After years of waiving fees on money market funds and only recently dodging proposals abandoned by the SEC in August that would have required funds to adopt a floating net asset value or establish a capital buffer, money fund managers once again see their industry at a watershed.
On one hand, hundreds of billions of dollars are poised to flow into money market funds in anticipation and following the expiration of the FDIC's guarantee on unlimited bank deposits at the end of 2012. But flows the past few months, while a positive reversal from post-financial-crisis years, have been less than expected as looming regulatory changes could result in sweeping changes to the industry.
While the SEC ditched its proposals in August, the Financial Stability Oversight Council has floated three proposals that could have lasting ramifications on the industry. The proposals involve requiring a floating NAV for money market funds, requiring the funds to have a buffer to absorb daily fluctuations and requiring a holdback on redemptions.
The comment period on the FSOC's proposals was extended last week to Feb. 15 from Jan. 18 with large money fund managers as well as the Investment Company Institute voicing concerns over some of the proposals the FSOC is urging the Securities and Exchange Commission to implement.
Washington-based ICI, in a recently released analysis of 2010 reforms on the money market industry, argues the reforms already in place were tested and passed market stresses in 2011 from the eurozone debt crisis and U.S. debt ceiling debate. The 2010 reforms included improving liquidity, reducing average maturity limits, increasing quality and diversification, and requiring a monthly posting of the shadow NAV, which is released on a 60-day lag.
“The study confirms that money market funds of 2013 are nothing like the funds of 2008, thanks to the SEC's far-reaching amendments to money fund regulation,” said ICI President and CEO Paul Schott Stevens in the report. “This is important analysis and perspective for regulators to consider as they look at additional regulations and for the public to understand, as the nation faces another debt ceiling debate in the coming weeks. Money market funds are stronger and well-positioned today to deal with market issues.”
Mr. Stevens has previously said the SEC is the appropriate agency to evaluate any reforms.
An early 2012 ICI-sponsored survey conducted by Treasury Strategies Inc. of 203 financial executives representing corporate, government and institutional investors found a significantly negative reaction to the three proposals.
Seventy-nine percent of respondents said they would decrease or stop using money funds if NAVs were required to float, and 90% had the same sentiment if funds were required to institute a 30-day holdback of 3% of all redemptions. If money funds were required to maintain a capital buffer, 36% of respondents said they would decrease or discontinue money market funds, a number that significantly increases if the capital buffer would result in a yield reduction.
The respondents had a combined $58.5 billion invested in money funds.
Henry Shilling, senior vice president at Moody's Investors Service, New York, said a reason institutional investors have favored money market funds through the years is they could treat the funds as cash or cash equivalents. If floating NAVs were adopted, they would have to account for gains and losses every time they buy and sell shares, making it less likely they would invest in those products.
Several of the largest money fund managers already have taken the step this year of disclosing the daily NAV of funds in an attempt to provide more transparency to investors.
Goldman Sachs Group (GS) Inc. was the first money fund manager to announce it will disclose daily NAV, shortly followed by large managers such as J.P. Morgan Asset Management (JPM), BlackRock (BLK) Inc. (BLK), Fidelity Investments and Federated Investors (FII) Inc. (FII)
“We hope it improves dialogue with regulators,” said James McNamara, New York-based managing director and president of Goldman Sachs Mutual Funds. “But the main driver of the decision is for shareholders and clients … we think the industry is ready for this transparency.”
Vanguard Group, in a comment letter to the FSOC, said it opposes options to add capital buffers, require redemption holdbacks or to float the NAV. It also stated the SEC is the proper agency to handle reforms and that any proposals should only apply to prime money market funds. Vanguard does support a proposal to require a standby liquidity fee that would be triggered if a fund's weekly liquidity drops below 15%.
J.P. Morgan Asset Management echoed the sentiment that reforms should only apply to prime funds in its comment letter to the FSOC. While JPMAM supports reforms that address structural vulnerabilities and decrease systemic risk, it cautions that proposals in the current wording could decrease demand for money funds and cause operational, programming and accounting problems.
