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The Association for Financial Professionals held a webinar earlier this week to dive into the details of its 2014 Liquidity Survey. (​See Crane Data'​s July 15 News, "​AFP Liquidity Survey: Corps Hold More Cash, Concern Over MMF Reform".) The webinar was hosted by Tom Hunt, director of Treasury Services, AFP, and featured our own Peter Crane, president, Crane Data, Jeffrey Graves, SVP, senior product manager, Treasury Solutions, RBS Citizens, and Mark Connor, principal, Corporate Treasury Investment Consulting. The hour-​long session focused on corporate cash management trends from the survey, as well as the impact the SEC money market reforms could have on how corporations manage their cash."

Hunt led off by highlighting some of the key trends from the 2014 survey. The survey found that 68% of respondents said that safety is the most important objective of a cash investment policy. About 28% said liquidity was the most important objective, while 4% said yield. Those percentages really haven'​t moved much since the 2008 financial crisis, he said. Of corporations who have seen an increase in cash holdings, the vast majority. 73%, said it was due to increased operating cash flow. Of those who have had a decrease in cash holdings, the reasons were more mixed -- 43% said increased capital expenditures, 36% said decreased operating cash flow, and 28% said they paid back or retired debt.

Crane said the buildup of offshore cash is what'​s driving this massive cash build up. "​The economy is growing, companies are making more money and a lot of that money is being trapped overseas. That'​s what'​s driving some of the cash numbers higher." If you factor in bank deposits and MMF assets, there is about $​10 trillion sitting in cash, he said.

On the impact of money fund reform on cash strategies, Crane was quick to point out that the new rules won'​t be phased in for another two-​plus years. "​There'​s plenty of time, but the big questions I get asked are -- Is money going to move? And how much? I don'​t believe the outflows will be substantial, but there will be outflows. We'​ve seen estimates out there that say anywhere from $​50 billion to $​500 billion will move out of prime institutional funds, but my estimate is more like $​80 billion, or 10% of the market," said Crane.

"​These are all wild guesses because who knows what'​s going to go on two years from now. But if rates are indeed rising, money market funds should look better when compared to different bank accounts, they'​ll actually have some yield. I do not believe it'​s going to be that disruptive." Crane believes the "​hot money," the newer assets that came in the run up before the Reserve Fund broke the buck, is already gone. The assets since have been relatively stable and he expects it to stay that way.

Graves talked about asset allocation. "The low rate environment, Basel III regulations, and now these [​money market reform] decisions being made final are continuing to force cash managers into some difficult decisions. Safety is still king, and certainly on top of mind for everyone, followed by liquidity and yield. But when it comes down to it, people are willing to sacrifice a few basis points into order to keep their company'​s money safe. There really aren'​t many options available in the market to tempt managers to go for higher rates because they just aren'​t there," said Graves.

The question going forward is when will rates rise? "​The market right now is talking about second half of 2015. As that happens, managers are going to be torn -- do I grab for that extra yield or do I continue to keep it in a safe vehicle and give up some of that yield? Or is there a happy medium?"

So what happens now? "With the SEC rulings on money funds coming out, will this drive money out of the funds because of the floating NAV and gates and fees? This issue is on everyone'​s mind -- it'​s '​top of the house' right now." He'​s been talking to fund managers and asking them if they are intending to develop new products and new approaches. "It'​s just too early in the game to know. It'​s certainly something that is going to be a focus for everyone. It will be fascinating to see how it plays out."

Connor spoke about cash investment policies. Not only is it paramount to have a written cash management investment policy, said Connor, but it'​s important to review it on a regular basis – at least once a year and ideally once a quarter. The survey found that most (​43%) review it annually, while 21% do once a quarter, and 19% do so every 2-​4 years. With regard to MMFs, he advises companies to review the policy between now and when the reforms kick in.

"​Many companies choose to be very specific about delineating parameters about money market funds in which they can invest. I would suggest that you are very specific about the variety, the class, and the new types that will be eligible. Meaning, if you don'​t want to buy a gated fund, make sure that'​s in your policy. If you want to buy a fund that is going to impose a liquidity fee, make sure you spell that out in your policy," he added. "In your policy, it'​s important to guard against putting too many eggs in one basket." Typically he recommends maximum limitation of somewhere between 50-​75% in MMFs as a class and up to 50% in any single MMF. "​Likewise, you don'​t want to be the biggest investor in a fund."

A well developed policy can be used for a separately managed account. "It can make sense to hire a money manager to invest your cash according to the parameters in your investment policy," he said. He has clients that pay 7-​8 basis points for a manager. Their investment policies are a little more liberal than they would be for a typical MMF, which can help them, net of fees, get 5–​15 basis points of yield."

Finally, there were three poll questions for the online audience. The first was: If you decide to move your company'​s cash, what will most influence your decision to leave prime MMFs? Most said "​better rates in bank products." The second poll question was: Where will your company'​s cash be deployed if leaving MMFs because of SEC regulations? The dominant answer was also "​bank deposits." The third poll question was: What changes might you consider to your investment policy? The top answer was, "more frequent review of the investment policy."

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It'​s been just over a month since the SEC adopted its voluminous 893-​page Money Market Fund Reforms, which we'​ve been digesting and excerpting since its release July 23. Following the rule'​s publication, there were a host of summaries and articles on the rules, but these have dried up lately. However, we came across a couple of new pieces yesterday that do a nice job of recapping the rules. One was published by Fidelity Investments in its August "​Insight & Outlook" newsletter. Entitled, "Money Market Mutual Fund Reform 2014: Key Changes Ahead," it says, "On July 23, 2014, the Securities and Exchange Commission (​SEC) issued final rules that would further regulate the money market mutual fund industry. The new rules will be implemented within the next two years, and will exempt government and U.​S. Treasury money market mutual funds from structural reform. Upon implementation, the new rules will create a new definition for "​government fund" and "​retail fund" and will require institutional prime (​general purpose) and institutional municipal money market mutual funds to price and transact at a "​floating" net asset value (​NAV)."

"Additionally, for prime and municipal funds -- regardless of whether they are retail or institutional -- the rules will establish liquidity fees that would be charged to shareholders upon redemption, as well as provide for redemption gates that would halt all withdrawals during periods of extraordinary market stress. Institutional investors will face some changes under the new SEC rules; however, some of the uneasiness associated with the uncertainty of the adjustments may be partially offset by knowing that the implementation period is lengthy, that guidance has been provided on several major concerns raised during the comment period, and that government and U.​S. Treasury money market mutual funds are exempt from structural reform," writes Fidelity.

So what are the impacts? There will be a new distinction between "​retail" and "​institutional" prime and municipal money market mutual funds. Implementation date: October 14, 2016. Retail funds will be limited to "​natural persons," that is, individuals or human beings. There is no specific definition of "​institutional fund;" however, the term will apply to all prime and municipal funds that do not qualify as being retail. Examples of types of institutional accounts include accounts with registrations based on a tax identification number with the beneficiary not being a natural person, small business accounts, defined benefit plans, and endowments. However, institutional funds will also be available to natural persons for purchase."

Also, "Institutional funds will be required to have a floating NAV. Implementation date: October 14, 2016. Funds deemed to be institutional will be required to price and transact using a floating NAV, pricing their shares out to four digits ($​1.​0000), a process known as "​basis-​point rounding." At this degree of precision, shareholders would experience a gain (​or loss) if the NAV moves up (​or down) by one basis point, potentially creating a taxable event. Concerns were raised during the comment period related to tax and accounting issues, as well as on same-​day settlement."

The Fidelity piece explains the concerns and how they were addressed by the Treasury, SEC, and IRS. Tax Reporting: The Treasury and the IRS issued guidance that shareholders will be able to report a single net number for the gains and losses experienced over the course of a year, rather than reporting individual transactions. This will significantly reduce the expected tax reporting burden, and is in effect immediately, without waiting for any further guidance from the Treasury. Wash-​sale rule: The Treasury and IRS also provided guidance that sales of money market mutual funds will not be subject to the wash-​sale rule. Cash equivalent: The SEC stated its position that floating NAV money market mutual funds will be considered a “​cash equivalent. Same day settlement: The SEC provided clarity that a floating NAV money market mutual fund could be eligible for same-​day settlement by pricing fund shares multiple times within a single day."

Institutional funds will also have new disclosure requirements. "​Beginning in April 2016, each floating NAV fund will disclose daily on its website the fund'​s: Daily market NAV, reported out to four decimal places; Daily and weekly liquid assets as a percentage of the fund'​s total assets; [​and] Net flows from the previous day."

Retail and institutional prime and municipal money market mutual funds can impose liquidity fees or redemption gates. "​Implementation date: October 14, 2016. The intent of a liquidity fee is to transfer the costs of liquidating fund securities from the shareholders who remain in the fund to those who leave the fund during periods when liquidity is scarce, to remove a "​first mover advantage." ... The gate could be in place for no longer than 10 consecutive days or for 10 days in total over the course of a 90-​day period. However, a prime or municipal fund must impose a liquidity fee of 1% if weekly liquid assets were to fall below 10%, unless the fund'​s board determines that such a fee is not in the fund'​s best interests. The board will have the authority to impose a lower fee or perhaps no fee at all if, in its opinion, that is in the best interests of the fund."

The piece concludes, "Fidelity Investments is well prepared for the new rules and we are ready to make any changes to our product offerings and fund operations that may be needed to comply with them. As we have done throughout the money market mutual fund reform debate, we will keep our customers well informed by providing information, updates, and perspective."

The law firm Grant Thornton also issued an informative recap of the Treasury/​IRS tax accounting changes. They write: "​By requiring floating MMFs to issue and redeem shares at a price that changes regularly, shareholders will typically recognize gain or loss on redemptions of floating MMFs, unlike before, when prices were constant. The SEC received comments that expressed concern that the frequent purchases and redemption of floating MMF shares combined with relatively small changes in share values could result in tax compliance burdens disproportionate to the amounts of gain or loss."

Under the proposed regulations, taxpayers may use the "NAV method" to determine gain or loss for a taxable year related to shares of a floating MMF.... The NAV method computes net gain or loss for each "​computational period" equal to the ending value of shares of a particular floating MMF minus the starting basis of the floating MMF shares, minus "​net investment" in the floating MMF during the computational period. The computational period may be the taxable year or a shorter period -- for example, a month or a week. A taxpayer'​s gain or loss related to floating MMF shares under the NAV method is capital if the underlying floating MMF shares would otherwise give rise to capital gain or loss. Similarly, a taxpayer'​s gain or loss related to floating MMF shares under the NAV method is ordinary if the underlying floating MMF shares would otherwise give rise to ordinary gain or loss."

The rule provides procedures for when the Section 1091 wash-​sale rule will not apply to the redemption of shares of an MMF. "​The wash-​sale rule disallows a loss realized by a taxpayer on a sale or disposition of stock or securities if the taxpayer acquires, or enters into a contract to acquire, substantially identical stock or securities, and the acquisition or contract is entered into within a period beginning 30 days before and ending 30 days after the date of the sale or disposition. Because investors may purchase and redeem MMF shares frequently, Section 1091 could apply to disallow a loss realized by a redeeming investor. Because the NAV method provides for no gain or loss for any particular redemption during a computational period, the NAV method would not implicate the wash-​sale rule. However, a shareholder of a floating MMF that doesn'​t use the NAV method may typically experience frequent wash sales.... The IRS won'​t treat a redemption of an MMF as part of a wash sale if the MMF constituted a floating MMF at the time of the redemption."

