Daily Links Archives: August, 2015

We wanted to remind those attending (or considering) our upcoming European Money Fund Symposium in Dublin, Sept. 17-18 to make hotel reservations asap if you haven't yet. Our block of rooms at the Conrad Dublin is almost sold out (and the hotel expects to sell out), and attendees only have a couple more days to get our discounted rate. Visit www.euromfs.com to see more Hotel details, to register or for more information. Crane's European Money Fund Symposium is the largest annual gathering of money fund professionals outside the U.S., and features two days of sessions and discussions on European and global money fund issues. (Note: Mark your calendars too for next year's U.S. Money Fund Symposium, the largest money fund conference in the world, which will take place June 22-24, 2016, in Philadelphia. Our next "basic training" event, Crane's Money Fund University, will take place Jan. 21-22, 2016 at the Hyatt Regency Boston, and we're also preparing to launch a new Bond Fund Symposium, though likely not until March 2017.) In other news, the Financial Times wrote late Friday, "Investors Head for Cash and Gold in Volatile Week. The piece says, "Stock market volatility ... drove investors out of equity funds this week and into gold and money market funds. Outflows of $29.5 billion from equity funds ... were the highest on record in nominal terms, according to an analysis of data from EPFR by Bank of America Merrill Lynch. Meanwhile, more than $22 billion flowed into money market funds, a cash proxy.... "The Chinese situation has some investors taking stock, and there certainly has been an increase in US money market fund assets," says Dennis Gepp, a managing director who runs the European money market funds for US-based Federated Investors." (Note: Crane Data's Money Fund Intelligence Daily shows money fund assets increasing by just $10.7 billion through Thursday (8/27), hinting that flows subsided late last week. Money fund assets inflows have been strong all summer though, even long before the recent market correction.)

Stephen Keen, Senior Counsel at Perkins Coie, posted two pieces on the SEC's updated FAQs. The first is entitled, "Good News for Retail Funds," while the other is, "Why Gating Would be an Emergency." In the first, Keen writes, "In Question 16 (formerly 15) of the FAQs, the staff clarified that it would look to the definition of "beneficial owner" in Rule 13d-3 when interpreting the definition of a "retail money market fund." Keen explains, "Rule 13d-3 uses voting, as well as investment, power to determine beneficial ownership. Voting power has nothing to do with the ability "to redeem quickly in times of market stress." Accordingly, the revised answer to Question 16 states that: "in the staff's view and notwithstanding Rule 13d-3, policies and procedures would be deemed 'reasonably designed to limit all beneficial owners of the fund to natural persons' even if they do not use voting power as a basis for identifying beneficial owners of the fund." He tells us, "Putting Question 16 together with Rule 13d-3, it appears that a retail fund's policies and procedures should be reasonably designed to confirm, for each shareholder’s account, that at least one natural person has investment power (as defined in Rule 13d-3) to redeem the shares held in the account." In his blog post on "Gating," Keen explains, "Section 22(e) of the Investment Company Act of 1940 prohibits mutual funds from suspending the right of redemption except in specified circumstances. These circumstances include: any period during which an emergency exists as a result of which (A) disposal by the company of securities owned by it is not reasonably practicable or (B) it is not reasonably practicable for such company fairly to determine the value of its net assets." Keen concludes, "It is important to note that the "extraordinary circumstances" include the board's determination that suspension of redemptions is in the best interests of the fund. So weekly liquidity assets falling below 30% of total assets should not always be considered, by itself, to constitute an emergency. The SEC does not have authority over the interpretation of fund organizational documents, which are governed by state laws. However, insofar as provisions of organizational documents permitting suspensions of redemptions are designed to conform to section 22(e), it makes sense to interpret "emergency” consistently in both contexts. Thus, the staff's response to new Question 31 should provide persuasive authority for directors and trustees to conclude that they have authority to gate a money market fund under its current organizational documents."

We noticed yesterday that several money funds were having trouble reporting their latest daily assets or nightly rate files. But we weren't sure what was happening until we say the WSJ story, "A New Computer Glitch is Rocking the Mutual Fund Industry. It says, "A computer glitch is preventing hundreds of mutual and exchange-traded funds from providing investors with the values of their holdings, complicating trading in some of the most widely held investments. The problem, stemming from a breakdown early this week at Bank of New York Mellon Corp., the largest fund custodian in the world by assets, prompted emergency meetings Wednesday across the industry, people familiar with the situation said. Directors and executives at some fund sponsors scrambled to manually sort out pricing data and address any legal ramifications of material mispricings, those in which stated asset values differed from the actual figures by 1% or more." It adds, "A swath of big money managers and funds was affected, ranging from U.S. money-market mutual funds run by Goldman Sachs Group Inc., exchange-traded funds offered by Guggenheim Partners LLC and mutual funds sold by Federated Investors. (Note: Federated money funds weren't involved though.) Fund-research firm Morningstar Inc. said 796 funds were missing their net asset values on Wednesday." In other news, the stock market slide has thrown into even more doubt the liftoff for interest rates. Reuters, reported "An interest rate hike next month seems less appropriate given the threat posed to the U.S. economy by recent global market turmoil, an influential Federal Reserve official said on Wednesday. In the clearest indication yet that fears of a Chinese economic slowdown could influence U.S. monetary policy, New York Fed President William Dudley said the prospect of a September rate hike "seems less compelling" than it was only weeks ago. Dudley, a dovish policymaker and close ally of Fed Chair Janet Yellen, however left the door open to raising rates for the first time in nearly a decade when the U.S. central bank holds a policy meeting Sept. 16-17.... [A]n initial rate hike "could become more compelling by the time of the meeting as we get additional information on how the U.S. economy is performing and (on) international financial market developments, all of which are important to shaping the U.S. economic outlook," he said." The Wall Street Journal writes, "Atlanta Fed's Lockhart Says Fed Is Still on Track to Raise Rates This Year." It says, "Federal Reserve Bank of Atlanta President Dennis Lockhart stuck to his guns Monday, saying he still expects the U.S. central bank to raise short-term interest rates in the next few months, even as he acknowledged stresses facing the U.S. economy and financial markets were making the outlook less certain. "I expect the normalization of monetary policy -- that is, interest rates -- to begin sometime this year," Mr. Lockhart said. "I expect normalization to proceed gradually, the implication being an environment of rather low rates for quite some time," he said."

