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Investment Guidelines Post-Money Fund Reform
Tony Carfang, Partner, Treasury Strategies
Greg Fayvilevich, Director, Fitch Ratings
New York Cash Exchange
June 1, 2016
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A New Landscape for Cash Management Challenge Impact
MONEY FUND REGULATIONS: Institutional prime money funds to “float” NAV and adopt “fees & gates”’; constant NAV government money funds will continue to exist without “fees & gates.”
Potential losses on cash held in prime funds and/or restricted access to liquidity during stress
Lower yields on government funds as demand overwhelms supply
BASEL III: Regulations penalize banks for relying on less-stable wholesale short-term funding.
Banks to turn away certain corporate deposits
Reduced bank issuance of short-term debt, limiting the supply of high-quality, short-term investments
ALTERNATIVE CASH MANAGEMENT PRODUCTS: Money fund regulation is leading asset managers to develop “alternative” cash management products such as private unregistered funds, short-term bond funds, separately managed accounts and 60-day maximum maturity money funds.
Treasurers and cash managers will need to evaluate the new products and update investment guidelines to incorporate these new strategies.
Emerging products are not as tightly regulated as traditional money funds, allowing for greater flexibility, but also the potential for greater risk and less transparency.
LOW OR NEGATIVE YIELDS: Yields in the U.S. remain extremely low and have turned negative in Europe, while the supply of high-quality, short-term securities continues to shrink.
Treasury professionals will need to re-think their cash management strategies and policies and better segment cash that does not serve a near-term operational need.
MATERIAL CHANGES IN RATING AGENCY CRITERIA AND COVERAGE: Post-crisis, there has been a material change in the markets covered by the “big three” rating agencies and increasingly divergent criteria for rating money funds.
Outdated investment guidelines fail to include all of the “big three” rating agencies (Fitch, S&P and Moody’s) who are out of step with market realities and best practices. This may unnecessarily restrict cash management options. Rating criteria for money funds is not the same across all three agencies, creating new risks.
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SEC Money Market Fund Reform
• Floating NAV for institutional prime and municipal funds • Potential for small losses • Some administrative burdens
• Liquidity fees and redemption gates for prime and municipal funds • Potentially limited access to liquidity during stress • Operational complexity for fund managers and intermediaries
• Government funds exempt from floating NAV and fees/gates • Potential for expected inflows to bump against limited supply
• Enhanced diversification, stress testing, and reporting requirements
• Floating NAV and fees/gates effective October 14, 2016; other provisions phased in earlier
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Key Post-Reform Considerations
• As retail investors are stripped out of institutional money funds, the remaining investor base is likely to be more volatile.
• Investor focus on the 30% weekly liquidity threshold in light of fees/gates may lead to pre-emptive runs on funds.
• While the SEC mandated additional fund disclosures, detailed information on a fund’s investor base is not available, but is key to evaluate in comparison to a fund’s portfolio liquidity.
• Fitch updated its criteria for money funds on December 10, 2015 anticipating reform-related changes, with a greater focus on money funds’ liquidity.
