Cash & Liquidity Management
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Constant Net Asset Value MMFs and the Financial Crisis

by Kathryn Kerle, Vice President – Senior Credit Officer, Moody’s Investors Service

Since August 2007, the financial markets have been roiled by distress in the U.S. sub-prime mortgage sector, volatility in the ABCP markets, illiquidity and ratings downgrades. Fund sponsors have responded to the crisis in a variety of ways, depending in part on the nature of the funds in question. In an effort to minimize the impact on the credit quality of the portfolios and volatility in the net asset values of the funds they manage, and in the absence of liquidity, sponsors of constant net asset value (NAV) money market funds have generally started communicating with fund investors more frequently and have built up the liquidity positions of the funds they manage. They have done so in an environment of generally positive net cash flows.

Sponsors of constant NAV money market funds, without exception so far, have also provided some form of support to these funds as required. When it has occurred, fund sponsor support has served to protect investors in constant NAV money market funds from the effects of credit losses or losses stemming from the forced sale of illiquid assets or both. Such support has taken various forms, including capital support agreements, indemnities, provision of liquidity and the outright purchase of distressed securities from funds.

Although it is too soon to draw any firm conclusions about the ultimate impact of the crisis on the European constant NAV money market fund sector, the outlines of a few trends may be emerging.

Emerging trends

For example, consolidation in the industry may accelerate in the wake of the crisis. The business of fund management is characterised by economies of scale. The cost of the infrastructure, both human and otherwise, needed to manage constant NAV market funds is material but the incremental cost is often negligible. This, coupled with the relatively low management fees the asset class attracts, has long given large funds an advantage over smaller ones. Further, the need to improve information technology and risk management had already been pushing costs upward. During the crisis, as noted above, a number of fund sponsors provided one or another form of support to their constant NAV money market funds. The cost of doing so, coupled with rising information technology and risk management costs, may make some fund sponsors, particularly mid-sized ones, reassess the attractiveness of their liquidity businesses. To the extent that they decide to exit as a result, consolidation may increase.