Reuters writes "U.S. money-market funds raise fees after years of cutting them. The article says, "U.S. money-market funds, which have lost billions of dollars in revenue since the height of the financial crisis, are raising fees after years of cutting them, according to industry executives and analysts. The $2.7 trillion industry has lost some $30 billion in revenue since 2009, according to the Investment Company Institute. Money funds reduced fees to ensure that investors did not actually lose money in an era of rock-bottom interest rates. But in recent months, top money-market fund sponsors including No. 1 Fidelity Investments, Federated Investors Inc and Charles Schwab Corp, have been charging higher fees as they recognize slightly better yields on the securities they buy for their funds." Reuters quotes our Peter Crane, president of money fund research firm Crane Data LLC, "Fund companies see the light at the end of the tunnel." The piece adds, "With expectations that the U.S. Federal Reserve will raise interest rates, yields on the securities that money-market funds purchase, such as short-term corporate debt and bank certificates of deposit, have risen slightly. To be sure, no major money-fund repricing is expected until the Fed actually makes a move.... That uptick in charged expenses continued into August, according to senior executives at two large money-fund sponsors. They declined to be named because they were not authorized to speak about fee trends. Analysts at Jefferies recently raised their outlook for Federated Investors, the No. 4 money-fund sponsor with $206 billion in assets, because of an expected reduction in waived expenses. In recent weeks, executives at Northern Trust Corp, T. Rowe Price Group Inc and Charles Schwab also have discussed rising fee trends during conference calls with analysts and investors. Meanwhile, a number of smaller money-market sponsors have been consolidated or they have liquidated fund assets amid low fees and more regulation. Profit margins have been crushed, according to Crane."

The Wall Street Journal published commentary by Gerald O'Driscoll, senior fellow at the Cato Institute and former vice president at the Federal Reserve Bank of Dallas, called "The Fed Flirts With the Right Move at the Wrong Time." He writes, "Financial markets and Federal Reserve watchers are focused on when the Federal Open Market Committee will vote to raise short-term interest rates, likely by 25 basis points. Investors and pundits would do better to ask why the Fed would raise rates now, when the arguments against a hike are so strong. The shudder felt through the global financial markets over the past few weeks, culminating on Friday with the Dow plunging more than 500 points, should give anyone pause about a Fed course change in the coming weeks or months. Let me be clear: I belong to the camp that has long argued for the Fed to raise short-term interest rates. The more the Fed held rates down, the more economic distortions its policy created.... Artificially low rates cause investors to chase yields and take on more risk. That was a goal of the Fed's extraordinary monetary policy (though it was stated more euphemistically). And near-zero rates harm savers and those living on retirement income, so the policy is inherently and perversely redistributional.... The question is why now, after seven years? It can't be for any of the standard criteria traditionally employed by the FOMC in its decision-making." It continues, "Low interest rates were thought to be stimulative. But we have learned that financial intermediaries struggle with spreads in a low-interest-rate environment. Hardest hit must surely be the money-market mutual-fund industry. Absent a dangerous lunge for risky returns, how much longer can that industry cope with the current interest-rate policy? One suspects that some combination of these motivations, reflecting a concern for financial stability, is behind the call for higher interest rates. To one degree or another, the concern is appropriate -- but that has been the case for many years. Now it appears that the FOMC is at last poised to do the right thing, but with bad timing." In other news, Bloomberg wrote Friday, "Treasuries Aren't So Special in Repo Market as Fed Bets Deferred." It says, "The $1.6 trillion market where dealers go to borrow U.S. government debt is adding to signs that Treasury bears are in retreat less than a month before a potential Federal Reserve interest-rate increase. Typically, when there is heightened interest in shorting Treasuries -- meaning bet they'll decline -- the securities are in demand in the repurchase agreement market as traders try to obtain the debt to sell. In the argot of repo traders, that's known as being "on special." Yet that phenomenon is barely in evidence, signaling traders aren't gearing up for bond losses with the Fed's Sept. 17 decision looming."