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What do mutual fund boards of directors need to know about the SEC'​s money market reform rules? There are several provisions that directly impact fund boards, particularly with regard to fees and gates and stress testing. According to the new SEC rules concerning fees and gates, fund boards are charged with determining whether or not to impose fees and gates on prime MMFs under certain circumstances. States the SEC'​s final rules, "​Today'​s amendments will allow a money market fund to impose a liquidity fee of up to 2%, or temporarily suspend redemptions (​also known as "​gate") for up to 10 business days in a 90-​day period, if the fund'​s weekly liquid assets fall below 30% of its total assets and the fund'​s board of directors (​including a majority of its independent directors) determines that imposing a fee or gate is in the fund'​s best interests. Additionally, under today'​s amendments, a money market fund will be required to impose a liquidity fee of 1% on all redemptions if its weekly liquid assets fall below 10% of its total assets, unless the board of directors of the fund (​including a majority of its independent directors) determines that imposing such a fee would not be in the best interests of the fund." It continues, "​In addition, under our proposal, a fund'​s board (​including a majority of independent directors) could have determined not to impose the liquidity fee or to impose a lower fee."

The fees and gates rules are designed to address issues stemming from the 2008 financial crisis. "In particular, the amendments should allow funds to moderate redemption requests by allocating liquidity costs to those shareholders who impose such costs on funds through their redemptions and, in certain cases, stop heavy redemptions in times of market stress by providing fund boards with additional tools to manage heavy redemptions and improve risk transparency. Although no one can predict with certainty what would have happened if money market funds had operated with fees and gates during the financial crisis, we believe that money market funds would have been better able to manage the heavy redemptions that occurred and limit contagion, regardless of the reason for the redemptions."

Another important function of boards relates to stress testing. The newly adopted stress testing provisions require MMF funds to periodically test their ability to maintain weekly liquid assets of at least 10%. "​The fund adviser must report the results of such stress testing to the board, including such information as may be reasonably necessary for the board of directors to evaluate the stress testing results."

On stress testing, the SEC established rules in 2010 that require funds to adopt procedures providing for periodic testing of the fund'​s ability to maintain a stable price per share based on certain hypothetical events: "​Funds are currently required to provide the board with a report of the results of stress testing, which must include the dates of testing, the magnitude of each hypothetical event that would cause a fund to "​break the buck," and an assessment of the fund'​s ability to withstand events that are reasonably likely to occur within the following year. We proposed modifications to these reporting requirements. First, we proposed adding a requirement that the fund report to the board the magnitude of each hypothetical event that would cause the fund to have invested less than 15% of its total assets in weekly liquid assets. Second, we proposed requiring funds to include in their assessment "​such information as may reasonably be necessary for the board of directors to evaluate the stress testing ... and the results of the testing."

The SEC had several opportunities to observe the effectiveness of stress testing in recent years, including the 2011 Eurozone crisis and the 2013 U.​S. debt ceiling impasse. "​Our staff has observed that funds that had strong stress testing procedures were able to use the results of those tests to better manage their portfolios and better understand and minimize the risks associated with these events," said the SEC in the final rules. Considering this information, the SEC proposed certain enhancements to strengthen the stress testing requirements.

The final rules say: "​We are adopting modifications to the proposed reporting requirements to boards regarding stress testing in response to comments we received on the proposal. Specifically, we are adopting a requirement that the board of directors be provided at its next annual meeting, or sooner if appropriate, a report that includes the dates on which the testing was performed and an assessment of the fund'​s ability to maintain at least 10% in weekly liquid assets and to limit principal volatility. Some commenters had concerns that the proposed requirement that funds report to the board the magnitude of each hypothetical event that would cause the fund to have invested less than 15% in weekly liquid assets was not feasible. We believe that requiring funds to provide an assessment of the fund'​s ability to maintain liquidity, rather than requiring the funds report a specific value for each hypothetical event, addresses such concerns."

On minimizing principal volatility, the rules explain: "We have also added the requirement for an assessment of the fund'​s ability to minimize principal volatility because, as discussed above, we have added this metric to the stress testing requirements in response to comments. We believe that requiring funds to provide an assessment of their ability to maintain liquidity and minimize principal volatility (​and in the case of stable NAV funds, to maintain a stable share price), rather than the more prescriptive requirements proposed and that are in the rule currently, is also appropriate because we have modified the rule so that each "​hypothetical event" is a combination of two events. We want to clarify that funds are not required to separately test for interest rate increases, a downgrade or default, a spread shift, or shareholder redemptions in isolation."

It continues, "​We understand that under the current requirements, many funds, in addition to reporting the magnitude of each event that would cause the fund to "​break the buck," provide a table showing how the fund'​s shadow NAV is affected by different combinations of events and different values. Some funds include information regarding, for example, the concentrations of several of the funds' largest portfolio holdings, both by individual issuer and by sector, and of historical redemptions rates, as points of reference. Several funds also include narratives to help explain the results. In some instances, for example, fund advisers used the narrative to compare results among funds or to explain results that they considered to be unusual. Some narratives also assessed the likelihood of the hypothetical events. We are not including requirements for any of these specific items in the rule because we recognize that there is no one set of factors that will be relevant for all funds, but we believe these are examples of items that we encourage fund advisers to consider when developing the required report assessing stress test results."

The amendments give boards oversight. "We are adopting as proposed the requirement that a fund'​s adviser provide "​such information as may reasonably be necessary for the board of directors to evaluate the stress testing conducted by the adviser and the results of the testing." One commenter supported this requirement, noting that it is a common practice to provide directors with information that helps to place stress-​testing results in context. Some commenters opposed this requirement, arguing that the provision of additional information could be burdensome for boards and would not provide useful information to fund boards. We disagree. As we noted in the Proposing Release, the staff'​s examination of stress testing reports revealed disparities in the quality of information regarding stress testing provided to fund boards. We believe that this requirement will allow boards of directors to receive information that is useful for understanding and interpreting stress testing results."

However, it does not require a fund adviser to provide the details and supporting information for every stress test that the fund administered. "​To the contrary, a thoughtful summary of stress testing results with sufficient context for understanding the results may be preferable to providing details of every test. For example, information about historical redemption activities, as mentioned above, and the fund'​s investor base could help boards evaluate the potential for shareholder redemptions at the levels that are being tested. Additionally, information regarding any contemporaneous market stresses to particular portfolio sectors could be helpful to a board'​s consideration of stress testing results."

Finally, the SEC final rules added a requirement that the adviser include in the report a summary of the significant assumptions made when performing the stress tests. "​We have, in response to comments, modified the required hypothetical events from the proposal to reduce the number and complexity of the assumptions funds are required to make. We recognize, however, that funds will need to make some basic assumptions when conducting the stress tests. These assumptions would include, for example, how the fund would satisfy shareholder redemptions (​e.​g., through weekly liquid assets or by selling certain portfolio securities, including any assumption of haircuts such securities can be sold at) and the amount of loss in value of a downgraded or defaulted portfolio security. We believe that having a summary of such assumptions will help the board better understand the stress testing results, and particularly the sensitivity of those results to given assumptions. We believe this information will allow the board to better understand money market fund risk exposures, and thus allow it to provide more effective oversight of the fund and its adviser."

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The European Securities and Markets Authority issued an amendment last Friday, August 22, that would tweak the Committee of European Securities Regulators' guidelines on the Common Definition of European Money Market Funds. The key change by ESMA says all references to credit ratings in guidelines and recommendations must be removed. Specifically, "​Article 5(​b)(​1) of the CRA Regulation -- as amended by the CRA3 Regulation -- states: [​ESMA, EBA and EIOPA], shall not refer to credit ratings in their guidelines, recommendations and draft technical standards where such references have the potential to trigger sole or mechanistic reliance on credit ratings by the competent authorities, the sectorial competent authorities, the entities referred to in the first subparagraph of Article 4(​1) of the CRA Regulation or other financial market participants. Accordingly, EBA, EIOPA and ESMA shall review and remove, where appropriate, all such references to credit ratings in existing guidelines and recommendations by 31 December 2013." (​Note: For those interested in more on European money market fund regulations, our European Money Fund Symposium, which is Sept. 22-​23 in London, is still accepting registrations.)

The definitions for money market funds in Europe were adopted by CESR in 2010. "​The CESR guidelines distinguish between Short-​Term Money Market Funds (​ST MMFs) and Money Market Funds (​MMFs) on the basis of certain key characteristics, such as the weighted average maturity and weighted average life. ESMA is the legal successor of CESR. The CESR guidelines also set out criteria that money market instruments should respect in order to be considered as eligible investments for ST MMFs and MMFs. In particular, ST MMFs and MMFs should only invest in high quality money market instruments. According to the CESR guidelines, a money market instrument should not be considered to be of high quality by managers of ST MMFs and MMFs unless it has been awarded one of the two highest available short-​term credit ratings by each recognised credit rating agency that has rated the instrument."

However, after reviewing the CESR guidelines against the provisions of the CRA3 Regulation, "ESMA concluded that they had the potential to trigger sole or mechanistic reliance on credit ratings. As a consequence, the Authority decided to review the CESR guidelines as required by Article 5(​b)(​1) of the CRA Regulation; this led to the publication on 6 February 2014 by ESMA, EIOPA and EBA of the joint final report on Mechanistic Reference to Credit Ratings in the ESA'​s Guidelines and Recommendations (​JC 2014 004). This report sets out the manner in which the CESR guidelines were to be amended, in particular with respect to the assessment of credit quality of money market instruments by managers of ST MMFs and MMFs. The purpose of this opinion is to explain how national competent authorities should apply the modifications set out in the aforementioned report when monitoring the application of the CESR guidelines by the relevant financial market participants." ESMA says national competent authorities should take into account the new amendments (​highlighted below) when they monitor the application of the CESR guidelines on a Common Definition of European Money Market Funds.

Specifically, Paragraph 4 of Box 2 of the original ESMA guidelines should be replaced with the following: "​For the purposes of point 3a), ensure that the management company performs its own documented assessment of the credit quality of money market instruments that allows it to consider a money market instrument as high quality. Where one or more credit rating agencies registered and supervised by ESMA have provided a rating of the instrument, the management company'​s internal assessment should have regard to, inter alia, those credit ratings. While there should be no mechanistic reliance on such external ratings, a downgrade below the two highest short-​term credit ratings by any agency registered and supervised by ESMA that has rated the instrument should lead the manager to undertake a new assessment of the credit quality of the money market instrument to ensure it continues to be of high quality."

The replaced language said a money market instrument should not be considered "​high quality unless it has been awarded one of the two highest available short-​term credit ratings by each recognised credit rating agency that has rated the instrument or, if the instrument is not rated, it is of an equivalent quality as determined by the management company'​s internal rating process." The amendment also crosses out two other references to credit ratings: paragraph 10 of the explanatory text under Box 2 of the original CESR guidelines and paragraph 25 of the explanatory text under Box 3 of the original CESR guidelines "​since this paragraph deals with the minimum credit rating of money market instruments."

