By Geri Westphal
As the market prepares for upcoming MMF regulations, iTreasurer sat down with ICD’s Jeff Jellison and Sebastian Ramos to discuss their perspective on how these regulations may impact corporate investment. They discuss what steps should be taken ahead of October 2016 to allow for the highest level of flexibility for managing short-term cash.
Money market funds have been a short-term investment mainstay for US MNCs because of their low risk, ease of liquidity and competitive yield. Their strength and popularity remained steady throughout the economic crisis, and investment managers continue to rely on these funds to manage short-term liquidity.
As part of recent discussions in preparation for The NeuGroup’s Spring 2016 Treasury Investment Manager Peer Group Members’ Summit, member concern over upcoming MMF reform was most frequently named the top priority for 2016 as investment managers seek to understand the full impact of the impending changes and how their investment strategies may change as a result.
To get a senior point of view we met with ICD, the world’s leading institutional trading and investment risk management company. We spoke to Jeff Jellison, ICD CEO Americas and Sebastian Ramos, ICD Head of Global Trading to discuss the key issues, insights and recommendations for navigating this new treasury investment era and what investment managers should do now to prepare for the upcoming MMF reform changes.
The 2007-09 financial crisis led the SEC on a course to strengthen the financial markets. On ICD’s April 14, 2016 MMF Reform Solutions Webinar, guest Tony Carfang, Treasury Strategies’ senior partner said, “During the past financial crisis, investors staged runs on entire asset classes, not just specific institutions. First, non-2a-7 enhanced cash funds and asset backed commercial paper froze, followed by the collapse of auction rate securities and mortgage derivative markets. A large investment bank failed, leading to well capitalized corporations experiencing difficulty placing highly rated commercial paper. Soon after, large commercial banks experienced runs and government-sponsored entities became unable to fund themselves in
securities markets. By August 2008, only two major liquidity asset classes had not experienced failure, US government securities and MMFs.” The latter finally fell when The Reserve Primary Fund was overexposed to Lehman Brothers when that investment bank went bankrupt.
That led to positive reforms to strengthen MMFs—one of the most important being the requirement of MMFs to publish their holdings. Jeff Jellison explained: “This requirement coupled with ICD leading the industry with its first-to-market Transparency Plus exposure analytics application, provided corporations with a clear understanding of their counterparty exposure and the ability to evaluate the relative financial strength of those counterparties. Other 2010 rules included the establishment of MMF liquidity minimums of 10% daily and 30% weekly, the reduction of WAM from 90 to 60 days and the establishment of a 120-day WAL.
But the regulations didn’t stop there. The key components of SEC 2a-7 reform (VNAVs, Fees and Gates) will become effective on October 14, 2016. This new reform requires institutional tax exempt and prime MMFs to move to a variable net asset value calculation and provides the boards of those funds with the discretion to impose fees and gates under extreme circumstances.
Variable Net Asset Value
MMFs are variable now—they are currently rounded to two decimal points. In October, they will round to four decimal points. Wells Fargo looked back and recalculated their flagship prime MMF, the Heritage Fund, based on four-decimal rounding. What they found was that MMFs’ maturity, credit quality and liquidity rules kept volatility extremely low. In fact, the difference between the highest and lowest market-based NAVs was only 2 bps. See Figure 1.
As Jellison noted, “Assuming a $100 million investment, if you purchased this MMF at its highest price and sold at its lowest price, the 2011 loss would have been $20,000. If you were unfortunate enough to buy and sell on the worst days in 2012-2014, the loss would have been $10,000 per year. In 2015, a gain or loss would not have happened as the fund did not stray from the 1.0000 price. The average spread between Prime and Government MMFs on ICD Portal is currently 19 bps. Assuming a $100 million investment, on average Prime MMFs would outperform Government MMF dividends by $190,000. For billion-dollar portfolios the opportunity cost becomes millions of dollars. Prime MMF volatility is expected to be nominal compared to yield.”
We asked Mr. Ramos about the burden on corporate treasury to account for MMF variability. Ramos noted that “The biggest issue for our clients was the additional record-keeping required for variable investments. Thankfully, the IRS and Treasury proposed eliminating wash sale rules for MMFs and a Simplified Tax Accounting Method, which measures net gains and losses over a computation period. In most cases the period will be a year, but could be less for corporations with shorter tax reporting periods. We developed a Gain/Loss report in ICD Portal that provides the computations for our clients, so there is no need to track individual transactions.” See Figure 2.
Variable Net Asset Value Settlement
Although the VNAV MMF settlement model is still being finalized, it is expected that there will be three intraday strikes used to establish mark-to-market values. These strikes are expected to be set at 9am, 12pm, and 3pm ET which will enable investors to receive cash settlements. Some fund companies are also adding an end-of-day strike at 5pm ET that would operate on a T+1 basis, which is useful for locking in the transaction and price to facilitate early morning redemption on the following day. It will be necessary for cash managers to build this into their daily cash management processes to account for the various strike times.
While the concept of multiple strike prices may be new, it is important to realize that the majority of prime MMFs currently operate in a similar capacity now, with specific payment “batches” occurring at specific times throughout the day. Similar to the strike prices, if an investor places a transaction that misses a payment batch, their payment is scheduled for the next batch release, typically 1-2 hours later. In the new settlement model, the “batches” may be slightly less frequent (3-4 vs. 5-7 per day) but the trade-off is greater transparency into those payment cycles.