Reuters featured an article entitled, "Goldman braces for big demand for U.S. government money market funds" on Friday, which says, "Goldman Sachs Group Inc. fund managers believe investors could pour $450 billion into money market funds that invest in U.S. government debt in response to new rules for the short-term funds, an executive told Reuters. Goldman Sachs joins other asset management firms in preparing for the rules, which are designed to protect investors from extreme market stress. The Securities and Exchange Commission approved the rules in July 2014, and they take effect in October 2016." The article explains, "Under the new rules, money market funds will impose fees to deter investors from pulling out all their money if too many want their cash at the same time. The rules will also require funds with institutional investors to record the value of their assets at market value daily, meaning the value of clients' holdings will fluctuate as the market rises and falls. These changes could be alarming to investors who view money market funds as places to park cash they might want on short notice. The funds now hold about $2.7 trillion, a figure that is rising as the U.S. stock market sells off. Government and U.S. Treasury money market funds are exempt from the new rules." It adds, "Jim McCarthy, Goldman Sachs' co-head of the global liquidity management business, said investors could end up pulling out about half of the $900 billion now in prime funds for institutional clients and shifting that money into government and U.S. Treasury funds. McCarthy said he had not yet seen this shift among Goldman Sachs clients, but it could happen in the future." The Reuters piece continues, "Not everyone expects a mass exodus from prime money market funds. Peter Crane, whose Crane Data LLC is a leading money fund research firm, said that if the Federal Reserve raises rates in coming months as expected, yields on prime money market funds might rise much faster than those on government funds. Those relatively higher yields may convince some institutional investors to stay in prime funds, he added." Finally, it says, "For Goldman's part, it said in July it would introduce a new government money market fund and convert another prime fund to a government fund to meet expected demand. Fund managers including BlackRock Inc have taken similar steps."

Money funds are continuing their summer asset tear in August. ICI's latest "Money Market Mutual Fund Assets" report shows assets up for the third straight week. It says, "Total money market fund assets increased by $11.01 billion to $2.69 trillion for the week ended Wednesday, August 19, the Investment Company Institute reported today. Among taxable money market funds, Treasury funds (including agency and repo) increased by $7.01 billion and prime funds increased by $3.01 billion. Tax-exempt money market funds increased by $980 million. Assets of retail money market funds increased by $4.59 billion to $881.06 billion. Among retail funds, Treasury money market fund assets increased by $1.11 billion to $199.13 billion, prime money market fund assets increased by $2.57 billion to $501.34 billion, and tax-exempt fund assets increased by $910 million to $180.59 billion. Assets of institutional money market funds increased by $6.41 billion to $1.80 trillion. Among institutional funds, Treasury money market fund assets increased by $5.90 billion to $811.05 billion, prime money market fund assets increased by $440 million to $925.53 billion, and tax-exempt fund assets increased by $70 million to $68.05 billion." Year-to-date, money fund assets are now down just $47 billion, or about 2%. Assets have been up 7 of the last 9 weeks and the past 4 months in a row. In other news, The Wall Street Journal writes, "Fed Preps September Term Reverse Repos as Extra Rate-Rise Tool." It says, "The Federal Reserve Bank of New York said it would again offer a "supplementary tool" called term reverse repos in September as a way of supporting its main levers for raising rates when the time comes. The New York Fed said in a statement Wednesday it had been instructed by the Federal Open Market Committee, a special rate-setting panel, to examine how the term reverse repos could support its key monetary policy tools when it moves to raise rates for the first time in nearly a decade.... In March, the FOMC authorized the New York Fed markets desk to conduct term repos over the end of each quarter, through Jan. 29, 2016." It continues, "The New York Fed's markets desk said it had been "working internally and with market participants" on how the reverse repo program would work in practice to control the federal-funds rate when it is taken out of test mode, where it has been for almost two years.... For the end of September this year, the desk said it plans to offer $200 billion in term reverse repos in addition to the overnight reverse repos it plans to use at liftoff. Currently, the overnight repos are capped at $300 billion."

The Federal Reserve released the Minutes from its July 28-29 FOMC meeting yesterday. The minutes say, "The staff next summarized some of the recent steps the System had taken to prepare further for the process of normalization of monetary policy. The staff also proposed that future changes in the FOMC's target federal funds rate range as well as associated changes in related administered interest rates -- including the interest rates on excess and required reserves, the ON RRP rate, and the primary credit rate -- all be effective on the day after the Committee's policy decision. Making all such rate changes effective on the same day would enhance the clarity of Federal Reserve communications. It would also help promote federal funds trading within the new target range, partly by enabling the Desk to conduct ON RRP operations at the new rate specified by the Committee on the same day that the new target range becomes effective. Participants supported the staff proposal.... During their discussion of economic conditions and monetary policy, participants mentioned a number of considerations associated with the timing and pace of policy normalization. Most judged that the conditions for policy firming had not yet been achieved, but they noted that conditions were approaching that point. Participants observed that the labor market had improved notably since early this year, but many saw scope for some further improvement. Many participants indicated that their outlook for sustained economic growth and further improvement in labor markets was key in supporting their expectation that inflation would move up to the Committee's 2 percent objective, and that they would be looking for evidence that the economic outlook was evolving as they anticipated. However, some participants expressed the view that the incoming information had not yet provided grounds for reasonable confidence that inflation would move back to 2 percent over the medium term and that the inflation outlook thus might not soon meet one of the conditions established by the Committee for initiating a firming of policy." In other news, Barclays' strategist Joseph Abate said in his last "US Weekly Money Market Update," "Earlier this week, the effective fed funds rate moved to 15bp -- its highest sustained level since April 2013. This back-up has widened the spread between the effective fed funds rate and the Fed's overnight RRP to 10bp and has raised questions about where the effective rate will settle at lift-off.... Indeed, it is probably not coincidental that the jump the fed funds rate has occurred at the same time that Treasury GCF repo rates have also cheapened. So far this month, the Treasury GCF repo rate has averaged 26bp (compared with 18bp and 19bp in June and July, respectively, and excluding month-ends). We think there are two potential explanations for the increase in repo rates: the G-SIB capital surcharge and the absence of a significant short-base in the Treasury market."

