to reduce the herding and "​cliff-​effects" associated with the use of ratings in relation to MMFs."
Finally, the report says, "These options are not mutually exclusive and some may be considered in combination. Pursuant to IOSCO Technical Committee approval, the consultation report will be published to obtain inputs from the stakeholders in assessing the different policy options. IOSCO envisages using the outcomes of the consultation to narrow down the policy options into policy recommendations by July 2012. FSB will separately provide its members' views on the consultation report to IOSCO to facilitate its preparation of policy recommendations."
ICI'​s Trends in Expenses Show Money Fund Fees Inched Lower in 2011
The Investment Company Institute, the trade group for the mutual fund industry, published a report entitled, "Trends in the Expenses and Fees of Mutual Funds, 2011" yesterday, which detailed expense trends over the past year and decade. (​See the press release here.) ICI'​s says, "Expense ratios of money market funds fell in 2011 following a sharp decline in 2010. The asset-​weighted average expense ratio of money market funds was 21 basis points in 2011, a drop of 3 basis points from 2010. Expense ratios on money market funds have fallen sharply in the past few years as the great majority of funds waived expenses to ensure that net returns to investors remained positive in the current low interest rate environment."
The report explains, "​Over the past two decades, on an asset-​weighted basis, average expenses paid by mutual fund investors have fallen significantly.... Expenses incurred by investors in money market funds dropped 61 percent, from 54 basis points in 1990 to 21 basis points in 2011."
ICI continues, "The average expense ratio of money market funds was 21 basis points in 2011, a drop of 3 basis points from 2010. Until 2009, the declining average expense ratio of money market funds largely reflected an increase in the market share of institutional share classes of money market funds. Because institutional share classes serve fewer investors with larger average account balances, they tend to have lower expense ratios than retail share classes of money market funds. Thus, the increase in the institutional market share helped reduce the industrywide average expense ratio of all money market funds."
They add, "By contrast, the market share of institutional share classes of money market funds dropped slightly in 2010 and 2011 (​to 65 percent from 68 percent in 2009), indicating that other factors pushed expenses down. Primarily, the steep decline in the average expense ratio of money market funds reflects developments stemming from the current low interest rate environment."
ICI tells us, "In 2007 and 2008, to stimulate the economy and respond to the financial crisis, the Federal Reserve sharply reduced short-​term interest rates, so that by early 2009 the federal funds rates and U.​S. Treasury bill rates hit historic lows, both hovering just above zero. Yields on money market funds, which closely track short-​term interest rates, also tumbled. In 2011, the average gross yield (​the yield before deducting fund expense ratios) on taxable money market funds was at a record low. In this setting, money market fund advisers increased expense waivers to ensure that fund net yields (​the yields after deducting fund expense ratios) did not fall below zero. Waivers raise a fund'​s net yield by reducing the expense ratio that investors incur."
They add, "Historically, money market funds have often waived expenses, usually for competitive reasons. For example, in 2006, before the onset of the financial crisis, 60 percent of money market fund share classes were waiving expenses. By the end of 2011, 98 percent of money market fund share classes were waiving at least some expenses."
Finally, ICI'​s report states, "​Expense waivers are paid for by money market fund advisers and their distributors, who forgo profits and bear more, if not all, of the costs of running money market funds. Money market funds waived an estimated $​5.​2 billion in expenses in 2011, four times the amount waived in 2006. These waivers substantially reduced revenues of fund advisers, and if gross yields on money market funds rise, advisers may reduce or eliminate waivers, which could cause expense ratios on money market funds to rise somewhat."
Barclays Abate Says Time to Consider Alternatives; Insurance for MFs?
Barclays Strategist Joseph Abate proposes FDIC-​like insurance for money market funds in the latest "Market Strategy Americas" update. He says, "Regulators and the industry appear to be at an impasse with respect to reforming money funds to reduce systemic risk. Moreover, current proposals are less than adequate in addressing investor risk run. Could it be time to consider alternatives? To the extent that run risk is driven by loss of principal fears, there might be a case for limited money fund insurance. Limited ex ante FDIC coverage could be set at a fixed amount, with a premium determined at a quarterly auction subject to a minimum. In 2008, money funds were willing to pay between 1 and 1.​5bp/​quarter for coverage from the Treasury. To mitigate moral hazard, funds buying insurance would be subject to capital requirements -- the capital would act as the insurance deductible. Alternatively, the Fed could sell liquidity options to money funds that would entitle the holder to a future collateralized loan from the central bank."
Abate explains, "Any government-​sponsored insurance or liquidity program would face stiff opposition from banks and regulators. This was reiterated by a Bloomberg editorial that noted that "​taxpayers shouldn'​t be forced to take this risk [​systemic risk from money funds] again". Although such support would be difficult to secure, we believe that a corresponding reduction of destabilizing run risk in money funds would have overwhelmingly positive benefits."
He continues, "​Regulators seek to avoid a replay of September 2008 where the buck-​breaking of one large money fund precipitated a surge in prime fund redemptions that destabilized CP and repo markets, exacerbating the financial crisis. Floating NAVs, redemption gates (​or minimum deposits, however structured), and capital buffers are deeply unpopular with institutional investors. Besides being expensive and difficult to implement, these solutions may not adequately reduce the propensity of institutional money fund investors to flee in a crisis. Dissatisfied with the SEC proposals, institutional investors (​who account for 70% of all taxable money fund deposits or about $​1.​6trn in balances) may shift their funds to other accounts with same day liquidity and stable principal. Such a shift into bank deposits or other, possibly off-​shore investments, would simply transfer systemic risk from one sector to another."
Abate tells us, "Although money fund balances are not covered by an explicit insurance guarantee like bank deposits, there is a strong implicit assumption that a fund sponsor will maintain the fund'​s stable NAV and same-​day liquidity by either buying out assets above par or providing some liquidity guarantee. The strength of the implicit guarantee is backed by reputational concerns -- a money fund that breaks a buck and loses money for its investors is out of business. But, as was the case for the Reserve Primary Fund, while the will to back up the stable NAV and meet redemptions was there, the ability was not. The fund very quickly experienced redemption demands that overwhelmed its available resources and forced it to close. Unsurprisingly, this led to a surge in redemptions at other prime funds as investors began to worry about their implicit support."
Abate writes, "Instead, there may be a case for insuring MMF investments along the lines of FDIC bank deposit insurance -- in effect, applying a banking "​solution" to a money market "​problem." Money fund investors and bank depositors (​at least checking account holders) are very similar -- each puts a premium on same-​day liquidity and principal protection. Thus, to the extent that depositors are driven by fears of impending principal loss to rush to withdraw their money in a run, the existence of deposit insurance prevents -- or at least slows -- "​impatient" redeemers from overwhelming the bank'​s available liquidity and forcing it to close.... [​T]​his is not to imply that there were no deposit runs at the height of the financial crisis in 2008 -- depositors still lined up outside the branches of some big name bank failures to withdraw money. But the reduced frequency of runs at banks does suggest that some form of insurance might be useful in slowing or reducing the probability of investor runs at money funds."
He adds, "The usefulness of explicit insurance for money funds became clear following the collapse of the Reserve Primary Fund. The Treasury created an insurance program for money funds using the $​50bn in the Exchange Stabilization fund (​ESF). Under the "​Guaranty Program for Money Market Funds", money funds paid a fee of 1-​1.​5bp per quarter to guarantee their balances (​as of September 19) for one year. Coverage was back-​dated so that it would not tempt bank depositors or other investors to pour money into money fund balances following the creation of coverage. Interestingly, the Dodd-​Frank provision of unlimited bank deposit insurance on non-​interest bearing transaction accounts was not back-​dated. We estimate that perhaps as much as $​500bn or more in money fund balances has moved to banks since FDIC coverage was expanded last year.... The pace of prime fund redemptions quickly slowed following the introduction of the Treasury'​s insurance program."
Abate'​s piece continues, "​Congress was deeply unhappy with the program even though the ESF never experienced a loss and instead collected $​1.​2bn in premiums from the industry. The nature of its displeasure may have had more to do with the program'​s ad hoc creation by the Treasury Department than with a philosophical objection to insuring money funds. That said, a fair number of members of Congress were unhappy about using tax payer money to "​bail out" another sector of financial markets. Interestingly, in a letter to SEC Chair Schapiro, two members of the House Financial Services Committee expressed concern about additional money market reform on the grounds that the SEC needs to undertake more ("​rigorous economic") research on the "​effectiveness of the 2010 amendments to Rule 2a-​7"."
He explains, "Replacing the Treasury'​s insurance program with a private sector version, however, is probably not feasible.... Instead, we propose that limited coverage be provided by the FDIC. Coverage could be limited to a small amount -- say, $​50bn or roughly the size of the Treasury'​s ESF program. The size of the insurance fund would be determined by the FDIC and itself could be a policy variable -- coverage could be lowered (​or raised) to influence risk-​taking by money funds. Interestingly, there has been relatively little academic work on figuring out the optimal level of bank deposit insurance. Work that has been done on the optimal amount of deposit insurance suggests that higher liquidity requirements reduce the optimal level of coverage. Thus, the SEC'​s high liquidity requirements help to mitigate the risk that the FDIC'​s insurance fund would be tapped and ultimately reduces the optimal size of the insurance pool."
Abate says, "The size of the insurance pool might also be small because losses from money funds are small and exceedingly rare. The Reserve Primary Fund lost less than 0.​5% for its investors even after all of its $​0.​8bn of Lehman paper was marked down to 0. Moreover, expected losses are probably even lower now as the SEC'​s 2010 reforms have lowered concentration limits and shortened up WAMs. Money funds would internalize the cost of their coverage by paying a premium to the FDIC, where the premium is determined via a competitive auction subject to some minimum level. Money funds would have the option of participating (​or not) and their coverage premium would be determined by the market demand for insurance. Coverage would start at the beginning of the following quarter to reduce the moral hazard of weak funds purchasing immediate coverage when they are in distress."
He states, "Further, any potential loss risk to the FDIC could be reduced by requiring money funds buying insurance coverage to maintain a reasonable capital buffer. In the event that a money fund breaks the buck, the FDIC would take it over, sell off assets (​or wait for them to mature) and deduct any losses from the fund'​s capital buffer. Only after the entire capital buffer had been depleted would additional losses be applied to the FDIC'​s insurance fund. In effect the capital buffer would become the insurance deductible for money funds buying FDIC insurance."
Finally, Abate tells us, "​Ultimately, these proposals may require considerable additional work in estimating optimal coverage and liquidity amounts. Expanding the FDIC'​s role would likely require congressional approval not to mention the support of the Federal Reserve and the SEC, both of whom are pushing strenuously for significant reform. By adding FDIC insurance coverage to money funds, the funds would become closer substitutes for checking account balances and the proposal would probably face stiff opposition from banks. Similarly, enabling the Fed to sell liquidity options from the discount window to non-​banks would also likely face stiff opposition from Congress and regulators. Moreover, money funds may have little interest in purchasing any of these instruments as the industry feels that they have more than ample liquidity to meet a pick-​up in redemptions and their underlying assets are already extremely safe. But, given the distance between regulators and the money fund industry around the current proposals of capital buffers, redemption gates and floating NAVs, it might be time to consider alternatives."
