Published: May 01, 2009
Since stable Net Asset Value (NAV) Money Market Funds (MMFs) were first introduced into the United States and Europe, they have been generally considered as safe investments, and most recently as a ‘safe haven’ in the face of volatile markets, offering security and liquidity as well as a competitive yield. As other investment classes suffered throughout 2007-2008, MMFs proved to be resilient; for example, from the time that the sub-prime mortgage crisis first came to the attention of the market in July 2007, until the collapse of Lehman Bros in September 2008, MMF Assets Under Management (AUM) worldwide grew by $800bn. However, even the MMF industry took a hit in the third quarter of 2008 largely due to significant outflows in September when the Lehman Brothers collapse spooked institutional investors. Nevertheless, Goldman Sachs Asset Management (GSAM) was able to face the significant redemption pressures experienced, along with many of its peers.
The situation has improved considerably since November 2008, with the result that overall MMF assets grew in Europe in 2008. However, the difficulties experienced by a small number of MMFs in Europe and the United States, perhaps best illustrated by the suspension of redemptions by the Reserve Primary Fund in the United States, have raised concerns about the risk characteristics of MMFs. Although stable NAV MMFs, both in Europe and in the United States, already adhere to strict investment guidelines, the industry has recently proposed a series of recommendations that aim to strengthen the resilience of MMFs in a crisis, and to ensure fair treatment of investors. In Europe EFAMA and IMMFA have agreed to work on a pan-European definition of money market funds.
Advised by senior individuals from many of the most respected money market fund managers, including GSAM, the report produced by the Money Market Fund Working Group (MMWG) to the Investment Company Institute (ICI) (“ICI Report”) in the United States argues for the implementation of regulatory and operational reforms intended to make MMFs even safer for investors.
Investor Confusion. “Money market fund” terminology is often used to describe funds which do not satisfy either SEC or IMMFA risk-limiting requirements, which can be confusing for investors. Some investors may have been under the impression that MMFs carry no investment risk whatsoever. Consequently, the MMWG now recommends a general revision of risk disclosures and regular disclosure of fund holdings.
Portfolio Liquidity. Although MMFs have historically provided shareholders with same-day liquidity, there has never been an explicit requirement for funds to maintain a specific amount of portfolios invested overnight. However, the severe redemption pressure experienced by MMFs in September 2008 revealed that the liquidity profiles of some funds were insufficient to meet investor demand in the face of extremely volatile markets. Therefore, the Working Group has recommended minimum daily and weekly liquidity standards for MMFs.
Portfolio Maturity. The MMWG also proposes enhancing and adding to existing portfolio maturity restrictions. The weighted average maturity (WAM) is a measure of the length of time to maturity of all the underlying securities in a MMF weighted to reflect the relative holdings in each instrument. In practice, WAM is used to measure the sensitivity of a MMF to changes in interest rates. Many MMFs, including those managed by GSAM in Europe however already comply with tighter WAM limits – rating agencies all enforce a 60 day maximum WAM for AAA-rated funds. But another proposal is the introduction of a ‘spread WAM’ that measures the time to the legal final maturity for both fixed and variable rate obligations. This effectively limits the degree to which MMFs could use spread product to enhance yield.
Credit Analysis. The MMWG recommends that credit ratings, based on a minimum of 3 rating agencies, should form the basis of credit decisions for MMF portfolios. These proposals therefore recognise that credit ratings remain the best starting point for credit analysis for MMFs, but that in addition, credit decisions should be separated from the investment process to ensure that credit analysis remains impartial. This remains an important feature of GSAM’s credit assessment process.
Client Risk. Investors with similar redemption practices and liquidity needs can cause adverse effects to MMFs. MMF providers are therefore now being encouraged by the MMWG proposals to implement “know your client” procedures and ensure that their client base is sufficiently diversified. [[[PAGE]]]
Likely OutcomesThe aim of these recommendations is to increase the ability of MMFs to withstand extreme market conditions and to protect investors, without creating additional risks for the money markets. The ICI report does however contrast with proposals from the Group of Thirty (G30), an international body of leading financiers, about how to alleviate systemic risk posed by MMFs. For example, the G30 Report proposes that MMFs should float their NAVs or re-organise as “special-purpose banks” and therefore be subject to more stringent regulation and supervision. While the G30 is also seeking to protect investors’ interests, it could potentially be damaging to the MMF industry and expose investors to other risks, if some of the proposals contained in the G30 were implemented.
For example, investors are highly unlikely to accept MMFs that do not have a stable NAV, which could result in cash being placed into less regulated pooled instruments. Imposing capital requirements would have significant tax and accounting implications, but would not be sufficient to protect investors in the event of a “run” on funds; similarly, private insurance on MMFs is not feasible as insurance companies would not be in a position to provide the level of capital which would be required. As the ICI Working Group concludes of the G30 Report,
“Given the important role that MMFs serve in the money market and the economy at large, reforms fundamentally altering or compromising the attractiveness of these funds to investors should be avoided, particularly at a time when the financial markets are so fragile and stabilising these markets is of such importance to global economic recovery.”
Report of the Money Market Fund Working Group to the Investment Company Institute. March 17th, 2009
The degree of change that MMFs will experience probably lies somewhere between the ICI and G-30 proposals. In Europe, as well as a definition of MMFs, EFAMA and IMMFA are likely to propose a strict codification of the assets in which funds can invest in order to clarify and limit exposure investment risk. However, what seems inevitable is that regulatory requirements for MMFs will tighten in order to enhance the resilience of funds in the event of further market extremes in the future.
From an investor perspective, fund managers such as GSAM have already enforced their own internal standards which seek to be consistent with, or exceed the requirements of the ICI Working Group and EFAMA proposals. For example, independence of the credit analysis is a feature which GSAM has long had in place. The focus on highly-rated instruments within the MMF portfolio, together with transparent, regular reporting of the portfolio are also important elements in the way that GSAM approaches its business. Looking ahead, while regulations will tighten, we believe that investors in GSAM funds are unlikely to see any significant changes in the way that they invest with us, but should be assured of greater industry protection in the event of extreme market events.
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