First American Funds released its quarterly money market funds "Portfolio Manager Commentary." Portfolio Managers Jim Palmer, Jeffrey Plotnik, and Mike Welle write, "During the second quarter, the U.S. short-term markets continued to speculate on the timing of the first Fed rate hike since 2006. Investors were generally in agreement with regard to the pace of any target range increases, with the expectation the Fed will opt for a modest and gradual approach.... The objectives of the First American money market funds in this environment were to maintain strong credit quality and incorporate future Fed rate expectations into portfolio investment selections to take advantage of a steepening yield curve. The Fed's Reverse Repo Program (RRP) continued to be a market stabilizing force by setting a floor on overnight inter-dealer repo rates in the five- to eight-bps range. Market consensus is the Fed's repo facility going forward will be instrumental in executing monetary policy, controlling short-term interest rates and providing access to quarter-end liquidity. While the final disposition of the RRP is still to be determined, we anticipate the Fed will continue to test various scenarios regarding the rate, size, auction timing and structure of the program. Ultimately we believe the Fed will expand the program enough to absorb investor demand for short-term instruments." They continue, "As the First American Prime and Tax-Free Obligations Funds prepare for reform implementation, they will be structured to implement strategies that coincide with the timing and expected market impact of reform." First American adds, "In the coming quarters, we anticipate the overall investment environment will be more volatile as the market interprets economic data and speculates on the timing of a Fed rate hike. We expect to see yields trend higher leading up to money fund reform and a Fed rate hike. As global demand for low-risk assets is expected to remain strong, we foresee any upward movement in yields impacting prime funds more significantly than government and Treasury funds. With our view the Fed will keep the current target range of 0.00 to 0.25% until at least September, we will continue seeking to capitalize and extend where opportunities arise from market volatility based on Fed expectations and impacts of money market fund reform." In other news, Fidelity's Head of Fixed Income Nancy Prior answered questions on MMF reform in a Q&A posted on Fidelity's web site earlier this summer. She discusses, among other things, Fidelity's conversion of the $112 billion Fidelity Cash Reserves from Prime to Government, saying, "We clearly heard that many customers want continued access to a money market fund that offers a stable $1 NAV and is not subject to liquidity fees that could be placed on redemptions in certain circumstances, or to gates, which prohibit redemptions in specific situations."

Plan Sponsor magazine writes, "Regulatory Change Brewing Beyond Fiduciary Rule." It says, "Beyond its own focus on fiduciary advice issues, the Securities and Exchange Commission (SEC) is in the process of implementing major money market fund reform provided for under rulemaking adopted in July 2014. The SEC is concerned the money market fund reforms could catch some plan sponsors and advisers unawares, so they are more aggressively warning about the changes qualified retirement plans will have to make to accommodate the reforms. Chances are a given plan sponsor will be impacted by the money market reforms, with the PLANSPONSOR Defined Contribution Survey showing upwards of two-thirds of plans currently offer money market funds. While the SEC has said its rules will allow most plans to remain in retail money market funds, some are concerned the reforms could make this untenable from a fiduciary perspective, given the emergence of liquidity gates and fees." It continues, "The widespread use of money market funds among retirement plans and other institutional investors means industry providers should be paying attention, and should be gearing up to help guide plan sponsors and their own sales representatives through the 2016 implementation. Two business leaders at Voya Financial tell PLANADVISER their firm is proactively preparing for the money market changes. According to Susan Viston, client portfolio manager, and Paula Smith, senior vice president for investment products-only business, Voya is actively talking with plan sponsors about what the reforms mean. "Probably half of them are still trying to decide what their next move is going to be, based on the money market reforms," the pair explains. "We foresee some people just staying put, but others are eyeing stable value more closely. Especially in the mid- to large-plan space, we're seeing more interest in stable value again. It's something service providers are paying increasing attention to." Months ago, the concerned industry groups warned that, despite a relatively long window provided for the reforms to take effect, as we near the fall of 2016, huge numbers of plan sponsors will all at once turn to reexamining their money market options in light of their fiduciary duty to plans and participants. The industry groups say they worry plan sponsors will feel compelled to replace their retail money market funds with government money market funds, which will not have liquidity fees or redemption gates. Again, the SEC has highlighted carve-outs in its rulemaking to prevent this outcome, but providers and fiduciary sponsors are being cautious."

Ignites published, "Northern Trust Plunks Down $45M to Top Up Funds." (See our July 27 News.) They write, "Northern Trust took a $45.8 million pre-tax charge in the second quarter to prop up the net asset values of two money market funds and two non-registered funds for institutional investors, according to the firm's second-quarter earnings report and a statement from the firm. The firm cited "legacy losses realized by the funds during the financial crisis" as the reason for the capital infusion, according to a Seeking Alpha transcript of the earnings call with analysts. The money funds are the $8.1 billion Northern Money Market Fund and the $4.4 billion Northern Institutional Liquid Assets Portfolio, Northern Trust said in the statement." It continues, "Fitch reviewed information from Crane Data and found that the shadow NAV of the firm's Money Market Fund increased from $0.9989 on July 9 to $1.00 the next day. If the bump-up in shadow NAV was the result of a capital injection, "it would have cost approximately $8 million," according to Fitch's recent report. Because it targets retail investors, the fund does not have to move to a floating net NAV, as required of institutional products under reform passed by the SEC last year, Fitch notes. Still, Northern Trust will have to post the fund's shadow NAV on its website, the research and rating agency notes, "which may have been one of the reasons for the top up."" In a statement, Northern commented, "As announced on July 22, 2015, Northern Trust recorded a pre-tax charge of $45.8 million in the second quarter of 2015 related to voluntary cash contributions to certain constant dollar net-asset-value (NAV) funds. These funds include the `Northern Money Market Fund, the Northern Institutional Liquid Assets Portfolio and two non-registered funds for institutional investors. These voluntary cash contributions offset legacy net losses in certain securities realized by these funds during the financial crisis. Prior to the contributions, all of these funds were trading well above the $0.9950 per share required by the U.S. Securities and Exchange Commission for constant NAV funds to transact at $1.00 per share. Northern Trust took this voluntary action to demonstrate its commitment to the constant dollar funds and their investors."