Also, ESMA recommends that paragraph 2 of box 3 of the original guidelines should be amended as such: "​May, as an exception to the requirement of point 4 of Box 2, hold sovereign issuance of a lower internally-​assigned credit quality based on the MMF manager'​s own documented assessment of credit quality. Where one or more credit rating agencies registered and supervised by ESMA have provided a rating of the instrument, the management company'​s internal assessment should have regard to, inter alia, those credit ratings. While there should not be mechanistic reliance on such external ratings, a downgrade below investment grade or any other equivalent rating grade by any agency registered and supervised by ESMA that has rated the instrument should lead the manager to undertake a new assessment of the credit quality of the money market instrument to ensure it continues to be of appropriate quality. '​Sovereign issuance' should be understood as money market instruments issued or guaranteed by a central, regional or local authority or central bank of a Member State, the European Central Bank, the European Union or the European Investment Bank." ESMA will not reissue the CESR guidelines on a Common Definition of European Money Market Funds as ESMA guidelines under Article 16 of the Regulation. "​This means that national competent authorities will not have to notify ESMA whether or not they comply or intend to comply with the amended version of the CESR guidelines. However, ESMA will monitor the application of this opinion by national competent authorities."

Here'​s some background on the CESR guidelines. "The key purpose behind a harmonised definition of '​money market fund' is improved investor protection. This reflects the fact that investors in money market funds expect the capital value of their investment to be maintained while retaining the ability to withdraw their capital on a daily basis. A common definition will also help provide a more detailed understanding of the distinction between funds which operate in a very restricted fashion and those which follow a more '​enhanced' approach."

CESR'​s guidelines define European money market funds in two ways: Short-​term money market funds and money market funds. The former is similar to U.​S.-​style money funds. "This approach recognises the distinction between short-​term money market funds, which operate a very short weighted average maturity and weighted average life, and money market funds which operate with a longer weighted average maturity and weighted average life." In the amendment, ESMA lays out the complete guidelines, including the new changes, as stated above, within the context of the guidelines.

The U.​S. Securities and Exchange Commission, along with its July 23 Money Fund Reform proposal, also recommended removing references to credit ratings. Says the SEC, from our July 23 article: "​The re-​proposed amendments would implement section 939A of the Dodd-​Frank Act, which requires the SEC to remove any reference to or requirement of reliance on credit ratings in its regulations and to establish appropriate standards of creditworthiness in place of certain references to credit ratings in SEC rules. Currently, to ensure that these funds are invested in high quality short-​term securities, rule 2a-​7 requires that money market funds invest only in securities that have received one of the two highest short-​term ratings (​that is, are rated either "​first tier" or "​second tier") or if they are not rated, are of comparable quality. It also currently requires that a money market fund invest at least 97 percent of its assets in first tier securities. In addition, rule 2a-​7 requires that a fund'​s board of directors (​or its delegate) determine that the security presents minimal credit risks. This determination must be based on factors pertaining to credit quality in addition to any rating assigned to the security.... The re-​proposed amendments to rule 2a-​7 would eliminate the credit ratings requirements for money market funds. Instead, a money market fund could invest in a security only if the fund'​s board of directors (​or its delegate) determines that it presents minimal credit risks, and that determination would require the board of directors to find that the security'​s issuer has an exceptionally strong capacity to meet its short-​term obligations."

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Jackson Hole, Wyoming was the center of the economic universe Friday as Federal Reserve Chair Janet Yellen was the featured speaker at the annual Economic Policy Symposium, sponsored by the Kansas City Federal Reserve. Interest rates were a hot topic, but there was also some discussion of the Fed'​s reverse repo program by St. Louis Fed President James Bullard during an interview with Bloomberg. In her keynote speech Friday morning, Chair Yellen said the Fed is waiting for further recovery in the job market before moving on interest rates. "​At the FOMC'​s most recent meeting, the Committee judged, based on a range of labor market indicators, that "​labor market conditions improved." Indeed, as I noted earlier, they have improved more rapidly than the Committee had anticipated. Nevertheless, the Committee judged that underutilization of labor resources still remains significant. Given this assessment and the Committee'​s expectation that inflation will gradually move up toward its longer-​run objective, the Committee reaffirmed its view "that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after our current asset purchase program ends, especially if projected inflation continues to run below the Committee'​s 2 percent longer-​run goal, and provided that longer-​term inflation expectations remain well anchored.""

She continued, "But if progress in the labor market continues to be more rapid than anticipated by the Committee or if inflation moves up more rapidly than anticipated, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target could come sooner than the Committee currently expects and could be more rapid thereafter. Of course, if economic performance turns out to be disappointing and progress toward our goals proceeds more slowly than we expect, then the future path of interest rates likely would be more accommodative than we currently anticipate. As I have noted many times, monetary policy is not on a preset path. The Committee will be closely monitoring incoming information on the labor market and inflation in determining the appropriate stance of monetary policy," said Yellen.

Committee members remain divided on when rates will go up. Bullard predicts late first quarter of 2015, while others, like Atlanta Fed president Dennis Lockhart, say mid-​2015, according to Bloomberg <​iEhttp://​www.​businessweek.​com/​news/​2014-​08-​22/​u-​dot-​s-​dot-​index-​futures-​little-​changed-​before-​yellen-​speaks>`​_.

In a live interview from Jackson Hole, Bullard talked to Bloomberg Radio'​s Kathleen Hays about a range of topics, including the Fed'​s reverse repo program. Writes Bloomberg reporter Matthew Boesler, "The Federal Reserve will probably borrow "​several hundred billion" dollars from money-​market mutual funds and others to anchor the federal funds rate when it begins tightening policy, according to St. Louis Fed President James Bullard. "​I don'​t think it would have to be that large of a program. Possibly several hundred billion would be enough," Bullard said, referring to the Fed'​s overnight reverse repurchase facility, which it has been testing since September. "​If that didn'​t work, the committee could revisit that and increase the size of the program if we thought that was necessary." ... The central bank has been testing overnight reverse repos with a limited set of counterparties, mostly money funds, as a tool to set a floor under short-​term interest rates when it begins guiding those rates higher, an event Fed officials forecast to occur in 2015."

In his daily newsletter, Wells Fargo Securities strategist Garrett Sloan commented on the RRP. Writes Sloan, "The expansion of the repo program would represent a significant increase in the amount of repo sitting in money market funds, and could possibly cause some "​crowding out" in front-​end markets, forcing issuers to increase rates even further to entice buyers. This would most likely be true in credit-​related markets, while we could potentially see other government-​related products such as bills and very short coupons lag the increases. This kind of "​policy leakage" is not likely a concern for the Federal Reserve unless it gets completely dislocated from other short-​term rates."

J.​P. Morgan Securities latest "​Short-​Term Fixed Income" says of the RRP program, "The likelihood that the Fed will extend the facility beyond its current sunset date of January 30, 2015 is almost certain at this point. Until then, the minutes noted that further testing could be done to limit the Fed'​s role in financial intermediation and mitigate run risks to the Fed during periods of financial market stress. In what form these additional tests could come in remains to be seen. Based on various Fed speeches and FOMC minutes, the Fed seems keen to include design features that could limit the program size while still be able to set a firmer floor under money market rates during normalization. To that end, it'​s possible that the Fed may test an aggregate cap on the RRP facility alongside or instead of the current allotment limit per counterparty."

Authors Alex Roever, Teresa Ho, and John Iborg add, "While the Fed is set to use the RRP facility during the normalization process, the minutes also noted that the RRP facility will only be a temporary facility, used as needed for effective monetary policy implementation. Eventually, the program will be phased out when it is no longer needed for that purpose. If this were to occur, this could of course become problematic for government money funds down the road to the extent that government supply continues to shrink and flows into government money funds remain prevalent post the implementation of money market reform in late 2016. As it stands, the RRP facility has been both a reliable and useful source of backstop supply for MMFs."

Finally, commenting on the Fed'​s reverse repo strategy from the July 29 FOMC minutes, Citi Research strategist Andrew Hollenhorst wrote "​Consistent with the tone of the last minutes, "​participants generally agreed that the ON RRP facility should be only as large as needed for effective monetary policy implementation." As we have previously discussed, recent reforms may increase money market mutual fund demand for repo and short-​term government assets and reduce bank supply of repo and other short-​term investments. The Fed may need to reconcile a fixed policy rate with the increased demand for and limited supply of short-​term government assets by allowing the size of the RRP facility to grow. The RRP facility was characterized as "​temporary" but in our view the large size of the Fed balance sheet may make RRP a necessary tool for flooring rates for the next few years at least."

​

ICI economists Sean Collins and Chris Plantier issued a rebuttal to NY Federal Reserve economists -- (​see our August 19 "​Link of the Day", "NY Fed Blog on Gates, Fees, and Runs") – in which they argue that the SEC'​s adoption of gates and fees on MMFs could increase run risk. In their August 20 column, "Preemptive Runs and Money Market Gates and Fees: Theory Meets Practice," Collins and Plantier disagree. They write, "​A recent post on the blog of the Federal Reserve Bank of New York discusses the possibility that new rules by the Securities and Exchange Commission allowing money market funds to temporarily impose fees or gates during times of market instability could increase the risk of preemptive runs on such funds during times of stress, rather than helping to limit destabilizing withdrawals, as the SEC intended. Although the Fed'​s blog post provides an interesting theoretical insight, the discussion brings to mind the quote by Yogi Berra that "​In theory, there is no difference between theory and practice. But in practice, there is." In "Gates, Fees, and Preemptive Runs," the authors -- Fed economists Marco Cipriani, Antoine Martin, Patrick McCabe, and Bruno Parigi -- note that the academic literature on banks has traditionally seen "​suspension of convertibility" (​preventing the exchange of deposits at par for cash) as a means of preventing damaging bank runs. For example, by requiring a bank that cannot meet all depositors' withdrawals to temporarily close its doors, regulators might prevent further and potentially destabilizing withdrawals."

Collins and Plantier continue, "​The authors then compare this to the new SEC rule, which -- among other things -- allows a money market fund to impose a liquidity fee of up to 2 percent and to "​gate" (​temporarily suspend) redemptions for up to 10 business days during a 90-​day period if the fund'​s weekly liquid assets fall below 30 percent <​b:>`​_ of its total assets, and if the fund'​s board of directors determines that imposing a fee and/​or gate is in the fund'​s best interests <​b:>`​_. In addition, a money market fund will be required to impose a liquidity fee of 1 percent on all redemptions if its weekly liquid assets fall below 10 percent of its total assets, unless the fund'​s board determines that this would not be in the best interests of the fund. Cipriani et al. suggest that this could in theory lead to "​preemptive runs" on money market funds because "​investors who face potential restrictions on their future access to cash may run when they anticipate such restrictions may be imposed."

