Immediately following the recent AFP webinar on money market funds, Jim Gilligan, CTP, FP&A, assistant treasurer for Great Plains Energy, and Tom Hunt, CTP, director of treasury services, AFP, held a question and answer session with treasury and finance professionals in which they provided further insights into the Securities and Exchange Commission’s new rules. The first part of this Q&A is available here.
What do you see being a bigger hurdle for financial professionals–money market fund reform or Basel III and why?
Right now it’s money fund reform, since it’s the most definite in terms of what the rules are. Both will continue to play out over time, but Basel III will have less transparency as it will be more specific to the relationship with each bank. Eventually we expect Basel III will also lead to higher borrowing costs as banks are required to increase the amount of capital they must hold.
Do you anticipate ECR rates declining as a result of impact of Basel III and anticipated new flows?
The answer to this depends on a number of macroeconomic factors. As the Fed continues to pay interest on reserves held by banks, the ECR rates will most likely stay in place. Furthermore, from the Fed’s website: “Since January 2009, the monthly average interest rate on both required reserve and excess reserve balances has been 25 basis points, or 0.25% at an annual rate, in keeping with the federal funds target range of 0 to 25 basis points during this period”. As interest rates are expected to rise over the time Basel III is expected to be implemented, the interest rate on reserves should move in tandem. However, it’s not a linear relationship as the customer’s deposits and risk profile will come into play, but overall, we would expect ECR rates to rise for those that have more favorable deposits.
Do you think a shift from prime to government money market funds will result in funds imposing investor caps on the amount that can be deposited into a government MMF?
Much of this will depend on the supply of government securities and the appetite for those securities by the funds. If there’s more demand than supply, the price will be adjusted and potentially funds will place investor caps on them. It’s best to inquire with your money fund during the implementation period of the new rules.
Do you expect municipal bond investors to shift their investments along the lines of public bonds versus private activity bonds?
It’s difficult to say, but since investing in muni funds will be subject to a floating NAV and gates and fees, it may cause them to look for funding that has more yield appeal to offset the risk profile associated with the administrative burden of the fund. Ultimately, investors will want to be compensated for the extra risk associated with the investments.
Can you speak a little as to what the SEC Board of Governors stated as to the reasons for these changes?
It’s probably best to directly quote Mary Jo White’s comments from the hearing. Ultimately the Fed wants to avoid providing a financial backstop again for money funds:
“Today’s reforms will fundamentally change the way that most money market funds operate. They will reduce the risk of runs in money market funds and provide important new tools that will help further protect investors and the financial system in a crisis. Together, this strong reform package will make our financial system more resilient and enhance the transparency and fairness of these products for America’s investors”…. “The recommendation before us today creates a very strong reform package that significantly mitigates the risks of a run in money markets funds and that will limit further contagion should a run occur”.
What is considered support for the disclosure on sponsor support?
It’s more about due diligence and making sure you are aware of any issues the fund had in the past for an indication of the likelihood going forward. If a sponsor has to support a fund much like what happened during the banking crisis, it’s important to know their level of support since they are potentially making an explicit guarantee on the fund and the prospectus might not cover this.
What steps must a company take to effect a change in its investment policy and how likely is it that companies will change their investment policies to allow investments in VNAV (variable net asset value) funds (so they can stay invested in prime funds)?
The first step is to determine the viability of the offering by educating yourself on the ramifications of the changes. Much of the determination will depend on the timing of the implementation by the fund companies. At a minimum, vetting the accounting changes and if the redemption gates or fees violate your policy currently. Making a case for staying in prime funds will depend on the interest rate environment, the risk profile of the fund/product, and ensuring there’s ample liquidity included. Internal education and auditor support would be the next steps prior to a policy amendment and approval by the board or committee.
Do you see the shift away from commercial paper more as a result of the floating NAV or do you think removal of the credit ratings also plays a role?
More than likely the floating NAV will play a larger role. As the 2014 AFP Liquidity Survey pointed out, the investor appetite for floating NAV funds has lessened and some will flow out of the funds altogether and some will go into government funds. The removal of credit ratings is important because it places the duty of care onto the fund board to determine which securities are credit worthy and the removal of the reference in rule 2a7 defining the allocation of tier 1 and tier 2 paper goes away.
Even though government and Treasury funds will not convert to a floating NAV, will they also be able to suspend redemptions?
Yes, it is up to the fund board to determine if they should opt-in on redemption gates and fees with prior investor disclosure.
Stay up-to-date on the SEC’s new rules with AFP’s Money Market Resource Center.