News Archives: June, 2010

The 2010 AFP Liquidity Survey was released earlier this week. (See the AFP Liquidity Survey page too.) The survey says, "During the rapid deterioration of business conditions over the previous two years, global credit markets froze, resulting in both corporate and individual investors fleeing from investment vehicles that previously had been deemed safe havens for short-term investments. Because of the detrimental impact that in the financial sector turmoil and the deep recession had on their access to short-term credit, organizations were increasingly emphasizing protecting principal of their short-term investment portfolio. A number of them moved investments into ultra-safe investment vehicles, such as bank deposits, money market mutual funds and Treasury securities."

Its Summary continues, "The question is when (and at what pace) organizations will begin to open up their short term investment portfolios and seek not only safety, but also increased liquidity and yield. At the same time, will organizations continue to hoard cash -- as many have in recent years -- or will they begin to seek other uses for this cash; such as for share repurchases and long-term business opportunities (e.g., M&A activity, capital investments)? In early May 2010, the Association for Financial Professionals conducted its fifth annual Liquidity Survey to provide financial professionals with an understanding of how organizations currently manage their short-term investment portfolios."

AFP explains, "This year's survey also explored the impact of the new Securities and Exchange Commission rules affecting money market funds. Through the end of May, the survey generated 337 responses, which are the basis of this report. The 2010 AFP Liquidity Survey was underwritten by Promontory Interfinancial Network, LLC."

The 24-page report says, "Key findings of the 2010 AFP Liquidity Survey include: A plurality of organizations increased their balances of cash and short-term investments in the six months leading up to May 2010. During May 2010, 43 percent of organizations held a larger balance in U.S. cash and short-term investments than they did six months earlier.... Organizations remain quite conservative in the strategies associated with their short-term investment portfolios. Overall, organizations' investment policies allow for the use of an average 4.7 short-term investment vehicles, in addition to bank deposits.... Eighty-three percent of organizations permit the use of Treasury bills while at least 60 percent of organizations permit the use of commercial paper, 'pure' Treasury money market mutual funds and agency securities."

The Key Findings continue, "Organizations allocate an average 74 percent of their short-term investment balances in three safe and liquid investment vehicles: bank deposits, money market mutual funds and Treasury securities. Bank deposits are the dominant investment vehicle for short-term investment portfolios. Forty-two percent of all short-term investment balances are held in bank accounts. Just two year earlier, the percentage was 25 percent." The survey, which split money market funds into two groups last year, shows "Diversified" money market funds with 15.8% of organizations' allocations and "pure" Treasury money funds with 9.3% of allocations. (So money fund holdings total 25.1% of "cash" assets.) "Bank deposits" are comprised of Time deposits (63% use), Non-interest bearing transaction (TAG) accounts (45% use), CDARS (17% use) and Insured cash shelter accounts (9% use).

On "Portals," AFP says, Twenty-one percent of organizations use an electronic, multi-family trading portal to execute at least some of their short-term investment transactions. Organizations using trading portals execute an average of 73 percent of their money market mutual fund transactions through the trading portal. " The survey adds, "The use of multi-family trading portals has remained stable over the past few years." (AFP's survey from two years ago showed usage at 25%.)

Finally, AFP writes, "In addition to questions related to cash and short-term investments, the 2010 AFP Liquidity Survey asked financial professionals about the impact that new SEC rules on money market funds (MMFs) may have on their organization's use of said funds." The survey found that the majority of respondents say, "It will have no bearing" when asked about the "Impact of 60-day shadow NAV on organizations' investment decisions in money market funds." Forty-five percent of respondents say their "Organization is generally comfortable with the [recent 2a-7] changes and will not modify its investment strategy."

On Friday, the U.S. Securities & Exchange Commission quietly posted its second set of Q&A's on its Money Market Fund Reforms. The newly-posted "Staff Responses to Questions about Rule 30b1-7 and Form N-MFP says, "The staff of the Division of Investment Management has prepared the following responses to questions related to rule 30b1-7 under the Investment Company Act and Form N-MFP and expects to update this document from time to time to include responses to additional questions.... Responses to questions regarding rule 2a-7 are included in a separate document that is available at: ('Money Market Fund Reform Q&A')."

The new Q&A asks about the "Scope of Rule 30b1-7," "Is compliance with new rule 30b1-7 and Form N-MFP mandatory for a registered fund that holds itself out to investors as a money market fund but that does not use the Amortized Cost Method of valuation or the Penny Rounding Method of share pricing?" It answers, "Rule 30b1-7 requires every registered fund 'that is regulated as a money market fund under [rule 2a-7]' to file Form N-MFP with the Commission. Accordingly, all funds subject to rule 2a-7, including those that do not use the Amortized Cost Method or Penny Rounding Method, must file Form N-MFP."

Regarding the new Form N-MFP, is asks, "If a money market fund has classes of shares, Form N-MFP requires disclosure of the shadow price of the series and of each class of shares. If the fund has a policy of paying daily dividends on each class of shares equal to the full amount of accrued net income attributable to the class (so no class will accumulate any value apart from its pro rata share of the fund's net assets), and only calculates its shadow NAV based on the total outstanding shares without regard to classes, can the fund use the series shadow NAV for each class?" The Staff answers, "If a money market fund's dividend and accounting policies assure that there will be no deviation between the market-based NAVs of the classes of shares offered by the fund, the fund may use the same shadow NAV for each class without a separate calculation."

On "Investment Categories, the Q&A asks, "Form N-MFP (like the monthly website posting provision under rule 2a-7) requires funds to indicate the specific category most closely identified with each portfolio security. Must funds use the categories specified in Form N-MFP or can they use other categories?" It answers, "Funds must use the categories specified in Form N-MFP."

The document also discusses the "Value of Capital Support Agreements," saying, "Q: Items 45 and 46 of Form N-MFP require disclosure of the value of a money market fund share, including and excluding the effect of any capital support agreement. The value of certain capital support agreements will be determined only at such time as a loss is determined. (For example, an affiliate may agree to provide sufficient capital, up to a maximum, to bring a fund's NAV to $.995, if a loss occurs.) How should a fund reflect the value of such an agreement? A: If an affiliate has agreed to provide sufficient capital up to a maximum to bring a fund's NAV to $.995, for example, then the value of the support agreement is the amount necessary to bring the fund's shadow NAV up to $.995. If the fund's shadow NAV is $.995 or above, then the support agreement has no value for purposes of Form N-MFP."

The Q&A asks on Gross Yields, "If the money market fund is a tax-exempt fund and it holds taxable paper, should the fund adjust the gross yield to reflect federal income taxes that would be imposed on the taxable paper?" It answers, "No." It also asks, "Q: In the absence of a CUSIP, if a security is assigned a 'dummy' CUSIP (i.e., a random series of digits used internally to identify a particular security), should the 'dummy' CUSIP be provided as the other unique identifier? A: Yes."

Finally, regardng the "Public Availability of Form N-MFP's Technical Specifications (Schema)," the document asks, "When will the technical specifications (schema) for Form N-MFP be available to the public?" It answers, "The technical specifications (schema) for Form N-MFP will be publicly available on the SEC website in mid to late summer."

(Note that Crane's Money Fund Symposium, July 26-28 at The InterContinental Boston, will discuss these issues and more in its final session "Critical Questions on The New Rule 2a-7. The panel includes: SEC Senior Special Counsel Sarah ten Siethoff, Reed Smith Counsel Leslie Ross, and PriceWaterhouse Coopers Partner Richard Grueter.)

Last Thursday, Treasury Strategies issued a "Client Advisory" entitled, "Interest on Business Checking Moves Closer to Passage in U.S.." The release says, "A provision was approved by the U.S. House and Senate financial reform conferees yesterday, which allows banks to pay interest on business demand deposit accounts for the first time since the Great Depression."