Money funds continued their summer asset tear in the first half of August. ICI's latest "Money Market Mutual Fund Assets" report shows assets up again in the latest week. It says, "Total money market fund assets increased by $5.33 billion to $2.67 trillion for the week ended Wednesday, August 12, the Investment Company Institute reported today. Among taxable money market funds, Treasury funds (including agency and repo) decreased by $3.22 billion and prime funds increased by $10.51 billion. Tax-exempt money market funds decreased by $1.96 billion. Assets of retail money market funds increased by $580 million to $876.46 billion. Among retail funds, Treasury money market fund assets increased by $390 million to $198.02 billion, prime money market fund assets increased by $800 million to $498.77 billion, and tax-exempt fund assets decreased by $610 million to $179.68 billion. Assets of institutional money market funds increased by $4.75 billion to $1.80 trillion. Among institutional funds, Treasury money market fund assets decreased by $3.61 billion to $805.15 billion, prime money market fund assets increased by $9.71 billion to $925.09 billion, and tax-exempt fund assets decreased by $1.35 billion to $67.97 billion." Year-to-date, money fund assets are now down just $58 billion, or 2.1%. Institutional assets are down just $23 billion, or 1.3%, while retail assets are down $35 billion, or 3.8%. Assets have been up 6 of the last 8 weeks, and in 10 of the last 15 weeks. Since the end of April, assets are up $92.8 billion, or 3.6%, and since June 17 MMF assets have risen $75.8 billion. (Note: A year ago, assets increased a mere $3.5 billion in the April 30-Aug. 13 timeframe.) Money fund assets are likely benefiting from banks pushing away deposits, as well as from a shift out of bond funds this summer.

Standish Mellon Asset Management posted its "U.S. Money Market Monthly Commentary" for August 2015. It reads, "Barring a significant deterioration in economic prospects, the first Fed increase in almost a decade is likely to occur before year-end. This shift in monetary policy had been anticipated for some time, but until recently had failed to translate into higher money market yields. The market is now on the move. Even 1yr Treasury Bills have broken to the upside (0.36%) despite heightened structural demand for Treasuries.... Prime money market funds continue to prepare for potential outflows, and are keeping liquidity high and maturities short. Overall, the outstanding amount of Commercial Paper has remained stable. In agencies, we continue to see diminished supply from Fannie Mae and Freddie Mac, though this shortfall has been made up by an increase in supply from FHLB. In Medium Term Notes, we note a shift to floating rate coupon for short maturities (18 months and in), while longer maturities are going the other way. While the final outcome of Money Market Reform is still highly uncertain, the path of least resistance appears to be the transition of a significant amount of assets (up to $400 Billion per our estimates) from Prime Money Market Funds to Government Money Market Funds at some point before October 2016. The US Treasury announced plans to increase US Treasury Bill supply to reduce funding risk, though this new supply will be insufficient to absorb all expected new demand. Additionally, political wrangling over the debt ceiling could sharply reduce Treasury bill supply in late November/early December. Another unknown is how banks will react to increased rates in light of higher capital and liquidity requirements. As noted by the 2015 AFP survey, bank deposits have proved an attractive alternative to Money Market Funds for Institutional investors over the past few years. This may change going forward as the rates offered on deposits could lag the Fed target, potentially significantly. All things considered, we continue to expect safe and liquid investments (bank deposits, treasury bills) to become relatively more expensive (e.g., lower yielding) than alternative short-term investments. Even moderate flexibility in maturity and/or credit should provide potential for higher yields.... We continue to see value in 6 to 9 month fixed-rate money market securities, which look attractive on a Fed Funds breakeven basis even under aggressive hike scenarios. We are also adding 2 to 3 year floating rate securities in anticipation of next year’s tightening cycle. We continue to view ABS as attractive, particularly prime Autos."