Treasurers Will Leave Money Funds If SEC Changes Regs Says TSI Study
A release headlined, "​U.​S. Treasurers Will Leave Money Marekt Funds Should the SEC Change Regulation, According to Treasury Strategies Study," was sent out by the Investment Company Institute Thursday morning. It says, "U.​S. treasurers report that they will sharply reduce their use of money market funds if the Securities and Exchange Commission (​SEC) adopts any of the three concepts it is considering to reform money market funds. The SEC has said it is pursuing these changes to change the structure of money market funds. Treasury Strategies, Inc., conducted a survey to study the receptiveness of corporate treasurers, government and institutional investors to each reform concept."
ICI tells us, "​The report, Money Market Fund Regulations: The Voice of the Treasurer, concludes that the overwhelming majority of treasurers will either scale back their use of money market funds or discontinue use of them altogether if any of its SEC'​s three concepts to change money market fund operations takes effect. Those three concepts include floating the net asset value (​NAV), imposing a redemption holdback, or imposing capital requirements."
Cathy Gregg, a Partner at Treasury Strategies, says, "The large cross section of treasurers surveyed gives this report the '​voice of the treasurer' -- a voice that spoke out with an overwhelmingly negative response to each reform concept."
The release explains, "ICI commissioned the study to help understand the effects of the SEC concepts on money market fund investors. The Institute will file the study as part of a new comment letter to the SEC. Treasurers are crucial users of money market funds: institutional share classes account for $​1.​7 trillion, or 65 percent, of the $​2.​7 trillion in money market funds asset as of the end of February 2012. Key study findings below."
Under the heading, "Every SEC Reform Concept Will Cause a Dramatic Drop-​Off in Both Treasurers' Use of Funds and Corporate Assets in Funds," it says, "​1. If money market fund NAVs were required to float: 79 percent of respondents would either decrease their use or discontinue altogether. 61 percent of corporate money market fund assets would move to other investments if this concept were adopted. 2. If money market funds were required to institute a 30-​day holdback of 3 percent of all redemptions: 90 percent of respondents would either decrease their use or discontinue altogether. 67 percent of corporate money market fund assets would move to other investments if this concept were adopted. 3. If money market funds were required to maintain a loss reserve or capital buffer: 36 percent of respondents would either decrease their use or discontinue altogether when the question did not suggest that investors would suffer any reduced yield."
ICI adds, "In a follow-​up question directed to the 64 percent who initially stated they would continue or increase their usage of money funds, 84 percent of the follow-​up respondents indicated they would decrease or stop their usage altogether if the capital buffer were to reduce the yield of the fund by 5 basis points. The report makes no estimate on the decline in assets if the SEC imposes a capital buffer on money market funds. However, the number of treasurers using money market funds is expected to decrease dramatically should this concept be adopted."
The study quotes ICI Chief Economist Brian Reid on "Further Regulation Would Push Corporate Money into Many Instruments," "​There'​s a belief in some quarters that treasurers would move their cash and short-​term assets to bank checking accounts if money market funds became unusable. This study indicates that such investors would move their cash to a variety of other vehicles and investments, some less regulated and transparent than money market funds."
Finally, under "Corporate Treasurers Value, Understand and Intensively Use Money Market Funds," the release says, "The report concludes that corporate treasurers view money market funds as an essential cash management tool and use them intensively. In addition, treasurers understand the risks, returns and tradeoff between the two. "The message from treasurers is clear. While they value money funds, they will simply abandon the instrument should any of these concepts be adopted. The potential implications of such a widespread run away from money funds are staggering," says Treasury Strategies' Gregg.
Treasury'​s Miller, BlackRock'​s Fink and House'​s Bacchus on Reforms
The public battle over pending money market fund reform proposals continues, as Treasury Under Secretary Mary Miller, BlackRock CEO Larry Fink and Representative Spencer Bachus all made comments on the issue yesterday. In a talk entitled, "Remarks by Under Secretary for Domestic Finance Mary Miller at the Annual Conference of the National Federation of Municipal Analysts," Miller comments, "Both SEC Chairman Mary Schapiro and Federal Reserve Chairman Ben Bernanke have recently expressed concerns with the inherent susceptibility of money market funds to liquidity runs during times of stress. Indeed, money market funds contributed to instability during the financial crisis in 2008 and at the time, the previous Administration was forced to intervene to prevent a widespread run. Since then, the SEC has taken actions to reduce the risk of this industry by adopting new portfolio credit, maturity, and liquidity requirements through 2a-​7 reforms in February 2010."
She continues, "However, while money market funds are more resilient today than they were in the lead-​up to the financial crisis, as noted in both the President'​s Working Group Report in 2010 and the Financial Stability Oversight Council'​s 2011 Annual Report, further steps are needed to improve the stability of the industry and reduce money funds' susceptibility to runs. The SEC and other members of the Financial Stability Oversight Council (​FSOC) are actively discussing the most appropriate way to affect this, while preserving the usefulness of these funds for investors and issuers, including those in the municipal market."
On BlackRock'​s latest quarterly earnings call, Chairman & CEO Larry Fink <​p:>`​_ was asked in the final question on the call about "money market fund reform and the likely outcomes." Fink answers, "We believe the industry has been reluctant to change. We need to be working with the SEC on money market reform. I have had dialogue with some of our fellow asset managers to work together on money market reform working with the SEC. It is our position that if we do not work together with the SEC on money market reform, the FSOC committee will make it for us. So we have been much more aggressive on addressing money market reform. We believe it'​s necessary for this business to ... grow again."
He adds, "We have been isolated, though, with that opinion. We have been remarkably one of the only firms to aggressively believe that we need money market reform working with the SEC with sensible, industry- and client-​oriented solutions. But I must say in recent weeks we have [​had] offline dialogues with other firms. I believe there is a good opportunity in front of us to work with the SEC."
Finally, a Bloomberg article, "​Bachus Urges Schapiro to Study Costs of Money Fund Rules", says, "House Financial Services Committee Chairman Spencer Bachus is urging Securities and Exchange Commission Chairman Mary Schapiro to rethink her approach to rules for the money-​market fund industry. In a letter to Schapiro dated yesterday, Bachus said he was unsure why the agency should spend time considering rules for money-​market funds when the SEC has struggled to meet deadlines to implement rules mandated by the 2010 Dodd-​Frank Act.... The letter was also signed by Representative Jeb Hensarling, a Texas Republican who is vice chairman of the financial services panel."
Bachus reportedly writes, "Given that the SEC has already missed numerous deadlines for mandatory rule-​makings, the suggestion that the agency is devoting time and resources to a discretionary rule without providing Congress or the public with empirical data and economic analysis to justify such a rule-​making raises significant questions regarding the Commission'​s priorities.... We would also like to remind you that the SEC'​s mandate is to ensure that investors have all of the material information about an investment, not to engineer investments so that they are free of any risk. If investors do not understand that their investments in money-​market funds can result in losses, then the Commission should use its existing authority to enhance disclosures rather than change the fundamental characteristics of money-​market funds."
Fitch Q1 Update Shows Eurozone Stabilization, Higher Yields, Expenses
Fitch Ratings sent out a press release entitled, "Fitch: Market Sentiment Improves Among U.​S. Money Market Funds; Regulatory Uncertainties Persist along with its "U.​S. Money Market Funds Sector Update: First-​Quarter 2012." The release says, "Fitch-​rated U.​S. money market funds (​MMFs) selectively increased their holdings of eurozone banks during the first quarter of 2012, according to Fitch Ratings. Fitch believes improved eurozone confidence by MMFs results in part from the stabilizing effects of the European Central Bank'​s long-​term refinancing operations. Allocations to banks in France, Germany, and Netherlands -- the three largest allocations for MMFs in the eurozone -- increased to 19.​7% at the end of February 2012, up 4.​1% from 15.​6% at the end of 2011. Investments in French banks remain well below the December 2010 level."
Fitch'​s press release continues, "Underscoring their defensive posture to liquidity management, Fitch-​rated prime MMFs held 30% of their portfolios in daily liquid assets. In February 2012, MMFs invested 18.​3% of their portfolios in repos, including 12.​5% in repos backed by the U.​S. government and 5.​8% backed by other types of collateral."
The release adds, "​Allocations to asset-​backed commercial paper (​ABCP) remain stable at 7-​8% of fund'​s assets, on average, despite a decline in ABCP outstanding. Longer term, ABCP holdings have declined, offset by rises in repos, government holdings and variable rate demand notes (​VRDN).... Regulatory uncertainty remains a key challenge for the sector, with expected publication of the SEC'​s proposal on U.​S. MMF sector structural reforms due in the second quarter of 2012."
The full "Sector Update" says, "The portfolio composition of Fitch-​rated prime MMFs has shown the long-​term shifts in asset types. This shift includes a significant long-​term decline in ABCP investments, notwithstanding a stable allocation to this asset class in the recent months, partially offset by an increase in VRDNs, higher allocations to repos backed by both government securities and other types of collateral, and a higher level of U.​S. government securities holdings. During the first quarter of 2012, Fitch-​rated prime MMFs invested primarily in seven major security types (​see Figure 6): certificate of deposits and commercial paper, including ABCP, repos, U.​S. government securities, corporate notes, and variable rate demand notes (​VRDNs)."
Fitch also writes, "Short-​term interest rates continue to rebound from their recent historic lows during the first quarter.... Figure 8 depicts a slightly higher average seven-​day annualized yield produced by prime institutional MMFs against the backdrop on the Fed funds and overnight LIBOR rates. Helped by an uptick in yield, expenses charged for prime government institutional funds have also slightly risen. Prime institutional MMFs' expense ratios averaged 23 bps at the end of March, representing an average increase of 2 bps since the fourth quarter, when the average expense ratio stood at 21 bps."
Worldwide Money Funds Shrink Due to European Reclassification in Q4
The Investment Company Institute released its latest "Worldwide Mutual Fund Assets and Flows for the Fourth Quarter 2011 last week, and the data showed both inflows into money market funds ($​97 billion) and an overall decrease in assets (-$​51.​0 billion). While U.​S. money funds showed a $​62.​2 billion rebound in Q4, European money funds dropped a precipitous $​154.​7 billion, primarily due to Europe'​s recent fund reclassifications and defining of the term "​money market fund". (​See this BNP release and our Aug. 29, 2011, News "​European Securities and Markets Authority Issues Q and A on MMF Defs" for more details.) Ireland and France in particular showed dramatic asset declines, losing $​109.​8 billion and $​40.​6 billion, respectively, from their money fund rolls.
