Published: May 02, 2012
The themes of transparency and risk have evolved in the US and international money market funds (MMF) industries over recent years as key stakeholders in the industry have sought to create new and improved standards for disclosure. In the aftermath of the financial crisis of 2006-2009 there is now an intensified environment for MMF reporting and analytics enabling investors to easily understand, manage and act on risks within their MMF portfolio holdings. We believe that this new landscape helps to contribute to a greater level of stability for the MMF industry and acts as a foundation for a deeper ongoing partnership and dialogue between investors and fund sponsors.
Transparency has become a key theme in today’s financial markets. Regulators have taken steps to mandate increased disclosure to investors and customers across almost all sectors of the financial markets including the banking, insurance and asset management industries. A major theme of the financial crisis in 2006-2009 was a lack of transparency and consequently inadequate appreciation of the risks inherent in many financial instruments and the associated funding structures of leading issuers and participants in the capital markets.
As the crisis intensified over time contagion brought on by the sub-prime mortgage crisis rapidly moved from one leading financial institution to another with historic results. In the US, Bear Stearns was acquired by J.P. Morgan Chase, Lehman Brothers went into bankruptcy, AIG was bailed out by the US taxpayer and in the MMF industry, the Reserve Primary Fund ‘broke the buck’. In Europe, major banks were also affected by the collapse of the mortgage market as institutions such as the Royal Bank of Scotland and Dexia required state intervention to prevent their failure.
The overall effect for the MMF industry was to create a new paradigm: investors became highly curious and sensitised to the different approaches taken by fund sponsors. Today, the themes of transparency and risk are common for stakeholders within the MMF industry. Regulators, investors, fund sponsors and technology platform providers have all taken steps to build rules, processes and tools to enhance disclosure, analysis and calibration of risks.
In the US, the Securities & Exchange Commission (SEC) amended Rule 2a-7 of the 1940 Act and introduced tightened regulations around credit, liquidity and portfolio maturity. New rules were also introduced to create increased transparency and investor understanding in the risks associated with MMF investing.
As a result of these changes, MMFs now have to send a detailed schedule of portfolio holdings and associated data to mark-to-market or ‘shadow’ NAV pricing (mark-to-market) to the SEC on a monthly basis. This information has to be published publicly for investor review 60 days after month-end. Additionally, fund sponsors now have to publish their portfolio holdings on their web site within five business days after each month-end.
Within the European Union (EU), the European Commission has created new rules around MMFs which categorise them into ‘money market funds’ and ‘short-term money market funds’. This has created a greater level of understanding for investors investing in MMFs sold as UCITS under EU law.
In the international market, the Institutional Money Market Funds Association (IMMFA), while an industry association and not a regulatory body, has published new guidelines within its Code of Conduct providing a framework for IMMFA members for both the frequency and content of portfolio holdings data and MMFs’ maturity buckets.
Before 2006, MMF investors rarely saw the need to contact a fund sponsor to discuss portfolio strategy and individual holdings, while regulators provided sparse rules to investment managers around transparency and disclosure. As the crisis evolved, culminating in a run on prime money market funds in September 2008, interactions between shareholders and fund sponsors were increasingly focused on instrument types and counterparties held within portfolios.[[[PAGE]]]
In the early days of the crisis for example, security types held by a number of US-based money market funds came into the spotlight, often linked to the progressive deterioration of the housing market. Two notable instances were linked to the asset-backed commercial paper (ABCP) market: extendible ABCP conduits and structured investment vehicles (SIVs and SIV-lites) experienced a lack of liquidity in their underlying investments (often linked to the housing market) which caused them to take measures to extend, re-structure and in a number of highly publicised instances, default on their debt.
The early stages of the crisis saw less concern around the creditworthiness of institutions than a focus on the structural flaws and poor underlying credit quality inherent in particular forms of short-term debt issuance. In March 2008 this situation changed markedly as Bear Stearns was acquired by J.P. Morgan Chase at the request of the Federal Reserve Bank of New York as the firm’s reliance on wholesale funding in an increasingly nervous market resulted in its near-bankruptcy.
As the ‘domino effect’ of the crisis moved from one leading institution to the next, fund sponsors frequently fielded questions from institutional investors around their MMF holdings. Questions had spread beyond specific instrument types to fundamental concerns around the creditworthiness of major institutions.
Regulators have clearly influenced a greater level of disclosure by MMF sponsors. However, many if not most sponsors have taken additional steps to publish holdings on a bi-monthly basis and in some instances even on a daily basis. Combined with this greater level of reporting, fund sponsors have consistently encouraged and sought to engage in dialogue with their investors.
Fund sponsors act as fiduciaries for their clients’ best interests and are keen to promote investor awareness and understanding of their funds’ investment strategies. This approach, combined with more effective technology should continue to enhance the value of MMFs to investors.
Many institutional investors diversify their cash across multiple fund families. Evaluating the overall risk exposures within an aggregate portfolio of MMFs can be challenging without the tools to do so efficiently and accurately.
As codes and market practice have evolved and moved towards greater transparency, firms associated with the MMF industry including both asset managers and technology providers, have developed analytics tools that allow investors to combine, analyse and interpret holdings within multiple MMF portfolios. These ‘aggregation’ or ‘transparency’ tools are now providing investors with the means to efficiently investigate and assess their exposures to individual counterparties, instrument types and geographies.[[[PAGE]]]
These new tools help investors answer questions such as
Using a high quality analytics tool in conjunction with an open dialogue with portfolio and credit professionals from fund sponsors should help investors to enhance their MMF risk management practices.
An effective tool will do the following:
The tool should also have both a robust quality control and data integrity process to scrub and maintain data from multiple fund families. The user should be confident that the data is accurate and has been properly verified by the firm providing the analytics tool. With this confidence, the investor is well-prepared to assess their overall portfolio.
For investors these new tools will be most powerful when combined with an ongoing dialogue with their fund sponsors. The investor should seek to understand a fund sponsor’s investment philosophy and the rationale behind its portfolio strategy. The fund sponsor has a fiduciary responsibility to its investors to ensure that the highest level of due diligence and research takes place when making investment decisions.
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