It explains, "Treasury Strategies has been following Regulation Q for several years. Its most recent incarnation is Rep. Scott Murphy's Business Checking Fairness Act which was appended to the Wall Street Reform & Consumer Protection Act of 2009. This is an interesting contradiction. A proposed solution to the current crisis is to allow interest on business checking, whereas a regulatory outcome of the Great Depression was to prohibit such interest."

Treasury Strategies synopsis says, "Commercial Banks will face higher cost of funds as they begin paying interest. However, they will be better able to compete for deposits through interest payments and FDIC guarantees under TAG. Higher cost of funds and deposit insurance premiums will probably be recouped through higher fees on transaction services. The challenge for banks is to carefully calibrate rate structures and transaction fees such that they attract a customer mix that optimizes their return on capital."

They add, "Fund Companies will face increased rate competition from the banking sector. Their challenge will be to convince customers that the resulting higher banking service charges will offset interest paid. They will need to position their funds as either yield-enhanced or safer than bank deposits -- a task made tougher by recent changes to rule 2a-7 and FDIC insurance. However, fund companies can point out to regulators that if customers exit funds and move into the banking system, 'too big to fail' banks will become even larger."

Finally, the release says, "Corporate Treasurers will need to sort through several changes that will result from the RegQ repeal. In the short run, they will experience a volatile market, characterized by new products, new rate structures and new fees, as well as promotional pricing. Credit worthiness of the institution becomes a larger issue. It's likely that companies will need to evaluate new and tiered rate structures, earnings credits, transaction fees, deposit insurance pass-thoroughs, short-term investments, and sweep accounts. These changes will impact companies differently depending on their balance levels, transaction volume, liquidity needs and financial situation."

Earlier this week, Moody's Investors Service released a study entitled, "Default and Recovery Rates of Corporate Commercial Paper Issuers, 1972-2009, a report which "documents and updates rating transition, default and recovery rates of corporate commercial paper (CP) issuers for the past 37 years." The NRSRO's press release says, "The commercial paper market experienced a challenging time during the 2007-2009 global financial crisis with concerns over liquidity and rising defaults causing debt outstanding in the corporate CP market to fall from $1,029 billion in August 2008 to $674 billion in December 2009, Moody's Investors Service said in a new report."

Sharon Ou, an Assistant Vice President & Senior Analyst at Moody's, comments, "The credit quality of commercial paper issuers is generally very high and the risk of default remote. However, the recent credit crisis that swept through the global financial markets in 2007-2009 led to the failure of several notable CP programs and resulted in a short-lived panic in the CP market."

The report's Summary comments, "This report updates Moody's previous studies on commercial paper rating performance and the default experience of corporate commercial paper issuers since 1972. Briefly, the study finds that: The commercial paper market experienced a challenging time during the 2007-2009 global financial crisis. Lehman's bankruptcy in 2008 triggered a disruption in the corporate CP market.... Credit quality for corporate CP issuers deteriorated sharply in 2009 as the P-1 downgrade rate climbed to an all-time high of 10.5%, more than doubling the past three-decade average of 4.8%."

The piece also found that, "CP defaults accelerated in 2008-09 with seven issuers failing to honor payments on a total of $4.1 billion of commercial paper. Lehman Brothers, with approximately $3.0 billion of paper, was the largest CP default in history. For the entire period 1972-2009, a total of 59 issuers defaulted on approximately $9.9 billion of rated and unrated CP. While highest number of defaults were registered in the 1989-1990 period, default volume peaked during 2008-2009."

In addition, Moody's adds, "Across regions, the U.S. recorded 20 defaults affecting $6.1 billion of CP. In Europe, another 20 issuers defaulted on a total of $2.3 billion of CP. Of the 59 defaulted issuers, 22 were rated by Moody's at the time of default, with $7.3 billion of CP affected. Of these 22 defaults, 14 issuers were rated Not Prime at the time of default and nine were rated either Not Prime or P-3 at least three months prior to default. Moody's short-term ratings effectively differentiate the default risk. Over a 180-day horizon, P-1 rated issuers historically have a 0.02% probability of default. The frequency of default rises to 0.03%, 0.15% and 0.82% for P-2, P-3 and Not Prime issuers, respectively."

See also our Crane Data News from May 24, "S&P Study Shows Short-Term Defaults Rare, Even After 2008-2009," which says, "Standard & Poor's published 'Default, Transition, and Recovery: Global Short-Term Ratings Performance And Default Analysis (1981-2009),' a study of defaults in the commercial paper and other short-term money markets. Unsurprisingly, it says, 'Consistent with all of our long-term default studies, our short-term corporate ratings performance analysis confirms that higher ratings generally correlate with greater stability and a lower likelihood of default, and vice versa.'"

The Investment Company Institute recently sent a letter to Barney Frank, Christopher Dodd, and members of the committees involved in reconciling the Restoring American Financial Stability Act of 2010, as well as to Treasury Secretary Tim Geithner. The letter, signed by a number of mutual fund companies, says, "We are writing you to express our concerns regarding a specific provision contained in the Restoring American Financial Stability Act of 2010, H.R. 4173, as passed by the Senate on May 20, 2010, which would result in significant unintended consequences for the capital markets. The provision would likely curtail the desire of market participants to invest in repurchase agreements ('repos'), particularly those backed by U.S. government collateral."

It continues, "The concerning language provides that a person who is party to a qualified financial contract (e.g., a repo) with a covered financial company may not exercise any contractual right that such person has to terminate, liquidate, or net such contract following the appointment of the FDIC as receiver for the covered financial company until after 5:00 p.m. on the third business day following the date of such appointment. [See H.R. 4173, Section 210(c)(10)(B)(i)(I)]"

The ICI letter explains, "If this provision becomes law, market participants may have to reconsider their use of repo. Such an automatic delay in payment of a money market investment can create liquidity and stability issues. Because investors cannot know in advance which financial institutions might be determined to be a covered financial company under the Act, investors may be reluctant to engage in repo transactions with any financial institution. In addition, the three day stay may result in repo transactions secured by government collateral ('government repo') to no longer be eligible investments for government money market funds. Today, the repo market provides $2.5 trillion in financing for government collateral."

It adds, "A significant reduction in money market fund participation in the government repo market would drastically reduce a critical and efficient source of funding for Treasuries and other government securities -- resulting in increased funding costs to the U.S. government. Indeed, the repo market is a critical component of the short term capital markets that provides daily funding for U.S. government securities as well as a safe and liquid investment for investors."

Finally, the letter says, "For the reasons noted above, we believe these outcomes are easily avoided by reducing the enforcement delay to no more than one business day, which is consistent with the treatment of financial contracts in a resolution by the Federal Deposit Insurance Corporation of an insured depository institution. A one-day delay does not materially impair a fund's right to liquidate collateral, as it generally takes a full day to provide the required notifications and prepare to sell the collateral following an event of insolvency. We recognize the significant challenges involved in crafting sweeping reform legislation and look forward to continuing to work with Congress to resolve the issues outlined above." (Word is that the one-day change has been accepted by the Committees crafting the compromise bill.)

See Crane Data's June 9 News article, "NB's Tank on Further Steps; Moody's on Financial Reform and Repos." Crane Data wrote, "Moody's published 'U.S. Financial Regulatory Reform Would Make Repo with Broker/Dealers Less Attractive for Money Market Funds,' which says, "On 20 May, the U.S. Senate passed the 'Restoring American Financial Stability Act of 2010,' which would give the FDIC expanded liquidation powers to delay or 'stay' collateral in connection with repurchase (or repo) agreements when liquidating 'covered financial companies'." See too The Washington Post's "Scott Brown's key vote gives Massachusetts firms clout in financial overhaul", which says, "State Street ... has a powerful advocate: Sen. Scott Brown (R-Mass.), whose vote the Democrats need to pass the financial overhaul bill."