Specifically, quoting the NY Fed piece, it says, "A bank, MMF, or other FI with the option to suspend convertibility may become more fragile and vulnerable to runs. In other words, we show that instead of offering a solution, policies relying on gates and fees can be part of the problem.... Giving an FI [​financial intermediary] the option to impose gates or fees may be destabilizing because the option itself can trigger damaging runs that otherwise would not have occurred. This result is likely to hold for a variety of adjustments to the assumptions in our model, because the intuition is stark: The possibility of a fee or any other measure that is costly enough to counter investors' strong incentives to run amid a crisis will give investors a strong incentive to run preemptively to avoid such measures. Even though our model does not address how runs on FIs can create large negative externalities for the financial system and the real economy, one important policy implication is clear: Giving FIs, such as MMFs, the option to restrict redemptions when liquidity falls short may threaten financial stability by setting up the possibility of preemptive runs."

To which the ICI economists reply, "Theory and practice differ, however. In practice, fees and gates are just one aspect of the nuanced package of money market fund reforms that the SEC adopted in July 2014 after long study. Most notably, the reforms require institutional money market funds -- the kinds of funds that were most at risk of redemptions during September 2008 -- to move away from a fixed $​1.​00 net asset value (​NAV) and adopt a floating NAV. All 12 Federal Reserve Bank presidents -- including William Dudley, the president of the Federal Reserve Bank of New York -- are on the record stating that money market funds are susceptible to runs because they seek to maintain fixed NAVs. If correct, the SEC'​s new rule addresses this issue by requiring institutional money market funds to float their NAVs. Thus, by the Fed'​s logic, it is unlikely that a money market fund with a floating NAV would need to adopt fees and/​or gates. Alternatively, putting this in the language of the Fed'​s blog post, requiring a money market fund to float its NAV means that a fund has already permanently suspended "​convertibility at par" -- rendering "​suspension of convertibility" through a fee or gate redundant."

Collins and Plantier add, "In addition, as the SEC pointed out in its rule proposal, gates and fees have in practice "​been used successfully in the past by certain non–​money market fund cash management pools to stem redemptions during times of stress." Some hedge funds and European-​domiciled mutual funds operating under the Undertakings for Collective Investment in Transferable Securities (​UCITS) directives have provisions allowing them to impose gates. These provisions, which are disclosed to investors, have not caused runs. Moreover, since February 2010 -- when the SEC adopted its first postcrisis reform of money market funds -- these funds have had the ability (​again, disclosed to investors) to halt shareholder redemptions, albeit with the restriction that a money market fund would then liquidate (​i.​e., go out of business). This provision has not fostered "​preemptive runs" on money market funds."

They conclude, "And, in a final way that practice would differ from theory, money market funds would almost certainly take strong measures to avoid ever having to impose fees or a redemption gate. Investors value money market funds as a cash management tool, and fund managers would work very hard -- just as they have always done -- to avoid reducing that value."

Here'​s what the SEC said about the ramifications in its final Money Fund Reform rules. "We acknowledge the possibility that, in market stress scenarios, shareholders might pre-​emptively redeem shares if they fear the imminent imposition of fees or gates (​either because of the fund'​s situation or because other money market funds have imposed redemption restrictions). A number of commenters suggested investors would do so. Some commenters also suggested that sophisticated investors in particular might be able to predict that fees and gates may be imposed and may redeem shares before this occurs. While we recognize that there is risk of pre-​emptive redemptions, the benefits of having effective tools in place to address runs and contagion risk leads us to adopt the proposed fees and gates reforms, with some modifications. We believe several of the changes we are making in our final reforms will mitigate this risk and dampen the effects on other money market funds and the broader markets if pre-​emptive redemptions do occur."

The final rules state, "As discussed below, the shorter maximum time period for the imposition of gates and the smaller size of the default liquidity fee that we are adopting in these final amendments, as compared to what we proposed, are expected to lessen further the risk of pre-​emptive runs. We understand that the potential for a longer gate or higher liquidity fee before a restriction is in place may increase the incentive for investors to redeem at the first sign of any potential stress at a fund or in the markets. We believe that by limiting the maximum time period that gates may be imposed to 10 business days in any 90-​day period (​down from the proposed 30 days), investor concerns regarding an extended loss of access to cash from their investment should be mitigated. Indeed, some money market funds today retain the right to delay payment on redemption requests for up to seven days, as all registered investment companies are permitted to do under the Investment Company Act, and we are not aware that this possibility has led to any pre-​emptive runs historically."

It adds, "In addition, we note that under section 22(​e), the Commission also has the authority to, by order, suspend the right of redemption or allow the postponement of payment of redemption requests for more than seven days. The Commission used this authority, for example, with respect to the Reserve Primary Fund. To our knowledge, this authority also has not historically led to pre-​emptive redemptions. We believe that the gating allowed by today'​s amendments extends and formalizes this existing gating framework, clarifying for investors when a money market fund potentially may use a gate as a tool to manage heavy redemptions and thus prevents any investor confusion on when gating may apply."

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The Federal Reserve Board of Governors released minutes from its July 29 Federal Open Markets Committee Meeting on August 20. While there was no major change in interest rate policy (see our July 31 Link of the Day), the minutes offer some insight into the boards' deliberations on interest rates. They also talk about the impact of the Fed'​s reverse repo program on money market funds. On monetary policy, it says: "Meeting participants continued their discussion of issues associated with the eventual normalization of the stance and conduct of monetary policy, consistent with the Committee'​s intention to provide additional information to the public later this year, well before most participants anticipate the first steps in reducing policy accommodation to become appropriate. The staff detailed a possible approach for implementing and communicating monetary policy once the Committee begins to tighten the stance of policy. The approach reflected the Committee'​s discussion of normalization strategies and policy tools during the previous two meetings. Participants expressed general support for the normalization approach outlined by the staff, though some noted reservations about one or more of its features. Almost all participants agreed that it would be appropriate to retain the federal funds rate as the key policy rate, and they supported continuing to target a range of 25 basis points for this rate at the time of liftoff and for some time thereafter. However, one participant preferred to use the range for the federal funds rate as a communication tool rather than as a hard target, and another preferred that policy communications during the normalization period focus on the rate of interest on excess reserves (​IOER) and the ON RRP rate in addition to the federal funds rate. Participants agreed that adjustments in the IOER rate would be the primary tool used to move the federal funds rate into its target range and influence other money market rates."

It goes on, "In addition, most thought that temporary use of a limited-​scale ON RRP facility would help set a firmer floor under money market interest rates during normalization. Most participants anticipated that, at least initially, the IOER rate would be set at the top of the target range for the federal funds rate, and the ON RRP rate would be set at the bottom of the federal funds target range. Alternatively, some participants suggested the ON RRP rate could be set below the bottom of the federal funds target range, judging that it might be possible to begin the normalization process with minimal or no reliance on an ON RRP facility and increase its role only if necessary. However, many other participants thought that such a strategy might result in insufficient control of money market rates at liftoff, which could cause confusion about the likely path of monetary policy or raise questions about the Committee'​s ability to implement policy effectively."

The Fed Minutes add, "​Participants generally agreed that the ON RRP facility should be only as large as needed for effective monetary policy implementation and should be phased out when it is no longer needed for that purpose. Participants expressed their desire to include features in the facility'​s design that would limit the Federal Reserve'​s role in financial intermediation and mitigate the risk that the facility might magnify strains in short-​term funding markets during periods of financial stress. They discussed options to address these concerns, including methods for limiting the program'​s size. Many participants noted that further testing would provide additional information that could help determine the appropriate features to temper the risks that might be associated with an ON RRP facility."

It continues, "Most participants supported reducing or ending reinvestment sometime after the first increase in the target range for the federal funds rate. A few, however, believed that ceasing reinvestment before liftoff was a better approach because it would lead to an earlier reduction in the size of the portfolio. Most participants continued to anticipate that the Committee would not sell MBS, except perhaps to eliminate residual holdings.... Participants requested additional analysis from the staff on issues related to normalization as background for further discussion at their next meeting. A few participants also suggested that the Committee should solicit additional information from the public regarding the possible effects of an ON RRP facility, but some others pointed out that the Committee would continue to receive such feedback informally in response to its ongoing communications regarding normalization.”

The minutes also stated, "​With respect to monetary policy over the medium run, participants generally agreed that labor market conditions and inflation had moved closer to the Committee'​s longer-​run objectives in recent months, and most anticipated that progress toward those goals would continue. Moreover, many participants noted that if convergence toward the Committee'​s objectives occurred more quickly than expected, it might become appropriate to begin removing monetary policy accommodation sooner than they currently anticipated. Indeed, some participants viewed the actual and expected progress toward the Committee'​s goals as sufficient to call for a relatively prompt move toward reducing policy accommodation to avoid overshooting the Committee'​s unemployment and inflation objectives over the medium term. These participants were increasingly uncomfortable with the Committee'​s forward guidance. In their view, the guidance suggested a later initial increase in the target federal funds rate as well as lower future levels of the funds rate than they judged likely to be appropriate."

At the conclusion of the discussion, the Committee voted to authorize the following domestic policy directive: "​Information received since the Federal Open Market Committee met in June indicates that growth in economic activity rebounded in the second quarter.... In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in August, the Committee will add to its holdings of agency mortgage-​backed securities at a pace of $​10 billion per month rather than $​15 billion per month, and will add to its holdings of longer-​term Treasury securities at a pace of $​15 billion per month rather than $​20 billion per month."

The directive continued, "To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to 1/​4 percent target range for the federal funds rate, the Committee will assess progress -- both realized and expected -- toward its objectives of maximum employment and 2 percent inflation.... The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee'​s 2 percent longer-​run goal, and provided that longer-​term inflation expectations remain well anchored. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-​run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-​consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run."

Only Charles Plosser voted against it. "Mr. Plosser dissented because he objected to the statement'​s guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for "​a considerable time after the asset purchase program ends." In his view, the reference to calendar time should be replaced with language that indicates how monetary policy will respond to incoming data. Moreover, he judged that the statement did not acknowledge the substantial progress that had been made toward the Committee'​s economic goals and thus risks unnecessary and disruptive volatility in financial markets, and perhaps in the economy, if the Committee reduces accommodation sooner or more quickly than financial markets anticipate."

Investors are eagerly awaiting further clues on the direction of interest rates from this week'​s Economic Summit in Jackson Hole, Wy.,, sponsored by the Kansas City Federal Reserve. The symposium, which runs August 21-​22, is an annual gathering of central bankers, economists, financial market participants, finance ministers, academics and to discuss economic issue facing the U.​S. and world economies. Certainly, a hot topic this year will be interest rates and when they will be raised. Fed Chair Janet Yellen will deliver the keynote address Thursday morning.

​

While much of the focus of the SEC'​s recent Money Market Fund Reforms has been on institutional MMFs, the final rules also establish new guidelines -- and definitions -- for government and retail money market funds. We take a look at the key rules changes around government and retail MMFs below. On page 202 of the final rules (​which were recently published in the Federal Register), it explains how the definition of government MMFs has changed, particularly with respect to the non-​government basket. "The fees and gates and floating NAV reforms included in today'​s Release will not apply to government money market funds, which are defined as a money market fund that invests at least 99.​5% of its total assets in cash, government securities, and/​or repurchase agreements that are "​collateralized fully" (​i.​e., collateralized by cash or government securities). In addition, under today'​s amendments, government money market funds may invest a de minimis amount (​up to 0.​5%) in non-​government assets, unlike our proposal and under current rule 2a-​7, which permits government money market funds to invest up to 20% of total assets in non-​government assets." [​Note: Though "​government" money funds are currently allowed to buy up to 20% in non-​govt assets, none do.]

