for institutional investors only. not for public distribution. state of play in the short-term fixed...
TRANSCRIPT
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION.
State of play in the short-term fixed income markets
Demystifying regulatory reform, interpreting implications and offering solutions
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION.
Contents
Reform update
Market, issuer and portfolio implications
Client implications
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3
Reform update
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Current industry climate
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I believe additional steps should be taken to address the structural features that make money market funds vulnerable to runs.Mary SchapiroChairman, SEC
“”
A debate is on in the money market fund industry concerning the need for additional regulatory reforms.
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
“”
Money market funds play a critical role in the U.S. economy.David HirschmannU.S. Chamber of Commerce
”“
Europe doesn’t have any (money market funds), and they have a financial system.Ben BernankeChairman, Federal Reserve
”“
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How strong are money market funds today?
Still, the SEC is proposing additional regulations with varying impact on systemic risk.
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Source: Investment Company Institute
Money market funds have shown great resiliency since significant reforms were enacted in 2010.
Prime Money Market Funds accommodated large outflows during U.S. debt ceiling and Eurozone debt crises
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The current regulatory environment
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Regulators, think-tanks and industry organizations are working on a wide range of potential solutions.
Split retail frominstitutional
Split credit fromgovernment funds
Structuralchange
Two-tier regulatory system
Status quo
Mandatory redemptions in kind
Redemption fee
Escrowed shares
Gatingprovisions
Sponsor capital
Shareholder funded
Subordinated share class
Capitalideas
Minimal risk of impact to short-term markets while addressing systemic risk concerns?
Floating NAVWith revisions to current
2a-7 rules
Unresolved systemic risk in the market?
Implications for theshort-term markets?
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Potential SEC money market fund reform
SEC writing proposal — expected April – May
Two commissioners oppose additional reforms — one undecided– Commissioner Aguilar on the fence
– 3 votes of 5 needed to pass proposal
– Potentially get 90 – 120 days to comment
Industry and investors — “Rare Alignment”
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Proposed money market fund reforms
Capital Redemption fee/holdback Floating NAV
Require money market funds to hold capital against a loss in market value.
Require funds to charge a transaction fee for redemptions. Potentially 5% of a client’s redemption would be held for 30 days. The 5% would be used as a first loss buffer in the event a money market fund breaks the buck.
Convert money market funds to floating NAV structure.
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Capital buffers
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This proposal requires funds to maintain dedicated capital for covering losses in times of trouble.
SEC position: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.
Capital buffer Redemption holdbackResources to address
significant falls in a fund’s value
+ =
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Redemption restrictions
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This proposal requires funds to hold back a percentage of a shareholder’s redemption proceeds for a set period of time.
SEC position: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.
Example: (Assumes a 5% holdback)
Investor owns shares worth
$100and redeems entire
amount
Receives
$95today
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
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Floating the NAV
SEC position: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.
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This proposal requires funds to stop using the amortized cost method of valuation and let their share prices float.
A historic look at market NAV fluctuations, 2000 – 2010Prime money market funds
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Market, issuer and portfolio implications
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Market Implications
Restructuring of intermediation in the short-term fixed income markets
AUM shift to offshore MMFs, LGIPs, STIFs and short/ultra-short bond funds – Transfer of systemic risk from one market segment to another
Yield curve implications unclear– shift to Tsy/Govt sector would pressure curves lower
– demand for shorter, liquid credit product would steepen the credit curve beyond 3 months
Dodd-Frank and Basel III – supply challenges
Shift to bank deposits. Wholesale deposits neither desirable, nor economical for banks and FDIC insurance on non-interest bearing accounts may not extend past 2012– deposit fees?
– funding shift to the Fed?
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Market Implications
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Is bank deposit growth sustainable?
Source: BofA Merrill Lynch Global Research, Haver, Federal Reserve
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Market Implications
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Banks unlikely to invest excess liquidity at current market levels
Source: BofA Merrill Lynch Global Research
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Issuer Implications
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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
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Issuer Implications
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Systemic risk reduced as short-term funding markets have contracted
*Data for 2010 are through October.
Sources: Investment Company Institute and Federal Reserve Board
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Portfolio Implications
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Floating NAV
Capital Buffer
Redemption Restrictions
Common Themes
Shorter WAM and WALs – first mover liquidity risks
NAV “arb” liquidity risks
Pricing considerations – premium on most liquid and easily-priced securities. Avoiding pricing “surprises”.
Increased levels of Tsy/Gov’t holdings in credit MMFs
Credit decisions become more conservative. Credit specific stress => NAV and cash flow implications
Unique liquidity considerations: how to account for and Manage the “hold back”. An additional liquidity requirement.
Sponsors with deeper capital resources attract a greater shareof industry AUM. Consolidation drives supply challenges.
Greater flexibility in regulatory framework if capital exists?
Consolidation impact on market liquidity. More concentrated buyer bases.
Existing supply challenges exacerbated. Demand for shorter,less volatile assets will not be met with issuer supply.
Shorter, more liquid and less credit-sensitive portfolios
More opportunity to add value in SMA structures?
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Client implications
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Corporate reactions
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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
“”
Investors and issuers of money market funds express concerns about the potential reforms.
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
”“
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Capital Buffers
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A capital reserve is an interesting idea, but there are limits on the amount of capital that could be raised.
Key considerations Implications
A buffer can absorb limited losses It cannot guarantee that a fund will not
break the dollar Key questions remain: how much capital
is needed, and who will fund it? Near-zero interest rates make
accumulating capital challenging for shareholders
Requiring funds to raise the capital would raises costs and lower returns
Higher costs, lower returns Requiring a capital buffer would almost certainly
lead to lower returns on money market funds
Limited protection A capital buffer would limit the actual protection
to investors from a fund breaking the dollar but WOULD give them a false sense of protection
Investment policy impact The implementation of capital buffers may
require changes to your investment policy
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Redemption Restrictions
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This proposal eliminates the very attribute investors value most in a money market fund – daily liquidity.
Key considerations Implications
Changes the very nature, utility and value of money market funds
May cause shareholders to actually redeem more quickly
Discourages the use of money market funds in a wide range of transactions
Disrupts the sweep capability so many investors rely on
Results in more arduous recordkeeping
Loss of daily liquidity Investors will no longer be able to redeem
their shares in full each day
More arduous recordkeeping A holdback position would eliminate the
current accounting simplicity of money market funds
Investment policy impact With many corporate investment policies
detailing liquidity requirements, investors may be less willing or unable to invest
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Floating the NAV
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Investment Policy Impact
This proposal eliminates the very attribute investors value most in a money market fund — a constant NAV.
Key considerations Implications
History shows that floating NAV funds are not immune to redemption pressure
Many investors are unable or unwilling to use floating NAV funds
Investors may turn to less-regulated products
Investors may increase use of bank deposits
This may lead to constriction of short-term credit
Accounting/tax implications A floating NAV generates taxable gains and
losses with each subscription and redemption
Investment policy restrictions Investors restricted from using floating NAV
products will have to find other cash management solutions
Investment policy impact Using a floating NAV money market fund may
require changes to your investment policy
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Appendix – Slide 14 Footnotes
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Important information
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