A release sent out late yesterday entitled, "FDIC Board Adopts Final Rule Extending Tag Program and Maintains Current Deposit Insurance Assessment Rates," says, "The Board of Directors of the Federal Deposit Insurance Corporation (FDIC) today adopted a final rule extending the Transaction Account Guarantee (TAG) program for six months, from July 1, 2010 through December 31, 2010. Under the TAG program, customers of participating insured depository institutions are provided full coverage on qualifying transaction accounts."

FDIC Chairman Sheila Bair comments, "While I believe that the TAG program has proven to be critical to ensuring our financial system's stability, it was established as a temporary program. Ultimately, it should be up to Congress to determine our insurance limits. Adoption of this final rule allows the opportunity for Congress to conclude its current deliberations relative to this program."

The release adds, "The final rule, adopted after a public comment period, is almost identical to the interim rule adopted on April 13, 2010. The rule requires that interest rates on qualifying NOW accounts offered by banks participating in the program be reduced to 0.25 percent from 0.5 percent. It requires TAG assessment reporting based on average daily account balances but makes no changes to the assessment rates for participating institutions. The rule also provides for an additional extension of the program, without further rulemaking, for a period of time not to exceed December 31, 2011."

The Final Rule comments, "Since its inception, the TAG program has been an important source of stability for many banks with large transaction account balances. Currently, over 6,300 insured depository institutions, representing approximately 80 percent of all IDIs, continue to participate in the TAG program and to benefit from the guarantee provided by the FDIC. These institutions held an estimated $356 billion of deposits in accounts currently subject to the FDIC's guarantee as of March 31, 2010. Of these, $280 billion represented amounts above the insured deposit limit and guaranteed by the FDIC through its TAG program. Among the current participants in the program, the average TAG account size was about $1.04 million. About 509 institutions rely on TAG accounts to fund 10 percent or more of their assets."

The FDIC's statement also says, "The FDIC Board also was updated on loss, income and reserve ratio projections for the Deposit Insurance Fund. The restoration plan maintains assessment rates at their current levels through the end of 2010 and applies a uniform 3 basis-point increase in assessment rates effective January 1, 2011. Current assessment rates are projected to return the DIF to a positive balance in 2012 and the reserve ratio to the statutory minimum target of 1.15 percent during the first quarter of 2017. The FDIC collected $46 billion in prepaid assessments at the end of last year, which is projected to be more than sufficient to fund resolution activities."

Chairman Bair says, "I'm pleased to see that events thus far have unfolded much as we anticipated when we adopted this Restoration Plan -- but we have a long way to go, and many uncertainties remain about the speed of economic recovery and our ultimate resolution costs. I'm hopeful about the prospects for the industry, and expect that we'll see far fewer failures in 2011 than what we're experiencing this year." Click here for the "Final Rule, Temporary Liquidity Guarantee Program" and click here for the "Deposit Insurance Fund Restoration Plan".

As we wrote yesterday, the Federal Reserve Bank of New York recently published "The Federal Reserve's Commercial Paper Funding Facility," a paper authored by Tobias Adrian, Karin Kimbrough and Dina Marchioni, which "examines the creation and performance of the CPFF, while simultaneously outlining the evolution and importance of the commercial paper market before and during the CPFF (which expired February 1, 2010)." We summarized the article yesterday, but today we excerpt highlights from the "Background on the Commercial Paper Market" and "Lenders in the Commercial Paper Market" (including of course money market mutual funds).

The New York Fed authors write, "The commercial paper market is used by commercial banks, nonbank financial institutions, and nonfinancial corporations to obtain short-term external funding. There are two main types of commercial paper: unsecured and asset-backed. Unsecured commercial paper consists of promissory notes issued by financial or nonfinancial institutions with a fixed maturity of 1 to 270 days, unless the paper is issued with the option of an extendable maturity. Unsecured commercial paper is not backed by collateral, which makes the credit rating of the originating institution a key variable in determining the cost of issuance. Asset-backed commercial paper (ABCP) is collateralized by other financial assets and therefore is a secured form of borrowing. Historically, senior tranches of asset-backed securities (ABS) have served as collateral for ABCP.... While the underlying loans or mortgages in the ABS are of long maturity (typically five to thirty years), ABCP maturities range between 1 and 270 days."

The paper continues, "Commercial paper is held by many classes of investors. The largest share of ownership is by money market mutual funds, followed by the foreign sector, and then by mutual funds that are not money market mutual funds. Other financial institutions that hold commercial paper include nonfinancial corporations, commercial banks, insurance companies, and pension funds. The creation of the Commercial Paper Funding Facility is closely tied to the operation of money market mutual funds. Money market funds in the United States are regulated by the Securities and Exchange Commission's (SEC) Investment Company Act of 1940. Rule 2a-7 of the Act restricts investments by quality, maturity, and diversity. Under this rule, money market funds are limited to investing mainly in highly rated debt with maturities of less than thirteen months. A fund's portfolio must maintain a weighted-average maturity of ninety days or less [soon to be 60 days], and money market funds cannot invest more than 5 percent in any one issuer, except for government securities and repurchase agreements (repos). Eligible money market securities include commercial paper, repos, short-term bonds, and other money market funds."

It explains, "Money market funds seek a stable $1 net asset value (NAV). If a fund's NAV drops below $1, the fund is said to have 'broken the buck.' Money market funds, to preserve a stable NAV, must have securities that are liquid and have low credit risk. Between 1971 -- when the first money market fund was created in the United States -- and September 2008, only one 2a-7 fund had broken the buck: the Community Bankers U.S. Government Money Market Fund of Denver, in 1994. In light of disruptions to the sector in 2008, the SEC is currently reevaluating 2a-7 guidelines and considering the mandating of floating NAVs and the shortening of weighted-average maturities.

The NY Fed paper says, "Considerable strains in the commercial paper market emerged following the bankruptcy of Lehman Brothers Holdings Inc. on September 15, 2008. Exposure to Lehman forced the Reserve Primary Fund to break the buck on September 16. As a result, money market investors reallocated their funds from prime money market funds to those that held only government securities."

It explains, "This reallocation unleashed a tidal wave of redemption demands that overwhelmed the funds' immediate liquid reserves. In the week following the Lehman bankruptcy, prime money market mutual funds received more than $117 billion in redemption requests from investors concerned about losses on presumably safe investments, possible contagion from Lehman's bankruptcy, and financial institutions with large exposures to subprime assets. As a result, 2a-7 money market mutual funds were reluctant, and in some cases unable, to purchase commercial paper (or other money market assets with credit exposure). Any purchases made were concentrated in very short maturities; shortening the duration of their asset holdings made it easier for money market funds to manage uncertainty over further redemptions."

Finally, it says, "As demand by money market funds shrank, commercial paper issuers were unable to issue term paper and instead issued overnight paper. Thus, with each passing maturity date of commercial paper outstanding, an issuer's rollover risk increased sharply. Banks bore the increasing risk of having their credit lines drawn by issuers unable to place commercial paper in the market precisely when the banks themselves were having difficulty securing funding from the market and were attempting to reduce risk."

The Federal Reserve Bank of New York recently released a study entitled, "The Federal Reserve's Commercial Paper Funding Facility," in a forthcoming "Economic Policy Review. The bank's release says of The Federal Reserve's Commercial Paper Funding Facility, "Established in the wake of Lehman Brothers' bankruptcy to stabilize severe disruptions in the commercial paper market, the Commercial Paper Funding Facility (CPFF) allowed the Federal Reserve to act as a lender of last resort for issuers of commercial paper, thereby effectively addressing temporary liquidity distortions and alleviating the severe funding stress that threatened to further exacerbate the financial crisis. In doing so, the CPFF can be considered a noteworthy model of liquidity provision in a market-based financial system, where maturity transformation occurs outside of the commercial banking sector. Authored by Tobias Adrian, Karin Kimbrough and Dina Marchioni, this paper examines the creation and performance of the CPFF, while simultaneously outlining the evolution and importance of the commercial paper market before and during the CPFF (which expired February 1, 2010)."