On not imposing gates and fees or floating NAV on government MMFs it says, "Government money market fund will not be required to, but may, impose a fee or gate if the ability to do so is disclosed in a fund'​s prospectus and the fund complies with the fees and gates requirements in the amended rule. With respect to the floating NAV reform, most commenters supported a reform that does not apply to government money market funds. Commenters noted that government funds pose significantly less risk of heavy investor redemptions than prime funds, have low default risk and are highly liquid even during market stress, and experienced net inflows during the financial crisis.... Government money market funds face different redemption pressures and have different risk characteristics than other money market funds because of their unique portfolio composition. The securities primarily held by government money market funds typically have a lower credit default risk than commercial paper and other securities held by prime money market funds and are highly liquid in even the most stressful market conditions. As noted in our proposal, government funds' primary risk is interest rate risk; that is, the risk that changes in the interest rates result in a change in the market value of portfolio securities. Even the interest rate risk of government money market funds, however, is generally mitigated because these funds typically hold assets that have short maturities and hold those assets to maturity.... Most government money market funds always have at least 30% weekly liquid assets because of the nature of their portfolio (​i.​e., the securities they generally hold, by definition, are weekly liquid assets)."

It talks about providing investor with clear choices. "​We expect that some money market fund investors may be unwilling or unable to invest in a money market fund that floats its NAV and/​or can impose a fee or gate. By not subjecting government money market funds to the fees and gates and floating NAV reforms, fund sponsors will have the ability to offer money market fund investment products that meet investors' differing investment and liquidity needs. We also believe that this approach preserves some of the current benefits of money market funds for investors. Based on our evaluation of these considerations and tradeoffs, and the more limited risk of heavy redemptions in government money market funds, we believe it is preferable to tailor today'​s reforms and not apply the floating NAV requirement to government funds, but to permit them to implement the fees and gates reforms if they choose."

It explains in more detail why it changed the size of the non-​government basket. "We agree with commenters who suggested that permitting government funds to invest potentially up to 20% of fund assets in riskier non-​government securities may promote a type of hybrid money market fund that presents new risks that are not consistent with the purposes of the money market reforms adopted today. It would limit the effectiveness of our floating NAV reform, for example, to allow a hybrid government fund to develop and potentially present credit risk to institutional investors seeking greater yield, while keeping the benefit of a stable NAV. In order to evaluate an appropriate de minimis amount of non-​government securities, Commission staff, using Form N-​MFP data, analyzed the exposure of government money market funds to non-​government securities between November 2010 and November 2013.... An analysis of the data also showed that, between November 2010 and November 2013, government money market funds generally invested between 0.​5% and 2.​5% of their total amortized cost dollar holdings in non-​government securities and, more recently closer to 0.​5% in non-​government securities from November 2012 to November 2013. We expect that the 0.​5% non-​conforming basket is consistent with current industry practices and strikes an appropriate balance between providing government money market fund managers with adequate flexibility to manage such funds while preventing them from taking on potentially high levels of risk associated with non-​government assets."

Retail MMFs also have their own new rules. "Our fees and gates reform will apply to retail money market funds, but our floating NAV reform will not. However, as discussed more below, we are revising the definition of a retail money market fund from our proposal to address concerns raised by commenters. As amended, a retail money market fund means a money market fund that has policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons."

On the differences between retail and institutional investors it says, "Retail investors historically have behaved differently from institutional investors in a crisis, being less likely to make large redemptions quickly in response to the first sign of market stress. During the financial crisis, institutional prime money market funds had substantially larger redemptions than prime money market funds that self-​identify as retail. As noted in the Proposing Release, for example, approximately 4-​5% of retail prime money market funds had outflows of greater than 5% on each of September 17, 18, and 19, 2008, compared to 22-​30% of institutional prime money market funds."

It also discusses why fees and gates are imposed on retail funds. "​Although, as discussed above, the evidence suggests that retail investors historically have exhibited much lower levels of redemptions or a slower pace of redemptions in times of stress, we cannot predict future investor behavior with certainty and, thus, we cannot rule out the potential for heavy redemptions in retail funds in the future. Empirical analyses of retail money market fund redemptions during the financial crisis show that at least some retail investors eventually began redeeming shares. Similarly, we note that when the Reserve Primary Fund, which was a mixed retail and institutional money market fund, "​broke the buck" as a result of the Lehman Brothers bankruptcy, almost all of its investors ran -- retail and institutional alike.... Moreover, as we recognized in the Proposing Release, retail prime money market funds, unlike government money market funds, generally are subject to the same credit and liquidity risks as institutional prime money market funds."

The rules continue, "As such, absent fees and gates, there would be nothing to help manage or prevent a run on retail prime money market funds in the future. While retail investors are unlikely to be motivated to a substantial degree by the first-​mover advantage created by money market funds' stable pricing convention, they may be motivated to redeem heavily in flights to quality, liquidity, and transparency (​even if they may do so somewhat slower than institutional investors). Fees and gates are designed to address these types of redemptions... Further, while we recognize that a retail money market fund may be less likely to experience strained liquidity (​and thus less likely to need to impose a fee or gate), we believe there is still a sufficient risk of this occurring that we should allow such funds to impose a fee or gate to manage any related heavy redemptions when the weekly liquid assets fall below 30% and doing so is in the fund'​s best interests. For the same reasons, we believe requiring a fund to impose a liquidity fee when weekly liquid assets fall below 10% is also appropriate, unless the board determines otherwise based on the fund'​s best interests. Accordingly, retail money market funds will be subject to the fees and gates reform."

Retail funds are not subject to floating NAV, however. "​We are not imposing the floating NAV reform on retail money market funds. For purposes of the floating NAV reform, we are defining a retail money market fund to mean a money market fund that has policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons. We continue to believe that the significant benefits of providing an alternative stable NAV fund option justify the risks associated with the potential for a shift in retail investors' behavior in the future, particularly given that retail money market funds will be able to use fees and gates as tools to stem heavy redemptions should they occur. We also note that, as discussed below, our revised approach to defining a retail fund based on shareholder characteristics should minimize the potential for gaming behavior by institutional investors."

On the "​natural persons" definition it says, "​Drawing a distinction between retail and institutional investors is complicated by the extent to which shares of money market funds are held by investors through omnibus accounts and other financial intermediaries. We also recognize that any distinction between retail and institutional funds could result in "​gaming behavior" whereby investors having the general attributes of an institution might attempt to fit within the confines of whatever retail fund definition we craft. We believe, however, that defining a retail fund using the natural person test will, as a practical matter, significantly reduce opportunities for gaming behavior because we believe that most funds will use social security numbers as part of their compliance process to limit beneficial ownership to natural persons, and institutional investors are not issued social security numbers. We expect that a fund that intends to qualify as a retail money market fund would disclose in its prospectus that it limits investments to accounts beneficially owned by natural persons. Funds will have flexibility in how they choose to comply with the natural person test. As noted by commenters, we expect that many funds will rely on social security numbers to confirm beneficial ownership by a natural person.... Funds that intend to satisfy the retail fund definition will be required to adopt and implement policies and procedures reasonably designed to restrict beneficial ownership to natural persons."

Finally, on costs it says, "The Commission estimates that based on those money market funds that self-​report as "​retail," approximately 195 money market funds are likely to seek to qualify as a retail money market fund under our amended rules. Based on staff experience and review of the comments received, as well as the changes to the retail definition in the final amendments, we estimate that the one-​time costs necessary to implement policies and procedures and/​or for a fund to qualify as a retail money market fund under our amended rules, including the various organizational, operational, training, and other costs discussed above, will range from $​830,​000 to $​1,​300,​000 per entity."

​

The Investment Company Institute released its latest "Money Market Fund Holdings" report, which tracks the aggregate daily and weekly liquid assets, regional exposure, and maturities (​WAM and WAL) for Prime and Government money market funds (​as of July 31, 2014). ICI'​s "Prime and Government Money Market Funds' Daily and Weekly Liquid Assets" table shows Prime Money Market Funds' Daily liquid assets at 23.​2% as of July 31, 2014, down from 24.​2% on June 30. Daily liquid assets were made up of: "​All securities maturing within 1 day," which totaled 19.​0% (​vs. 19.​7% last month) and "​Other treasury securities," which added 4.​2% (​vs. 4.​5% last month). Prime funds' Weekly liquid assets totaled 37.​9% (​vs. 36.​1% last month), which was made up of "​All securities maturing within 5 days" (​31.​6% vs. 30.​0% in June), Other treasury securities (​4.​2% vs. 4.​4% in June), and Other agency securities (​2.​1% vs. 1.​7% a month ago).

Government Money Market Funds' Daily liquid assets total 59.​1% as of July 31 vs 62.​8% in June. All securities maturing within 1 day totaled 25.​4% vs. 27.​8% last month. Other treasury securities added 33.​7% (​vs. 35.​0% in June). Weekly liquid assets totaled 79.​8% (​vs. 81.​6%), which was comprised of All securities maturing within 5 days (​37.​4% vs. 39.​0%), Other treasury securities (​31.​7% vs. 32.​5%), and Other agency securities (​10.​7% vs. 10.​1%).

ICI'​s "​Prime and Government Money Market Funds' Holdings, by Region of Issuer" table shows Prime Money Market Funds with 41.​6% in the Americas (​vs. 47.​9% last month), 19.​9% in Asia Pacific (​vs. 20.​0%), 38.​2% in Europe (​vs. 32.​0%), and 0.​2% in Other and Supranational (​same as last month). Government Money Market Funds held 83.​1% in the Americas (​vs. 89.​9% last month), 1.​0% in Asia Pacific (​vs. 0.​5%), 15.​9% in Europe (​vs. 9.​6%), and 0.​1% in Supranational (​vs. 0.​0%).

The table, "Prime and Government Money Market Funds' WAMs and WALs" shows Prime MMFs WAMs at 44 days as of July 31 vs. 45 days in June. WALs was at 78 days, down from 80 last month. Government MMFs' WAMs increased to 45 days, up from 42 last month, while WALs jumped to 74 days from 71 days. ICI'​s release explains, "Each month, ICI reports numbers based on the Securities and Exchange Commission'​s Form N-​MFP data, which many fund sponsors provide directly to the Institute. ICI'​s data report for May covers funds holding 94 percent of taxable money market fund assets." Note: ICI doesn'​t publish individual fund holdings.

In other news, Fitch Ratings released its "US Money Market Funds Quarterly 2Q14" in which it tracks money market fund flows following the SEC money market reforms. Writes Fitch, "It appears that money fund investors have thus far taken a wait-​and-​see approach to the SEC'​s reform efforts, and many are still reviewing the final rules. Institutional investors will need to re-​examine and update their investment policies to be able to use the new money fund structures or access alternative liquidity management solutions. Once this process is under way, prime money funds may experience more significant outflows and will need to be prepared to handle them." According to Crane Data'​s Prime Institutional Money Fund Index, as of August 15, prime institutional funds had $​784.​5 billion, down from $​800.​5 billion on July 23, when the SEC adopted money fund reforms, a decrease of 2.​0%.

