Published: August 18, 2014
In the myriad dissections of the credit crunch – What caused it? Could we have avoided it? How do we prevent another one? – a recurring theme is transparency, and how better transparency might lead to a more robust financial system.
But what do we understand by transparency? How does it help? And more specifically, what does it mean when we’re talking about money market funds?
At the most fundamental level transparency is simply openness about what a fund is holding and how it operates.
In the case of money market funds this would cover:
IMMFA MMFs have made a great progress in the amount of information they share with investors in the years since the credit crisis.
“It’s very important for investors to have full insight into what they are buying,” said Jonathan Curry, chair of the IMMFA Board. “If investors are looking for an MMF to handle daily cash operation, then they need to be vigilant. These funds should prioritise capital preservation and provision of daily liquidity ahead of all other criteria such as yield. Some MMF providers may give the impression that they are selling a money market fund by using names which imply ‘cash’ or ‘liquidity’, but which in fact either take on more risk or don’t genuinely have the ‘in-built’ liquidity which an IMMFA MMF must have.”
Pre 2007 there were no specific rules governing MMFs in Europe. Following the crisis the ESMA Guidelines were introduced (2011), but these confusingly had two different categories of funds:
Only ‘Short Term Money Market Funds’ have the profile that most IMMFA investors would recognise as a same-day liquidity fund.
Beyond following the ESMA Guidelines, all IMMFA funds also follow the IMMFA Code of Practice which is much more exacting. Amongst various other criteria the Code of Practice asks for certain best practice standards of investor reporting. However, most IMMFA fund managers are currently providing investors with even greater amounts of information.
However standards are highly variable across other money market funds in Europe. This level of disclosure – particularly with regard to the list of holdings, the available liquidity and the concentration of exposure to any related institutions – is not included in the ESMA Guidelines. The upcoming European Regulation for Money Market Funds presents an excellent opportunity to make the provision of such information compulsory.
Casting our minds back to the stressful days of 2007/2008 or even 2012, investors were vexed not only by the known problems – the insolvencies or downgrades – but by the concern about what they didn’t know. Is my MMF holding paper from that particular bank? What is its exposure to a certain country?
Money market funds are the choice of risk-averse investors – those looking for an investment opportunity where preservation of capital, easy operation and provision of daily liquidity are key, and only once these have been accomplished does return become a consideration.
Consequently these cautious investors with minimal risk tolerance are likely to be highly sensitive to a deterioration in the overall credit environment. Given any uncertainty, the easiest thing for them to do is to move to an even more conservative option, to ‘fly to quality’ - by moving their investment to an MMF restricted to investment in government-backed debt for example.[[[PAGE]]]
However this movement of funds can lead to broader problems, as the reduction of assets in the funds reduces the amount of funding available to those banks and corporates for example who fund themselves through the short-term debt markets.
Reducing this systemic risk - the risk of large-scale movements in MMF assets having a damaging knock-on effect on other parts of the financial system - is the primary aim of the proposed European Regulation of Money Market Funds.
Giving investors full disclosure of the assets which the fund is holding is an effective way of quelling unease amongst investors when the markets become more volatile. Instead of nursing a gnawing doubt about whether an MMF is holding a particular headline name, a full list of securities and investment counterparties quickly solves the problem. Being made - and kept - aware of the assets owned by the fund gives the investors confidence to remain in their funds even if other MMFs are experiencing problems.
Paul Wilson, Head of Sales, Liquidity Solutions at Aberdeen Asset Management, and also a Board Member of IMMFA adds “We see greater transparency as a means of developing a better dialogue. We want investors to understand the underlying investments and the mechanics of how the fund works. We think we can only do this by being transparent with them.”
Disclosure of this type isn’t without its downside to the fund providers. Professional managers have extensive teams of analysts to find and monitor suitable credits. By disclosing their list of assets, fund managers are at least partially sharing the fruits of the labours of these teams of analysts. However, managers agree that investor confidence is more important to a healthy short-term investment space than proprietary credit work.
One remaining concern therefore is whether there is a level playing field across the EU market. “IMMFA members are all convinced that transparency in money market funds is a good thing.” says Jim Fuell, IMMFA Board Director and Head of Global Liquidity, EMEA for JPMorgan AM. “The practice of disclosing holdings on at least a monthly basis and of being very clear about the liquidity available in the fund are commonplace in IMMFA funds but not always provided in other parts of the European market. Investors understand why this is important and should insist on being provided with accurate and timely information. These funds should not be trying to hide or disguise anything.”
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