Assets have been flowing out of institutional prime money funds ahead of the Oct. 14 implementation of new regulations that will require prime funds to adopt a floating net asset value (NAV). At the same time, though, a recent survey of finance executives suggests some are warming up to the idea of funds with floating NAVs.
Back in 2014, the Securities and Exchange Commission adopted new rules to try to curb future runs on money funds. In addition to requiring that prime funds let their NAVs float, instead of using a constant $1-a-share value, the new rules mandate that funds’ boards consider imposing redemption fees and gates if a fund’s weekly liquidity falls below 30%.
There were predictions earlier this year that institutional prime funds could see up to half their assets exit ahead of the changes. Between last October and this May, assets held by institutional prime funds shrank by more than $150 billion, a shift that mostly reflected fund companies’ conversions of prime funds into government funds because they thought the changes would make prime funds less popular.
But the outflows this summer mostly reflect moves by investors, including corporate treasuries. As of last Thursday, data from the Investment Company Institute showed that institutional prime funds held $625.7 billion of assets, down $139.9 billion from the level in late May. Much of the money leaving institutional prime funds seems to be shifting into institutional government funds, which have seen their assets grow by $161.61 billion over the same time period.
Roger Merritt, managing director at Fitch Ratings, said that while there have been outflows, “the feedback from fund managers is that they’re continuing to maintain liquidity because they do expect it to happen, but the corporate treasurers have been very slow to react.
“How much more moves out remains an unknown, and that’s why the funds continue to operate with a very high amount of liquidity,” Merritt added.
The movement of prime fund assets is a “dynamic situation,” said Greg Fayvilevich, a senior director at Fitch, with the spread that institutional prime funds offer over government funds a key factor.
Until recently, “the yield spread between prime and government funds has been fairly compelling,” he said, but noted that in recent weeks the spread has come in. As of Aug. 2, the spread between institutional prime and government funds stood at 13 basis points, down from a peak of 17 basis points, he said.
“Because prime funds are obligated to build up so much liquidity, that’s starting to impact their yield,” Fayvilevich said, adding that as the spread narrows, “there will be less of an incentive for investors to stay in prime.”
Lance Pan, director of investment research and strategy for Capital Advisors Group, predicted that the bulk of the move out of prime funds will be accomplished by mid-September.
“I’ve had conversations with people, and Labor Day kept being brought up,” Pan said, adding that few corporate investors will want to wait until the end of September to make a move, given that that is quarter-end.
At this point, Pan said, organizations that have decided to stay in prime funds will be keeping an eye on the pace of outflows to see if they want to rethink that decision.
There’s also a potential issue with the supply of securities that prime funds buy. Pan estimates that two-thirds of the assets of prime funds are commercial paper issued by banks. But as money funds shorten their average maturities ahead of October, they’re looking for shorter securities. Pan said that could be a problem for banks, since the liquidity coverage ratio, one of the capital requirements that came out of the post-financial-crisis reforms, means it no longer makes sense for banks to sell commercial paper that matures in less than 30 days.
“Banks can try to accommodate by coming in shorter, but there’s going to be a time when they bump against that 30-day [limit],” he said. Banks may decide to shift to other ways of funding themselves, like selling CDs, he said.
And prime funds, which are already buying some government securities and using repo transactions as they bolster their liquidity amid the outflows, may rely on those instruments even more heading into October. “It’s possible that in the couple of weeks before and after Oct. 17, prime funds may essentially look like old government funds—very short and mostly non-corporate paper,” Pan said.
By Susan Kelly