Money Market Funds and Corporate Treasury in France
by Kathleen Hughes, Head of Global Liquidity for EMEA, JPMorgan Asset Management
Money market funds have been providing high levels of liquidity and security, in addition to yield, for over three decades. JPMorgan Asset Management is a leading global money market fund provider in terms of market share and global assets under management. In light of the extraordinary recent market events, it is now invaluable more than ever to take a look at the evolution of money market funds and how it has affected the corporate treasury industry.
The introduction of money market funds
Money market funds were first introduced in both the United States and France in the 1970s at a time when interest rates were high on both sides of the Atlantic. Regulation had capped interest rates on bank deposits which gave way to the creation of money market funds which could address the need for overnight liquidity while providing competitive yields for cash investments.
The industry in both regions developed slightly differently however, with US money market funds developing the stable Net Asset Value (NAV) model (e.g. one dollar or one euro equalling one share of the fund), while French funds were typically priced using a variable NAV model with accumulating shares. With the introduction of Rule 2a-7 as part of the 1940 Company Act by the Securities and Exchange Commission, the US market created a common set of constraints that all fund managers had to adhere to. Meanwhile in France and the broader European industry, a wider array of funds were developed under the classification of money market funds, ranging from ultra conservative to riskier short term bond funds. This lack of unified definition led to the incorporation of the International Money Market Funds Association (IMMFA), an industry run body that provided guidance to managers.
A body to ensure best practice in Europe: IMMFA
All JPMorgan money market funds domiciled in Europe are members of IMMFA and Kathleen Hughes, European Head of Global Liquidity, is a board director. This trade association for providers of AAA-rated stable NAV money market funds domiciled in Europe exists primarily to represent and promote this product. IMMFA maintains a Code of Practice for the industry, provides generic information and performance data about funds, lobbies governments and regulatory bodies for appropriate treatment of institutional money market funds and supports the formal recognition of institutional money market funds in the UK, Europe and elsewhere. The IMMFA code of practice is based on Rule 2a-7 in the US and sets out best practices for managing stable NAV money market funds. In Europe there are now over 30 IMMFA member fund managers. Market size is over $554 billion in AUM (Source: IMMFA report dated 17 October 2008 using FX rates as of 17 October).
The cornerstone of the US money market, and something that has also profoundly influenced the international market, is Rule 2a-7 of the Investment Company Act of 1940, although this regulation was actually introduced at the start of the 1980s. Rule 2a-7 sets out the strict criteria which US domiciled funds must adhere to if they want to call themselves money market funds and use the ‘amortised cost’ method of accounting to maintain a stable NAV (instead of mark-to-market methodology).
Rule 2a-7 guidelines aim to limit managers to only buy high quality, low maturity securities with a high degree of overall portfolio diversification. This is because 2a-7 money market funds should aim to preserve principal at all times and maintain value day-after-day, and not simply seek to perform well over time. Specifically the securities themselves that are held within the funds must be ‘first tier’ while, in order to maintain a high degree of liquidity, the overall portfolio must have a Weighted Average Maturity (WAM) of less than 90 days with individual securities having a maturity of less than 397 days. Finally, to ensure diversity, a fund may only hold a maximum of 5% of its holdings with any one issuer.
The escalation of the financial crisis
Recent events in financial markets have had a large impact on the money market sector and individual funds. While the earlier events significantly stressed the financial system, more recent developments have been positive for money market funds.
The takeover of Fannie Mae and Freddie Mac by the US Government on 7 September was both a positive and a negative. It was positive for the many money market funds which had exposure to the mortgage giants’ securities in lieu of commercial paper, believing the mortgage giants to already be implicitly guaranteed by the US Government and thus proved correct. Up until this point most financials had managed to raise capital successfully, but the Fannie and Freddie rescue only highlighted to investors the risks of placing capital with companies that didn‘t have government backing and it added to the pressure on banks to raise capital.
This pressure was acutely felt by Lehman Brothers. The American investment bank had been talking with potential backers and had hoped for a merger or government bailout, but was forced to file for bankruptcy on 15 September. This had a direct knock-on effect on money market funds and was very damaging for those that held Lehman securities (JPMorgan Asset Management Global Liquidity Funds had no unsecured Lehman exposure on the date of their filing for bankruptcy). In particular, it contributed to the Reserve Fund, a US money market fund, ‘breaking the buck’ when its shares fell below their par value of $1 on 17 September after writing off Lehman-issued debt that it held.