Treasury Today Country Profiles in association with Citi

US MMF reform: the initial assessment

Mechanism of clockwork of a watch

Last week, Treasury Today provided a brief refresher on the US money market fund reform. Now, just under a week since the reforms went live, we speak to Andrew Linton, Head of Global Liquidity Product Development at J.P. Morgan Asset Management who provides commentary on the changes and offers some practical advice for corporate treasurers.

The long-awaited changes in the US money markets went live last Friday.

In brief, the reforms have forced prime funds to move from a stable net asset value (NAV) to a floating NAV and to impose liquidity fees and redemption gates. It is a big change and over the last two-plus years, the industry has undertaken a massive effort to implement the reforms.

Key concerns

In the build up to the reforms, much of the concern had been around the impact on the credit markets, worries that cash investors could move to unregulated stable NAV equivalents and potential operational problems caused by the wholesale transition from stable to floating NAVs.

“Despite these concerns, the move to floating NAVs has been relatively smooth,” says Andrew Linton, Managing Director, Head of Global Liquidity Product Development at J.P. Morgan Asset Management. “One significant mitigating factor has been the SEC’s decision to treat floating NAV prime money market funds (MMFs) as cash and cash equivalents for accounting purposes.”

Linton also notes that the transition has been eased by the US Treasury and the US internal Revenue Service’s decision to grant tax relief to facilitate compliance with the new regulations. Moreover, MMF sponsors have worked very hard to recreate the operational benefits for clients that stable NAV funds had offered, notably the ability to allow multiple T+0 cash settlements per day and accept relatively late cut-off times for trading.

What has been more of a challenge for investors, however, is the imposition of liquidity fees and redemption gates. In Linton’s view, these provide a major obstacle to investing in prime MMFs.

“For corporate treasurers, the existence of liquidity fees and redemption gates theoretically jeopardises their ability to access their cash at all times – reducing the attraction of investing in prime funds,” he says. “As a result, we now have a dramatically smaller market for prime MMFs, while government funds have seen massive inflows.”

The move away from prime funds, however, took place much later than expected. “We anticipated that most of the money would move in the second quarter of 2016, but the flows didn’t really start until midway through the third quarter,” Linton adds.

Understanding govies

For those corporates whose attention has been placed elsewhere in the build-up to the changes, or who are perhaps sporadic users of the money fund industry there are a number of considerations that need to be made. Most notably, investors who wish to continue to use CNAV funds must ensure that their chosen fund qualifies as a government MMF.

Firstly, these funds will be required to state in its prospectus that it invests at least 99.5% of its assets in cash, securities issued or guaranteed by the US government, US government agencies or instrumentalities, and/or fully-collateralised repurchase agreements.

The prospectus will also state whether or not the board has elected to subject the fund to fee and gate requirements at this time. Any change to this provision would require 60 days’ notice to shareholders.

Treasurers may need to reconsider the size of the funds they use. “Larger government MMFs could potentially help reduce risk,” says Linton. “Investing in a larger fund can be particularly important in a rising rate environment, where investors are withdrawing cash and liquidity is constantly being used up. In a larger fund, the smaller impact of withdrawals on the market-based NAV (shadow NAV) could potentially give investors of all sizes added protection in the event of a sudden increase in redemptions.”

A positive future

So what does the future hold for the US MMF industry? For Linton, it will be largely positive with the caveat of short-term uncertainty as investors and the industry adapt to the changes.

A big question that many are wondering is when, or if, flows will return to prime funds. And whilst Linton believes this will happen the tipping point is impossible to forecast. “The move from prime to government funds has caused the yield spread between government and prime funds to widen sharply—up from 12-15 basis points (bps) historically to 25-35bps today,” he explains. “At some stage, yields will attract investors back but spreads may continue to increase before flows reverse.”

Practical questions for the corporate treasurer to be asking asset managers:
  1. What are the asset manager’s total assets under management, and how much does the firm manage in MMFs?

  2. Does the asset manager’s money market fund business reside in a diversified fixed income and asset management business?

  3. Does the asset manager have a successful track record in the MMF business?

  4. Does the asset manager have depth and breadth of products across the liquidity spectrum?