ICI'​s quarterly says, "Mutual fund assets worldwide increased 2.​4 percent to $​23.​78 trillion at the end of the fourth quarter of 2011. Worldwide net cash flow to all funds was $​85 billion in the fourth quarter, compared to $​171 billion of net outflows in the third quarter of 2011. Flows out of long-​term funds slowed to $​12 billion in the fourth quarter from an outflow of $​108 billion in the previous quarter. Equity funds worldwide had net outflows of $​70 billion in the fourth quarter compared to $​108 billion of net outflows in the third quarter. Flows into bond funds totaled $​66 billion in the fourth quarter, rising from $​10 billion of net inflows in the previous quarter. Flows into money market funds were $​97 billion in the fourth quarter of 2011, reversing the $​63 billion of net outflows in the third quarter of 2011. 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 fourth quarter of 2011 contains statistics from 46 countries."
The report explains, "​The growth rate of total mutual fund assets reported in U.​S. dollars was made smaller by U.​S. dollar appreciation. For example, on a U.​S. dollar–​denominated basis, mutual fund assets in Europe decreased by 1.​3 percent in the fourth quarter, compared with an increase of 3.​0 percent on a Euro-​denominated basis. On a U.​S. dollar–​denominated basis, equity fund assets increased 4.​5 percent to $​9.​5 trillion at the end of the fourth quarter of 2011. Balanced/​mixed fund assets rose 1.​3 percent in the fourth quarter, and money market fund assets fell 1.​6 percent due to a reclassification of some money market funds in Europe. Bond fund assets increased 3.​1 percent in the fourth quarter to $​5.​8 trillion."
ICI continues, "Money market funds worldwide experienced $​97 billion of net inflows in the fourth quarter of 2011, the first global inflow since the first quarter of 2009, and contrasts with the $​63 billion of net outflows seen in the third quarter of 2011. These inflows reflect increased risk aversion amongst mutual fund investors in the fourth quarter, and positive inflows were recorded in the Americas, Europe, and Asia and Pacific regions. Money market funds in the Americas and in Europe posted net inflows of $​61 billion and $​15 billion, respectively, in the fourth quarter after witnessing net outflows of $​54 billion and $​6 billion, respectively, in the previous quarter. Money market funds in the Asia and Pacific region posted a net inflow of $​23 billion in the fourth quarter, compared with $​1 billion of net outflows in the third quarter.... Money market fund assets represented 20 percent of the worldwide total."
The United States continues to dominate worldwide money fund assets with $​2.​691 trillion, or 57.​3% of the global total (​up $​62.​2B in Q4). France remains in second place, though its totals declined by $​40.​6 billion to $​449.​7 billion (​9.​6% of the global total). Luxembourg ranks third with $​387.​5 billion (​8.​3%), and Ireland ranks fourth with $​364.​8 billion (​7.​8%). Fifth-​ranked Australia showed gains (​up $​15.​9B to $​283.​8 billion, or 6.​0% of the total), as did sixth ranked Mexico ($​57.​8B, or 1.​2%). Seventh-​ranked China showed a jump of $​27.​0 billion to $​46.​8 billion, or 1.​0%. Korea, Rep. of ($​46.​8B, 1.​0%), Brazil ($​40.​3B, 0.​9%) and Italy ($​34.​3, 0.​7%) rounded out the top 10 largest money fund markets.
Note that Crane Data is assisting German conference company IQPC in producing European Money Fund Summit, which will be held in Frankfurt November 19-​21, 2012 (​see www.​moneyfundsummit.​com). We'​ve been tracking Dublin and Luxembourg-​based money market funds for several years now (​including the new collection of portfolio holdings on these funds), and we intend to expand our coverage of the European and global market in 2012. (​For more information on the European Money Fund Summit e-​mail or call Pete. To request a copy of our XLS spreadsheet ranking global money fund markets based on ICI'​s Worldwide Asset totals or for a copy of our Money Fund Intelligence International, e-​mail Natalia.)
MFs Reduce Repo, European Exposure; Treasuries Now Largest Holding
Crane Data'​s Money Fund Portfolio Holdings, with data as of March 31, 2012, were sent to subscribers late last week. The latest disclosures show Total Taxable money fund holdings dropped by $​67.​6 billion in March driven by a drop in European holdings (​mostly repo). This followed a two-​month rebound earlier in 2012. Repurchase Agreement (​Repo) holdings fell $​70.​5 billion in March to $​500.​9 billion (​24.​3% of taxable holdings) after rising $​25.​7 billion in February and $​69.​4 billion in January. Treasury Debt rose again by $​10.​0 billion (​after rising $​18.​8 billion last month) to become the largest segment of taxable fund composition at $​508.​7 billion (​22.​3% of holdings). Government Agency Debt fell by $​9.​0 billion to $​322.​7 billion (​14.​1%).
Repo holdings were comprised of $​249.​9 billion in Government Agency Repurchase Agreements (​10.​9%), $​133.​0 billion in Treasury Repo (​5.​8%) and $​118.​0 billion in Other Repo (​5.​2%). CDs increased by $​10.​9 billion to $​404.​3 billion (​17.​7%) while CP declined slightly (​down $​3.​6 billion) to $​354.​6 billion (​15.​5%). (​CP was comprised of $​193.​7 billion (​8.​5% of all holdings) in Financial Company CP, $​113.​5 billion (​5.​0%) in Asset Backed Commercial Paper, and $​47.​4 billion (​2.​1%) in Other CP. Other securities dipped to $​126.​6 billion (​5.​5%) with Other Notes (​the largest subcategory of this segment) rising to $​85.​0 billion (​3.​7%). VRDNs accounted for $​67.​5 billion (​3.​0%) of the total securities held by taxable money funds as of March 31, 2012.
Among all Taxable money funds, the U.​S. Treasury remains by far the largest issuer with 23.​9% of all investments ($​508.​7 billion). (​Treasuries are the largest segment of Prime money funds too at 9.​8%, or $​124.​8 billion of the total.) Federal Home Loan Bank again ranked second among money market issuers with $​135.​7 billion (​6.​4%) of the money held in taxable money funds tracked by Crane Data'​s MF Portfolio Holdings collection. Barclays Bank remained in third place with $​94.​2 billion (​4.​4%) of Taxable holdings. Federal Home Loan Mortgage Co. had $​76.​2 billion ($​76.​2 billion) of outstandings vs. $​70.​8 billion (​3.​3%) for Fannie Mae among taxable money fund holdings.
The rest of the top 10 issuers include: Credit Suisse ($​62.​3B, 2.​9%), Deutsche Bank ($​61.​5B, 2.​9%), Bank of America ($​59.​8B, 2.​8%), JPMorgan ($​54.​8B, 2.​6%), and UBS ($​53.​3B, 2.​5%) <​b:>`​_. Numbers 11-​20 include: RBC ($​50.​6B), Citi ($​49.​1B), Bank of Nova Scotia ($​46.​7B), Bank of Tokyo-​Mitsubishi UFJ Ltd ($​44.​1B), Rabobank ($​42.​1B), BNP Paribas ($​42.​0B), Goldman ($​40.​0B), Sumitomo Mitsui Banking Co ($​36.​5B), Westpac Banking Co ($​35.​5B), and National Australia Bank Ltd ($​35.​4B).
J.​P. Morgan Securities' "Update on prime money fund holdings for March 2012 comments, "Prime MMFs saw $​49bn (-​3.​4%) of outflows in March, mostly accounted for by institutional outflows (-$​41bn). Typical seasonal quarter-​end activity accounted for most of this (​Exhibit 1) but some could also be attributed to the renewed focus on the Eurozone and upcoming conclusions of Moody'​s ratings review of major global banks. Although prime MMFs reduced overall bank exposures in March due to seasonal repo and time deposit reductions, some large funds continued to increase Eurozone bank unsecured CP/​CD exposures reflecting better tone in short-​term credit markets."
They add, "Prime MMFs reduced total global bank exposures by $​67bn while increasing Treasury bill and coupon holdings by about $​18bn. Eurozone bank exposures declined by $​20bn after two consecutive months of increases totaling nearly $​60bn (​Exhibit 2). Non-​Eurozone European bank exposures declined by $​14bn, driven by reduced exposures to the UK banks (-$​24bn). Non- European bank exposures which grew by $​107bn from May 2011 to February 2012, dropped $​33bn in March, driven by reduced exposures to US, Canadian, Australian, and Japanese banks (​Exhibit 3). Declines in bank exposures were primarily driven by seasonal reductions to repo (-$​40bn) and time deposits (-$​21bn). Overall unsecured CP/​CD exposures fell (-$​6bn) but data reveals that Eurozone bank unsecured CP/​CD exposures grew by $​14bn. Overall ABCP exposure remained unchanged."
Finally, Deutsch Bank'​s latest look at Portfolio Holdings comments, "[​A]​n analysis of the month-​end holdings of the U.​S. money fund industry for March doesn'​t do much to resolve the mystery [​of why funding rates have been under pressure]. On the one hand, total assets under management hasn'​t really changed much at all over the past few months -- at least among the funds that we track (​which are the largest prime funds in the industry). So it'​s not as if funding supply is going down.... In addition, risk appetite within this industry seems to be doing just fine."
Schwab'​s Chandoha Urges SEC to Undertake Industry Wide MF Analysis
The most recent Comment on Money Market Fund Reform to be posted on the SEC'​s President'​s Working Group webpage comes from Charles Schwab Investment Management Executive Vice President Marie Chandoha. She writes, "Charles Schwab Investment Management, Inc. ("​CSIM") appreciates the opportunity to provide additional perspective on the ongoing debate over money market mutual fund reform. CSIM is one of the largest managers of money market fund assets in the United States, with 3.​2 million money market fund accounts and $​160 billion in assets under management as of December 31, 2011. Approximately 85% of those assets are in sweep funds, with the remainder in purchased funds. Sweep accounts automatically invest idle cash balances while providing investors with convenience, liquidity and yield. The Charles Schwab Corporation also offers other cash options for clients, including bank deposits through Charles Schwab Bank, which currently holds more than $​60 billion in deposits. The firm believes clients prefer having the option of choosing from among a variety of options for managing their cash."
Chandoha explains, "CSIM is extremely concerned about reports that the Commission is considering additional proposals to regulate money market funds. Of particular concern is the fact that little analysis appears to have been undertaken to analyze the effectiveness of the 2010 amendments to Rule 2a-​7, which significantly enhanced the stability, resiliency and transparency of money market funds. Without an in-​depth study of the impact and effectiveness of these recent reforms, we question whether the Commission has a sufficient basis upon which to take further action. We offer in this letter evidence that those reforms have been effective, and urge the Commission to undertake a larger study of the 2010 amendments before proposing additional reforms."
