The next 12 to 14 months will be a very critical period for the money market fund industry — a period of preparation and implementation for the changes that are due to be implemented in October 2016, said Ben Campbell, CEO, Capital Advisors, speaking during a webinar this week entitled, “Recent Money Fund Developments and Key Issues for Corporate Cash Investors.” Campbell and Lance Pan, Director of Investment Research at Capital Advisors, shared their thoughts on how the recent reforms in both the banking and money market fund sectors will impact fund sponsors, investors, and fund flows.
Pan started by reviewing some of the statements that 5 major MMF companies have already made this year. He started with Fidelity’s announcement, saying, “The main focal point of their announcement was that they were going to convert Fidelity Cash Reserves from a prime fund to a government fund.” It is significant in a couple of different ways: number 1, it is the largest fund in the country, and two, it is a prime retail fund. Up until that point, much of the discussion around possible outflows had centered on Prime Institutional. Then he discussed JP Morgan’s press release, which said it intends to keep the largest Prime Institutional fund in the country, JP Morgan Prime Money Market Fund, as a Prime Institutional fund, which means, going forward, it will be subject to the floating NAV and emergency gates and fees. “So the largest retail fund and the largest institutional prime fund will both undergo some pretty dramatic structural changes,” he said.
Then he discussed Federated’s announcement, which said it was looking at converting some prime institutional funds to 60-day maximum maturity funds, which are technically floating NAV funds, but will act more like a Stable NAV fund because of the short maturities. After that, Dreyfus also announced that it is looking at the 60-day maximum maturity funds, but, like Federated, is committed to having a range of options, including floating NAV MMFs. Then BlackRock made its own announcement just this week. “The two things that caught our eyes is their largest institutional prime fund, the TempFund will be a floating NAV prime fund, and with their other prime fund, the TempCash Fund, they are going to explore the opportunity to have a 7-day maximum maturity,” said Pan.
Pan segued into a discussion on potential MMF flows, given some of the moves that have been made by fund sponsors to date. In what he called their “middle of the road forecast,” Pan said that of the approximately $1 trillion in Prime Institutional funds, “we assume about one third of that money is leaving, and that’s conservative,” he said. Of Prime Retail, he said, “before the Fidelity announcement, there wasn’t a significant assumption of any money leaving the retail prime space. Right now, Moody’s is saying in addition to Fidelity’s $115 billion, maybe another $100 to $200 billion will be leaving, so we assume about $230 billion coming out of retail.” When you add their assumption that about one-third of the Tax Exempt market will leave, overall, he estimates a potential migration of about $615 billion from prime and muni funds.
Next, Campbell talked about bank deposits and the regulations that sector is facing. “What sort of flows may occur out of the banking world because of the new Basel 3 Liquidity Coverage Ratios?” he asked. “There is a potential outflow over time of about $450 billion.” Campbell continued, “On the money fund side we have identified roughly $615 billion that may transition out of prime money market funds, potentially into Government Funds. If you look at the $450 billion in deposit outflows that I talked about, this is over $1 trillion that potentially will have to find a new home.”
“Now, in as much as the prime money market funds, as well as the deposits, are considered to be liquidity vehicles, and the objectives of most of the investors in both of these vehicles is that of liquidity, it would certainly make sense that these same investors would look for those same characteristics in their new choices,” said Campbell. “If you consider that Government money market funds will be one of the primary choices, we wanted to take a look at the potential impact of those flows on that market…. Currently, there is approximately $500 billion in Government MMFs. Add to that the potential of roughly $1 trillion of assets flows from deposits and prime funds and that almost triples the size of the market. That supply/demand imbalance could in turn lead to a change in the spreads between the government and corporate securities. Historically, there’s about a 12 basis point difference between those two investment categories, he said. [Excluding] times of stress [like] 2007-2009, that was compressed to about 6 basis points. But shifting about $1 trillion in new demand to the government space is likely to widen that spread significantly,” he added.
“The message here is that it’s a good idea to explore diversity in any of the solutions that you are looking for,” said Campbell. “Government money market funds should certainly not be the only place to park cash.” He concluded, “This is one of the largest table resets I’ve seen in my 30 years in the industry. The changes will impact the utility of the investments that you’re currently in, investment policy considerations, the supply and demand of existing products, and the risk/reward of various securities. The industry will get through this; it’s just a matter of a reset as to the types of investment vehicles that you use. Everyone is going to have to look at changing the mix that they have had in the past.”
Fitch Ratings released a report, “U.S. Banks to Weather Money Fund Reform,” which says, “The largest U.S. banks will likely be only marginally impacted by asset shifts resulting from money fund reform, given the banks’ low reliance on money fund financing, according to a Fitch Ratings report. Fitch Ratings expects new U.S. money market fund (MMF) regulations to gradually result in outflows from institutional prime money funds and a shift to alternative investments during the two-year reform implementation period ending in October 2016.”
It continues, “Estimates of the magnitude of `potential outflows range from 10% to more than 60% of the $1 trillion institutional prime money fund assets. Retail prime money funds are also expected to shift some of their $0.5 trillion of assets. Institutional prime money funds historically have invested primarily in the banking sector. As of June 30, 2014, 76% of the $939 billion of total institutional prime fund assets were securities issued by banks or bank-related entities. Reform-induced outflows will reduce prime fund investments in banks, along with other assets. However, a portion of the outflows may migrate to products with similar investment mandates or bank deposits, reducing the likely impact on the banks.”
The reports adds, “Based on a review of funding for the eight largest U.S. banks, the impact of any decrease in funding from money funds will likely be manageable for the large U.S. banks. These banks have ample deposits and rely to a small extent on funding from money funds as a percentage of total liabilities. As of June 30, 2014, money fund financing accounted for only 4.9% of the eight largest U.S. banks’ wholesale funding, and only about 1.1% of their total liabilities. For U.S. banks, reliance on wholesale funding has declined in the wake of the financial crisis, falling from 26% of total liabilities in 2007 to 18% in 2014. This trend is expected to continue due to regulatory considerations.”