State of play in the short-term fixed income markets. Demystifying regulatory reform, interpreting implications and offering solutions. Contents. Reform update Market, issuer and portfolio implications Client implications. Reform update. Current industry climate.
Demystifying regulatory reform, interpreting implications and offering solutions
A debate is on in the money market fund industry concerning the need for additional regulatory reforms.
I believe additional steps should be taken to address the structural features that make money market funds vulnerable to runs.
Mary SchapiroChairman, SEC
Money market funds play a critical role in the U.S. economy.
David HirschmannU.S. Chamber of Commerce
It’s disappointing that the success of the 2010 amendments is ignored in pursuit of changes that will compromise core features of money market funds.
Paul StevensPresident, Investment Company Institute
Europe doesn’t have any (money market funds), and they have a financial system.
Ben BernankeChairman, Federal Reserve
Money market funds have shown great resiliency since significant reforms were enacted in 2010.
Still, the SEC is proposing additional regulations with varying impact on systemic risk.
Prime Money Market Funds accommodated large outflows during U.S. debt ceiling and Eurozone debt crises
Source: Investment Company Institute
Regulators, think-tanks and industry organizations are working on a wide range of potential solutions.
Two-tier regulatory system
With revisions to current 2a-7 rules
Mandatory redemptions in kind
Split retail frominstitutional
Split credit fromgovernment funds
Subordinated share class
Unresolved systemic risk in the market?
Minimal risk of impact to short-term markets while addressing systemic risk concerns?
Implications for theshort-term markets?
This proposal requires funds to maintain dedicated capital for covering losses in times of trouble.
Resources to address significant falls in a fund’s value
A capital buffer, in combination with the holdback proposal, would mitigate the incentive for investors to run since there would be capital to address potential losses.
This proposal requires funds to hold back a percentage of a shareholder’s redemption proceeds for a set period of time.
Example: (Assumes a 5% holdback)
Investor owns shares worth $100and redeems entire amount
Receives remaining $5in 30 days…
…UNLESS a crisis happens, in which case the first losses would be funded by the fund’s capital buffer and then by that $5holdback
Discourages a run on the fund as shareholders redeeming the full amount of their investment would bear the first loss in the event that a fund broke the dollar.
This proposal requires funds to stop using the amortized cost method of valuation and let their share prices float.
A floating NAV reflects a fund’s true market value, demonstrates that money market funds are not free from risk and helps reduce large redemptions during periods of financial stress.
A historic look at market NAV fluctuations, 2000 – 2010Prime money market funds
Is bank deposit growth sustainable?
Source: BofA Merrill Lynch Global Research, Haver, Federal Reserve
Banks unlikely to invest excess liquidity at current market levels
Source: BofA Merrill Lynch Global Research
MMFs are a vital source of short-term funding to a variety of issuers
Sources: Investment Company Institute, Federal Reserve Board, U.S. Treasury Department, Fannie Mae, Freddie Mac, Federal Housing Finance Agency, Federal Reserve Bank of New York, Municipal Securities Rulemaking Board, Municipal Market Advisors
Systemic risk reduced as short-term funding markets have contracted
*Data for 2010 are through October.
Sources: Investment Company Institute and Federal Reserve Board
Investors and issuers of money market funds express concerns about the potential reforms.
We rely upon the convenience and simplicity that the stable NAV provides for accounting, recordkeeping and tax treatment of cash balances.
New Jersey Association of Counties
Money market mutual funds are a reliable source of direct, short-term financing for millions of businesses, non-profits, and others, including colleges and universities.
American Association of State Colleges and Universities
Holding back a portion of an investor’s money to guard against changes in share value would drive investment away from the funds.
The Pennsylvania League of Cities and Municipalities
A capital reserve is an interesting idea, but there are limits on the amount of capital that could be raised.
This proposal eliminates the very attribute investors value most in a money market fund – daily liquidity.
This proposal eliminates the very attribute investors value most in a money market fund — a constant NAV.
Investment Policy Impact
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