Money market mutual fund managers continue the post-crisis trend of producing frequent communications with shareholders. Two of the most recent are publications from Invesco, which recently jettisoned the AIM moniker, and Wells Fargo, which continues to produce its monthly "Overview, Strategy, and Outlook. Invesco's May 3 "Global Cash Management" publication is entitled, "Ongoing financial reform could lead to unintended consequences on short-term markets," while the Wells piece says, "After an extended period of relative calm, credit concerns once again leapt to the forefront, this time in the form of concerns about the viability of certain sovereign credits."
Invesco's update says, "While the implied government support has lifted the long-term credit ratings of these [large U.S. financial] institutions during the crisis, a long-term credit rating downgrade will likely, at a minimum, increase their cost of obtaining capital. What is much less clear and potentially more harmful is the effect on these firms' short-term credit ratings." It discusses the "Impact of new regulations on large U.S. financial institutions," saying, "With the recent amendments that the Securities and Exchange Commission (SEC) has implemented to Rule 2a-7, which govern U.S.-registered money market funds, a downgrade could be detrimental to these banks due to the estimated $800 billion in funding they obtain from the short-term debt market."
It continues, "If these institutions did experience a downgrade to Tier 2, this does not align well with the new Rule 2a-7 which are now further reducing money market funds' exposure to Tier 2 credits in both dollar and term limits, and in addition, removing the look through provisions of repurchase agreements (repo) counterparties. Previously, a fund's advisor could look through the repo counterparty to the collateral underlying the repo transaction for credit and diversification purposes. However, the amendment to Rule 2a-7 now mandates a credit analysis of the counterparty, which makes their short-term ratings even more important. Before too dire a picture is painted, if a downgrade did occur, it may not lead to another credit crisis. These institutions have substantial cash balances and any ratings action would lead these firms to seek some combination of funding outside of the money markets, increase deposits and/or capital raises while potentially resizing their respective balance sheets."
Wells' most recent commentary says, "For money market funds, Greece itself does not pose a problem, as it does not appear that any U.S. money funds have direct exposure to Greek sovereign debt, but as in every credit event since 2007, the fear of contagion looms large. There are questions about which banks may have direct exposure to Greece and whether a similar problem could confront other European nations. Fuel was added to this fire when Standard & Poor's downgraded Spain from AA+ to AA on April 28. Now, AA is still a mighty strong rating, but the direction of the change and the fact that there was an actual downgrade caused concern that other countries might be in the ratings agencies' sights."
It continues, "Bank exposure to Greece sovereign debt appears to be manageable, especially by those banks in which we invest. We would view bank exposure to actually be a positive in a macro sense, as it is yet another reason for the European Union to step up and assist Greece in a significant way. Still, we would prefer to see the matter resolved sooner rather than later in order to stem the uncertainty."
On rates, Wells writes, "But away from any overt action by the Fed, rates have begun to creep higher. We think several factors have been at work here: First, the settlements of new U.S. Treasury debt have been large, and the need to finance those securities in the repo market has been putting upward pressure on those rates. As overnight repo rates move higher, longer-term money market rates must also move higher in order to induce investors to extend the term of their investments. Second, we've seen a slow but steady increase in the effective federal funds rate."
Finally, they say, "The amendments to Rule 2a-7, the section of the Investment Company Act that governs money market funds, that were adopted at the SEC's January 27 meeting start to take effect May 5, 2010; however, required compliance dates are staggered throughout 2010 and into 2011. The SEC had proposed certain amendments last June, asking for public comment. After receiving over 150 comments from the public, the final amendments largely mirrored the initial proposals. We have been supportive of regulatory reform in this area. The SEC states that the rule changes will 'increase the resilience of these funds to economic stresses and reduce the risks of runs on the funds,' and 'improve liquidity, increase credit quality and shorten maturity limits ...' and 'also enhance disclosures.' Having long emphasized high credit quality and liquidity in our funds, the new rules required few changes on our part, and the portfolios of the Wells Fargo Advantage Money Market Funds are currently positioned in a manner that is in compliance with the rule changes."