She says of "The 2010 Amendments to Rule 2a-​7," "​In 2009, when amendments to Rule 2a-​7 of the Investment Company Act of 1940 were first proposed, CSIM expressed its strong support for many aspects of the proposal. Indeed, in our comment letter of September 4, 2009, we stated that "the Commission has taken a thoughtful and measured approach to modifying Rule 2a-​7, seeking to enhance investor protection while retaining the many benefits money market funds provide to retail and institutional investors alike." The Commission approved the Rule 2a-​7 amendments on January 27, 2010, and they went into effect on May 5, 2010. The 2010 amendments were a specific response to the market crisis of 2008, during which a combination of unprecedented market conditions and unusually large redemption requests put pressure on numerous money market funds and contributed to a single fund "​breaking the buck" by failing to hold its share price at $​1.​00 per share."
Chandoha continues, "​As the Commission considers whether additional reforms are needed, we believe it is critically important that a careful analysis of the 2010 amendments to Rule 2a-​7 be completed. The key questions are whether the risks have been reduced to an acceptable level and whether money market funds are better able to withstand market volatility and potential spikes in redemptions. The Commission then must consider whether the benefits of additional regulation are significant enough to outweigh the intended and unintended consequences to the users of money market funds. To assist the Commission with its analysis, we provide data from CSIM funds that we believe demonstrates that the 2010 Rule 2a-​7 amendments have been enormously effective in strengthening money market mutual funds. We hope that the Commission finds this information useful as its deliberations continue."
She explains, "The 2010 amendments to Rule 2a-​7 made a number of major changes to the regulatory environment for money market funds, but perhaps none were more significant than the implementation of new liquidity standards. Where there were previously no liquidity requirements at all, the amendments now require that at least 10% of a prime fund'​s assets be convertible to cash within one day, and at least 30% of any fund'​s assets be convertible to cash within one week.... Together these changes have made the funds significantly more resilient to volatile market conditions by requiring portfolio managers to respond proactively to changing market conditions. We believe this combination of strong regulatory oversight and prudent portfolio management enhances investor confidence and ensures that the fund could weather even the most extreme market circumstances -- including circumstances that go well beyond the crisis of September 2008."
Schwab tells the SEC, "To illustrate further the real-​world implications of the Commission'​s 2010 reforms, we examined the net asset values of each CSIM money market fund during the year 2011, as well as the monthly flows in and out of CSIM money market funds during the same period. Last year represented a real test of the 2010 amendments to Rule 2a-​7. It was a year of unusual volatility in the markets, with several market events that caused concern to investors, notably the ongoing EuroZone crisis, the uncertainty of the U.​S. debt ceiling debate in the summer, and the first-​ever downgrade of U.​S. debt by Standard & Poor'​s on August 5, 2011. As a result of these and other market events, there were several periods during 2011 in which redemption requests were higher than normal. Figure 3 illustrates the average shadow NAV of all CSIM money market funds. As can be seen, the chart shows remarkable price stability, even during periods of enormous volatility. The average shadow NAV for prime funds, for example, reached its peak in April at $​1.​000185, and its trough in September with a price of $​0.​999938. The total price fluctuation from high to low, over the course of one of the most volatile market years in history, was less than two and a half hundredths of a penny."
She adds, "This data provides evidence that the 2010 reforms have contributed greatly to the strengthening of CSIM money market funds. During 9 of the 12 months in calendar year 2011, CSIM prime money market funds experienced outflows. But all CSIM funds were able to satisfy all redemption requests without significant impact to any of the funds' NAVs. Moreover, the amount of redemption requests was considerably lower than the fund experienced during 2008, a reflection, we believe, of the investor confidence in money funds. During a period of instability in the market, money market funds performed with remarkable stability."
Chandoha concludes, "CSIM believes that our recent experience demonstrates that the reforms of Rule 2a-​7 in 2010 have accomplished and are accomplishing the goals of making money market funds more transparent, more resilient and more resistant to sudden changes in redemption behavior. Investors are demonstrating confidence in the product, not only by continuing to keep more than $​150 billion in money market funds at CSIM, but by not overreacting to market volatility with large redemption requests. CSIM also believes that some of the additional reforms under consideration at the Commission have the potential to devastate the product, reducing choice for individual investors and limiting options for short-​term financing for businesses, municipal issuers and non-​profit organizations. Proposals such as requiring money market funds to float their net asset values or imposing a mandatory holdback that would prohibit investors from having immediate access to all of their assets are unworkable for funds and for individual investors. Perhaps more importantly, it remains far from certain that these proposals would provide any additional benefit, beyond the substantial benefits provided by the 2010 reforms, to funds in addressing their ability to withstand redemption pressures in extraordinary markets."
Finally, she adds, "Before considering such proposals, it seems only logical that the Commission undertake a rigorous, industry-​wide analysis of how money market funds have behaved since the 2010 reforms were implemented. In fact, we believe doing so is a necessary step before any additional reform is contemplated. We believe that the experience of our funds is representative of the entire industry, but only a broad study can confirm that. We strongly urge the Commission to conduct a broad study of the effectiveness of the 2010 reforms before proposing any additional reforms. Should the Commission'​s analysis reveal specific areas of weakness or concern, we would be happy to work with the Commission staff on targeted reforms that address specific issues raised in a study. We thank the Commission for the opportunity to add our perspective to this important debate. We would be pleased to provide additional information or respond to any questions from the Commissioners or the staff."
Boston Fed'​s Rosengren on MMFs, Credit Risk; Reforms Months Away?
Eric Rosengren, President & Chief Executive Officer of the Federal Reserve Bank of Boston, gave a speech Wednesday morning at the Federal Reserve Bank of Atlanta'​s 2012 Financial Markets Conference ("Financial Reform: The Devil'​s in the Details") entitled, "Money Market Mutual Funds and Financial Stability. Rosengren says, "​The focus of my remarks today will be financial stability. Both the financial crisis in 2008 and the more recent sovereign debt problems in Europe underscored the significance of money market fund flows to short-​term credit markets, and the potential for disruptions in those flows and markets to create broader economic difficulties. I will leave it to other panelists to focus on the impact of recently implemented and proposed regulations on individual funds or suppliers of short-​term funds. Instead I will look at potential reforms in the context of whether they promote financial stability."
He continues, "​Money market funds serve as important intermediaries between investors who want low-​risk, highly liquid investments, and banks and corporations that have short-​term borrowing needs. Money market funds are a key buyer of the short-​term debt instruments issued by banks and corporations -- commercial paper, bank certificates of deposit, and repurchase agreements. Given the importance of short-​term credit markets to both investors and businesses, any disruptions to those credit markets represent a potential financial stability issue of both domestic and global significance. I would add that in discussions about ways that financial problems could, potentially, be amplified into a financial crisis, I hear money market funds often brought up."
Rosengren explains, "My comments today are going to focus on prime money market funds, as opposed to government funds or tax-​free funds. Prime funds hold a mix of short-​term debt instruments including commercial paper and large certificates of deposit, as well as Treasury and agency securities. Prime funds played a critical role in the amplification of financial problems in recent years. To summarize, my key points today will be the following: Some prime funds have taken on significant credit risk -- at times incurring losses that necessitated the support of the parent or sponsor of the fund, and in one case substantial government support. In my view the assumption of significant credit risk is not appropriate for intermediaries that have no capital and implicitly promise a fixed net asset value (​NAV)."
He adds, "Without additional reforms, this structural problem could trigger or amplify future financial stability problems. Issues of potential financial instability were not fully resolved by the 2010 reforms, although those reforms were important steps forward. Fragilities related to money market funds could be significantly mitigated by proposed SEC reforms and, potentially, by monitoring and reducing the credit risk taken by prime funds."
Rosengren reviews past issues with Prime funds, and says, "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. The credit risk taken by some money market funds is still significant, even after the financial problems experienced from 2007 to 2010 and the recent SEC reforms. As recently as the fall of 2011, a sponsor provided support to a fund as a result of its holding of downgraded Eksportfinans paper."
He states, "A significant source of the credit risk in many prime money market funds over the past year has been the large exposure to European banks. Figure 5 shows the exposure of the industry to financial institutions in France, Italy, and Spain. While these exposures were substantially reduced as the risks became more apparent, I have to question whether investors in money market funds would have been willing to directly hold such large exposures in foreign financial institutions, and whether such investments were consistent with the perceptions of very low credit risk that many investors expect to be associated with prime money market funds. Figure 6 shows that while the exposure to Europe declined significantly through December 2011, 36 percent of prime money market fund assets remain in Europe (​granted, generally in the stronger countries). So, when considering the so-​called "​tail" risk from unexpected problems in Europe, money market funds remain an important potential transmission channel to the United States."
Rosengren claims, "Despite the experience of the Reserve Primary Fund during 2008, a number of money market funds held securities that posed significant credit risk during the 2011 period of European problems. While there were significant outflows, no losses or runs occurred -- but in my view this should provide us little solace. We should care not only about the realized losses, but also about the potential losses associated with risk exposures. From a public policy perspective, we should in short care that significant risks were taken even though the potential bad outcome did not occur. The willingness of multiple money market funds to take excessive credit risk even after the 2010 reforms suggests that money market funds, absent some changes, still pose some risks to financial stability. Simply put, my view is that taking large credit risks is incompatible with being an intermediary that has no capital and implicitly promises a fixed net asset value."
He continues, "While the 2010 reforms improved the liquidity and credit risk of money market funds, I believe the data I have presented today suggest that more substantial initiatives are needed to reduce the risks to financial stability. One possible way to mitigate the risks is to no longer transact at a fixed net asset value. This has several possible benefits, but also potential drawbacks. As with other mutual funds, a floating NAV would highlight that the underlying asset values do fluctuate, and that the investor is taking some risk. By observing movements in the NAV, investors would have regular reminders that investments in money market funds are not riskless, and that absent sponsor or government support the fund cannot guarantee that it will always be able to return an investor'​s money dollar for dollar."
Rosengren also comments, "Furthermore, a money market fund that takes credit risk simply cannot guarantee that it will on its own pay a fixed net asset value. Should a large credit loss occur, the fixed net asset value will not be able to be maintained unless the sponsor is willing and able to provide financial support. Still, there are two potential negatives to a floating rate NAV. First, it transforms the product from a near-​substitute for bank deposits into an asset with a fluctuating price. Those fluctuations in price, and the taxable gains or losses that result, would make money market funds less attractive as a transaction account for many investors -- in part due to the taxable gains or losses. Second, it only partially prevents runs, because as soon as investors become concerned about credit losses, there is a strong incentive to get out of the fund early. The first investor to leave the fund (​to redeem) avoids the large drops in valuation and loss of liquidity that typically accompany a run."
He adds, "While the incentive to run is not eliminated by a floating NAV, it is certainly less than for a fund with a fixed NAV that risks "​breaking the buck." Interestingly, floating NAV funds are used in Europe. In sum, a move to a floating NAV would more accurately reflect the fundamental nature of the product actually offered, rather than making implicit promises to investors that cannot always be kept during stressful times."
Rosengren continues, "Another alternative would be to require money market funds to hold capital, and to impose a cost on redemptions. An appropriate redemption policy could substantially reduce the incentives to run. With appropriately calibrated capital and redemption policies, the incentive to run (​and thus the inability to fully pay investors) would be greatly reduced. To digress for a moment, it is important to distinguish between solvency issues and liquidity problems. Slowing down redemptions would assist in situations where there is underlying value but a drying up of liquidity may lead to losses from "​fire sale" prices."