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U.S. Money Market Fund Reform Deadlines
Implementation Date MMF Reform
July 14, 2015 • Website disclosures related to Form N-CR
- Default or Event of Insolvency - Provision of Financial Support - NAV Deviation
April 14, 2016 • Diversification • Stress Testing • Website disclosures
- Daily and Weekly Liquid Assets - Daily Net Inflows and Outflows - NAV per share rounded to four decimal
places
October 14, 2016 • Floating NAV • Liquidity Fees • Redemption Gates • Retail Fund Definition
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U.S. Money Fund Flows Since Reform
0
100
200
300
400
500
600
7/14 9/14 11/14 1/15 3/15 5/15 7/15 9/15 11/15 1/16 3/16
(Billions of
Dollars) Government Retail Prime Retail
600
700
800
900
1,000
1,100
7/14 9/14 11/14 1/15 3/15 5/15 7/15 9/15 11/15 1/16 3/16
(Billions of
Dollars) Government Institutional Prime Institutional
Source: iMoneyNet
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Government Assets Rising in Taxable Money Funds as Funds Convert
800
900
1,000
1,100
1,200
1,300
1,400
1,500
1,600
1,700
08/14 09/14 10/14 11/14 12/14 01/15 02/15 03/15 04/15 05/15 06/15 07/15 08/15 09/15 10/15 11/15 12/15 01/16 02/16
(Billions of Dollars) Prime Assets Government Assets
Source: Crane Data, Fitch
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Agencies Benefit at the Expense of CDs in Converting Prime Money Funds
0
20
40
60
80
100
120
140
160
180
200
02/15 04/15 06/15 08/15 10/15 12/15 02/16
Major Security Types Within Converting Money Funds
Cer-ficateofDeposit
FinancialCompanyCommercialPaper
GovernmentAgencyDebt
GovernmentAgencyRepurchaseAgreement
TreasuryDebt
(Billions of Dollars)
Source: Crane Data, Fitch
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Yield Spreads Between Prime and Government Money Funds Widening
0.00%
0.20%
0.40%
0.60%
0.80%
1.00%
1.20%
1.40%
1.60%
Spread Pre-Crisis Average Crisis Average Post-Crisis Average
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Maturity Declines Reflect Reform Preparation and Interest Rate Policy
25
35
45
55
65
75
85
02/13 06/13 10/13 02/14 06/14 10/14 02/15 06/15 10/15 02/16
(No. of Days)
Average WAM and WAL in Prime Money Funds
WAL WAM
Source: SEC
30
40
50
60
70
80
90
100
02/13 06/13 10/13 02/14 06/14 10/14 02/15 06/15 10/15 02/16
(No. of Days)
Average WAM and WAL in Government Money Funds
WAL WAM
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Money Funds Avoiding Long Dated Maturities Ahead of Reform
0
50
100
150
200
250
0
2
4
6
8
10
12
14
Feb 15 Mar 15 Apr 15 May 15 Jun 15 Jul 15 Aug 15 Sep 15 Oct 15 Nov 15 Dec 15 Jan 16 Feb 16
% of Portfolio
Prime Money Fund Allocations to Long-Dated Securities (>180 Days) Declining on Reform Caution
% Allocation (LHS)
$ Allocation (RHS)
Source: Fitch, Crane Data Source: Fitch, Crane Data
(Billions of Dollars)
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Prime Money Funds Build Liquidity, Create Buffer to Regulatory Threshold
20
22
24
26
28
30
32
34
2/13 5/13 8/13 11/13 2/14 5/14 8/14 11/14 2/15 5/15 8/15 11/15 2/16
(%) Daily Liquidity
Source: SEC
35
37
39
41
43
45
47
49
2/13 5/13 8/13 11/13 2/14 5/14 8/14 11/14 2/15 5/15 8/15 11/15 2/16
(%) Weekly Liquidity
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Fund Industry Responds
• Restructuring of existing 2a-7 prime money funds - “Short-maturity” funds: investing inside of 60 days or 7 days to limit applicability of floating
NAV and/or fees and gates
• Launching or expanding alternative liquidity products to meet clients’ needs - Private/unregistered prime money funds - Short-term bond funds - Separately managed accounts
• Converting retail prime money funds to government funds to handle “sweep” accounts
• Merging funds to reduce costs
• Smaller fund managers exiting the industry
• Investor outreach
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Liquidity Management: What Are the Options?
Product Valuation Redemption Restrictions Regulated
Restricted Accessibility
Bank demand deposit Stable No Yes No
Time/certificates of deposit Stable Yes Yes No
Private money funds Stable (generally) By contract No Yes (large clients)
Ultra-short bond funds Floating NAV Some Yes No
Short-duration ETFs Floating NAV No Yes No
Separately managed accounts Market value No, but investor bears losses on sale
No Yes (large clients)
Direct investments in money market instruments
Market value No, but investor bears losses on sale
No Some
Retail prime MMFs Stable NAV Yes, fees & gates Yes Yes (retail only)
Inst. prime MMFs Floating NAV Yes, fees & gates Yes No
“Short maturity” prime MMFs Potentially stable Yes, but potentially less likely
Yes No
Government MMFs Stable NAV No Yes No
Source: SEC, Fitch.