Treasury and Risk magazine published an article, "Short-Term Investors at Crossroads." It says, "Corporate treasuries continue to stow the majority of their short-term cash in bank deposits, according to a recent survey, and put the largest chunk of the remaining money into money-market funds, a traditional short-term investment option. But those patterns could change in the next year or so as U.S. interest rates rise and new regulations make banks and money funds less hospitable places for corporate funds. "As I talk to treasurers, it's a very much wait-and-see approach," said Tom Hunt, director of treasury services at the Association for Financial Professionals (AFP). "The decisions will get made when all the options are presented to them." It continues, "The outlook for companies' use of money market funds is clouded by new Securities and Exchange Commission regulations requiring prime funds -- those that invest in corporate securities -- to switch to a floating net asset value (NAV) instead of the stable $1-a-share money funds use now. Government money funds are not required to switch to a floating NAV. The rules, which also allow money funds to impose fees and gates in times of market stress, take effect in October 2016. Hunt suggested that as more money funds announce the date when they'll switch prime funds to a floating NAV, more corporate treasuries may make changes. Lee Epstein, CEO at Decision Analytics ... predicted that investors would wait until the last minute to make a move. "If there is any migration, you'll start seeing it next summer, or even after the October 2016 implementation of floating NAV," he said. According to the AFP survey, more than a third (37%) of respondents don't plan any significant changes in the way they invest in prime funds, while just under a third (29%) expect to avoid using prime funds and 17% will move money out of prime funds. Lance Pan, director of research at Capital Advisors Group, expects $600 billion to exit prime funds. Given the possibility that those flows or the rule changes lead to disruption or systems glitches, Pan said, institutional investors should plan for the switch to floating NAV and talk to their fund sponsors sooner rather than later.... Others doubt there will be any large-scale migration out of money funds. "I think investors have a high degree of confidence in money-market funds," said Paul LaRock, a principal at consultancy Treasury Strategies. "I don't see any movement away from money-market funds." He adds, "When interest rates return to historical norms, I think [investors] will largely do what they've done in the past," LaRock said. "Corporates and large nonprofits for their short-term cash will seek the combination of safety, liquidity, and yield they've sought in the past and that is still presented to them by money market funds."

Investor Analytics authored an article, "Riskology: What money markets can teach hedge funds." IA's Damian Handzy writes, "Hedge funds have regularly been at the forefront of innovation when it comes to investing strategies, alpha generation, asset class creation and risk management. Part of that innovation comes from adopting practices and analysis from other fields, and it is in that spirit that I claim hedge funds can benefit from understanding the practices of an investment vehicle they themselves use for cash management: money markets. Recent updates to the regulations governing these funds are directly applicable to hedge fund risk management, and offer improvements in ways to manage liquidity risk and perform simultaneous stress tests.... Among the new regulations was a set of stress tests that closely resembled what some of our hedge fund clients had been doing for years, but these stress tests required simultaneous multi-dimensional stresses. Specifically, they require the funds to stress interest rates, credit spreads and liquidity/redemption requests to the point of breaking the buck, defined as not being within 0.5% of the target $1 price. Their logic is sound: unless you actually go to the breaking point, how can you know how safe or how much danger your fund is in? This is a very engineering-like approach, in which a sample material is tested to its physical breaking point to ensure that the force required to break it is well outside the expected real-life load. With money market funds, they are required to simulate how the combination of rates, spreads and redemptions might bring their fund NAV to below the point of breaking the buck. While they are required to stress each of those dimensions separately, the more realistic stresses are those that simultaneously move the three dimensions to see what combinations of interest rate move, credit spread changes and redemption requests would, in fact, cause the fund to break the buck." He continues, "The application to floating rate money markets and to hedge funds is clear: by defining an appropriate threshold as an equivalent breaking point, the fund can simultaneously stress the relevant factors for its investment types to that breaking point.... The same redemption risk that affects money funds can impact hedge funds: matching investor redemption requests with liquidation of assets is a universal function of portfolio managers." He concludes, "Cross-fertilisation of ideas is a hallmark of innovation, and learning from others is an efficient way of improving our own practices. While it may seem strange to voluntarily adopt a regulator's requirements for a different part of the financial services industry, I believe that the SEC's money market stress tests present a thoughtful approach to practical risk management so that the manager of a money market fund or hedge fund has better foresight of possibly damaging scenarios and increased time to react. These analyses can help fund managers make better risk decisions."

Below, we have more coverage of the SEC's updated "2014 Money Market Fund Reform Frequently Asked Questions, which we first reported Friday. The SEC writes for FAQ 2: Would a capital contribution made by the fund's investment adviser to correct an NAV error qualify as financial support that must be reported on part C of Form N-CR? The answer was amended to add: "The staff will not object if a fund board determines in advance that these types of routine actions will not constitute financial support." There was also an amendment to an FAQ related to "topping up." The amended question now reads: "Would a capital contribution made by the fund's investment adviser to a fund to avoid dilution or other unfair results during a fund reorganization pursuant to the exemptive relief provided in the Adopting Release or in connection with a conversion of a fund to a floating NAV qualify as financial support that must be reported on Form N-CR?" The answer explains, "No, provided that the contribution occurs as part of a transition for money market funds to implement the floating NAV reform before the October 16, 2016 compliance deadline. As discussed in the previous question, financial support reporting is intended to increase transparency of investment risks. For example, a capital contribution meant to "top up" a fund as part of a voluntary reorganization made in the ordinary course of business would normally qualify as financial support that would be reported on Part C of Form N-CR because it would be an action meant to stabilize or increase the value of the fund. However, the staff recognizes that reorganizations made pursuant to the exemptive relief are primarily intended to bring a fund into compliance with the 2014 money market fund reforms. In addition, the staff recognizes that an adviser or its affiliates may elect to top-up a fund converting to a $1.0000 floating NAV, so that all shareholders will receive the same value per share at the time of the transition from a stable NAV to a floating NAV. This may be important to assure a smooth transition to floating NAV funds. Accordingly, the staff would not object if associated capital contribution actions designed to avoid unfair results or dilution made to bring a fund into compliance with the 2014 money market fund reforms are not reported as financial support on Form N-CR (or in Form N-1A and on funds' websites). However, in the staff's view, any such future contributions would need to be reported as financial support on Form N-CR once the compliance period for the amendments has passed."