Fitch also commented on the Federal Reserve'​s reverse repo program. "Prime and government money funds allocated a record $​275 billion to the Fed'​s reverse repo facility (​RRP) at the end of 2Q14 to offset the seasonal reduction in banks' balance sheet capacity. Between May-​end and June-​end, money funds increased their allocations to the RRP facility by $​148 billion, according to Crane Data. At the same time, the funds reduced investments in government and treasury repos with banks by $​72 billion. Banks have historically sought to reduce the size of their balance sheets and leverage on quarter-​end reporting dates, but the phenomenon seems to have been exacerbated due to new bank regulatory requirements."

The Fitch quarterly saw little change in liquidity in Q2. "At the end of June, Fitch-​rated prime MMFs had on average 25% and 39% of their portfolios in daily and weekly liquid assets, respectively. This is almost unchanged compared to liquidity numbers at the end of March and remains well above Fitch'​s criteria guidelines for '​AAAmmf' funds."

The ratings agency also saw stable durations. "The weighted average maturity (​WAM) and weighted average life (​WAL) of Fitch-​rated prime MMFs were at 41 and 66 days at the end of June, compared with March figures of 40 and 68 days. All funds remain under the respective WAM and WAL thresholds for Fitch'​s '​AAAmmf' rating of 60 days and 120 days. The average portfolio credit factor (​PCF) of Fitch-​rated prime MMFs ticked up slightly to 1.​17 at the end of June, compared with 1.​16 at the end of March. The maximum PCF threshold for Fitch'​s '​AAAmmf' rated funds is 1.​50. PCF is a fund’​s asset-​weighted average of credit risk factors, based on each portfolio security'​s rating and maturity."

On holdings, Fitch commented: "The use of the Fed'​s reverse repo facility was at a record high of $​339 billion for the June quarter end. Fitch-​rated prime MMFs invested nearly 9.​5% of assets altogether with the Fed. Demand for CP holdings in Fitch-​rated prime MMF decreased to 22% of total assets in June, down from 23% at the end of March. Government MMFs made asset allocation changes by moving out of Treasuries and into repo. Municipal fund allocations were largely stable over the quarter."

Fitch also saw increased exposure in the U.​S. "Allocations to the U.​S. continue to increase as money funds take advantage of the availability of the Federal Reserve Bank of New York'​s reverse repo facility. Exposure to Germany decreased the most across countries, driven by reduced investments in Deutsche Bank. All other country allocation changes amounted to less than 1% of prime funds' portfolios, reflecting the current relative stability of short-​term markets."

​

Citi'​s Vikram Rai writes in their latest "​Short Duration Strategy" a piece entitled, "Why it is NOT "​Prognosis Negative" for money funds. He says, "As the money fund industry continues to absorb the newly minted SEC reform rules there is significant dispersion in opinion among market participants regarding the impact of these changes on the overall money fund industry and specifically on the institutional prime money fund sector. Speculation regarding outflows from institutional prime MMFs (​which have about $​950 billion in AUM) has ranged from $​50-$​450 billion. While we might witness higher yields for commercial paper as the compliance date for rules comes nearer, which will act as a countervailing factor against outflows from institutional prime funds (​as we discuss in more detail below), the yields increase is unlikely to be sufficient to clog the CP markets."

Rai writes, "Short term investors should jog their long term memory and recall that while the size of the institutional prime money fund industry has grown largely with the overall money fund industry, the CP market has declined significantly over the past decade. Thus, even if drastic outflows of $​450 billion were to materialize, and we sincerely doubt that, the AUM for institutional prime funds would drop to about $​500 billion, which is roughly the size of the sector in 2000. Now, in 2000, the size of the CP market was $​1.​6TR (​vs. about $​1TR now). If the CP markets weren'​t clogged then, it is unlikely that they would clog now, especially since asset scarcity is more prevalent now given the greater demand for HQLA."

The Citi piece continues, "While we do expect inflows into govt. MMFs at the expense of institutional prime MMFs, we wholly disagree with egregious estimates of $​500 billion and expect net outflows to be a fraction of this number. While it is true that stable NAV funds are preferred by most corporate treasurers due to their investment guidelines, it is also well understood that just a change to reporting requirements will not change the fundamental nature of the fund. Additionally, short-​term investors have shown flexibility and resilience when adapting to shocks in the past, for instance modifying AAA only mandates when US Treasuries were downgraded. Thus, an increase in this spread could incentivize corporate treasures and other investors to modify their guidelines such that they are able to invest in floating NAV funds and take advantage of higher yields."

Finally, Rai writes, "And, much as we would like to subscribe to the belief that demand for Tier 2 paper would increase, in our view, the changes should have limited impact on investment policies for most funds because: Most fund boards understand that a loosening of credit standards is unlikely to be one of the objectives of the new rules and they would prefer to avoid SEC scrutiny, especially since the SEC plans to keep an even closer watch on money funds with its enhanced disclosure rules. While the Tier 2 CP market has shrunk over the last 5 years, demand for such paper remains limited given that AAA funds constitute almost 2/​3rds of the money funds universe."

In other Citi research, Andrew Hollenhorst writes in his latest "Short-​End Notes" a brief entitled, "More repo regulation to come." He comments in his summary, "Regulators focused on reducing short-​term funding - Boston Federal Reserve President Rosengren suggested a range of reforms to limit bank and broker-​dealer reliance on short-​term borrowing to fund longer term assets. We think minimum repo haircuts and a short-​term funding "​capital surcharge" remain the most likely reforms."

The piece adds, "Opportunity to shorten T-​bill duration – Increased 1m bill auction size led frontend bills to sell off while geopolitical concerns brought down 12m bill yields. In our view this presents an opportunity to shorten duration. Fed minutes and Jackson Hole next week – We will look to the release of the July Fed minutes on Wednesday next week for any signals regarding an aggregate cap on the reverse repo facility."

In other news, an update entitled, "SEC New Money Market Fund Rules - Overview and Implementation Guidance was written by Peter Fariel of Rimon P.​C.. It says, "​On July 23, 2014, the Securities and Exchange Commission adopted final amendments to the rules governing money market mutual funds (​MMFs). This article provides an overview of key provisions of the Rule and offers practical insights on next steps that MMF sponsors and fund boards should consider in implementing the Rule."

Fariel writes, "The Rule contains two key elements: Institutional prime and municipal/​tax-​exempt MMFs will be required to maintain a floating net asset value (​NAV) for sales and redemptions that is generally based on the current market value of their portfolio securities rounded to four digits (​e.​g. $​1.​0000). All MMFs other than government money market funds will be subject to "​default" rules that provide for permissive and mandatory use of fees upon redemptions ("​liquidity fees") and temporary suspension of redemptions ("​gates"). The Rule'​s application to a particular MMF hinges on two definitions: Retail Fund. A "​retail fund" is a MMF that has policies and procedures reasonably designed to limit all beneficial owners to natural persons (​referred to as the "​natural person test") [​and "​Government Fund"]."

He continues, "The Rule also imposes enhanced disclosure, reporting, governance and investment requirements for MMFs, including a new report, Form N-​CR on material events (​e.​g. the imposition of liquidity fees/​gates), additional reporting requirements on Form N-​MFP, immediate public availability of portfolio holding reports on Form N-​MFP, stress testing of a MMF'​s ability to satisfy the weekly liquid assets requirement and stricter portfolio diversification requirements. The Rule also requires enhanced SEC reporting for private liquidity funds. Separately, the Internal Revenue Service and and U.​S. Treasury Department issued guidance that simplifies MMF tax accounting and reporting to address the impact of the Rule. The compliance date for the floating NAV and liquidity fee/​gate provisions is two years [​the `​Federal Register version was published Thursday, Aug. 14, and the effective date is 60 days from publication, so Oct. 14, 2016]."

​

Crane Data published its latest Money Fund Intelligence Family & Global Rankings yesterday, which ranks the asset totals and market share of managers of money funds in the U.​S. and globally. The August edition, with data as of July 31, shows continued moderate asset decreases for the majority of money fund complexes in the latest month, and over the past three months, but assets have been virually flat over the past year. (​These "Family" rankings are available to our Money Fund Wisdom subscribers.) Schwab, Northern, Franklin, and BofA were some of the few that showed gains in July, rising by $​1.​4 billion, $​1.​4 billion, $​1.​3 billion, and $​1.​3 billion respectively, while Goldman Sachs, BofA Funds, Morgan Stanley, Wells Fargo and SSgA led the increases over the 3 months through July 31, 2014, rising by $​6.​6B, $​4.​3B, $​2.​5B, $​1.​9B, and $​1.​8B, respectively. Money fund assets overall decreased by $​21.​8 billion in July, decreased by $​29.​5 billion over the last three months, but fell by just $​2.​4 billion over the past 12 months (​according to our Money Fund Intelligence XLS).

Our latest domestic U.​S. money fund Family Rankings show that Fidelity Investments remained the largest money fund manager with $​404.​7 billion, or 16.​5% of all assets (​down $​440M in July, down $​3.​9B over 3 mos. and down $​14.​9B over 12 months), followed by JPMorgan'​s $​231.​2 billion, or 9.​4% (​down $​7.​0B, down $​9.​2B, and up 2.​1B for the past 1-​month, 3-​months and 12-​months, respectively). Federated Investors ranks third with $​196.​9 billion, or 8.​0% of assets (​down $​5.​0B, down $​13.​7B, and down $​23.​4B), BlackRock ranks fourth with $​181.​6 billion, or 7.​4% of assets (​down $​2.​7B, down $​10.​4B, and up $​35.​4B), and Vanguard ranks fifth with $​171.​3 billion, or 7.​0% (​up $​495M, down $​797M, and up $​148M).

The sixth through tenth largest U.​S. managers include: Schwab ($​159.​6B, 6.​5%), Dreyfus ($​153.​4B, or 6.​2%), Goldman Sachs ($​135.​0B, or 5.​5%), Wells Fargo ($​108.​5B, or 4.​4%), and Morgan Stanley ($​101.​4B, or 4.​1%). The eleventh through twentieth largest U.​S. money fund managers (​in order) include: SSgA ($​82.​0B, or 3.​3%), Northern ($​75.​9B, or 3.​1%), Invesco ($​59.​3B, or 2.​4%), BofA ($​48.​0B, or 2.​0%), Western Asset ($​40.​1B, or 1.​6%), UBS ($​37.​2B, or 1.​5%), First American ($​36.​6B, or 1.​5%), Deutsche ($​33.​1B, or 1.​3%), Franklin ($​19.​7B, or 0.​8%), and RBC ($​18.​7B, or 0.​8%). Crane Data currently tracks 74 managers, down one from last month.

