Money-market funds to get a new rating structure from Moody’s; they’re also creeping into riskier assets.
Lows yields can be treasury’s best friend or sometimes its worst enemy. On the friend side of course is the wonderful opportunity that low rates provide those companies seeking to punch up balance sheets, make acquisitions or make capital improvements by issuing debt. But lurking on the enemy side could be the fund managers investing the company’s excess cash.
This is not to say that managers are the enemy – far from it. But for treasurers with lots of cash managed outside the company, it might be worth of revisit of the chain of cash control to see where the money is. This would be a relevant exercise at any time. But in a low-yield environment dotted with new rules and regs and amid two recent developments in the money-market fund space, it should be a priority.
Ratings change
One development is that recently Moody’s released for comment a proposal to change its rating methodology as well as introduce a new rating scale for money-market funds. Moody’s said in its release that the new methodology aimed to “more effectively capture these risks by introducing objective measures to better assess factors such as liquidity risk and market risk, as well as asset quality and obligor concentrations.” As for the rating scale, it would also seek to better capture the risks of money market funds but also reflect the fund’s ability to execute “immediate payment on demand.” Therefore, it will offer an opinion on a fund’s ability to preserve principal and provide liquidity.
Because its other scales, the long-term rating scale of Aaa-C and short-term Prime rating scale of P1-Not Prime, aren’t adequate Moody’s said the new scale would have a “distinct symbol set with its own definitions” and would follow the form of MF[n], on a rating scale from MF1+ to MF4.
In its statement Moody’s noted the troubles funds faced in 2008 prompted the changes. That’s when the $62 billion Reserve Primary fund dropped below the critical $1 per share level that money funds try to maintain. One result Moody’s said, was that 31 rated funds suspended redemptions, leading to delayed distributions. And in two cases, shareholders in those funds saw principal losses.
Further to this, Moody’s separately released a report showing that at least 20 fund managers of US and European money market funds spent at least $12bn to preserve the net asset values of their constant net value funds, and not just during the 2007-09 financial crisis. Moody’s said in its report that “throughout their history, both in the U.S. and in Europe, more than 200 funds, including rated and unrated funds, were the beneficiaries of some form of sponsor support, without which they would have ‘broken the buck.’”
Getting a little too risky
The Moody’s proposal is well timed, since another recent development is news that some money-market funds are becoming riskier. According to the Wall Street Journal, funds are becoming riskier on the one hand because the market for assets that meet the requirements of new amendments to SEC rule 2a-7 (part of the Investment Company Act of 1940), which limit the types of investments money funds can hold, has also been hamstrung by them. The amendments, adopted in January, target portfolio quality, maturity, liquidity as well as repurchase agreements and disclosures of portfolio holdings.
The updated 2a-7 also mandates a fund’s ability to process sales and redemptions at a net asset value per share other than $1. As such, 10 percent of fund’s instruments must mature overnight and 30 percent would have to be able to be liquidated within seven days. The consequence is that the shrinking pool of securities available to meet the new criteria are subjected to higher liquidity risk.
Such call provisions and a shrinking pool of quality assets has money funds scrambling to find new paper to invest in to solve the supply problem. This search will naturally lead to riskier assets as money fund managers look to also boost yield. Some of these will also be structured to meet the updated rules; for example, instruments with step up provisions to give investors added yield if they don’t exercise their call option within seven days.
Another concern for treasurers is that supply constraints will force funds back into being overweight in financial paper, a lot of it in Europe, after the financial crisis caused so many to scrub their holding of such paper to please concerned customers. While MMF risk is a concern, it is also provides further opportunity for quality non-financial corporates to issue short-term paper and do their part to help the supply problem. Demand should be high for it.