We wrote last week about the SEC's recent "Staff Analysis of Data and Academic Literature Related to Money Market Fund Reform" release (see our March 25 News, "SEC Posts 4 Mini Studies: Liquidity Costs, Non-Govt, Muni Backing, Safe"; comments should be submitted by April 23). Today, we take a closer look at one of the 4 papers, "Demand and Supply of Safe Assets in the Economy," which attempts to defuse the criticism that reform proposals could cause a massive shift away from Prime funds and assets and into Government funds and securities. The brief study uses an example a 20 percent shift in assets from Prime funds into Governments, but it oddly includes securities outside of Treasuries in its estimate of securities "with virtually no default risk". We also note below the announcement of FSOC of a conference on asset management to take place May 19.
The "SEC's Safe Assets" piece says, "The Division of Economic and Risk Analysis ("DERA") has reviewed recent evidence on the availability of domestic government securities and global "safe assets." The memorandum is intended to assist the Commission in the development of final rules regarding Money Market Fund (MMF) Reform that could possibly increase the demand for these assets. We focus not only on the availability of domestic government securities, but also global safe assets. The fungibility and hence substitutability of global safe assets in other contexts (but not for money market funds) would likely free up supplies of domestic government securities elsewhere. DERA staff ("staff") note a marked increase in the global demand for domestic government securities and global safe assets but do not anticipate that, if such changes were adopted, the impact would be large relative to the domestic and global markets for safe assets."
It continues, "A safe asset is defined as any debt asset that promises a fixed amount of money in the future with virtually no default risk.... Historically, bank deposits and Treasuries constitute the vast majority of domestic safe assets. Questions are now being raised as to whether the global economy has and will have an adequate supply of safe assets. Analysts from the International Monetary Fund and Credit Suisse, for example, predict a shortfall. Arguments supporting the idea of a shortfall, however, ignore the ability of market participants to adjust to a changing landscape. For example, sustained excess demand for safe assets should increase the price of safe assets and lower rates."
Under a section entitled, "Shift in Investment from Prime Money Market Funds to Government Funds," the paper explains, "In the 2013 Proposing Release, the Commission proposed to exempt government MMFs from a floating NAV requirement and fees and gates. If adopted, some investors that today invest in prime MMFs may shift their investments to government MMFs, thereby raising the demand for domestic government securities and safe assets in the economy."
It continues, "In November 2013, prime funds held approximately $1,783 billion in assets, whereas government and treasury funds held $952 billion in assets, or around 32 percent of all money market fund assets. It is difficult to estimate the amount of money that might shift from prime MMFs into government funds if the Commission adopts the floating NAV exemption, but if even 20 percent of prime fund investments shifted into government funds, approximately $357 billion dollars would need to be invested in government securities. Given the global market for safe assets is estimated to be $74 trillion, it is difficult to envision such flows would create a problem. Moreover, evidence from the 2008 Financial Crisis indicates government funds are able to absorb large inflows, especially if they occur over a period of time. As shown in Figure 1, government money market fund assets increased by $409 billion (44 percent) during the Crisis Month (9/2/2008 to 10/7/2008), whereas prime fund assets fell by $498 billion (24 percent)."
The SEC study adds, "An increase in demand for safe assets without a concomitant increase in supply could increase safe-asset prices and lower returns.... Currently, government MMFs may invest up to 20 percent of their portfolios in non-government securities. A credit event in the 20 percent portion of a government fund's portfolio could trigger a drop in shadow price, thereby creating incentives for shareholders to redeem shares ahead of other investors. The Commission therefore asked questions in the 2013 Proposing Release as to whether there should be additional limits or requirements on the 20 percent threshold." (See also the SEC's mini-study, "Government Money Market Fund Exposure to Non-Government Securities".)
Finally, the Safe Assets comment adds, "As Figure 4 shows, on average government MMFs invest less than five percent of their assets in non-government securities today, 85 percent invest less than eight percent, and 90 percent invest less than 15 percent. Government funds invested approximately $2.8 billion in non-government assets as compared to $503 billion in government assets in November 2013. Given the size of the global market for safe assets, the staff does not anticipate a problem if the Commission lowers the 20 percent threshold. Concomitantly, the staff does not anticipate that lowering the 20 percent threshold would impose heavy portfolio rebalancing costs on funds. Even if some funds must rebalance their portfolios towards more government securities, the market appears to be able to absorb some rebalancing, as evidenced during the 2008 Financial Crisis."
In other news, a statement entitled, "Financial Stability Oversight Council (FSOC) to Host Public Asset Management Conference," tells us, "In order to help inform the ongoing assessment by the Financial Stability Oversight Council (Council) of risks to U.S. financial stability, the Council will host a conference on the asset management industry and its activities. The Council welcomes the opportunity to hear directly from the industry and other stakeholders, including academics and public interest groups, on this issue. The asset management conference will be held on May 19, 2014 in the Cash Room at the Department of the Treasury. The program will include several panels, moderated by senior staff of Council members. Panels will focus on an in-depth examination and discussion of targeted issues associated with asset management in order to further inform the work of the Council. A full agenda outlining discussion topics, panelists, and viewing information will be released before the conference. The conference will be webcast live in its entirety on www.fsoc.gov."