Over the past year, BlackRock showed the largest asset increase (​up $​35.​4B, or 24.​7%; note that most of this is due to the addition of securities lending shares to our collections), followed by Goldman Sachs (​up $​6.​9B, or 4.​9%), and Morgan Stanley (​up $​6.​7B, or 7.​2%). Other gainers since July 31, 2013, include: BofA (​up $​5.​9B, or 13.​9%), SSgA (​up $​5.​6B, or 7.​4%) American Funds (​up $​4.​0B, or 30.​0%), and JPMorgan (​up $​2.​1B, or 0.​9%). The biggest declines over 12 months include: Federated (​down $​23.​4B, or -​10.​6%), Fidelity (​down $​14.​9B, or -​3.​6%), UBS (​down $​11.​6B, or -​22.​4%), and Deutsche (​down $​9.​0B, or -​21.​4%). (​Note that money fund assets are very volatile month to month.)

When "​offshore" money fund assets -- those domiciled in places like Dublin, Luxembourg, and the Cayman Islands -- are included, the top 10 managers match the U.​S. list, except for BlackRock moving up to No. 3, Goldman moving up to No. 4, and Western Asset appearing on the list at No. 9. (​displacing Wells Fargo from the Top 10). Looking at these largest Global Money Fund Manager Rankings, the combined market share assets of our MFI XLS (​domestic U.​S.) and our MFI International ("​offshore), we show these largest families: Fidelity ($​410.​7 billion), JPMorgan ($​354.​3 billion), BlackRock ($​297.​5 billion), Goldman Sachs ($​214.​9 billion), and Federated ($​206.​3 billion). Dreyfus ($​178.​2B), Vanguard ($​171.​3B), Schwab ($​159.​6B), Western ($​132.​7B), and Morgan Stanley ($​120.​4B) round out the top 10. These totals include offshore US dollar funds, as well as Euro and Sterling funds converted into US dollar totals.

In other news, our August 2014 MFI and MFI XLS show that both net and gross yields remained at record lows for the month ended July 31, 2014. Our Crane Money Fund Average, which includes all taxable funds covered by Crane Data (​currently 841), remained at a record low of 0.​01% for both the 7-​Day and 30-​Day Yield (​annualized, net) averages. (​The Gross 7-​Day Yield was also unchanged at 0.​13%.) Our Crane 100 Money Fund Index shows an average yield (​7-​Day and 30-​Day) of 0.​02%, also a record low, down from 0.​03% a year ago. (​The Gross 7- and 30-​Day Yields for the Crane 100 remained unchanged at 0.​16%.) For the 12 month return through 7/​31/​14, our Crane MF Average returned a record low of 0.​01% and our Crane 100 returned 0.​02%.

Our Prime Institutional MF Index yielded 0.​02% (​7-​day), the Crane Govt Inst Index yielded 0.​01%, and the Crane Treasury Inst, Treasury Retail, Govt Retail and Prime Retail Indexes all yielded 0.​01%. The Crane Tax Exempt MF Index also yielded 0.​01%. (The Gross Yields for these indexes were: Prime 0.​18%, Govt 0.​10%, Treasury 0.​06%, and Tax Exempt 0.​13% in July.) The Crane 100 MF Index returned on average 0.​00% for 1-​month, 0.​00% for 3-​month, 0.​01% for YTD, 0.​02% for 1-​year, 0.​04% for 3-​years (​annualized), 0.​06% for 5-​year, and 1.​62% for 10-​years.

In other news, ICI released its latest "​Money Market Fund Assets" report, which showed money funds increasing for the second week in a row (​up $​23.​3 billion in 2 weeks). It says, "Total money market fund assets increased by $​10.​51 billion to $​2.​58 trillion for the week ended Wednesday, August 13, the Investment Company Institute reported today. Among taxable money market funds, Treasury funds (​including agency and repo) increased by $​8.​15 billion and prime funds increased by $​2.​93 billion. Tax-​exempt money market funds decreased by $​570 million." Year-​to-​date, money fund assets have declined by $​141 billion, or 5.​2 percent.

The release continues, "Assets of retail money market funds increased by $​1.​22 billion to $​906.​60 billion. Among retail funds, Treasury money market fund assets increased by $​220 million to $​202.​88 billion, prime money market fund assets increased by $​1.​33 billion to $​517.​03 billion, and tax-​exempt fund assets decreased by $​340 million to $​186.​69 billion. Assets of institutional money market funds increased by $​9.​30 billion to $​1.​67 trillion. Among institutional funds, Treasury money market fund assets increased by $​7.​93 billion to $​714.​58 billion, prime money market fund assets increased by $​1.​60 billion to $​884.​46 billion, and tax-​exempt fund assets decreased by $​240 million to $​71.​80 billion."

​

The Federal Reserve continued its crusade to blame the Great Recession on everyone except banks with another set of speeches (​and a conference) on the evils of "​wholesale funding". The Federal Reserve Bank of Boston and the Federal Reserve Bank of New York hosted a "Workshop on the Risks of Wholesale Funding" yesterday, which featured academics but no market participants. NY Fed President & CEO William Dudley gave the "Welcoming Remarks at Workshop on the Risks of Wholesale Funding" while Boston Fed President Eric Rosengren gave the keynote, "Broker-​Dealer Finance and Financial Stability." The conference Overview explains, "Wholesale funding refers to a firm'​s use of deposits and other liabilities from institutions such as pension funds, money market mutual funds and other financial intermediaries. When a firm relies on short-​term wholesale funds to support long-​term illiquid assets, it becomes vulnerable to runs by its wholesale creditors. This risk manifested itself during the recent financial crisis, when many firms experienced an outflow of wholesale funds following the failure of Lehman Brothers. The resulting need to dispose of illiquid assets led to "​fire sales" and the transmission of shocks throughout the financial system. The purpose of this workshop is to promote a better understanding of the risks posed by wholesale funding, and to explore policy options for minimizing these risks." (​Note: The Federal Register version of the SEC'​s Money Fund Reform has been published; see today'​s "Link of the Day" for details.)

Dudley comments, "​As you all know, the financial system plays an essential role in modern economies, and liquidity is in turn critical to the functioning of the financial system. Because financial intermediation is critical to economic activity and intermediation is dependent on funding and liquidity, disruption to funding and liquidity can cause severe damage to the economy. The experience of recent years revealed serious flaws in the system.... The extensive use by financial firms of short-​term wholesale funding was one critical factor in the crisis. Not only did this reliance on short-​term funding create the potential for a firm to fail in an extraordinarily rapid manner when faced with a loss of market confidence, but it also served as a channel through which the effects of those failures were widely propagated throughout the broader financial system."

He continues, "In the pre-​crisis period, the growth of securitization was accompanied by an increasing reliance on short-​term funds raised in wholesale markets to finance securities and activities essential to securitization. This ranged from the use of repo funding to finance inventories of securities held for market-​making purposes to the issuance of asset-​backed commercial paper by conduits created to acquire and hold securities. Both demand and supply factors drove the increased use of short-​term wholesale finance. On the supply side, the growth of savings from corporations and institutional investors in need of deposit-​like products in which to place their cash balances created a plentiful source of funds. These products were viewed as "​safe" since, after all, the funds were only exposed for a short period of time, and in the case of repo, they were secured by collateral. On the demand side, setting aside any possible instabilities in this funding source, it was more profitable to use shorter-​term funds to finance longer-​term assets."

Dudley tells us, "​In fact, the growing reliance on short-​term wholesale funding to finance longer-​term assets increased liquidity and maturity mismatch risk in the financial system.... Short-​term funding of longer-​term assets is inherently unstable, especially in the presence of information and coordination problems.... Of course, this insight is not a new one. Prior to the establishment of a lender of last resort and retail deposit insurance for banks -- which came with the quid pro quo of prudential regulation -- bank runs were a regular and disruptive feature of our financial system. These innovations solved the coordination problem and stabilized this source of funding."

He adds, "​What was new prior to the crisis was the extent to which maturity transformation and financial intermediation had migrated outside of commercial banks. The growth of what we call the shadow banking system occurred largely without the types of safeguards -- robust prudential regulation, deposit insurance, lender of last resort -- that have safeguarded the commercial banking system from the types of widespread panics and runs that are capable of destabilizing the financial system. The systemic risk created by this gap in coverage was not well recognized by regulators or the private sector prior to the global financial crisis."

Dudley continues, "Heavy reliance on short-​term wholesale funding exposed the system to a series of intertwined downward spirals in asset and funding markets. This spread in waves. It began in the market for asset-​backed commercial paper (​ABCP) issued by off-​balance-​sheet conduits, and spread via auction-​rate securities to the repo, money market and financial commercial paper markets that formed the core financing for market-​based financial intermediation.... The inherent fragility of short-​term wholesale funding was greatly aggravated by certain institutional shortcomings in these markets, particularly in the structure of the tri-​party repo system and the U.​S. money market mutual fund business."

He says, "​Through the tri-​party repo market, each day the two large clearing banks were providing a large amount of intraday credit to securities firms to facilitate the daily "​unwind" of the prior day'​s transactions. In the run-​up to the crisis, the daily "​unwind" helped make tri-​party repo look like a very liquid investment while still being an apparently highly durable source of funding. This masked the underlying risks and contributed to weak risk management practices. As the concerns about the U.​S. housing market escalated in 2007, participants in the tri-​party repo market became increasingly concerned about the liquidity and credit risks that they faced."

Dudley explains, "The "​breaking the buck" by the Reserve Fund following the Lehman bankruptcy also made it clear that the monies provided to the money market mutual funds by their own investors were also inherently unstable. This made such funds, in turn, an unreliable source of finance in repo, commercial paper and other markets. Investors in a fixed net asset value (​NAV) money market fund could take their money out on a daily basis at par value, with no redemption penalty. This could occur even if the money market fund did not have sufficient cash or liquid assets that it could easily sell to meet all potential redemptions. As with bank deposits prior to deposit insurance, this created an incentive for investors to be the first to get out whenever there was any uncertainty over the underlying value of the assets in the fund. By being first in line, they could exit while the fund could still repay at par, leaving others to bear any losses. The longer the investor waited, the greater the risk that the fund would be forced into the fire sale of assets to meet redemptions and end up breaking the buck."

He states, "As the crisis unfolded, the Federal Reserve, the U.​S. Treasury and others took a series of actions to contain the spiral of funding runs and asset fire sales.... [​T]​he lender of last resort liquidity provision was extended to directly backstop key wholesale funding markets and made available to certain nonbank firms. The Federal Reserve created a direct backstop to the tri-​party repo system through the Primary Dealer Credit Facility (​PDCF). When the Reserve Fund broke the buck after the failure of Lehman Brothers, precipitating a run on money market mutual funds, the Treasury guaranteed money market fund assets and the Fed introduced the Asset-​Backed Commercial Paper Money Market Fund Liquidation Facility (​AMLF). The Fed also backstopped the commercial paper market (​formerly funded in large part by money market mutual funds) by introducing the Commercial Paper Funding Facility (​CPFF). When wholesale funding for non-​residential mortgage securitizations evaporated, the Fed rolled out the Term Asset-​Backed Lending Facility (​TALF)."