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Ratings and Market Evolving
• As the market evolves, investment guidelines should reflect “best practices” with regard to ratings.
• Investment policies that rely on only one or two rating agencies are not reflective of market coverage, and put cash managers at a competitive disadvantage compared to peers.
• Barclays’ Capital Aggregate Bond Index requires that an asset should be “rated investment-grade using the middle rating of Moody’s, S&P, and Fitch Ratings after dropping the highest and lowest available ratings.”
• In short-term markets, the Daily Euro Commercial Paper Index tracks the yield of Euro CP with A1/P1/F1 ratings.
Sample investment guidelines language: “Investments must be rated A/A/A2 or higher on the long-term scale and/or F-1/A-1/P-1 or higher on the short-term scale by at least two of three said rating agencies (Fitch Ratings, S&P, or Moody’s). Money market funds must be rated equivalent of “AAA” by at least two of three said rating agencies (Fitch Ratings, S&P, or Moody’s).”
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Fitch AAAmmf Rating Evaluates Liquidity Risk the Same Way Cash Investors Do
Money Market Fund ratings (assigned to money market funds and other cash management products) are an opinion on a fund’s capacity to fulfill its investment objectives of providing ready liquidity and preserving principal.
S&P AAAm Rating Doesn’t Address Fees and Gates
“A money market fund rating is a forward-looking opinion about a fixed-income fund’s ability to maintain principal value (i.e., stable net asset value and to limit exposure to principal losses due to credit risk. We generally do not lower ratings to “Dm” when the manager of any fund suspends redemptions for up to five business days.” Additionally, if a fund elects to impose a 2% redemption fee this is a “credit positive.”
MMF Investors Focus on Liquidity
Liquidity is essential for managing cash, but not all ratings criteria focus on liquidity.
Fitch’s MMF Rating Criteria Assesses the Same Risks as Treasurers
Which Approach is More Aligned with Your Concerns?
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People in pursuit of answers
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Disclaimer
Fitch Ratings’ credit ratings rely on factual information received from issuers and other sources. Fitch Ratings cannot ensure that all such information will be accurate and complete. Further, ratings are inherently forward-looking, embody assumptions and predictions that by their nature cannot be verified as facts, and can be affected by future events or conditions that were not anticipated at the time a rating was issued or affirmed.
The information in this presentation is provided “as is” without any representation or warranty. A Fitch Ratings credit rating is an opinion as to the creditworthiness of a security and does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. A Fitch Ratings report is not a substitute for information provided to investors by the issuer and its agents in connection with a sale of securities.
Ratings may be changed or withdrawn at any time for any reason at the sole discretion of Fitch Ratings. The agency does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security.
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS AND THE TERMS OF USE OF SUCH RATINGS AT WWW.FITCHRATINGS.COM.
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Regulation Reform Investment Strategies Corporate investing in post-regulatory environment
Regulation Impacts Every Money Market and Deposit Instrument Available to Treasurers
Massive Intrusive Global
21
¥258T
Source: Bank of Japan, Treasury Strategies
€2.3T
Corporate Cash Levels – Higher Than Ever
Japanese Corporate Cash Eurozone Corporate Cash
UK Corporate Cash
22
$1.94T
£0.61T
Source: European Central Bank, Treasury Strategies
Source: Federal Reserve, Treasury Strategies
US Corporate Cash
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
Cor
pora
te C
ash
($T)
160
180
200
220
240
260 C
orpo
rate
Cas
h (¥
T)
0.800
1.000
1.200
1.400
1.600
1.800
2.000
2.200
2.400
Cor
pora
te C
ash
(€T)
0.2
0.3
0.4
0.5
0.6
Cor
pora
te C
ash
(£T)
Source: UK Office for National Statistics, Treasury Strategies
Value Proposition of Money Market Instruments
Imagine the perfect liquidity management instrument. Let’s call that 100 on a 0-100 scale.
