by Joseph W. Sarbinowski, Managing Director, Global Head of Liquidity & Sara L. Flour, Managing Director, Liquidity Specialist, Global Client Group, Deutsche Asset & Wealth Management
The proverb ‘The more things change, the more they stay the same’ (plus ça change, plus c’est la même chose in its original French form) might be aptly applied to the money market fund industries of the United States and Europe. For example, despite the flurry of rule changes by both regulators and rating agencies over this period with the likelihood of more on the horizon, the structure of these products remain substantially the same operationally—namely stable net asset value (NAV) and utilisation of amortised cost accounting. These key attributes have led to huge growth in this segment over the last decade on both sides of the Atlantic. And from an investor’s perspective, these funds remain as widely utilised today as in 2007, providing professional management, ease of use from an accounting and operational angle, and late-in-the-day, same-day access to liquidity and markets.
However, there has been a clear evolution in the money market fund industry with changes driven by both regulatory mandates and market dynamics. As a result, many underlying characteristics of prime money market funds now have a distinctly different profile from those they had nearly a decade ago. Regulators and industry associations globally have been particularly focused on enhancements that could reduce money market funds’ susceptibility to risk during times of market turmoil. Many of the regulatory changes so far have been focused on funds’ investment strategy, while other changes have enhanced oversight and investor transparency. With the global fund industry now poised to receive further potential regulatory changes from the Securities and Exchange Commission (SEC) and from the European Union’s (EU’s) European System of Financial Supervision (ESFS), it is important to understand the impact on these strategies.
In order to improve overall liquidity, regulatory changes established minimum thresholds for daily and weekly maturities that could provide cash to support investor redemptions. Before the financial crisis, some funds had been able to keep less than 10% of their portfolio maturing within a week, enabling them to enhance yield by sacrificing liquidity. Currently, with the mandate of 10% on an overnight basis, and at least 30% on a weekly basis, there is very little competitive yield advantage available to be captured in that part of the portfolio any longer. Perhaps less broadly known are some of the changes that have been made by the major ratings agencies related to their monitoring of money funds. With specific guidelines in place to earn an Aaa-mf or AAAm rating from Moody’s or Standard & Poor’s, funds undergo even more detailed scrutiny. For example, based on the concentration assets from the largest three investors in a fund, Moody’s can require even higher levels of overnight and weekly liquidity than regulations set forth. This goal of this requirement is to customise the potential liquidity needs of a fund, based on the potential redemption risk of their largest shareholders.
These standardised liquidity requirements have provided more consistent maturity profiles across fund complexes, and serve well to buffer potential cash flow needs, but this has come at a cost. With short-term rates remaining at historic lows, portfolio managers are challenged to find yield in securities that meet these liquidity requirements. And with nearly a third of the total money market fund industry’s assets needing to be invested in this range, this extraordinary demand keeps downward pressure on yields as well.