New York: With a seismic overhaul of the $2.6 trillion (Dh9.5 trillion) money market industry weeks away from kicking in, money managers are bracing for a last-minute exodus of as much as $300 billion from funds in regulators’ cross hairs.
Prime funds, which seek higher yields by buying securities like commercial paper, are at the centre of the upheaval.
Their assets have already plunged by almost $700 billion since the start of 2015, to $789 billion, Investment Company Institute data show.
The outflow has rippled across financial markets, shattering demand for banks’ and other companies’ short-term debt and raising their funding costs.
The transformation of the money-fund industry, where investors turn to park cash, is a result of regulators’ efforts to make the financial system safer in the aftermath of the credit crisis.
Prime funds will soon have to adhere to new regulations meant to safeguard investors in times of stress. If weekly liquidity in the funds drops below 30 per cent, the funds can impose liquidity fees or temporarily bar redemptions.
Funds want to avoid crossing that threshold, pushing them to hold more liquid assets. Further, ahead of those reforms, many investors are also shifting their holdings out of prime funds altogether. Investors have pulled $733 billion from all prime funds since last October.
Much of that money has flowed into government money market funds, which aren’t subject to the new rules.
Uncertainty
Companies such as Federated Investors Inc and Fidelity Investments, which have already reduced or altered prime offerings, are preparing in case investors yank more money as the new era approaches.
“All managers, like ourselves, are positioning around the uncertainty of the exact magnitude of the outflows,” said Peter Yi, director of short-term fixed income at Chicago-based Northern Trust Corp, which manages $906 billion.
While Yi sees the additional outflow from prime-fund investors potentially reaching $200 billion in the next 30 days, TD Securities predicted in a September 7 note that it may tally as much as $300 billion.
Yi is preparing by shortening his funds’ weighted average maturity and avoiding short-term debt that matures beyond September. He’s not alone. For the biggest institutional prime funds tracked by Crane Data LLC, the weighted average maturity of holdings fell to an unprecedented 10 days as of September 12. It’s not just floating net-asset values that investors are avoiding. Prime funds can also impose restrictions such as redemption fees.
Risky offerings
Amid the tumult, money-fund assets have held steady because most of the cash leaving prime and tax-exempt funds has streamed into less risky offerings focusing on Treasuries and other government-related debt, such as agency securities and repurchase agreements. These funds are exempt from the new rules, which the US Securities and Exchange Commission issued in 2014.
A major repercussion of the flight from prime funds is that there’s less money flowing into commercial paper and certificates of deposit, which banks depend on for funding. As a result, banks’ unsecured lending rates, such as the dollar London interbank offered rate, have soared. Three-month Libor was about 0.85 per cent last week, close to the highest since 2009.
Libor may stabilise after mid-October because prime funds may begin to increase purchases of bank IOUs, although the risk of a Federal Reserve interest-rate hike by year-end will keep it elevated, said Seth Roman, who helps oversee five funds with a combined $3.2 billion at Pioneer Investments in Boston.
“You could picture a scenario where Libor ticks down a bit,” Roman said. But “you have to keep in mind that the Fed is in play still.”
Financial firms paying higher rates to attract investors to their IOUs will push three-month Libor to about 0.95 per cent by the end of September, according to JPMorgan Chase & Co.
Factbox: No more ‘constant’ share price
Money market mutual funds are essentially ultra-short-term bond funds that offer investors liquidity — as in quick access to their cash — and a small yield that’s typically more attractive than merely parking cash in a bank savings account.
Among the changes, institutional money market funds will no longer be allowed to have a “constant” share price, but instead will have to have floating net asset values determined by market factors, according to the SEC.
As the commission put it, “With a floating NAV, institutional prime money market funds are required to value their portfolio securities using market-based factors and sell and redeem shares based on a floating NAV. These funds no longer will be allowed to use the special pricing and valuation conventions that currently permit them to maintain a constant share price of $1.00.”
Money market funds will also have fees and “gates” on the redemption side to avoid what the SEC calls “investor runs.” In other words, investors could be told they can’t redeem their shares for a certain period or be faced with fees for redemptions in times of market stress.
