Presentation on theme: "FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. State of play in the short-term fixed income markets Demystifying regulatory reform, interpreting."— Presentation 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 1
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 2 Reform update
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Current industry climate 3 I believe additional steps should be taken to address the structural features that make money market funds vulnerable to runs. Mary Schapiro Chairman, 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 Stevens President, Investment Company Institute “ ” Money market funds play a critical role in the U.S. economy. David Hirschmann U.S. Chamber of Commerce ” “ Europe doesn’t have any (money market funds), and they have a financial system. Ben Bernanke Chairman, Federal Reserve ” “
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. How strong are money market funds today? Still, the SEC is proposing additional regulations with varying impact on systemic risk. 4 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
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. The current regulatory environment 5 Regulators, think-tanks and industry organizations are working on a wide range of potential solutions. Split retail from institutional Split credit from government funds Structural change Two-tier regulatory system Status quo Mandatory redemptions in kind Redemption fee Escrowed shares Gating provisions Sponsor capital Shareholder funded Subordinated share class Capital ideas Minimal risk of impact to short-term markets while addressing systemic risk concerns? Floating NAV With revisions to current 2a-7 rules Unresolved systemic risk in the market? Implications for the short-term markets?
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 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” 6 Proposed money market fund reforms CapitalRedemption fee/holdbackFloating 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.
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Capital buffers 7 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 bufferRedemption holdback Resources to address significant falls in a fund’s value +=
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Redemption restrictions 8 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 $100 and redeems entire amount Receives $95 today Receives remaining $5 in 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 $5 holdback
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 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. 9 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 – 2010 Prime money market funds
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 10 Market, issuer and portfolio implications
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 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? 11
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Market Implications 12 Is bank deposit growth sustainable? Source: BofA Merrill Lynch Global Research, Haver, Federal Reserve
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Market Implications 13 Banks unlikely to invest excess liquidity at current market levels Source: BofA Merrill Lynch Global Research
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Issuer Implications 14 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
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Issuer Implications 15 Systemic risk reduced as short-term funding markets have contracted *Data for 2010 are through October. Sources: Investment Company Institute and Federal Reserve Board
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Portfolio Implications 16 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 share of 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?
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 17 Client implications
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Corporate reactions 18 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 ” “
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Capital Buffers 19 A capital reserve is an interesting idea, but there are limits on the amount of capital that could be raised. Key considerationsImplications 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
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Redemption Restrictions 20 This proposal eliminates the very attribute investors value most in a money market fund – daily liquidity. Key considerationsImplications 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
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Floating the NAV 21 Investment Policy Impact This proposal eliminates the very attribute investors value most in a money market fund — a constant NAV. Key considerationsImplications 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
FOR INSTITUTIONAL INVESTORS ONLY. NOT FOR PUBLIC DISTRIBUTION. Appendix – Slide 14 Footnotes 22
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