MMF Reform Preparedness Checklist
In order to be fully prepared for the rollout of VNAV regulations in October, we’ve provided a checklist of important tasks every investment manager must do now to prepare for MMF reform:
- Evaluate the language in your investment policy. It is important to review your investment policy to ensure proper definition of approved asset classes and levels of investment. Nearly half of TIMPG members have made changes to their investment policies in the past year and 40% have made changes in the last three.
- Review your overall bank relationships. Banks are continuing to feel the strain of the Dodd-Frank Act, Basel III and SEC 2a7 and are grappling with how to manage corporate relationships going forward. The denial of short-term cash deposits is one outcome of the new regulations, so make sure you have a place for your short-term cash.
- Integrate and implement technology solutions. Technology has transformed treasury. The integration of treasury workstations, banking, ERP and investment portals has become invaluable for managing, reporting, efficiency and workflow.
- Utilize on-demand exposure analytics reporting. Risk management has become a major concern for all enterprises and exposure analytics is at the center of institutional trading and investment risk management.
- Optimize your portfolio. Look for ways to increase yield without sacrificing safety of principal and liquidity needs.
Integration and Automation
Integrated systems and automation become even more important with the complexities of intraday pricing and settlement. “Straight-through processing achieved by integration between trading, TWS, ERP, client banking and accounting systems, becomes even more important with the complexities of intraday pricing and settlement. We have worked with over 100 entities including fund companies, transfer agents, clearing and custody banks, technology vendors and clients on streamlining VNAF MMF workflows to provide seamless integration with treasury workstations and automated settlement solutions. These integrations have led to significant gains in efficiency,” explained Mr. Ramos.
Liquidity Fees and Redemption Gates
The new ‘Fees’ rule give fund boards the ability to impose a liquidity fee if a fund’s level of weekly liquid assets falls below 30% of its total assets. In that instance the MMF’s board would be allowed to impose a liquidity fee of up to 2% on all redemptions. Furthermore, if an MMF’s level of weekly liquid assets falls below 10%, the MMF would be required to impose a liquidity fee of 1% on all redemptions if the board deems the fee to be in the best interest of the shareholder of the fund.
Redemption Gates will similarly enable Institutional Prime MMF board of directors to suspend redemptions if a fund’s level of weekly liquid assets falls below a certain threshold. If an MMF’s level of weekly liquid assets falls below 30%, an MMF’s board could in its discretion, temporarily suspend redemptions by imposing a “gate” to stop all activity. Any MMF that imposes a gate would be required to lift that gate within 10 business days, although the board of directors could determine to lift the gate earlier. MMFs would not be able to impose a gate for more than 10 business days in any 90 day period.
We asked Mr. Jellison if fees and gates would have a big impact on ICD clients. “Fees and gates exist in some fashion in most other treasury investment options,” he said. “For example, early withdrawal of a time deposit could result in a fee and under extreme duress, banks could put up a gate by suspending convertibility. Prior to liquidity rules being implemented in 2010, Prime MMFs would routinely operate with liquidity levels of 10-15% so the 30% minimum is very high.”
Simply falling below the prescribed threshold does not mean that a fund will need to impose a fee or gate, Mr. Jellison added. Rather, it gives fund boards the flexibility to impose fees and gates if faced with extreme, unforeseen redemptions. Since fund managers will not want to call board meetings to discuss inadequate liquidity, Prime MMFs should be managed to comfortably stay above the 30% minimum. For additional peace of mind, treasury practitioners have an abundance of liquidity compliance and monitoring tools available for them to maintain Prime MMF portfolios with sufficient liquidity. These factors will significantly minimize the impact of fees and gates on our clients.
ICD Portal Enhancements
ICD has worked with clients on several ICD Portal and Transparency Plus enhancements to help clients efficiently keep Prime MMFs in their diversified portfolios. Mr. Ramos highlighted one example: “ICD clients can set compliance rules where 7-day and 1-day liquidity minimums can be established to prevent ICD Portal trades from being executed in a fund with insufficient liquidity. The compliance tool can also provide trade override rights and has a back-end feature that will email a compliance distribution list if a fund has subsequently dropped below the liquidity minimum. Other enhancements include comparison views and reporting portraying new liquidity pricing and asset flow metrics.
Government MMF Supply
During a panel discussion at ICD’s April 14, 2016, roadshow in San Francisco, Debbie Cunningham, an executive vice president and chief investment officer at Federated Investors, noted that worries over supply might be overblown. “The amount of eligible government supply in the market as well as on the Fed’s balance sheet is about $8.3 trillion,” she told roadshow participants. “Approximately $5T of that is being used regularly if you exclude the Fed balance sheet. That provides a big cushion. While we don’t expect a short-term supply issue, we may see a pricing issue with increased government security demand.” See Figure 3.
Summary Recommendation
“Prime MMFs have proven their resilience and staying power. In 2008, MMFs were the only remaining asset class standing alongside government securities. There is simply no other better cash equivalent in terms of utility and performance,” Mr. Jellison said.
The IRS and the Treasury proposed the Simplified Tax Accounting method and Wash Sales Rule relief, so managing VNAV funds has been minimized. The ICD Portal offers on-demand intelligence, portfolio optimization, product diversification, deep reporting, risk compliance, portfolio managing and monitoring and highly secure automated wire settlement.
Treasurers are being asked to do more with less and in the heat of the current regulatory environment, having a strong partner who provides a leading global institutional trading and investment risk management portal is critical. While there are some changes taking place, the primary utility that MMFs offer institutional investors safety, liquidity, yield, diversity and transparency, are still what makes them so strong.”
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