How Ratings are Affecting Money Market Funds
by Britta Hion, Director, BlackRock Investment Management
The 2007-2009 credit crisis brought about fundamental changes in the landscape for money market funds. Not least of these is the role and importance of Credit Ratings Agencies (CRAs). Regulators responded to a pre-crisis perceived over-reliance on CRAs in the securities industry and by investors by proposing laws that would specifically prohibit the reference to issuer ratings in legislation. In turn CRAs amended their credit matrices, or the scoring process they used to gauge the credit strength of issuers and their various instruments, often resulting in a downward shift in their credit assessments of specific counterparties. From a number of perspectives it has become arguably less likely that CRAs will continue to play as significant a role for the money market industry as they have done up to this point.
In our view CRAs are important as an information point to the investment process for both asset managers and clients but should be viewed as just one component in a process that should include dialogue and partnership between an asset manager and a money market fund investor.
A confluence of factors has led to a difficult investing environment as cash investors seek to find balance between their quest for stability, liquidity and yield. In this article, we explore what the impact has been on money market funds (MMFs) and options that may help cash investors find relief in this challenging environment.
Current market and background
The current economic climate has caused investing in the short-term markets to be increasingly challenging. Whether for an MMF portfolio manager or a corporate treasurer investing directly in the markets, it has never been harder to invest cash assets whilst aiming to achieve flat or positive yields. This situation has arisen due to a number of factors:
1) Diminishing Supply: Over the last year there has been a decreasing supply of eligible money market instruments particularly from the banking sector, most notably in maturities under one year. This is primarily due to the two LTROs (Long-term Refinancing Operations) which have funded the banks for three years, meaning decreasing bank appetite for cash balances. In addition, there are pending regulatory changes - like Basel III - which incentivise banks to terming out their funding.
2) Credit Deterioration: It would be hard to not have noticed the plethora of ratings downgrades that have taken place in the last year. In fact, there is no longer a bank in the UK that carries an AAA rating, which has led to a single-A banking universe. Western European banks and financials in the investment grade space were downgraded at a rate of 22 to 1 by Moody’s in 2012. For Standard & Poor’s the figure is 10 to 1 over the same period. Many treasurers and MMFs have had to amend their investment guidelines by either reducing their % allocation to lower rated counterparties or by removing some counterparties from their approved list. Credit deterioration further exacerbates the challenges in supply due to these requirements.
3) Prolonged low interest rates: In July 2012 the European Central Bank (ECB) cut the deposit rate to an unprecedented level of 0.00%, with the UK also having the lowest interest rates since records began at 0.50%. Market indicators tell us that this yield environment is expected to continue, impacting investors in the short-term markets.