ICI's latest "Money Market Mutual Fund Assets" report shows assets up in the latest week. It says, "Total money market fund assets increased by $21.34 billion to $2.67 trillion for the week ended Wednesday, August 5, the Investment Company Institute reported today. Among taxable money market funds, Treasury funds (including agency and repo) increased by $15.24 billion and prime funds increased by $2.39 billion. Tax-exempt money market funds increased by $3.71 billion. Assets of retail money market funds increased by $4.64 billion to $875.88 billion. Among retail funds, Treasury money market fund assets increased by $830 million to $197.63 billion, prime money market fund assets increased by $1.52 billion to $497.97 billion, and tax-exempt fund assets increased by $2.29 billion to $180.28 billion. Assets of institutional money market funds decreased by $670 million to $1.78 trillion. Assets of institutional money market funds increased by $16.70 billion to $1.79 trillion. Among institutional funds, Treasury money market fund assets increased by $14.41 billion to $808.77 billion, prime money market fund assets increased by $870 million to $915.38 billion, and tax-exempt fund assets increased by $1.42 billion to $69.32 billion." Year-to-date, money fund assets are down $64 billion or 2.3%. However, assets have been up 5 of the last 7 weeks. In other news, Marketwatch posted an article, "Warning Sounds as Mutual-Fund Cash Levels Hit All-Time Low." It says, "Mutual-fund cash levels just shriveled to 3.2%, an all-time low. [M]utual-fund cash levels also dropped to new all-time lows just before the 2000 and 2007 market tops. People's antennae tend to perk up every time an indicator matches or exceeds 2000 or 2007 extremes.... Mutual-fund cash levels fell to new all-time lows in July 2010 (3.4%) and July 2011 (3.3%). Although nasty corrections coincided with the 2010 and 2011 mutual-fund cash level lows, markets recovered thereafter."

The Association for Financial Professionals, or AFP, host a webinar this afternoon to go over the results of its 2015 AFP Liquidity Survey. The "2015 Liquidity Survey Companion Webinar" will take place Thursday, August 6, from 3:00 to 4:00 p.m. EDT. (The webinar is free to AFP Members and $50 for Non-Members.) Speakers include: AFP's Thomas Hunt, State Street Global Advisors' Matt Steinaway, Crane Data's Peter Crane, and Great Plains Energy's Jim Gilligan. The webinar description says, "Treasury professionals continue to be optimistic but cautious with their organizations' short-term cash and investment holdings. The 2015 Liquidity Survey shows that bank deposits are at an all-time high in terms of investment allocation in operating cash portfolios. Regulations such as Basel III and 2a7 Money Fund Reform will be impacting cash investments over the next couple of years. Come and hear from industry experts on highlights from the 2015 Liquidity Survey along with practical tips for updating your investment policy statement ahead of these regulations changes and allocating short term investments considerations that fit within your investment parameters." The webinar's learning objectives include: "Understand the liquidity issues facing corporates, and what reasons there are to be optimistic and what risk corporates should keep in mind; Walk away with clear ideas about how corporates can manage short term investments in light of recent regulatory changes." Click here to register. In other news, Bloomberg posted an article, "The Fed's New Repo Tool Could Affect Millions of U.S. Home Loans." It reads, "RRP. IOER. MBS. EEK! The alphabet soup of financial acronyms is about to get more crowded with the expansion of the Fed's overnight reverse repo agreements (known as overnight RRPs).... Enter the RRPs. Years of quantitative easing have left the Federal Reserve with a $4.5 trillion balance sheet. Once the central bank begins to raise interest rates, it plans to use the overnight RRPs to drain the extra cash sloshing around the financial system by lending out (or repo-ing) of some of the U.S. Treasuries it holds on its balance sheet. It's a new venture for the Fed, as the so-called repo market has remained the purview of banks, money market funds, and investment managers for many, many years."

Bloomberg writes, "Fed's Limited-Time Offer in Money Markets May Be Hard to Cut Off." The article says, "The Federal Reserve is about to take an unprecedented plunge into money markets. It plans to make it a limited-time offer, but the assets are so attractive that it may be forced to extend the life of the deal. As soon as this year, Fed policy makers will greatly expand a $100 billion-dollar market for overnight loans known as reverse-repurchase agreements. They are designed to suck money out of the financial system so the Fed can raise short-term interest rates. They will also provide money-market funds and banks with safe investments that are now in short supply as financial-market reforms have heightened their need to hold exactly such assets. The U.S. central bank's potentially gigantic footprint in money markets poses risks. Establishing a long-term presence could crowd out private borrowers who use the markets for everything from financing inventories to managing seasonal flows of cash. Fed officials are trying to convince investors that eventually they want to stop using reverse repos. Their arguments don't seem credible to many, including economists who once worked there. "It is very fair to say this is going to be a permanent feature of the financial landscape whether they like it or not," said Roberto Perli, a partner at Cornerstone Macro LLC." Bloomberg continues, "The Fed's intended retreat from the program is "going to be a challenge, but I take the Fed at its word," said Steven Meier, head of cash, currency and fixed income at Boston-based State Street's money management unit. "It's not their intention to be the dominant player in the market." The piece adds, "Demand for the facility "could conceivably be much greater than what we have seen" in recent tests "as regulatory and structural changes in money markets boost demand for safe assets," according to Simon Potter, head of open-market operations for the FOMC and executive vice president at the New York Fed.... Contributing to that demand, regulators now require money-market funds to have 10 percent of their assets in cash, Treasury securities or other securities that can convert to cash in one day.... What's more, starting next year, so-called prime funds that invest in corporate debt for institutional shareholders must convert to floating share prices instead of the once dependable $1 per share. That change could also create new demand for stable net-asset-value products that invest solely in government debt." In other RRP news, the NY Fed announcing this week that it was expanding its Reverse Repo Counterparties List to include Federal Home Loan Bank of Pittsburgh and The Money Market Portfolio managed by Franklin Advisors.

