Published: August 01, 2009
In March 2009, Travis Barker, Head of Business Development for HSBC’s money market funds business was appointed as Chairman of IMMFA (Institutional Money Market Funds Association). In this interview, we talk to Travis about his thoughts on the past year and IMMFA’s plans for the future.
It’s been a tough year! The failure of Lehman Brothers and the ensuing crisis had two consequences for money market funds.
Firstly, it led to an extraordinary contraction in liquidity in the instruments in which we invest. This reaffirmed the crucial importance of liquidity management, on both sides of a money market fund (MMF)’s balance sheet: on the asset side by ensuring appropriate levels of natural maturity; and on the liability side by managing shareholder concentration risk.
Secondly, the year also witnessed the failure of a US money market fund managed by The Reserve Management Corporation. This was a timely reminder to investors that money market funds are not risk free and, indeed, different funds exhibit different levels of risk. Investors are now more attentive to their fund provider’s credit process and asset portfolio.
Despite the challenges described previously, the crisis served as a healthy reminder of the benefits of money market funds.
In a nutshell: the cash assets managed by most corporate treasurers are typically in excess of the amount guaranteed by deposit insurance schemes; therefore, cash deposits result in counterparty risk. That counterparty risk is best managed by diversifying deposits between many institutions and diversification is what money market funds do well. Money market funds meet a real economic need: if they did not exist, they would need to be invented.
Money market funds meet a real economic need: if they did not exist, they would need to be invented.
Of course, treasurers could diversify assets on their own, without the need for a money market fund. But that would require significant credit resources (to distinguish relatively strong counterparties from relatively weak counterparties) and operational resources (to match term deposits with cash flow needs, and to roll those deposits in a controlled way). For many treasurers, it makes sense to “outsource” those credit and operational tasks via a money market fund.
And treasurers have voted with their feet: assets of IMMFA funds increased by EUR 60bn to EUR 407bn over the course of 2008, and in the year-to-date have increased by a further EUR19bn to EUR426bn. In other words, the inflows received since the failure of Lehman and The Reserve demonstrate the confidence of investors in the product. We can observe similar shareholder confidence in 2a-7 funds in the US and “régulière” funds in France.
Treasurers need to appreciate the risks inherent in every investment – including money market funds. To do this effectively, they should perform due diligence before investing, in order to understand their manager’s credit and investment process. This does not mean doing the fund manager’s job – for example, treasurers don’t need to continually review lists of portfolio assets, but they do need to understand the basis on which the fund manager is selecting those assets and controlling risk. [[[PAGE]]]
President Obama’s Chief of Staff, Rahm Emanuel, recently said, “Never let a good crisis go to waste.” That is good advice! IMMFA has concluded two priorities since the crisis:
Firstly, the urgent need to agree a consistent definition of the term “money market fund” in the European Union. It may come as a surprise to many, but there are in fact several different types of money market fund in the EU. For example, IMMFA-style money market funds are defined primarily in terms of how much credit and duration risk they can take, whereas certain money market funds in Germany are defined primarily in terms of their money market-like yield. In the absence of a common definition, there is a risk of “contagion” between these different types of fund. IMMFA is therefore working with the European Fund Asset Management and Association (EFAMA) to propose such a definition.
Secondly, to review IMMFA’s own Code of Practice (which is binding on all members) in light of the financial crisis. Ultimately, we want the Code of Practice to be:
i) A comprehensive statement of “best practice”;
ii) Consistent with other international standards wherever possible (in particular, with “rule 2a-7” which regulates money market funds in the USA); and
iii) A “kitemark” for corporate treasurers and other investors so they can be assured that any IMMFA fund in which they invest will meet certain minimum standards.
The Code review is likely to focus on four key areas: liquidity; credit; pricing; and disclosure.