The release continues, "Supported by in-depth analysis, detailed data and first-hand accounts, this paper offers a complete overview of the CPFF, including the economic role of the commercial paper market, the events preceding the creation of the facility, operational details of the CPFF and the economics of the facility in the context of the financial system and in relation to the Federal Reserve's role as lender of last resort. As explained by the authors, the careful operational design of the CPFF permitted the Federal Reserve to effectively relieve temporary stress in the commercial paper market while protecting itself from any credit loss. Moreover, the facility's ability to provide liquidity to a particular market as opposed to a particular set of institutions allowed the Federal Reserve to extend its reach beyond depository institutions, a critical factor given the primacy of institutions without discount window access in the commercial paper market."

It says, "Fashioned as a market-based liquidity facility that naturally wound down as the private sector regained its footing, the CPFF serves as a guide for providing emergency backstop liquidity to modern financial markets, where 'the shadow banking system' accounts for a quantitatively and economically important share of the activity. Additionally, while the public sector's role in providing backstop liquidity to the shadow banking system will continue to be debated, the CPFF's successful design could serve as a guide for future policy discussions about reducing the vulnerability of markets to liquidity crises."

The paper's "Conclusion says, "The legal basis for the CPFF stemmed from section 13(3) of the Federal Reserve Act, requiring the use of such a facility in 'unusual and exigent circumstances.' As such, the Federal Reserve does not have the authority to make the CPFF a permanent liquidity backstop. This in turn has implications for the ongoing debate on regulatory reform. The financial market crisis of 2007-09 demonstrated the current financial architecture's vulnerabilities to liquidity crises emanating from nondepository institutions. As such, an important component of regulatory reform focuses on improving the resiliency of money markets to financial and economic shocks. Many ongoing reform efforts aim to reduce the vulnerability of money markets to liquidity crises. These efforts focus particularly on reforming money market funds, the commercial paper market, and the repo markets."

It continues, "It has long been understood that the public sector plays a crucial role in the provision of liquidity. In times of aggregate liquidity shortages, only the monetary authority can act as lender of last resort, owing to its ability to create money. Traditionally, the lender of last resort has been available only to depository institutions because the vast majority of maturity and liquidity transformation took place in those institutions. Since the mid-1980s, however, the rapid growth of a market-based system of credit formation has allowed for maturity transformation by a wide range of institutions, including money market funds, finance companies, and securities broker-dealers, and through a range of market instruments, such as asset-backed commercial paper and tri-party repo."

Finally, the paper says, "Despite the recent crisis, it seems likely that large amounts of maturity and liquidity transformation will continue to be conducted outside of depository institutions -- and therefore without access to the traditional lender of last resort -- in what is known as 'the shadow banking system.' The public sector's role in providing backstop liquidity to the shadow banking system will continue to be debated. Although the duration of the CPFF was necessarily limited, the facility provides a model for a market-based lender-of-last-resort liquidity backstop, which could serve as a guide for future policy discussion."

Though outflows have moderated following very heavy declines in the first four months of 2010 and the last six months of 2009, money funds continue to bleed assets. The latest weekly figures from the Investment Company Institute show money fund assets declining by $34.5 billion to $2.806 trillion. While three of the last six weeks have seen inflows into money funds -- their best inflow to outflow ratio since January 2009 -- assets have declined by $487 billion, or 14.8% year-to-date in 2010, a larger percentage decline than 2009's 14.0% (down $537 billion).

ICI's weekly report says, "Taxable government funds decreased by $7.69 billion, taxable non-government funds decreased by $26.22 billion, and tax-exempt funds decreased by $600 million.... Assets of retail money market funds increased by $180 million to $993.38 billion.... Assets of institutional money market funds decreased by $34.69 billion to $1.813 trillion." Institutional money funds, which represent 65.8% of all assets, have declined by $413 billion, or 18.5%, YTD, while retail money funds have declined by just $74 billion, or 7.0%.

Prime institutional money funds remain the largest market segment with $1.014 trillion, or 36.1% of assets, followed by Government institutional money funds (including Treasury) with $695 billion, or 24.8%. Prime retail money funds are the third largest segment with $607 billion, or 21.6%; Tax-Exempt retail money funds are the fourth largest with $213 billion, or 7.6%; Government retail money funds are the fifth largest with $173 billion, or 6.2%; and Tax-Exempt institutional money funds are the smallest segment with $139 billion, or 5.0% of assets.

Money fund assets have declined by over $1.0 trillion since December 2008 and they've declined by $1.114 trillion since their record high of $3.920 trillion set on Jan. 14, 2009. Asset levels were last at their current $2.8 trillion level in September 2007, the official start of the "Subprime Liquidity Crisis." So money funds climbed by over $1 trillion, and then declined by over $1 trillion all in the space of less than three years. Over three full years, money fund assets actually remain up by $276 billion, or 11.2%, and they remain almost $1 trillion higher than their 2004 year-end level of $1.913 trillion.

A recent research publication entitled, "The Fed's Exit Strategy for Monetary Policy," written by Glenn Rudebusch, senior V.P. and associate director of research at the Federal Reserve Bank of San Francisco, posits that it may 2012 before the Federal Reserve begins hiking interest rates. The introduction says, "As the financial crisis has receded, the Federal Reserve has scaled back its extraordinary provision of liquidity. Eventually, the Fed will remove all remaining monetary stimulus by raising the federal funds rate and shrinking its balance sheet. The timing of such renormalizations depends crucially on evolving economic conditions."

Rudebusch writes, "To many observers, the Federal Reserve's extraordinary policy actions during the recent crisis averted a financial Armageddon and curtailed the depth and duration of the recession (Rudebusch 2009). To combat panic and dislocation in financial markets, the Fed provided an enormous amount of liquidity. To mitigate declines in spending and employment, it reduced the federal funds interest rate -- its usual policy instrument -- essentially to its lower bound of zero. To provide additional monetary stimulus, the Fed turned to an unconventional policy tool -- purchases of longer-term securities -- which led to an enormous expansion of its balance sheet."

He continues, "As financial market strains eased and economic recovery began, discussion turned to how the Fed would unwind its actions (Bernanke 2010). Of course, after every recession, the Fed has to decide how quickly to return monetary conditions to normal to forestall inflationary pressures. This time, however, policy renormalization is especially challenging because of the unprecedented economic conditions and Fed actions. This Economic Letter describes various considerations in formulating an appropriate policy exit strategy. Such a strategy must unwind each of the Fed's three key actions: the establishment of special liquidity facilities, the lowering of short-term interest rates, and the increase in the Fed's securities holdings."

The paper explains, "Starting in August 2007, money markets experienced periods of dysfunction with sharply higher short-term interest rates for commercial paper and interbank borrowing. This intense liquidity squeeze, in which even solvent borrowers found it difficult to secure essential short-term funding, appeared likely to have severe financial and economic repercussions. Therefore, the Fed, acting in its traditional role as liquidity provider of last resort, introduced a variety of special facilities to supply funds to banks and the broader financial system."

It says, "By the end of 2008, the Fed was providing over $1 1/2 trillion of liquidity through short-term collateralized credit. Generally, this liquidity was designed to cost more than private credit when financial markets were functioning normally. Therefore, as financial conditions improved during 2009, borrowers switched to private financing. By early 2010, demand had dried up for the Fed's special facilities and they were closed. The facilities incurred no credit losses and provided a sizable return of interest income to taxpayers. More importantly, the liquidity facilities helped limit a pernicious financial and economic crisis (Christensen, Lopez, and Rudebusch 2009)."