He tells us, "These remedies also raise potential concerns and have costs. In general any reforms that, in the language of economists, would "​internalize the costs" associated with systemic risk would to some degree make money market funds less attractive for investors. Raising capital in a low interest rate environment would be challenging and, depending on how it is raised, would impact returns to sponsors or investors. A change in redemption practices would pose a potential risk to investors that would make the money market fund less attractive relative to other products. But despite these concerns, appropriately calibrated capital and redemption policies would reduce the risk that investors would not be able to get full value on their redemptions or that runs would occur."
Rosengren says, "Beyond the two alternatives I have discussed, there may be additional ways to address these issues. There may be opportunities for SEC policymaking and monitoring to inhibit funds from taking on excessive credit risk. As I have shown today, the extent of credit risk taken by some money market funds is shown by the number of times sponsors have needed to provide support and by the makeup of underlying assets in certain funds. The SEC limitations placed on credit risk are currently too broad to avoid significant credit risk exposure and there may be ways to use market information to determine if assets in the funds are inconsistent with the intent to limit significant credit risk exposures at money market funds."
He concludes, "In summary and conclusion, I believe the approaches I have mentioned today could significantly mitigate financial stability concerns around money market funds. Of course, none of the proposals eliminate the risk entirely, and none are costless. Neither are they mutually exclusive -- elements could be adopted in some combination. Everyone knows the SEC is working very hard on this, and could have a proposal for reforms out in the coming months. I strongly commend their efforts to arrive at reforms that reduce the risks surrounding money market funds. The bottom line, in my view, is that the status quo is not acceptable. As I have shown today, a number of money market funds took significant credit risk that ultimately led to them needing sponsor support in the period from 2007 to 2010. Substantial government support was required after the Reserve Primary Fund experienced losses. Moreover, a significant number of money market funds continued to take substantial credit risk during the recent European financial problems. So, I must conclude that reforms enacted to date do not seem to sufficiently limit money market funds' ability to assume excessive credit risks."
Finally, he says, "A money market fund with a fixed net asset value set by an intermediary with no capital that takes on credit risk will, eventually, result in the failure to meet obligations in the absence of outside support by either a sponsor or government. Funds need to be structured so that neither sponsor support nor government support is likely or necessary, even during times of stress. I realize the industry is opposed to measures that would decrease the attractiveness of funds but in the end a stronger industry could result, beyond the financial stability improvements that are my main focus. But all in all I believe the risks to the stability of the financial system that underpins the economy are too great not to take the actions that will make the industry, and our financial system, more stable."
OCC Proposes Rules on 112 Billion Short-​Term Investment Fund Market
On Monday, a "Notice of proposed rulemaking" was published by the Office of the Comptroller of the Currency on "Short-​Term Investment Funds," or "​STIFs". The proposal, which requests comments by June 8, 2012 (​send to: regs.​comments@​occ.​treas.​gov), says, "The OCC is requesting comment on a proposal that would revise the requirements imposed on banks pursuant to 12 CFR 9.​18(​b)(​4)(​ii)(​B), the short-​term investment fund (​STIF) rule (​STIF Rule). The proposal would add safeguards designed to address the risk of loss to a STIF'​s principal, including measures governing the nature of a STIF'​s investments, ongoing monitoring of its mark-​to-​market value and forecasting of potential changes in its mark-​to-​market value under adverse market conditions, greater transparency and regulatory reporting about a STIF'​s holdings, and procedures to protect fiduciary accounts from undue dilution of their participating interests in the event that the STIF loses the ability to maintain a stable net asset value (​NAV)."
The OCC writes, "A Collective Investment Fund (​CIF) is a bank-​managed fund that holds pooled fiduciary assets that meet specific criteria established by the OCC fiduciary activities regulation at 12 CFR 9.​18. Each CIF is established under a "​Plan" that details the terms under which the bank manages and administers the fund'​s assets. The bank acts as a fiduciary for the CIF and holds legal title to the fund'​s assets. Participants in a CIF are the beneficial owners of the fund'​s assets.... CIFs are designed to enhance investment management capabilities by combining assets from different accounts into a single fund with a specific investment strategy. By pooling fiduciary assets, a bank may lower the operational and administrative expenses associated with investing fiduciary assets and enhance risk management and investment performance for the participating accounts."
They explain, "A STIF is a type of CIF that permits a bank to value the STIF'​s assets on an amortized cost basis, rather than at mark-​to-​market value, for purposes of admissions and withdrawals. This is an exception to the general rule of market valuation. In order to qualify for this exception, a STIF'​s Plan must require the bank to: (​1) Maintain a dollar weighted average portfolio maturity of 90 days or less; (​2) accrue on a straightline or amortized basis the difference between the cost and anticipated principal receipt on maturity; and (​3) hold the fund'​s assets until maturity under usual circumstances. These conditions are designed to protect fiduciary accounts from the risk of dilution of the value of their participating interests. In particular, by limiting the STIF'​s investments to shorter-​term assets and generally requiring those assets to be held to maturity, realized differences between the amortized cost and mark-​to-​market value of the assets will be rare, absent atypical market conditions or an impaired asset."
The Proposal continues, "The OCC'​s STIF Rule governs STIFs managed by national banks. In addition, regulations adopted by the Office of Thrift Supervision, now recodified as OCC rules pursuant to Title III of the Dodd-​Frank Wall Street Reform and Consumer Protection Act, have long required federal savings associations (​FSAs) to comply with the requirements of the OCC'​s STIF Rule. Thus, the proposed revisions to the national bank STIFs Rule would apply to a federal savings association that establishes and administers a STIF fund. As of December 31, 2011, there was approximately $​112 billion invested in STIFs administered by national banks [​15 total] and there were no STIFs administered by FSAs reported."
It says, "The OCC is proposing to revise the requirements of the STIF Rule. While fiduciary accounts participating in a STIF have an interest in the fund maintaining a stable net asset value (​NAV), ultimately the participating interests remain subject to the risk of loss to a STIF'​s principal. The OCC is proposing additional safeguards designed to address this risk in several ways. These include measures governing the nature of a STIF'​s investments, ongoing monitoring of the STIF'​s mark-​to-​market value and assessment of potential changes in its mark-​to-​market value under adverse market conditions, greater transparency and regulatory reporting about the STIF'​s holdings, and procedures to protect fiduciary accounts from undue dilution of their participating interests in the event that the STIF loses the ability to maintain a stable NAV."
The OCC explains, "​There are other types of funds that seek to maintain a stable NAV. By far, the most significant of these from a financial market presence standpoint are "​money market mutual funds" (​MMMFs). These funds are organized as open-​ended management investment companies and are regulated by the U.​S. Securities and Exchange Commission ("​SEC") pursuant to the Investment Company Act of 1940, particularly pursuant to the provisions of SEC Rule 2a–​7 thereunder ("​Rule 2a–​7"). MMMFs seek to maintain a stable share price, typically $​1.​00 a share. In this regard, they are similar to STIFs."
They add, "However, there are a number of important differences between MMMFs and STIFs; most significantly, MMMFs are open to retail investors, whereas, STIFs only are available to authorized fiduciary accounts. MMMFs may be offered to the investing public and have become a popular product with retail investors, corporate money managers, and institutional investors seeking returns equivalent to current short-​term interest rates in exchange for high liquidity and the prospect of protection against the loss of principal. In contrast to the approximately $​112 billion currently held in STIFs administered by national banks, MMMFs, as of December 2011, held approximately $​2.​7 trillion dollars of investor assets."
The Notice states, "​Based on the market turmoil from 2007 through 2009 and the work done by the PWG, among others, the SEC adopted amendments to Rule 2a–​7 to strengthen the resilience of MMMFs. The OCC'​s proposed changes to the STIF Rule are informed by the SEC'​s revisions to Rule 2a–​7, but differ in certain respects in light of the differences between the money market mutual fund as an investment product and the STIF, e.​g., a bank'​s fiduciary responsibility to a STIF and requirements limiting STIF participation to eligible accounts under the OCC'​s fiduciary account regulation at 12 CFR part 9."
It continues, "The proposed changes to the STIF Rule would enhance protections provided to STIF participants and reduce risks to banks that administer STIFs. The proposed changes add new requirements or amend existing requirements that a CIF must meet to be considered a STIF and value assets on an amortized cost basis. The OCC believes many banks that offer STIFs are already engaged in the risk mitigation efforts set forth in this proposed rule."
OCC explains, "The proposal would amend the "​dollar-​weighted average portfolio maturity" requirement of the STIF Rule to 60 days or less.... The proposal would add a new maturity requirement for STIFs, which would limit the dollar-​weighted average portfolio life maturity to 120 days or less.... In determining the dollar-​weighted average portfolio maturity of STIFs under the current rule, national banks generally apply the same methodology as required by the SEC for MMMFs pursuant to Rule 2a–​7."
It adds, "To ensure that banks managing STIFs include practices designed to limit the amount of credit and liquidity risk to which participating accounts in STIFs are exposed, the proposal would require adoption of portfolio and issuer qualitative standards and concentration restrictions.... The proposal would require a bank managing a STIF to adopt shadow pricing procedures. These procedures require the bank to calculate the extent of the difference, if any, between the mark-​to-​market NAV per participating interest using available market quotations (​or an appropriate substitute that reflects current market conditions) from the STIF'​s amortized cost value per participating interest.... The proposal would require a bank managing a STIF to adopt procedures for stress testing the fund'​s ability to maintain a stable NAV for participating interests."
It says, "The proposal would require banks managing STIFs to disclose information about fund level portfolio holdings to STIF participants and to the OCC within five business days after each calendar month-​end. Specifically, the bank would be required to disclose the STIF'​s total assets under management (​securities and other assets including cash, minus liabilities); the fund'​s mark-​to- market and amortized cost NAVs, both with and without capital support agreements; the dollar-​weighted average portfolio maturity; and dollar-​weighted average portfolio life maturity as of the last business day of the prior calendar month. The current STIF Rule does not contain a similar disclosure requirement."
The Proposed Rule adds, "​Also, for each security held by the STIF, as of the last business day of the prior calendar month, the bank would be required to disclose to STIF participants and to the OCC within five business days after each calendar month-​end at a security level: (​1) The name of the issuer; (​2) the category of investment; (​3) the Committee on Uniform Securities identification Procedures (​CUSIP) number or other standard identifier; (​4) the principal amount; (​5) the maturity date for purposes of calculating dollar-​weighted average portfolio maturity; (​6) the final legal maturity date (​taking into account any maturity date extensions that may be effected at the option of the issuer) if different from the maturity date for purposes of calculating dollar-​weighted average portfolio maturity; (​7) the coupon or yield; and (​8) the amortized cost value."
