Transparency and Risk in Money Market Funds
by Mark Stockley, Managing Director and Head of International Cash Sales, BlackRock
The themes of transparency and risk have evolved in the US and international money market funds (MMF) industries over recent years as key stakeholders in the industry have sought to create new and improved standards for disclosure. In the aftermath of the financial crisis of 2006-2009 there is now an intensified environment for MMF reporting and analytics enabling investors to easily understand, manage and act on risks within their MMF portfolio holdings. We believe that this new landscape helps to contribute to a greater level of stability for the MMF industry and acts as a foundation for a deeper ongoing partnership and dialogue between investors and fund sponsors.
It’s hip to be clear – how we got here
Transparency has become a key theme in today’s financial markets. Regulators have taken steps to mandate increased disclosure to investors and customers across almost all sectors of the financial markets including the banking, insurance and asset management industries. A major theme of the financial crisis in 2006-2009 was a lack of transparency and consequently inadequate appreciation of the risks inherent in many financial instruments and the associated funding structures of leading issuers and participants in the capital markets.
As the crisis intensified over time contagion brought on by the sub-prime mortgage crisis rapidly moved from one leading financial institution to another with historic results. In the US, Bear Stearns was acquired by J.P. Morgan Chase, Lehman Brothers went into bankruptcy, AIG was bailed out by the US taxpayer and in the MMF industry, the Reserve Primary Fund ‘broke the buck’. In Europe, major banks were also affected by the collapse of the mortgage market as institutions such as the Royal Bank of Scotland and Dexia required state intervention to prevent their failure.
The overall effect for the MMF industry was to create a new paradigm: investors became highly curious and sensitised to the different approaches taken by fund sponsors. Today, the themes of transparency and risk are common for stakeholders within the MMF industry. Regulators, investors, fund sponsors and technology platform providers have all taken steps to build rules, processes and tools to enhance disclosure, analysis and calibration of risks.
The regulator’s influence
In the US, the Securities & Exchange Commission (SEC) amended Rule 2a-7 of the 1940 Act and introduced tightened regulations around credit, liquidity and portfolio maturity. New rules were also introduced to create increased transparency and investor understanding in the risks associated with MMF investing.
As a result of these changes, MMFs now have to send a detailed schedule of portfolio holdings and associated data to mark-to-market or ‘shadow’ NAV pricing (mark-to-market) to the SEC on a monthly basis. This information has to be published publicly for investor review 60 days after month-end. Additionally, fund sponsors now have to publish their portfolio holdings on their web site within five business days after each month-end.
Within the European Union (EU), the European Commission has created new rules around MMFs which categorise them into ‘money market funds’ and ‘short-term money market funds’. This has created a greater level of understanding for investors investing in MMFs sold as UCITS under EU law.
In the international market, the Institutional Money Market Funds Association (IMMFA), while an industry association and not a regulatory body, has published new guidelines within its Code of Conduct providing a framework for IMMFA members for both the frequency and content of portfolio holdings data and MMFs’ maturity buckets.
A shifting investor focus
Before 2006, MMF investors rarely saw the need to contact a fund sponsor to discuss portfolio strategy and individual holdings, while regulators provided sparse rules to investment managers around transparency and disclosure. As the crisis evolved, culminating in a run on prime money market funds in September 2008, interactions between shareholders and fund sponsors were increasingly focused on instrument types and counterparties held within portfolios.