The FRBSF work explains, "Figure 1 also provides a simple perspective on when the Fed should raise the funds rate. The dashed line combines the benchmark rule of thumb with the Federal Open Market Committee's median economic forecasts (FOMC 2010), which predict slowly falling unemployment and continued low inflation. The dashed line shows that to deliver future monetary stimulus consistent with the past -- and ignoring the zero lower bound -- the funds rate would be negative until late 2012. In practice, this suggests little need to raise the funds rate target above its zero lower bound anytime soon. This implication is consistent with the Fed's forward-looking policy guidance (FOMC 2010) that 'economic conditions -- including low rates of resource utilization, subdued inflation trends, and stable inflation expectations -- are likely to warrant exceptionally low levels of the federal funds rate for an extended period.' This guidance indicates that the length of the 'extended period' depends on the expected path of unemployment and inflation. Similarly, the benchmark policy rule would prescribe an earlier or later increase in the funds rate if unemployment or inflation rose or fell more rapidly than predicted in the forecasts underlying Figure 1."

But it says, "In contrast, some have argued that holding short-term interest rates near zero for much longer could foster dangerous financial imbalances, such as asset price misalignments, bubbles, or excessive leverage and speculation (see FOMC 2010). The risk of such financial side effects could shorten the appropriate length of a near-zero funds rate. However, the linkage between the level of short-term interest rates and the extent of financial imbalances is quite erratic and poorly understood. For example, during the past decade and a half, Japanese short-term interest rates have been essentially at zero with no sign of building financial imbalances. Therefore, some remain skeptical that monetary policy should directly aim to restrain excessive financial speculation, especially while prudential financial regulation remains available for this task (Kohn 2010)."

Finally, the piece concludes, "Many predict that the economy will take years to return to full employment and that inflation will remain very low. If so, it seems likely that the Fed's exit from the current accommodative stance of monetary policy will take a significant period of time."

Below, we excerpt from an article in the most recent Money Fund Intelligence entitled, "Money Funds in Europe: Q&A w/IMMFA's Le Coz." It says, "Recently, the Committee of European Securities Regulators, or CESR, published a two-tiered definition of money market funds in Europe. Another milestone in money funds' development in Europe also occurs this month as IMMFA, the London-based Institutional Money Market Funds Association which was founded to spread U.S.-style money fund standards, celebrates its 10th anniversary. We wanted to get an update on the status of money funds in Europe, so we interviewed Gail Le Coz, IMMFA's CEO. Our Q&A follows."

First MFI asked, "How will the CESR news impact IMMFA and money funds in Europe? Le Coz responded, "The impact is different for us, as we already had the IMMFA Code of Practice, as well as the guidelines from the ratings agencies in order to maintain the AAA rating. So, we already had our European money market fund rules by virtue of the Code and the rating. With the changes that we made to the Code last year, we have a 60 day WAM, we have a 120 day WAL, we have maturity limits, and we have credit limits by virtue of the credit rating agencies guidelines.... But now, within the short term money market fund subcategory, we will more likely be compared with funds that are purchasing similar types of investments."

She continued, "We were pretty much already there [in regards to the new CESR guidelines]. With certain things, such as the liquidity buckets that we have -- just like 2a-7 -- the CESR guidelines are not as strict. Their guidelines say you need to manage liquidity, but they don't specify minima. So with a lot of the CESR work, we were already there, and in certain instances we're still ahead."

MFI also asked, "In general, how is IMMFA doing on its 10th anniversary?" Le Coz answered, "We've seem phenomenal growth in the European currency funds, the Euro funds and the Sterling funds. We have seen similar types of outflows in Dollar funds as you have seen in the U.S. industry as a whole, which makes sense. This is due to some of the same trends -- you've got very low net yields, you may have people repatriating money back to the U.S., rather than leaving it in London or in Europe, if it's a subsidiary of an American company. But where we've been lucky is the fact that the market for money market funds wasn't quite as mature in the other two currencies. The European market is still growing as people start realizing the benefits of these funds."

We asked, "What makes IMMFA funds different?" She said, "There are a lot of different factors.... CESR is trying to create a European 2a-7 with their new guidelines. Before they did that, there were no specific guidelines in regulation that were as detailed as what our members had to respect by virtue of the Code of Practice.... I think that is what investors look at when they see that a fund is an IMMFA fund. They like the fact that we have these guidelines and they like the transparency.... The whole point of the Code, really, is to insure that the best practice standards are applied across the industry."

Finally, we asked, "What are IMMFA's future priorities? Le Coz answered, "In terms of things that we are working on, clearly we are trying to keep in the center of all of the regulatory debate and discussion around money market funds to ensure that the quality of the product and the information that investors are receiving is the best that they can have.... We have been doing investor outreach. We have been going to more conferences to talk about money market funds, as well as discussing them with investor associations.... We have been explaining what the product is, how it works, and why it's a good idea for someone [such as a treasurer] who's got excess cash to invest."

A new type of money market security began appearing last week designed to address both the recent SEC Money Market Fund Reform liquidity mandates and concerns about European debt with longer maturities. Intesa SanPaolo, Italy's largest bank, issued $1.6 billion in floating rate notes with a 7-day "put" feature, a "step-up" interest rate feature (1-month LIBOR for the first month plus 5 bps for every additional month) and a 1-year final maturity. The securities were distributed by Barclays Capital and JPMorgan Securities, according to the Bloomberg description.

With bank regulators demanding longer maturity issuance and money fund regulators requiring shorter issuance, it appears that Wall Street's financing wizards are once again busy trying to meet the market's needs. Natixis is expected to follow soon with a similar issue, and money fund demand was said to be very robust. While we have yet to see a "no-action" letter on these securities, we expect many more hybrids such as these to appear.

As we wrote in our March 4 Crane Data News piece, "Goodwin's John Hunt Reads Regulatory Tea Leaves in Ignites Webinar," which quoted Hunt, "I do think it's likely that in response to the new rules that there could be new kinds of products that are going to be designed for money market funds.... As these products start to test the limits of Rule 2a-7 ... I think it's likely that there could be further no-action relief."

While "hard put" features, or the ability to return the security to the issuer or to a dealer, are common in the tax-exempt sector, they're rare among taxable money markets, especially since extendible asset-backed commercial paper disappeared in 2007. As with previous changes to Rule 2a-7 of the Investment Act of 1940, debt issuers and securities dealers have been quick to adapt to changes in money fund regulations.

(Note that both Intesa Sanpaolo and Natixis are among the over 20 exhibitors and sponsors scheduled to display at our Crane's Money Fund Symposium, which will take place on July 26-28 at The InterContinental Boston. The conference also recently added a session on "Europe & Stresses in the Money Markets," featuring Barclays' Joe Abate and Fidelity's Michael Morin.)

In other Europe news, a Wall Street Journal blog yesterday featured a "Q&A: ECB's Orphanides Dismisses Concerns of Greek Default", which quotes the European Central Bank's Athanasios Orphanides. He was asked, "Is the euro-zone's economic upswing robust enough to cope with rising money market rates?" Orphanides answered, "We are sensitive to the liquidity needs in the banking sector. Currently the ECB supplies as much liquidity as demanded by the banking sector in order to defuse any concerns about the availability of liquidity. With a fixed-rate, full allotment procedure for the three-month operations for the third quarter already announced, the ECB has ensured that banks will have available as much liquidity as needed through the end of the year, and we are still in June."

The Federal Reserve Board released its latest Z.1 "Flow of Funds" report for the First Quarter of 2010. It showed money fund assets falling sharply in Q1, down $328 billion, or 10.0%, led downwards by funding corporations (which includes securities lenders), nonfinancial corporate businesses, and the household sector. Each of these three segments accounted for well over $100 billion in declines.