Finally, the OCC writes, "The proposal would require a bank that manages a STIF to notify the OCC prior to or within one business day after certain events. Those events are: (​1) Any difference exceeding $​0.​0025 between the NAV and the mark-​to-​market value of a STIF participating interest based on current market factors; (​2) when a STIF has re-​priced its NAV below $​0.​995 per participating interest; (​3) any withdrawal distribution-​in-​kind of the STIF'​s participating interests or segregation of portfolio participants; (​4) any delays or suspensions in honoring STIF participating interest withdrawal requests; (​5) any decision to formally approve the liquidation, segregation of assets or portfolios, or some other liquidation of the STIF; and (​6) when a national bank, its affiliate, or any other entity provides a STIF financial support, including a cash infusion, a credit extension, a purchase of a defaulted or illiquid asset, or any other form of financial support in order to maintain a stable NAV per participating interest.... The proposal would require a bank managing a STIF to adopt procedures for suspending redemptions and initiating liquidation of a STIF as a result of redemptions."
Additional MMF Reg Steps Warrant Serious Consideration Says Bernanke
Last night, Federal Reserve Chairman Ben Bernanke spoke at the 2012 Federal Reserve Bank of Atlanta Financial Markets Conference in Stone Mountain, Georgia on "Fostering Financial Stability." The Chairman weighed in on "​shadow banking" extensively, and had several things to say on money market funds. He says, "Tonight I will discuss some ways in which the Federal Reserve, since the crisis, has reoriented itself from being (​in its financial regulatory capacity) primarily a supervisor of a specific set of financial institutions toward being an agency with a broader focus on systemic stability as well. I will highlight some of the ways we and other agencies are working to increase the resiliency of systemically important financial firms and identify and mitigate systemic risks, including those associated with the so-​called shadow banking system. I will also discuss the broad outlines of our evolving approach to monitoring financial stability. Our efforts are a work in progress, and we are learning as we go. But I hope to convey a sense of the strong commitment of the Federal Reserve to fostering a more stable and resilient financial system."
Bernanke explains, "Gaps in the regulatory structure, which allowed some systemically important nonbank financial firms to avoid strong, comprehensive oversight, were a significant contributor to the crisis. The Federal Reserve has been working with the other member agencies of the Financial Stability Oversight Council (​FSOC), established by the Dodd-​Frank Act, to close these regulatory gaps. On April 3 the FSOC issued a final rule and interpretive guidance implementing the criteria and process it will use to designate nonbank financial firms as systemically important. Once designated, these firms would be subject to consolidated supervision by the Federal Reserve.... The FSOC'​s rule provides detail on the framework the FSOC intends to use to assess the potential for a particular firm to threaten U.​S. financial stability. The analysis would take into account the firm'​s size, interconnectedness, leverage, provision of critical products or services, and reliance on short-​term funding, as well as its existing regulatory arrangements."
He continues, "​I have been discussing the oversight of systemically important financial institutions in a macroprudential context. However, an important lesson learned from the financial crisis is that the growth of what has been termed "​shadow banking" creates additional potential channels for the propagation of shocks through the financial system and the economy. Shadow banking refers to the intermediation of credit through a collection of institutions, instruments, and markets that lie at least partly outside of the traditional banking system."
Bernanke says, "Although the shadow banking system taken as a whole performs traditional banking functions, including credit intermediation and maturity transformation, unlike banks, it cannot rely on the protections afforded by deposit insurance and access to the Federal Reserve'​s discount window to help ensure its stability. Shadow banking depends instead upon an alternative set of contractual and regulatory protections--​for example, the posting of collateral in short-​term borrowing transactions. It also relies on certain regulatory restrictions on key entities, such as the significant portfolio restrictions on money market funds required by rule 2a-​7 of the Securities and Exchange Commission (​SEC), which are designed to ensure adequate liquidity and avoid credit losses. During the financial crisis, however, these types of measures failed to stave off a classic and self-​reinforcing panic that took hold in parts of the shadow banking system and ultimately spread across the financial system more broadly."
He adds, "Because of these and other connections, panics and other stresses in shadow banking can spill over into traditional banking. Indeed, the markets and institutions I mentioned--​the repo market, the ABCP market, and money market funds--​all suffered panics to some degree during the financial crisis. As a result, many traditional financial institutions lost important funding channels for their assets; in addition, for reputational and contractual reasons, many banks supported their affiliated funds and conduits, compounding their own mounting liquidity pressures."
On the "Status of Shadow Banking Reform Efforts," Bernanke comments, "​Given the substantial stakes, I am encouraged that both regulators and the private sector have begun to take actions to prevent future panics and other disruptions in shadow banking. However, in many key areas these efforts are still at early stages."
He tells us, "A second area of ongoing reform is money market funds. In an important step toward greater stability, the SEC in 2010 amended its regulations to, among other things, require that money market funds maintain larger buffers of liquid assets, which may help reassure investors and reduce the likelihood of runs. Notwithstanding the new regulations, the risk of runs created by a combination of fixed net asset values, extremely risk-​averse investors, and the absence of explicit loss absorption capacity remains a concern, particularly since some of the tools that policymakers employed to stem the runs during the crisis are no longer available. SEC Chairman Mary Schapiro has advocated additional measures to reduce the vulnerability of money market funds to runs, including possibly requiring funds to maintain loss-​absorbing capital buffers or to redeem shares at the market value of the underlying assets rather than a fixed price of $​1. Alternative approaches to ensuring the stability of these funds have been proposed as well. Additional steps to increase the resiliency of money market funds are important for the overall stability of our financial system and warrant serious consideration."
Bernanke comments, "A third set of emerging reforms is aimed at repo markets, an area in which the Federal Reserve has taken an active role. The initial efforts have focused on the vulnerabilities created by the large amounts of intraday credit provided by clearing banks in the triparty repo market.... An industry task force recognized this mutual vulnerability in 2010 and recommended the "​practical elimination" of intraday credit in the triparty repo market. Although some progress has been made, securities dealers and clearing banks have yet to fully implement that recommendation. Nevertheless, through supervision and other means, we continue to push the industry toward this critical goal. In doing so, we are collaborating with other agencies, notably the SEC, which has regulatory responsibility for money market funds and securities dealers, institutions that are active in the triparty repo market. At the same time, we continue to urge market participants to improve their risk-​management practices, and, in particular, to ensure that tools are in place to address the risks that would be posed to the repo market by the default of a major firm."
Finally, he adds, "International regulatory groups have also been focused on addressing the financial stability risks of shadow banking. The Group of Twenty leaders have directed the Financial Stability Board (​FSB), whose membership consists of key regulators from around the world, including the Federal Reserve, with developing policy recommendations to strengthen the regulation of the shadow banking system. The FSB currently has five major projects under way devoted to understanding the risks of, and developing policy recommendations for, shadow banking. The areas under study include money market funds, securitization, securities lending and the repo market, banks' interactions with shadow banks, and "​other" shadow banking entities. Given the substantial variation in the structure of shadow banking in different countries, the FSB'​s agenda is ambitious. But it is also critical in light of the potential risks to stability from shadow banking and the ease with which shadow banking entities can create intermediation chains across national borders."
April MFI Features Real Consolidation, Western T-​E, No Reform Truce
The April issue of Crane Data'​s Money Fund Intelligence was e-​mailed to subscribers Monday morning, and our March 31, 2012 monthly performance data and rankings were distributed via our Money Fund Intelligence XLS monthly spreadsheet, our Money Fund Wisdom database query website and our Crane Index money fund averages series. (​Our monthly Money Fund Portfolio Holdings with 3/​31/​12 data will be distributed on the 9th business day, April 13.) The new edition of MFI features the articles: "Another Two Bite the Dust: Consolidation Becomes Real," which discusses the pending liquidations and exits of Fifth Third and Victory Funds from the money fund space; "Talking Tax Exempts w/​Western Asset'​s Amodeo," our monthly fund "​profile" which interviews Western Muni MMF Managers Robert Amodeo and Charles Bardes; and, "No Truce in MMF Reform Debate; No Proposal Yet," which discusses recent (​unsuccessful) attempts to compromise over pending regulations.
Our lead piece says, "We'​ve been arguing for years that predictions of consolidation in the money fund space have been greatly exaggerated, but the latest couple of announcements have us rethinking our position. Two decent-​sized, long-​term players (​as opposed to the fringe outfit that have folded to date) have recently announced exits -- Fifth Third will have its money funds liquidated and its assets merged into Federated, and KeyBank'​s Victory Funds is also calling it quits and liquidating."
Money Fund Intelligence explains, "In the past two years, we'​ve seen Old Mutual, Paypal, Pacific Capital, Pioneer (​partial), Scout (​UMB), Ridgeworth (​merged into Federated), Eagle (​Raymond James), and a handful of others announce liquidations. The number of funds tracked by Crane Data has fallen from 1,​310 to 1,​209, which also includes lots of mergers and stream-​linings."
The Western Asset Profile, which we'​ll excerpt later this month, tell us, "This month, MFI interviews managers of `​Western Asset Management'​s Municipal Money Market Funds. We speak with Robert Amodeo, Portfolio Manager and Head of the Municipal Group, and Charles Bardes, a Portfolio Manager on the Tax-​Exempt Money Market Mutual Funds. The two have been running money funds with the unit since its days as Salomon Brothers Asset Management (​in the late '​80'​s/​early '​90'​s), which then became Citigroup Asset Management and eventually was acquired by Western parent Legg Mason. Our Q&​A involving tax-​exempt money fund issues follows."
The third feature piece in our monthly says, "Despite SEC Commissioner Elisse Walter'​s recent call for a "​step back" and a "​re-​engage"-​ment in the discussion over additional money market fund regulatory reforms, the public battle between the money fund industry and the bank regulatory community rages on. While a number of the most public comments occurred at the ICI'​s Phoenix Mutual Funds and Investment Management Conference, regulators and industry participants continue to wage a PR war on multiple fronts. The pending reform proposal, which The Wall Street Journal claimed was imminent, remains nowhere to be seen. (​We'​re guessing June.)"
The April MFI also contains monthly News, Indexes, top rankings and extensive performance tables. E-​mail info@​cranedata.​us to request the latest issue. Subscriptions to Money Fund Intelligence are $​500 a year and include web access to archived issues and fund "​profiles". Additional users are $​250 and bulk pricing and "​site licenses" are available. Crane Data'​s other products include: Money Fund Intelligence XLS ($​1K/​yr), MFI Daily ($​2K/​yr), Money Fund Wisdom ($​4K/​yr), MFI International ($​2K/​yr), and Brokerage Sweep Intelligence ($​1K/​yr).