Liquidity
Fundamentally, the recent crisis was one of liquidity - Libor became a meaningless benchmark as interbank lending all but dried up, and the secondary market essentially closed down. We therefore propose to require that each member should adopt a “liquidity policy”, describing how they manage liquidity risk.
IMMFA is mindful that money funds play an important role in supporting the market for highy quality commercial paper (CP).
The Code will establish certain minimum standards for all members’ liquidity policies. For example, the crisis made clear that funds cannot rely wholly on the secondary market for liquidity, so they must also build “natural maturity” into their portfolio. We therefore propose to prescribe a minimum “liquidity ladder”. Our starting point is to endorse the minimum liquidity ladder recommended by the Investment Company Institute (ICI) Report of the Money Market Fund Working Group2, namely: at least 5% of assets should be available overnight and at least 20% of assets should be available within one week. We also propose to require that a fund should disclose its actual liquidity ladder, to enable investors to better understand the liquidity available to it.
The flipside of managing liquidity through the asset side of the balance sheet is to manage it through the liabilities side. Therefore, we also propose to require members to consider shareholder concentration when determining their liquidity ladder, and even to establish an individual shareholder concentration target limit. Again, consistent with the ICI report, we propose disclosure of the proportion of a fund held by its top ten shareholders.
Credit
The IMMFA Code currently requires members’ funds to be triple-A rated. And, as a condition of that rating, the ratings agents narrowly limit the credit risk that a fund can accept. Consequently, the Code does not directly stipulate a credit policy – rather, in effect, it outsources credit policy to the rating agencies.
In order that the Code should provide “stand alone” guidance on best practice vis-à-vis credit, it is proposed that the revised Code should require members to adopt a credit policy, and specify certain minimum standards, including: that the weighted average maturity of an IMMFA fund should be no more than 60 days; that the weighted average life of an IMMFA fund should be no more than 120 days; that the maximum legal maturity of an instrument (excluding treasuries) should be 397 days; and other requirements in relation to credit resources.
In addition, we are also looking into the viability of commissioning a third party to provide a cash index, which would enable money market funds to explain their approach to credit risk by comparing their portfolio allocation with the index. Third party indices work well in other areas of asset management and may have value for money market funds. [[[PAGE]]]
Pricing
Pricing and related matters (such as escalation procedures and the smoothing of losses) are already covered by various parts of the Code of Practice. We now propose to bring those various parts together, by requiring IMMFA members to adopt a pricing policy.
Again, the Code will establish minimum standards in this area, such as that: the amortised price and the mark-to-market price of portfolio assets should not deviate by more than 50bps; deviations should be escalated to the Board at certain predefined points; and how realised gains and losses should be dealt with.
Disclosure
Different money market fund providers take different positions on credit and duration risk (albeit within very tight guidelines set down by regulators, the rating agencies and the IMMFA Code of Practice).
Fundamentally, the recent crisis was one of liquidity - Libor became a meaningless benchmark as interbank lending all but dried up, and the secondary market essentially closed down.
In retrospect, I do not think the industry has been as effective as it could have been in capturing those differences in risk in easily understood metrics that can be communicated to money market fund investors. And, in the absence of such metrics, investors have had little to work with other than the yield, which, by its nature, focuses less on risk than it does reward.
IMMFA wants to remedy this situation. In the context of the Code review, we have proposed disclosure of various metrics which should help investors better understand risk, including: a fund’s weighted average life (“WAL”); a fund’s liquidity ladder; and the proportion of a fund held by its top ten shareholders.
Finally, with various initiatives to tighten the definition and management of MMFs globally, particularly in the United States, is there a risk that the markets will be negatively impacted?
IMMFA is mindful that money market funds play an important role in supporting the market for high quality commercial paper (CP). We are therefore committed to working with issuers to ensure any changes that are made to our Code do not unnecessarily and negatively impact the market for CP.
1 See Hugh Briscoe, Goldman Sachs,TMI 174, April 2009
2 http://www.ici.org/new/ppr_09_mmwg.pdf
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