The Federal Reserve's L.206 table, "Money Market Mutual Fund Shares," says the Household Sector remains the largest segment of money fund holders with $1.202 trillion, or 41.0% of all assets. Assets here declined by $118 billion, or 8.9% in the first quarter of 2010, and assets have declined by $345 billion, or 22.3% over the past 12 months.

Funding Corporations represent the second largest money fund investor segment with $786 billion, or 26.8% of assets, according to the Fed's statistics. Sec lending, which dominates this category, saw its investment in money funds drop by $138 billion, or 14.9% in Q1. Money funds assets here declined by $282 billion, or 26.4%, over the past year.

Nonfinancial Corporate Business ranks third in money fund holdings with $563 billion, or 19.2%. Companies' holdings of money funds plunged $121 billion, or 17.6% in the first three months of this year, while assets have declined by $184 billion, or 17.6%, over the past year. Other segments of money fund investors tracked by the Fed include: Nonfarm corporate businesses ($72 billion, 2.4% of assets), State and local governments ($91 billion, or 3.1%; this was the only segment to show an increase in assets), and `Private pension funds ($96 billion, or 3.3%).

Money market mutual funds reduced their holdings of Agency and GSE backed securities, Time and savings deposits and Open market paper by the largest amounts in the quarter, with assets declining by $78 billion, $69 billion, and $62 billion, respectively. Over the past year, money funds have seen Agency holdings plunge by $311 billion, Treasury securities fall by $145 billion and open market paper (which we believe means CP) fall by $130 billion. (Let us know if you'd like to see our spreadsheet with money fund info from the Fed's Z.1 series.)

See also, today's Wall Street Journal, which writes on the Z.1. series with "U.S. Firms Build Up Record Cash Piles". It says, "U.S. companies are holding more cash in the bank than at any point on record, underscoring persistent worries about financial markets and about the sustainability of the economic recovery. The Federal Reserve reported Thursday that nonfinancial companies had socked away $1.84 trillion in cash and other liquid assets as of the end of March, up 26% from a year earlier and the largest-ever increase in records going back to 1952. Cash made up about 7% of all company assets, including factories and financial investments, the highest level since 1963."

The June issue of Crane Data's monthly Money Fund Intelligence newsletter features the lead article, "Yields Climb Off Floor; MMF Reforms, Europe," which discusses the recent gradual rise in money fund yields, as well as the impact of recent SEC Reforms and concerns over European debt exposure. We excerpt from the article below.

MFI writes, "Concerns over European exposure and the impact of the first phase of the SEC's Money Market Fund Reforms going into effect dominated the money fund landscape in May. But there was also a fair amount of good news during the month too. Asset outflows slowed considerably, and yields continued their slow climb off of the zero floor."

It continues, "While expectations of a Federal Reserve rate hike have shifted into early 2011 from late 2010 due to Greece, fund managers appear to be enjoying a reduction in fee waivers due to higher repo and now LIBOR rates. The number of taxable money funds with yields of 0.00% or 0.01% has fallen from 603 to 538, but the amount of money fund assets with yields of 0.00% or 0.01% has fallen from almost half (46.7% of assets) to about one-third (33.4%) over the past 3 months."

The June issue's lead article explains, "Each basis point of fee waivers reclaimed represents about $250 million in annualized revenue on a $2.5 trillion base. (Funds are at $2.8 trillion currently.) Funds have likely already reclaimed several bps back from their lows of February, and more could be in the pipeline due to the newly-elevated LIBOR levels. We're guessing that fund managers are sharing any rate increases at these levels with investors. Our Crane 100 has climbed from 0.04% to 0.07% during the past 3 months." (It climbed another basis point Monday to 0.08%.)

The article also says, "Finally, though it of course is a concern given the sensitivity to headline risk, Europe does not appear to be a clear and present danger to money funds. It even looks like it is even a net positive for funds given the higher rates and traditional flight to quality move from stocks and bonds. Managers and analysts in the know, as opposed to some of the reporting of late, do not believe there is a real threat of anyone 'breaking the buck' or requiring a bailout. This is even though money funds do hold substantial amounts of European debt. Our estimate is $400 billion in European-affiliated CDs and CP [and likely decreasing by the day], down from $500 billion."

MFI continues, "Federated's Debbie Cunningham said last week at the New York Cash Exchange that Europe was 'more perception risk as opposed to credit quality risk.' `Greece and Portugal, she said, were never eligible for money market funds. (This is contrary to what was implied by a Fitch press release.)"

Neuberger Berman Fixed Income CIO Brad Tank said money funds "should take further steps" to increase liquidity according to news reports from and Investment News. The former publication wrote "Neuberger PM Thinks More Money Fund Ties Will Prevent Another Tanking" while the latter wrote "Reforms to money funds don't go far enough, Neuberger executive says" late yesterday.

The Investment News piece says, "Although the new rules 'are a step in the right direction, they fail to address the unrealistic expectations that one should have unlimited liquidity and some kind of return,' said Bradley C. Tank, managing director, chief investment officer of fixed income at Neuberger Berman. He made his comments during a panel discussion at a media event for the firm in New York."

IN quotes Tank, "We should take further steps," to address "investors' unrealistic expectations" but "requiring the funds to be insured, as some fund companies have suggested, isn't the answer." Funds could lower yields and raise expenses by requiring insurance, or firms could restructure money funds to better offer liquidity. Tank "prefers the latter." The article adds, "In other comments, Neuberger Berman executives expressed concerns about the amount of money going into fixed-income assets."

Moody's published "U.S. Financial Regulatory Reform Would Make Repo with Broker/Dealers Less Attractive for Money Market Funds," which says, "On 20 May, the U.S. Senate passed the 'Restoring American Financial Stability Act of 2010,' which would give the FDIC expanded liquidation powers to delay or 'stay' collateral in connection with repurchase (or repo) agreements when liquidating 'covered financial companies'."

Authors Marty Duffy and Rory Callagy say, "The proposed changes will reduce the attractiveness of repo for money-market funds, and will likely increase allocations to government securities, which is a credit positive for money-market funds. The potential to stay collateral liquidation will also renew money-market funds' focus on counterparty risk and reinforce the funds' preference for counterparties with higher ratings. Currently, cash lenders in repurchase agreements with broker/dealers or other non-banks benefit from an exemption from the 'automatic stay' that takes effect under Section 362 of the Bankruptcy Code upon a bankruptcy filing."

Moody's continues, "This change is directly contrary to the appeal of repurchase agreements to money-market funds, which is centered on the expectation of immediate access to collateral, consistent with the fund's liquidity objectives. The receiver's ability to effect a delay in the lending fund's access to its collateral makes repo less attractive, and will inevitably force money-market funds to find other sources of overnight liquidity."

Finally, they say, "We believe that if this change is included in final financial reform legislation, money-market funds will turn to the government-securities market directly as an alternative to repo. Our expectation is further supported by the reduced pool of highly rated counterparties, combined with tighter counterparty exposure limits and the reduction in the supply of repo available to money funds. Nonetheless, we also believe that repo will remain a popular form of overnight liquidity, but expect that the stay provision of the new bill, if passed in its current form, will cause funds to gradually shift repo exposures to more highly rated counterparties."

Money fund attorney John Hunt writes "CESR Issues Guidelines Relating to a Common Definition of a Money Market Fund," in the June 8 edition of Goodwin Procter LLP's Financial Services Alert. Hunt says, "The Committee of European Securities Regulators (CESR) recently issued guidelines relating to any European fund that calls itself or markets itself as a 'money market fund.' (See also our new June Money Fund Intelligence, which features "Money Funds in Europe: Q&A w/IMMFA's Le Coz," and our May 20 Crane Data News "European Regulators Keep Two-Tiered Definition of Money Market Fund.")