ICI'​s Stevens Commends FSOC'​s Thoughtful Approach on MMFs as SIFIs
Last Wednesday, we wrote about the most recent news involving money funds and the Financial Stability Oversight Council (​see FSOC Approves Final Rule to Designate Nonbank SIFIs; MMFs Not Likely?), and today we feature Investment Company Institute President & CEO Paul Schott Stevens' commentary on the action, "Money Market Funds and Financial Stability: Reason and the Facts Must Guide Regulators." Stevens writes, "We are pleased to see that the Financial Stability Oversight Council continues to take a thoughtful approach on the issue of designating "​systemically important financial institutions." That'​s in stark contrast to some commentators, who would have regulators rush to put money market funds under that designation. As ICI has argued in a number of venues, a "​SIFI" designation is inappropriate for these funds and plainly would run counter to facts and reason. Let'​s review why."
ICI'​s leader says, under "Money Market Funds Have Stringent Risk-​Limiting Characteristics," "One key reason why the SIFI designation is not appropriate for money market funds is that these funds are among the most strictly regulated financial products offered to investors. As ICI conveyed to the Financial Stability Oversight Council (​FSOC) in a 2011 letter, money market funds must comply with the comprehensive requirements of the Investment Company Act -- plus an additional set of regulatory requirements specific to these funds. These legal requirements, recently strengthened by the Securities and Exchange Commission in 2010, include tough standards on credit quality, liquidity, maturity, and diversification. The basic objective here is to limit a fund'​s exposure to credit risk, interest rate risk, liquidity risk, and the risk that big shareholders may suddenly exit a fund."
Stevens continues, "Critics of money market funds frequently fail to recognize the 2010 SEC updates -- and their success. As I'​ve discussed recently, money market funds, under these enhanced regulatory requirements, have weathered three severe challenges: the European sovereign debt crisis, the impasse over the U.​S. federal debt ceiling, and the historic downgrade of the U.​S. debt rating -- all while enduring the long-​running punishment of near-​zero interest rates."
He explains, "​These challenges prompted investor movement out of money market funds; last summer'​s outflows were significant. Yet money market funds easily met these redemptions because the funds held liquidity that met and exceeded the standards set by the 2010 reforms. This industry-​wide approach makes far more sense than designating hundreds of money market funds -- or even just prime money market funds -- offered in the U.​S. market as SIFIs, thus subjecting each to inappropriate, bank-​like prudential standards applied by the Federal Reserve Board."
Stevens says, "Money Market Funds are Not "​Shadow Banks," commenting, "​In a recent editorial, Bloomberg View addressed these matters by, unfortunately, perpetuating the misperception that money market funds are "​shadow banks." In comment letters and elsewhere, we'​ve confronted this misperception. I commend readers to a December ICI Viewpoints post by ICI Chief Economist Brian Reid, who succinctly reviews why it'​s wrong to assume that all investing and lending that occurs outside the banking system is somehow shadowy or inappropriate."
Finally, he continues, "Namely: Banking and capital markets are both highly regulated and have successfully coexisted for centuries. Robust capital markets add resiliency to the financial system, because the capital markets sometimes weather times of crisis better than banks. Moving more financial activity into the banking system will concentrate risks and make the financial system more vulnerable. Bloomberg'​s editorial urges FSOC to err on the side of "[​sweeping] up more firms than it expected to have to oversee." We urge the FSOC to err on the side of reason and the facts."
Federated To Acquire (​The Rest of) Fifth Third Money Market Funds
A press release entitled, "Federated Investors, Inc. to Acquire Money Market Assets from Fifth Third Asset Management, Inc. says, "Federated Investors, Inc. (​NYSE: FII), one of the nation'​s largest investment managers, and Fifth Third Bank announced that a definitive agreement has been reached regarding the acquisition of certain assets relating to the management of Fifth Third money market funds. In connection with the acquisition, approximately $​5 billion of money market assets will be reorganized from four Fifth Third money market funds into four existing Federated money market funds with similar investment objectives. The transaction is not expected to have a material impact on Fifth Third Bancorp'​s results."
J. Christopher Donahue, president and chief executive officer of Federated Investors, says, "​For decades, Federated has worked closely with banks to offer investment products that meet the needs of their customers. That experience, combined with our expertise in diligent credit analysis and fundamental research, provides an ideal opportunity for Fifth Third to transition these assets. Federated will continue to closely review further opportunities for strategic alliances that best serve our bank clients."
Kevin T. Kabat, president and CEO of Fifth Third Bancorp comments, "Our relationship with Federated provides us an exciting opportunity to grow our business in an area where scale is increasingly important. This action reduces risk and moves us more closely to trusted advisor status by being able to offer clients a broader choice of investment products. We look forward to working with Federated and leveraging our distribution platform to provide value to shareholders."
The release adds, "Closing of the transaction is subject to certain conditions and approvals and is expected to be completed in the third quarter of 2012. Cambridge International Partners Inc. is advising Fifth Third on the transaction." Fifth Third, currently the 34th largest money fund manager with $​5.​07 billion, had previously outsourced its Municipal money market funds to Federated back in 2008 (​see Money Fund Intelligence Sept. 2008).
Capital Advisors Suggest Dual NAV; Fitch European Money Fund Update
Boutique cash manager Capital Advisors has published a comment entitled, "Can Money Market Funds Survive Variable Net Asset Values? Introducing a Dual-​NAV Approach" (​recently released on the SEC'​s "​President'​s Working Group Report on Money Market Fund Reform (​Request for Comment)" page). It says, "We propose a variable Net Asset Value (​NAV) approach based on a dual-​NAV structure to preserve the transactional utility of money market funds. This approach would require funds to publish daily intrinsic NAVs up to the 4th decimal place, and would allow shares to be traded at rounded NAVs (​RNAVs) up to the 2nd decimal place. Results from our studies show that, when prudently managed, RNAVs at $​1.​00 are achievable even under severe market conditions. Such studies cover shadow NAVs of large prime funds, normalized NAVs of an ETF and an ultra-​short bond fund, and prime fund NAVs in FundIQ stress tests."
The letter continues, "We believe that recent regulations have sufficiently addressed portfolio risk within money market funds. However, the dual-​NAV approach may provide further shareholder risk mitigation. We think that this approach is less disruptive than the proposals being considered, and since a variation of the approach already exists, its implementation likely will encounter the least resistance. With each passing day, constituents of the money market fund industry wait with growing anxiety for the Securities and Exchange Commission (​SEC) to announce its proposals for additional industry reform. Based on recent speeches from SEC officials and reports by the media, variable net asset values (​VNAVs), capital buffers and holdbacks on share redemptions seem to be the three likely outcomes."
Capital Advisors adds, "Not surprisingly, the fund industry and many institutional shareholders dislike all three solutions, suggesting that implementing any of them could mark the end of the popular investment vehicle as we know it and bring unnecessary stress to financial markets at large. On the other hand, government officials, notably SEC Chairman Mary Schapiro, feel strongly that the fund industry is operating without a safety net and that additional regulation is needed to address the funds' structural vulnerability."
Finally, they explain, "​Are the views from the two sides irreconcilable? Can money market funds operate under the existing SEC Rule 2a-​7 framework and sufficiently avoid the dramatic capital flight that occurred in the wake of the Lehman Brothers bankruptcy in 2008? After studying the NAV history of a number of pooled vehicles, we suggest that a modified version of the VNAV approach may bridge the gap between the private sector and the regulators. The dual-​NAV approach mimics the daily premium/​discount presentation of closed-​end funds and exchange-​traded funds. It modifies the conventional VNAV approach by abolishing the amortized cost method, requiring funds to publish intrinsic NAVs (​INAVs) daily up to the 4th decimal place ($​0.​0000), but allowing shares to be traded at rounded NAVs (​RNAVs) up to the 2nd ($​0.​00) decimal place. Results from our studies show that RNAVs at $​1.​00 are achievable even under severe market conditions when managed prudently. The INAV disclosure eliminates information asymmetry in underlying asset values, a primary cause for shareholder runs."
In other news, Fitch Ratings has released a "Sector Update: European Money Market Funds." It says, "Fitch-​rated European MMFs continue to maintain high exposure to sovereign and financial institutions from the core European countries of France, Germany, the UK and the Netherlands, as illustrated in Figures 1 and 2. Sources of diversification have been found in the form of increased investments in financial institutions from Australia, Switzerland, the Nordics (​Norway, Sweden), Japan, Canada, and, to a lesser extent, Singapore, the Middle East and China (​see Figure 3)."
The report adds, "Most MMFs continued to maintain low WAM in 2011 (​see Figure 6), before showing signs of a timid increase in WAM over the first two months of 2012, as fund managers risk aversion eased somewhat. The average WAM across the universe of Fitch-​rated euro, sterling and US dollar European MMFs stood at 29, 37 and 36 days, respectively, at end-​February 2012.... The average overnight and one-​week liquidity in euro, sterling and US dollar Fitch-​rated MMFs remained at high levels for the six months to February 2012 (​see Figure 7). Peak levels were reached in December 2011, with average overnight maturity at close to 35% of euro and sterling portfolios, and ending at around 30% on average (​end-​February 2012) for each of the three currencies."
FSOC Approves Final Rule to Designate Nonbank SIFIs; MMFs Not Likely?
On Tuesday, Treasury Secretary Geithner presided over an open session of the Financial Stability Oversight Council (​FSOC), which voted on a "​final rule and interpretive guidance on the Council'​s authority to require supervision and regulation of certain nonbank financial companies." While we likely won'​t know until late this year whether money funds, or just some (​perhaps $​50 billion plus) money funds, may be classified as SIFIs (​systematically important financial institutions), our reading is that the latest guidance has lowered the odds of this happening slightly. The "​final rule and interpretive guidance" is entitled, "Authority to Require Supervision and Regulation of Certain Nonbank Financial Companies."
It says, "Section 113 of the Dodd-​Frank Wall Street Reform and Consumer Protection Act (​the "​Dodd-​Frank Act") authorizes the Financial Stability Oversight Council (​the "​Council") to determine that a nonbank financial company shall be supervised by the Board of Governors of the Federal Reserve System (​the "​Board of Governors") and shall be subject to prudential standards, in accordance with Title I of the Dodd-​Frank Act, if the Council determines that material financial distress at the nonbank financial company, or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the nonbank financial company, could pose a threat to the financial stability of the United States. This final rule and the interpretive guidance attached as an appendix thereto describe the manner in which the Council intends to apply the statutory standards and considerations, and the processes and procedures that the Council intends to follow, in making determinations under section 113 of the Dodd-​Frank Act."
The rules' "Background" explains, "​Section 111 of the Dodd-​Frank Act (​12 U.​S.​C. 5321) established the Financial Stability Oversight Council. Among the purposes of the Council under section 112 of the Dodd-​Frank Act (​12 U.​S.​C. 5322) are "(​A) to identify risks to the financial stability of the United States that could arise from the material financial distress or failure, or ongoing activities, of large, interconnected bank holding companies or nonbank financial companies, or that could arise outside the financial services marketplace; (​B) to promote market discipline, by eliminating expectations on the part of shareholders, creditors, and counterparties of such companies that the Government will shield them from losses in the event of failure; and (​C) to respond to emerging threats to the stability of the United States financial system."