There is an important distinction between disclosing the daily NAV, which provides more transparency and shows investors how little the stable value deviates, and requiring a floating NAV, said Robert Kurucza, chairman of the financial services group in the Washington office of law firm Goodwin Procter LLP.
“The operational and functional headaches it creates is significant,” Mr. Kurucza said, adding he hopes regulators take a step back and give due consideration to regulations already in place. “The (daily) disclosure should not be mistaken for buying into floating NAV. The biggest problem with a floating NAV is it is going to destroy this product.”
Moody's Mr. Shilling agreed with that and said the floating NAV is not appealing to all investors and managers would stand to lose assets. That should not affect the largest money fund managers, but could lead to smaller managers deciding whether to stay in the business, he added.
The daily NAV almost serves as a regulatory constraint on managers that will likely invest more conservatively to ensure the NAV stays at a stable $1 per share, Mr. Kurucza said. He added the performance of money funds has been quite strong measured against the reality of the marketplace and it is important to keep the main functionality of the products in place.
The regulatory uncertainty comes at a time when managers were likely to see large increases in flows following the FDIC expiration.
According to Moody's, non-interest-bearing transaction account balances greater than $250,000 grew by $446 billion to $1.492 trillion at the end of September from June 30, 2010, the closest reporting date to when the FDIC extended the unlimited guarantee on deposits. Mr. Shilling said the $446 billion is largely institutional money.
Moody's, in a report credit outlook report, said money funds could gain as much as $147 billion in assets from bank deposits, resulting in incremental annualized fees of about $248 million, citing a study published by the Association for Financial Professionals in June.
Money market fund managers already have seen a giant drop in fee revenue in a challenging credit environment with low interest rates, Mr. Shilling said. He added 98% of funds waived fees in 2011, resulting in $5.2 billion in fees lost.
“Rate pressure will continue into this year,” Mr. Shilling said.
Still, corporate treasurers and pension plans have limited options and an AAA money fund is a good option as a relatively safe and liquid investment, said Robert Deutsch, New York-based managing director and head of global liquidity business at J.P. Morgan Asset Management.
“It's relatively attractive out of a small list of cash alternatives,” Mr. Deutsch said.
It's also more difficult for managers to find highly-rated short-duration products for investments, Mr. Shilling said. From Dec. 31, 2011, to Nov. 30, prime money fund assets invested in securities rated Aa2 and higher declined to 45% from 59%.
Despite that, the expiration of the FDIC guarantee has helped fuel the turnaround for the money market industry in the past few months, said Peter Crane, president and CEO of Crane Data LLC, which publishes the monthly newsletter Money Fund Intelligence. Money market funds had net inflows of $170 billion, including $114 billion in institutional money, since Oct. 31, according to Mr. Crane. Institutional assets make up about two-thirds of total money fund assets.
Dan Lomelino, Chicago-based senior investment consultant and head of U.S. fixed-income manager research at Towers Watson & Co., said institutional money fund assets are only up about 5% since August.
“Given how big the FDIC program was … I don't think there's been that much institutional money,” Mr. Lomelino said. “I would've thought it would be more.”
Capital preservation products on the defined contribution side are struggling with uncertain times and potential new regulations that could make massive changes to the sector, Mr. Lomelino added.
The inflows have been steady the past few months, but not a flood, Mr. Crane said. “It would've been the last week or two but we only saw a couple inches of water,” Mr. Crane said. “The flows are still there, but not anything gigantic like some expected.” He added any proposals from the FSOC will likely affect flows, but it is unknown what the effect will be before anything is passed, Mr. Crane said.
Last year ended with net inflows of $10.5 billion, the first positive flow year since 2008 according toMr. Crane. Money funds had institutional outflows of $230 billion in 2009, $400 billion in 2010 and $120 billion in 2011.
Sources said the trickle-down from the FDIC expiration will keep a floor on money fund assets for now. But as JPMAM's Mr. Deutsch said, “There's such a wide range of possible regulations and possible outcomes.”
“Money funds will continue to get flows, but in terms of a permanent rebound, we will probably see that when rates go up,” Mr. Deutsch said. “When rates start to move up, and it doesn't have be that high, is when we will see a more significant rebound with money fund assets.”