• High relative yield
• Daily liquidity
• Ultra-low risk
• Low minimum transaction size
• Low fees
• Diversification
• Convenience
• TMS connectivity
• Portfolio accounting
• Professional management
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Instrument Attributes
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Source: Treasury Strategies
Prime MMF Treasury MMF
T-Bills/ Repo Bank DDA
Ultra-Short Bond Funds
Direct CP SMAs In-House Mgt
High relative yield x x x x x
Daily liquidity x x x x x x
Ultra-low risk x x x x
Low minimum transaction size x x x x x
Low fees x x x x x x x
Diversification x x x x
Convenience x x x
TMS connectivity x x x x
Portfolio accounting x x x x x
Professional management x x x x x
Value Proposition of Money Market Instruments
Ranking of each instrument prior to the post-crisis regulations (Dodd-Frank, Basel III, MMF):
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Prime money funds 95
Treasury/government MMFs 92
Treasury bills – direct 90
Bank demand deposits 85
Ultra-short bond funds 80
Commercial paper – direct 75
SMAs 60–80
Internally-managed portfolios 40–80
Treasury Strategies’ estimate
The Market Already Imposes VNAV, Fees and Gates on All Other Instruments
VNAV • Treasuries
• Agencies • CP
Fees
• Bank deposits
• CP and other money market instruments
Gates
• Banks – suspension of convertibility
• FDIC resolution
• Liquidity gaps
• Auction rate securities
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Value Proposition of Money Market Instruments
Ranking of each instrument after the post-crisis regulations (Dodd-Frank, Basel III, MMF):
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Prime money funds 95 à 92
Treasury/government MMFs 92 à 90
Treasury bills – direct 90 à 88
Bank demand deposits 85 à 80
Ultra-short bond funds 80 à 80
Commercial paper – direct 75 à 70
SMAs 60–80 à 55–75
Internally-managed portfolios 40–80 à 35–75
Treasury Strategies’ estimate
How US Money Fund Regulations Impact Corporate Investment Policies
Final regulations address many of the concerns raised by Treasury Strategies and others during the consultation process with the SEC.
• Significant recordkeeping relief under new U.S. Treasury/IRS guidance
• Relief from the “wash sale” rule
• Preservation of amortized cost accounting for securities maturing in 60 days or less
• Enhanced tools for fund boards to act in the best interests of fund shareholders
These four items go a long way toward preserving the investor utility provided by MMFs.
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How US Money Fund Regulations Impact Corporate Investment Policies
This requires careful evaluation of the language in the current investment policy. • A stated objective of “preservation of principal” does not necessarily rule out VNAV funds.
- Even commercial paper and government securities fluctuate in value daily.
- Unless held to maturity, all money market instruments fluctuate.
• However, more restrictive language such as “a constant net asset value” requirement would necessitate a policy change to permit continued investment.
• A stated objective of “daily liquidity” does not necessarily rule out funds subject to fees or gates.
- Fees and gates are board options, not requirements. The “requirement” in the regulation is that the board act in the best interest of the fund shareholders.
- The fee is analogous to an early withdrawal penalty in a bank time deposit. Each can be avoided by continuing to hold the instrument.
- Gates are analogous to "bank holidays” and withdrawal suspensions – extremely rare, but authorized under various statutes.
- Even an FDIC-insured deposit at a failed bank can be “gated.” Regulations stipulate only that the FDIC must begin the process of resolving a bank failure within 48 hours.
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What Our Clients Are Doing
Examining investment policies Considering redesigning operating bank structure Assessing opportunities to relocate their balances Some basic corporate treasury activities will have more utility; our clients are:
• Thinking about operating vs. reserve cash levels
• Improving cash forecasting
• Improving visibility of all cash balances
• Watching the money fund industry’s new products
• Monitoring bank prices and rates
• Being alert for new deposit products
• Considering consolidating vs. fragmenting bank services
• Talking with their banks about their Basel III impacts/plans
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Conclusion
It is clear that the traditional bank-corporate relationship will change significantly. It is clear that the value proposition of prime MMFs retains its superior position. It is clear that the traditional bank–corporate relationship will change significantly. It is not clear to Treasury Strategies that many investment policies will need to be altered. We strongly recommend that treasurers initiate a dialogue with their CFO or appropriate board committee.
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