Federated Investors' CIO of Global Money Markets, Deborah Cunningham writes in her latest "Month in Cash" "How times have changed." She says, "The incessant buzz surrounding whether the Federal Reserve will or won't initiate liftoff in September (put me in the "will" camp) got me thinking about just how much times have changed. I can recall a meeting years ago in the board room on the 27th floor of our Downtown office building. It was with members of the New York Federal Reserve Bank, and the discussion centered on the possibility the target funds rate, 1% at the time, could be lowered another 25 basis points to 0.75% ... 0.75%! We thought that was madness; now, we'd be jumping for joy over such a rate! And, frankly, we believe we will get to 0.75% at some point next year, likely in the first half of 2016. We also think the Fed will initiate its first increase in the funds rate in nine years at its meeting next month, the noise surrounding its late July post-meeting statement notwithstanding. If you strip that statement down, there were less than 10 word changes, with a lot of consternation focused on the addition of the word "some," as in policymakers to need to see "some" further improvement in the labor markets to justify a rate hike. Honestly, this all sounds like word sniffing to me." Cunningham continues, "We do think the Fed will tread very gingerly once it begins to move. Our scenario sees a rate hike of 25 basis points or so every second or third meeting, starting with September as opposed to December, as some are currently suggesting. Given the cash-flow complications and all the funding and window-dressing moves that occur in the money market toward the end of every year, to toss in the beginning of a policy of raising rates when they've effectively been a zero for seven years wouldn't make a lot of sense from our perspective. That said, we wouldn't be surprised if the Fed only makes one move this year; its first meeting in 2016 is in late January, so skipping December wouldn't be such a big deal. Our expectation is the Fed will nudge the target rate to 1% and then pause to make an assessment.... With the cash market starting to price in a move, we've been able to find value in floaters -- floating-rate instruments that reset periodically and generally benefit in a rising-rate environment -- and further out on the cash yield curve. This has resulted in unique circumstance in our portfolios -- the weighted average life of our holdings has extended by about 10 days over the past month as we moved out on the curve, but the weighted average maturity hasn't budged, reflecting a big increase in holdings of floaters that reset monthly." In other news, StoneCastle Cash Management, which "amalgamates" FDIC insured deposits, issued a press release saying it posted record asset and account levels in 2Q. Business highlights include: "Increasing balances by 20% year to date, with FICA and ICA balances up over 30%; Exceeding 1,000 total institutional accounts; Successfully launching the new Institutional Cash Account, a non-insured, large balance bank deposit solution. "It is not coincidental that as firms deal with the impact of regulatory reform, SCCM and its FICA offering are reaching historic asset levels. We continue to see strong growth in assets as treasurers seek out proven cash management solutions," said StoneCastle's Brandon Semilof.

Dale Albright, head of money market portfolio management at BofA Global Capital Management, recently co-authored a white paper called, "Variable NAV Prime Money Market Funds: Risks and Rewards." Albright and co-author Jeremy Harman, Senior Institutional Sales Representative at BofA, write, "Prime money market funds have been used for decades because they have offered the potential for attractive yields, daily liquidity, diversification and principal stability. The evolving interest rate environment and sweeping regulatory reforms represent changes whose impact investors should understand as they use VNAV money market funds. The sponsors of institutional prime money market funds have time to implement the VNAV reform, and investors have time to consider the impact of the change in the context of their risk tolerance, return objectives and liquidity requirements. While some investors may not have the appetite for even a few basis points of NAV deviation, others might view such NAV movement as they would transaction fees on bank, sweep or custody accounts -- a cost of doing business justified by the risk/return profile and overall benefits of the investment. Investors' make this trade-off today. Most investment policies state that preservation of principal is the primary objective, yet most short-duration investors do not limit themselves to U.S. Treasuries. They use institutional prime money market funds knowing there is no guarantee that the funds' NAVs will remain stable at $1.00 because they believe the additional yield potential institutional prime money market funds have offered adequately compensates them for the additional risk. So, while principal preservation is, and should be, liquidity investors' primary objective, yield and return are considerations today and will be in the future. Absent large and unpredictable dislocations in the short-term debt markets, the advent of a floating NAV for institutional prime money market funds is unlikely, in our view, to negate the benefits offered by this category of funds. Under normal circumstances, the potential impacts of a shift to a floating NAV are likely to be small, and they are, in many ways, quantifiable (and thus manageable). Moreover, investors understand that market dislocations, such as the global financial crisis, threaten principal preservation whether a fund's NAV is pegged at $1.00 or floats. We believe that in a normal operating environment, a VNAV structure would not, by itself, undermine principal stability. Investors might choose to use VNAV prime money market funds differently in the future (using them for reserve cash instead of operating cash, for example), but we believe institutional prime funds will remain a valuable component of a diversified liquidity-management program even after these funds adopt the variable NAV in October 2016."

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