It adds, "​In the recent financial crisis, financial distress at certain nonbank financial companies contributed to a broad seizing up of financial markets and stress at other financial firms. Many of these nonbank financial companies were not subject to the type of regulation and consolidated supervision applied to bank holding companies, nor were there effective mechanisms in place to resolve the largest and most interconnected of these nonbank financial companies without causing further instability. To address any potential risks to U.​S. financial stability posed by these companies, the Dodd-​Frank Act authorizes the Council to determine that certain nonbank financial companies will be subject to supervision by the Board of Governors and prudential standards. The Board of Governors is responsible for establishing the prudential standards that will be applicable, under section 165 of the Dodd-​Frank Act, to nonbank financial companies subject to a Council determination. Title I of the Dodd-​Frank Act defines a "​nonbank financial company" as a domestic or foreign company that is "​predominantly engaged in financial activities," other than bank holding companies and certain other types of firms."
The rule explains, "​The Council issued an advance notice of proposed rulemaking (​the "​ANPR") on October 6, 2010 (​75 FR 61653), in which it requested public comment.... Commenters representing the asset management industry contended that asset managers are unlikely to pose a threat to U.​S. financial stability, and some noted that the legal distinction between investment advisers and the funds they manage make the prudential standards contemplated by section 165 of the Dodd-​Frank Act an inappropriate mechanism for addressing any threat posed by such firms. Others commented on behalf of financial guaranty insurers, captive finance companies, money market funds, and the Federal Home Loan Banks."
It continues, "Pursuant to the provisions of the Dodd-​Frank Act, the Council is required to consider the following statutory considerations when evaluating whether to make this determination with respect to a nonbank financial company: (​A) The extent of the leverage of the company; (​B) The extent and nature of the off–​balance-​sheet exposures of the company; (​C) The extent and nature of the transactions and relationships of the company with other significant nonbank financial companies and significant bank holding companies; (​D) The importance of the company as a source of credit for households, businesses, and State and local governments and as a source of liquidity for the U.​S. financial system; (​E) The importance of the company as a source of credit for low-​income, minority, or underserved communities, and the impact that the failure of such company would have on the availability of credit in such communities; (​F) The extent to which assets are managed rather than owned by the company, and the extent to which ownership of assets under management is diffuse; (​G) The nature, scope, size, scale, concentration, interconnectedness, and mix of the activities of the company; (​H) The degree to which the company is already regulated by one or more primary financial regulatory agencies; (​I) The amount and nature of the financial assets of the company; (​J) The amount and types of the liabilities of the company, including the degree of reliance on short-​term funding; and (​K) Any other risk-​related factors that the Council deems appropriate."
The FSOC says of its three-​stage process, "The first stage of the process ("​Stage 1") is designed to narrow the universe of nonbank financial companies to a smaller set of nonbank financial companies. In Stage 1, the Council intends to evaluate nonbank financial companies by applying uniform quantitative thresholds that are broadly applicable across the financial sector to a large group of nonbank financial companies. These Stage 1 thresholds represent the framework categories that are more readily quantified: size, interconnectedness, leverage, and liquidity risk and maturity mismatch. A nonbank financial company would be subject to additional review if it meets both the size threshold and any one of the other quantitative thresholds.... In Stage 1, the Council intends to apply six quantitative thresholds to a broad group of nonbank financial companies. The thresholds are -- $​50 billion in total consolidated assets."
While there are a number of factors and criteria, there are only seven money fund portfolios currently with over $​50 billion in assets. These include: JPMorgan Prime MM Capital (​CJPXX, $​120.​2B), Fidelity Cash Reserves (​FDRXX, $​116.​6B), Vanguard Prime MMF (​VMMXX, $​113.​7B), JPMorgan US Govt MM Capital (​OGVXX, $​64.​5B), Fidelity Instit MM: MM Port Inst (​FNSXX, $​58.​1B), Fidelity Instit MM: Prime MMP Inst (​FIPXX, $​56.​3B), and Federated Prime ObIigations IS (​POIXX, $​51.​6B).
Fein Comment Says Fed Shooting Messenger, Deflecting Crisis Blame
Comments continue accumulating on the SEC'​s web page for the "​President'​s Working Group Report on Money Market Fund Reform (​Request for Comment)". The most recent links to a 236-​page work entitled, "Shooting the Messenger: The Fed and Money Market Funds," which was written by Melanie Fein of The Law Offices of Melanie Fein. (​We previously mentioned this in a "Link of the Day," but the work has since been updated and submitted to the SEC.) Fein explains, "The Securities and Exchange Commission is considering regulatory proposals that may threaten the future viability of money market funds. Industry members believe the SEC is acting under pressure from the Federal Reserve Board to address Fed concerns that MMFs are "​susceptible to runs," part of an unregulated "​shadow banking system," and pose a "​systemic threat" to the financial system. According to industry members, the Fed'​s narrative on MMFs distorts the facts and obscures the true sources of systemic risk in the financial system. Some in the industry believe the Fed'​s attack on MMFs is intended to deflect blame for the financial crisis from itself and the regulated banking industry. Many in the industry surmise that the Fed'​s ultimate goal is to eliminate MMFs as competitors of banks."
Her "Abstract" continues, "This paper examines the Fed'​s narrative on MMFs and finds it to be inaccurate and misleading in key respects. Among other things, this paper finds no basis for the view that MMFs are "​susceptible to runs." It shows that the "​run" that started the financial crisis was not a run on MMFs but a run on bank-​sponsored commercial paper during which risk-​averse investors fled to MMFs for safety. The "​run" by MMF shareholders that did occur in 2008 was caused by the Fed'​s sudden reversal of its lender of last resort policy that ignited a massive run on the entire financial system."
Fein says, "This paper looks closely at the commercial paper market, which the Fed has said MMFs destabilized, and finds it to be largely an extension of the banking system operating under Fed supervision. The analysis herein strongly suggests that the Fed'​s overriding concern during the crisis was to prop up banks that had effectively guaranteed their asset-​backed commercial paper, which risk-​averse MMFs no longer would buy. The analysis suggests that the Fed'​s liquidity facilities and related regulatory actions that ostensibly benefited MMFs in reality were designed to support banks and the bank commercial paper market and that the bank commercial paper market was the source of systemic risk, not MMFs."
She adds, "Contrary to the Fed'​s narrative in which MMFs are part of an unregulated shadow banking system that threatens the financial system, this paper shows that banks are the shadow banking system and MMFs are merely the equivalent of its depositors. Moreover, the Fed subsidized the growth of the shadow banking system by lowering bank capital requirements for bank asset-​backed commercial paper activities, thereby sowing the seeds of the financial crisis."
Fein writes, "This paper posits that the Fed'​s proposals for MMFs -- particularly the capital buffer concept -- would force MMFs to act as lenders of last resort to the bank commercial paper market -- a role for which they are not suited and could lead to their extinction. On the other hand, to the extent the bank commercial paper market provides a useful and cost-​effective alternative to loans to finance business activity, MMFs offer efficiencies that can assist this important market while providing a much-​needed service to investors that banks cannot provide."
Finally, she adds, "This paper concludes that imposing structural changes on MMFs to prevent a future "​flight to safety" by MMF shareholders is equivalent to shooting the messenger who brings bad news and would punish investors for their prudent behavior much as if the government imposed a tax on depositors who withdraw their money from failing banks. Further, regulating MMFs and their shareholders to prevent them from acting in a risk-​averse manner is a perverse way of preventing systemic risk. It would seem more appropriate for the Fed to encourage MMFs than to thwart them."
ICI'​s Feb. Trends Show Assets Flat, Confirms Repo, Treasury Buildup
Late last week, the Investment Company Institute released its latest monthly "Trends in Mutual Fund Investing: February 2012," which showed money market mutual fund assets inched lower by $​2.​8 billion to $​2.​6531 trillion last month. Money fund assets accounted for 21.​4% of overall mutual fund assets, which moved $​328 billion higher to $​12.​4 trillion. Bond funds broke $​3.​0 trillion for the first time ever, accounting for 24.​6% of assets ($​3.​047 trillion). Separately, ICI'​s "`​Month-​End Portfolio Holdings of Taxable Money Market Funds showed Taxable MMFs continued increasing Repos and added Treasuries. They also continued extending maturities.
ICI'​s "​Trends" says, "The combined assets of the nation'​s mutual funds increased by $​328.​1 billion, or 2.​7 percent, to $​12.​393 trillion in February, according to the Investment Company Institute'​s official survey of the mutual fund industry. In the survey, mutual fund companies report actual assets, sales, and redemptions to ICI.... Money market funds had an outflow of $​3.​01 billion in February, compared with an outflow of $​36.​30 billion in January. Funds offered primarily to institutions had an inflow of $​5.​93 billion. Funds offered primarily to individuals had an outflow of $​8.​94 billion."
In March, Crane Data'​s Money Fund Intelligence Daily shows money fund assets declined by $​44.​1 billion (​through 3/​29/​12). YTD, we show an overall assets decline of $​89.​57 billion, or 3.​5%. Our daily series shows the outflows coming primarily from Institutional and Prime Institutional funds in March; they lost $​37.​5 billion and $​24.​4 billion, respectively. (​Note: Our MFI Daily made some changes last week, including removing, renaming and adding funds.)
ICI'​s Portfolio Holdings series shows Repurchase Agreements jumped again in February, rising by $​37.​3 billion in to $​566.​9 billion. Repos remain the largest portfolio holding among taxable money funds with 24.​0% of assets, followed by Treasury Bills & Securities at 19.​8% ($​469.​0 billion). Holdings of Certificates of Deposits, which rank third among portfolio holdings, continued to fall, dropping by $​10.​3 billion to $​401.​8 billion (​17.​0%).
CP moved ahead of Government Agencies as the fourth largest composition sector. U.​S. Government Agency Securities saw holdings continue to drop in February, falling by $​27.​1 billion to $​350.​9 billion, or 14.​8% of assets, while Commercial Paper dipped by $​2.​9 billion, or 0.​8%, to $​370.​7 billion (​15.​7% of assets). Notes (​including Corporate and Bank) accounted for $​5.​6% of assets ($​132.​8 billion), while Other holdings accounted for 3.​3% ($​77.​7 billion).
The Number of Accounts Outstanding in ICI'​s Holdings series for taxable money funds dropped to 25.​71 million from 25.​81 million the month before, while the Number of Funds declined by 1 to 430. The Average Maturity of Portfolios lengthened to 45 days in February from 44 days in January and 42 days in December. (​Our Crane Money Fund Average currently shows a WAM of 43 days vs. one of 40 days at the start of the year, while our Crane 100 Money Fund Index shows a WAM of 45 days vs. a WAM of 41 days as of Dec. 31, 2011.)
Finally, note that the archived version of our Money Fund Intelligence XLS monthly spreadsheet (​see our Content Page to download) now has its Portfolio Composition and Maturity Distribution totals updated as of Feb. 29, 2012. We'​ve begun updated these towards month-​end based on our monthly Money Fund Portfolio Holdings information, so will revise these fields late in the month.