The Goodwin piece explains, "The Guidelines cover both a UCITS fund (a fund that complies with the requirements of the European directives relating to 'Undertakings for Collective Investment in Transferrable Securities') and a non-UCITS fund regulated under a national law of a European Union member state. Currently, there is no commonly accepted definition in Europe of what constitutes a money market fund. Commission Directive 2006/73/EC (commonly known as the 'MiFID Level 2 Directive') providers for a 'qualifying money market fund.'"

Hunt continues, "The Guidelines on the other hand are intended to ensure that money market funds meet investor expectations. As a result, the adoption by CESR of the Guidelines is roughly equivalent to the SEC's adoption in 1983 of Rule 2a-7 under the Investment Company Act of 1940. Although CESR guidance does not have legal status, as a practical matter, all European securities regulators apply CESR guidance."

He writes, "The Guidelines describe a two-tiered approach consisting of a 'Short-Term Money Market Fund' and a 'Money Market Fund.' The critical distinction between a Short Term Money Market Fund and a Money Market Fund is that a Short-Term Money Market Fund may purchase and sell its shares using a stable share price, but a Money Market Fund may not. This two-tier approach was recommended to the SEC by the Committee on Federal Regulation of Securities, Section of Business Law, American Bar Association (ABA) in its September 8, 2009 letter commenting on amendments to Rule 2a-7 proposed by the SEC in June 2009. (John Hunt of Goodwin Procter participated in drafting that comment letter.)"

Finally, Hunt says, "The Guidelines specify the following criteria for both types of money market funds: A fund must have as its primary investment objective maintaining the fund's principal, and must aim to provide a return in line with money market rates.... A fund must disclose in its prospectus and, in the case of a UCITS fund, its 'key information document,' whether the fund is a Short-Term Money Market Fund or a Money Market Fund. To qualify as a Short-Term Money Market Fund, a fund generally must: Limit its investments in securities to those with a residual maturity ... of no more than 397 days; and Ensure that its portfolio weighted average maturity is no more than sixty days, and its portfolio weighted average maturity life is no more than 120 days."

The Goodwin piece adds, "The Guidelines take effect on July 1, 2011. A money market fund created after July 1, 2011 will have to comply with the Guidelines immediately. A money market fund created on or before July 1, 2011 generally must comply with the Guidelines' prospectus and, if applicable, the Guidelines' key information document disclosure requirements, by that date, and is allowed a six-month transitional period with respect to investments acquired on or before July 1, 2011."

The June 2010 issue of Crane Data's Money Fund Intelligence newsletter, which goes out to subscribers this morning, features the articles: "MMF Reforms, Europe, Yields Climb Off Floor," which discusses shortening maturities and slowly unwinding fee waivers; "Money Funds in Europe: Q&A w/IMMFA's Le Coz," which interviews Institutional Money Market Funds Association Chairwoman Gail Le Coz; and "Plaze on History of 2a-7, Hinting at PWG Content," which reviews comments from a recent SEC Investor Advisory Committee presentation. MFI also contains money fund news, performance statistics, rankings and our benchmark Crane Money Fund Indexes. MFI XLS, our monthly spreadsheet "complement" to MFI, contains much more data, such as percentile rankings and fund family rankings too.

The lead article in our June issue says, "Concerns over European exposure and the impact of the first phase of the SEC's Money Market Fund Reforms going into effect dominated the money fund landscape in May. But there was a fair amount of good news during the past month too. Asset outflows slowed considerably, and yields continued their slow climb off of the zero floor.... [F]fund managers appear to be enjoying a reduction in fee waivers due to higher repo and now LIBOR rates."

Our interview with IMMFA's Le Coz asks, "How will the CESR news impact IMMFA and money funds in Europe? She tells us, "The impact is different for us, as we already had the IMMFA Code of Practice, as well as the guidelines from the ratings agencies in order to maintain the AAA rating. So, we already had our European money market fund rules by virtue of the Code and the rating. With the changes that we made to the Code last year, we have a 60 day WAM, we have a 120 day WAL, we have maturity limits, and we have credit limits by virtue of the credit rating agencies guidelines."

Finally, the SEC's Bob Plaze recently discussed the pending `President's Working Group report and its discussion of possible changes and options for money funds, saying, "They are really complex problems, and the problem is that ... if you pull here, you fix one problem and you created another set of problems over here. So you go over here and pull here and the same thing happens. What we've been doing is working with the Treasury, Federal Reserve Board and CFTC to come up with a paper that I hoped to be able to present with you this afternoon. But unfortunately it has not been issued yet. The Treasury controls that."

Look for more excerpts in the coming days, and let us know if you'd like to see the latest issue.

Yesterday's New York Cash Exchange sessions on cash investing featured Federated Investors' Debbie Cunningham and Fidelity Investments' Michael Morin. The conference also attracted a camera crew from CNBC, which discussed European debt concerns with conference-goers and broadcast a brief segment.

Cunningham reviewed recent Rule 2a-7 changes in the morning and weighed in on the President's Working Group report, the cost of the new SEC Money Market Fund Reforms (in basis points), and on European worries. She said of the PWG report, "It likely won't be released until financial services legislation goes through." The report should contain suggestions on a possible floating NAV, the potential for money funds becoming specialty banks and holding capital and reserves, and the likelihood of an industry-sponsored liquidity facility, the latter being the most preferable, she said. Cunningham said the impact of the new reforms should be 3-8 basis points, and that Europe was "more perception risk as opposed to credit quality risk." Greece and Portugal, she said, were never eligible for money market funds.

In the afternoon, Morin said money funds have outyielded bank products by over a full percentage point historically. He commented, "There is a clear advantage for cash investors to utilize money funds over MMDAs." He also estimated the costs of the new SEC rules at a higher 11-29 basis points and said, "They are a little premature to label this a European sovereign crisis. This is likely from a liquidity perspective to not become a problem.... But you do have headline risk."

CNBC ran a story entitled, "European Concerns and Money Market Funds on its "Power Lunch" program, which said, "There are reasons to be nervous at the Treasury Management Conference in New York [New York Cash Exchange] where concerns about some of the safest debt offerings have reached a sort of post-financial crisis peak. At issue is the lack of confidence in Europe and the ripples throughout that lending landscape.... Some people are very concerned about what is going on in Europe.... However, not everybody sees this as a huge problem. Some shrug it off as a lot of media hype, [saying] that it's going to die down due to the ECB package."

Cunningham told CNBC her moves to shorten maturities are driven by the interest rate environment as much as anything else. She says, "Our outlook is that we're going to be into a rising rate environment going into the end of this year into 2011. We've already seen the LIBOR curve steepen out pretty nicely, and shortening weighted average maturities is the right tack to take from a strategy perspective during that time because it makes the funds more nimble, more able to react in a rising rate environment and have more cashflow available to invest at the higher rates ... down the road."

Another CNBC segment later that day quoted Cunningham, "I think there has been a lot of reconstructing of portfolios to shorten and make sure people are in compliance with those 10 and 30 [percent] rules that didn't exist prior to last Friday."

We learned from Strategic Insight's SimFundFiling product, which tracks the SEC's EDGAR Mutual Fund Filings with a more user-friendly interface, that money market mutual fund families continue to file prospectus supplements to reflect the SEC's recent Money Market Fund Reforms. Dreyfus, Federated, and John Hancock were among those complexes updating their filings recently. (See our previous April 6 News article, "Money Funds Changing Prospectuses to Reflect New SEC MMF Reforms, which mentioned Evergreen's filings.")

The Dreyfus Money Market Fund Supplement says, "The Securities and Exchange Commission has recently amended its regulations with respect to money market funds. Beginning May 28, 2010, all money market funds will be required to comply with SEC requirements with respect to the liquidity of the funds' investments. Specifically, taxable money market funds will be required to hold at least 10% of their total assets in 'daily liquid assets' and all money market funds will be required to hold at least 30% of their total assets in 'weekly liquid assets.' Daily liquid assets include cash (including demand deposits), direct obligations of the U.S. Government and securities (including repurchase agreements) that will mature or are subject to a demand feature that is exercisable and payable within one business day. Weekly liquid assets include cash (including demand deposits), direct obligations of the U.S. Government, agency discount notes with remaining maturities of 60 days or less, and securities (including repurchase agreements) that will mature or are subject to a demand feature that is exercisable and payable within five business days."

The filing adds, "Also beginning May 28, 2010, new limits will be placed on the ability of a money market fund to acquire second-tier securities. Specifically, money market funds will be prohibited from (i) investing more than 3% of total assets in second-tier securities, (ii) investing more than 1 / 2 of 1% of total assets in second-tier securities issued by any single issuer, and (iii) acquiring second-tier securities with a remaining maturity of more than 45 days. In addition, beginning June 30, 2010, a money market fund will be required to limit its dollar-weighted average portfolio maturity to 60 days or less, and its dollar-weighted average life (portfolio maturity measured without reference to any maturity shortening provisions of adjustable rate securities by reference to their interest rate reset dates) to 120 days."

Federated Investors said in its recent prospectus updates, "On February 23, 2010, the Securities and Exchange Commission adopted amendments to Rule 2a-7 under the Investment Company Act of 1940, which governs all money market funds. The changes to the Prospectuses, as set forth in the following supplement, are generally in response to such amendments." Federated's multiple supplement changes include removing all references of 90 day WAMs to 60 days, and adds a, "Risk Associated with Use of Amortized Cost" disclaimer. It says, "In the unlikely event that the Fund's board of trustees were to determine pursuant to Rule 2a-7 that the extent of the deviation between the Fund's amortized cost per share and its market-based NAV per share may result in material dilution or other unfair results to shareholders, the board will cause the Fund to take such action as it deems appropriate to eliminate or reduce to the extent practicable such dilution or unfair results, including, but not limited to, considering suspending redemption of Shares and liquidating the Fund under Rule 22e-3 under the Investment Company Act of 1940."

John Hancock Money Market Fund's Prospectus Supplement says, "The fund maintains an average dollar-weighted maturity of 60 days or less and a dollar-weighted average life of 120 days or less. Unlike the fund's weighted average maturity, the fund's weighted average life is calculated without reference to the re-set dates of variable rate debt obligations held by the fund.... Beginning in October 2010, the following information for the fund will be posted on the Web site by the fifth business day after month end: weighted average maturity; weighted average life; and complete portfolio holdings by investment category and other related information. Beginning in December 2010, the fund will report certain information to the SEC monthly on Form N-MFP, including the fund's portfolio holdings and other pricing information, which will be made public 60 days after the end of the month to which the information pertains."

In a rare convergence, several publications related to money market investing were posted yesterday. Capital Advisors writes in its monthly publication, "The Capital Advisor," on "How Greek Tragedies May Affect Cash Investments," BNY Mellon writes in its quarterly "Liquidity Directions" newsletter on "New SEC Reforms for Money Market Funds," and SVB Financial Group writes in its "Observation Deck" publication on "Adding Value to a Portfolio." We excerpt briefly from each below.

Capital Advisors Group writes "The European sovereign debt crisis and various responses by global financial bodies have continued to rattle the markets and have driven the 3-month LIBOR rate to more than double that of its February levels. The contagion that has spread from this event is an ever-present reminder of the interdependence of the global markets, where fiscal policy in one euro member sovereign state can have far reaching global implications. Needless to say, it's a challenge for any Treasury investment professional to calculate or predict how a Greek budget crisis could impact the risk and return of his cash investments, but in today's interconnected world it is important to have the tools to help identify these kinds of exposures."

The piece continues, "Against the backdrop of the Greek debt crisis, we thought it would be interesting to focus this month's Research Spotlight piece on the differences we've found in euro finance exposures from one money market fund to another. The freshly adopted revised SEC Rule 2a-7 dictates, among other things, that money market funds manage to a shorter WAM and that they maintain higher overnight and 7-day liquidity levels. However, the new SEC regulation sets no restrictions on euro or finance exposure for money market funds; a factor that we feel supports our view that regular and thorough monitoring of money market fund investments is necessary given the interconnectivity of the global financial world."

BNY Mellon's Liquidity DIRECT portal newsletter says, "The Securities and Exchange Commission (SEC) amended Rule 2a-7 promulgated under the Investment Company Act of 1940. The amendments are designed to increase the resilience of money market funds to economic stresses, reduce the risks of runs on funds, facilitate the orderly liquidation of a money market fund that breaks or is about to break the dollar, and improve the SEC's oversight of money market funds. The amendments became effective on May 5, 2010, and the compliance date for most of the amendments is May 28, 2010." `Highlights include: Daily and Weekly Liquidity, Shorter WAM, Portfolio Disclosure, Stress Testing, Second-tier Securities, and Illiquid Securities says BNY Mellon.

SVB's Head of Portfolio Management Ninh Chung, writes, "We realize a zero-bound interest-rate environment, along with uncertainty in economic growth globally, has limited investment choices for corporate cash investors. Complicating the situation is the probability that the Federal Reserve may leave the federal funds rate at exceptionally low levels for the rest of the year. Given these challenges an investor should explore the advantages of a duration neutral strategy that encompasses liquidity needs, overall risk tolerance and aversion, and any future liabilities."

As we wrote last Thursday in "Crane Reviews State of Money Funds, Regulations and Outlook," Crane Data LLC President Peter Crane has given several talks on the state of money funds recently. We excerpt from one of them, Crane's recent AFP Webinar, "Money Market Mutual Funds: Reviewing the New Regulations & Discussing the Outlook for Future Changes", below. Here Crane discusses portfolio holdings and the pending shadow NAV disclosure requirement in more detail.

Crane says about examining money fund portfolios, "Money fund holdings are like subatomic particles -- by the time you look at them they are gone. I also say, 'Looking at a money fund portfolio is like looking at the control panel of a 747.' It is not going to make you feel any better, and the pilot is going to say, 'Get the heck out of the cockpit.'"

He also discussed the "shadow NAV", saying, "Money funds have always produced a shadow NAV.... With a 60 day lag [disclosure], by the time you see a shadow NAV the vast majority of the securities that have made up that shadow NAV will be gone." Crane explained that any deviation between mark-to-market and amortized cost accounting would have already disappeared during this period. "It would already have paid off ... unless [something] defaulted and didn't pay off, in which case you wouldn't have to look at the shadow NAV [to know something was wrong].... You'd hear a giant sucking sound."

Crane continues, "The shadow NAV, I don't believe it's going to be a real big issue. It may be a pain in the butt for a fund company, servicers and representatives who may have to explain to investors why 0.9999 equals a $1.00. Why, I'm not sure, but we chose to use two decimals in this world and to round to dollars.... I don't think this is going to be a real big deal ... once you start seeing the numbers. With the shadow NAV in general, you are going to see almost all 9's. It's going to be 0.999 and then another number. A 0.998, which may trigger somebody to say, 'There is something different' -- that level of depreciation in the underlying prices of securities normally would be caused for action anyhow."

He says, "A lot of people are under the misconception that money market funds, during the SIV crises, broke the buck and then put were back together.... The board and directors of a money market fund would be on high alert, red alert, when a fund was half way to breaking the buck. At a money market fund shadow NAV or underlying NAV of 0.9975, you already at the point of no return, where you either take action to push the NAV up or the investor's 'spider senses' are tingling and they are already beginning to pull assets and make that discrepancy larger."

Finally, Crane adds, "Anyone with a 0.998, or whatever the market decides is a dangerous level, you would expect 60 days after the fact that the company would already taken action to push that back, to support it or to do something. Once you reach that half way towards breaking the buck that is usually the point of no return.... Anyone that does show significant deviation is going to have their response ready."

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