Finally, Dudley comments, "​Much has been done over the past few years to mitigate the structural flaws that make wholesale funding a point of weakness in the global financial system. The New York Fed, for example, has led a Federal Reserve effort to make the tri-​party repo system more resilient to stress, while the SEC has taken steps to address risks associated with money market mutual funds. Nonetheless, some important issues and vulnerabilities remain. Moreover, because the Dodd-​Frank Act raised the hurdle for the Federal Reserve to exercise its Section 13.​3 emergency lending authority, extraordinary interventions will be more difficult to undertake, perhaps causing investors to be even more skittish in the future. This is why it is essential to make the system more stable."

The "​Summary" of Rosengren'​s speech says, "In a speech in New York, Federal Reserve Bank of Boston President Eric Rosengren called for a comprehensive re-​evaluation of the regulation of broker-​dealers (​intermediaries that effect transactions in securities), given the lessons of the financial crisis." "​Broker-​dealers played a dramatic role during the crisis," said Rosengren. Given their dependence on unstable, short-​term funding, "broker-​dealers can experience significant funding problems during times of financial stress and, unfortunately, that potential for problems has not been fully addressed since the crisis."

It explains, "Before the crisis, broker-​dealers' reliance on collateralized borrowing in the form of repurchase agreements was assumed to insulate them from runs, perhaps because many viewed collateralized lending as providing little default risk. But as Rosengren notes, this proved to be wrong once the crisis hit.... Rosengren added that the largest domestic net suppliers of repurchase agreement financing are money market mutual funds." He says, "​During the financial crisis, deteriorating confidence in broker-​dealers was compounded by the fact that investors were also fleeing money market mutual funds."

The summary says, "​Given the lessons learned from the crisis, one might have expected less reliance by broker-​dealers on repurchase agreements, and a significant increase in capital required of broker-​dealers. "What is striking is the lack of change -- while there has been some improvement in capital, the 2013 liability structure looks surprisingly similar to the structure that prevailed before the financial crisis," said Rosengren.

Finally, Rosengren'​s speech comments on money funds, "​That experience led to regulatory reforms by the Securities and Exchange Commission, including new liquidity requirements for money market mutual funds and recently issued rules that, among other things, will result in the fluctuation of net asset values of shares for some of these funds. While I would have preferred even more protection against financial runs on money market mutual funds, this element of the recent rulemaking does represent a meaningful improvement. Still, I am certainly on record as questioning whether the imposition of withdrawal restrictions ("​gates") and fees will help to stabilize money market mutual funds in crisis situations."

​

Preparations are being made for our 2nd annual Crane'​s European Money Fund Symposium, which will be held Sept. 22-​23, 2014 at the Hilton London Tower Bridge in London, England. Crane Data has attracted 20 sponsors for the event so far, and we expect our second "​offshore" money fund conference to again be the largest gathering of money fund professionals outside the U.​S. European Money Fund Symposium features an unmatched speaking faculty, including many of the world'​s foremost authorities on money funds in Europe and worldwide. We review the latest conference agenda and details below. (​Visit www.​euromfs.​com to register, or contact us to request the PDF brochure or for more details.)

President Peter Crane comments, "Crane Data'​s first European event, held last September in Dublin, attracted 100 attendees, sponsors and speakers, and our latest U.​S. Money Fund Symposium attracted almost 500. We expect our London event to be even bigger and better than Dublin. European Money Fund Symposium offers "​offshore" money market portfolio managers and professionals, investors, issuers, dealers, regulators and service providers a concentrated and affordable educational experience, as well as an excellent and informal networking venue. Our mission is to deliver great conference content at an affordable price. With the recent passage of the SEC'​s Money Fund Reforms and pending regulatory changes in Europe, we expect that there will be a lot to talk about."

The Day One morning Agenda for Crane'​s European Money Fund Symposium includes: "State of MMFs in Europe & IMMFA Update" with Jonathan Curry, Chairman, IMMFA and Susan Hindle Barone, Secretary General, IMMFA; "Regulations in Europe: Bullet Dodged?" with Dan Morrissey of William Fry and Paul Wilson of SWIP; "Senior Portfolio Manager Perspectives," moderated by Yaron Ernst of Moody'​s Investor'​s Service and featuring Debbie Cunningham of Federated Investors, Joe McConnell of J.​P. Morgan Asset Mgmt, and Jennifer Gillespie of Legal & General I.​M.

The afternoon of Sept. 22 features: "MM Securities: New Sources of Supply," moderated by Laurie Brignac of Invesco and featuring Kieran Davis of Barclays, David Hynes of Northcross Capital LLP, and Jean-​Luc Sinniger of Citi Global Markets; "Portals, Transparency & Investor Issues," with Greg Fortuna of State Street'​s Fund Connect, Justin Meadows of MyTreasury, and Maryum Malik of SunGard; "Accounting and Floating NAV Issues" with Sarah Murphy and Ken Owens of PwC Dublin; and an "Ireland & IFIA Update" with Kevin Murphy of Arthur Cox.

The Day Two Agenda includes: "MM Strategists Speak: Rates, Regulations, Risks" with Giuseppe Maraffino of Barclays and Vikram Rai of Citi; "Distribution: Major Issues & Client Concerns moderated by Peter Crane with Jim Fuell of J.​P. Morgan A.​M., Kathleen Hughes of Goldman Sachs A.​M., and Kevin Thompson of SSgA; "Recent Ratings Research: Trends & Issues" with Yaron Ernst of Moody'​s; "State of US Money Funds & Rule 2a-​7" with Charlie Cardona of BNY Mellon Cash Investment Strategies, Jane Heinrichs of the Investment Company Institute, and John Hunt of Nutter, McClennen & Fish; "Euro & Sterling MMF Issues" with David Callahan of Lombard Odier I.​M. and Dennis Gepp of Federated Investors (​UK) LLP; "Beyond MMFs: Enhanced Cash Strategies" with James Finch of UBS Global Asset Mgmt, Jason Granet of Goldman Sachs A.​M., and Guyna Johnson of Standard & Poor'​s; "MMFs in Asia & Emerging Markets" with Peter Crane of Crane Data and Andrew Paranthoiene of Standard & Poor'​s; and "Offshore Money Fund Data & Statistics with Crane and Aymeric Poizot of Fitch Ratings.

Sponsors of the event and exhibitors to date include: HSBC Global Asset Management, J.​P. Morgan Asset Management, Moody'​s Investors Service, BofA Global Capital Management, Federated Investors, Standard & Poor'​s, State Street Global Advisors, BNY Mellon Liquidity Funds, Cachematrix, Invesco, R.​P. Martin, MyTreasury, Northcross Capital, Nutter, McClennen & Fish, UBS, Treasury Management International, and Treasury Today. Registration for the 2014 Crane'​s European Money Fund Symposium is $​1,​500 (​or 900 GBP), and registrations are still being accepted. A block of sleeping rooms has been reserved at The Hilton London Tower Bridge, and the conference negotiated rate of L261 (​GBP) single and L272 (​GBP) double are available through August 20th. (Please reserve soon as the hotel is sold out outside of our block and won'​t guarantee the rate beyond Aug. 20.) We hope to see you next month in London!

Crane Data publishes Money Fund Intelligence and produces the largest annual gathering of money market professionals in the world, Crane'​s Money Fund Symposium. (​We had 495 this past June in Boston.) Our next U.​S. Symposium is scheduled for June 24-​26, 2015 in Minneapolis, Minn., and our next "​basic training" event, Money Fund University is scheduled for January 22-​23, 2015, in Stamford, Conn. Note: Our 2015 European Money Fund Symposium is tentatively scheduled for Sept. 21-​22 in Dublin, Ireland, so mark your calendars.

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Crane Data released its August Money Fund Portfolio Holdings Monday, and our latest collection of taxable money market securities, with data as of July 31, 2014, shows a plunge in Repos, a drop in Treasuries, and a jump in Other securities (​Time Deposits), Agencies and CDs. Money market securities held by Taxable U.​S. money funds overall (​those tracked by Crane Data) decreased by $​6.​2 billion in July to $​2.​364 trillion. Portfolio assets decreased by $​18.​0 billion in June, $​3.​7 billion in May, $​39.​1 billion in April, and $​43.​0 billion in March. CDs again surpassed Repo as the largest portfolio composition segment among taxable money funds, followed by CP, then Treasuries, Agencies, Other (​Time Deposits), and VRDNs. Money funds' European-​affiliated holdings jumped to 30.​0% of holdings (​up sharply from 23.​5% last month), primarily due to a plunge in holdings of the NY Fed'​s RRP (​repo) program (​which replace dealer repo and TDs at quarter-​ends). Below, we review our latest Money Fund Portfolio Holdings statistics.

Among all taxable money funds, Repurchase agreement (​repo) holdings plummeted by $​83.​6 billion to $​507.​9 billion, or 21.​5% of fund assets, after rising $​76.​1 billion in June and $​32.​9 billion in May. (​Holdings of Federal Reserve Bank of New York repo fell by $​158.​5 billion to a record $​116.​0 billion.) Certificates of Deposit (​CDs) rebounded in July, increasing $​14.​2 billion to $​564.​9 billion, or 23.​9% of holdings. Commercial Paper (​CP), which rose to become the third largest segment, increased by $​12.​4 billion to $​375.​4 billion (​15.​9% of holdings). Treasury holdings, dropping to the fourth largest segment, decreased by $​22.​0 billion to $​368.​5 billion (​15.​6% of holdings). Government Agency Debt was up $​24.​7 billion. Agencies now total $​346.​8 billion (​14.​7% of assets). Other holdings, which include primarily Time Deposits, rebounded sharply (​up $​52.​8 billion) to $​173.​1 billion (​7.​3% of assets). VRDNs held by taxable funds decreased by $​4.​8 billion to $​27.​5 billion (​1.​2% of assets).

Among Prime money funds, CDs still represent over one-​third of holdings with 37.​7% (​up from 37.​2% a month ago), followed by Commercial Paper (​25.​0%, up from 24.​5%). The CP totals are primarily Financial Company CP (​15.​3% of holdings) with Asset-​Backed CP making up 5.​7% and Other CP (​non-​financial) making up 4.​1%. Prime funds also hold 6.​2% in Agencies (​up from 5.​4%), 3.​9% in Treasury Debt (​down from 4.​2%), 5.​4% in Other Instruments, and 5.​9% in Other Notes. Prime money fund holdings tracked by Crane Data total $​1.​499 trillion (​up from $​1.​481), or 63.​4% of taxable money fund holdings' total of $​2.​364 trillion.

Government fund portfolio assets totaled $​425.​6 billion, down from $​431.​6 billion last month, while Treasury money fund assets totaled $​439.​7 billion, down from from $​457.​7 billion at the end of June. Government money fund portfolios were made up of 59.​4% Agency securities, 25.​2% Government Agency Repo, 3.​6% Treasury debt, and 11.​2% Treasury Repo. Treasury money funds were comprised of 66.​9% Treasury debt and 32.​0% Treasury Repo.

European-​affiliated holdings increased $​150.​2 billion in July to $​708.​2 billion (​among all taxable funds and including repos); their share of holdings is now 30.​0%. Eurozone-​affiliated holdings also jumped (​down $​77.​5 billion) to $​401.​5 billion in July; they now account for 17.​0% of overall taxable money fund holdings. Asia & Pacific related holdings rose by $​3.​3 billion to $​294.​8 billion (​12.​5% of the total), while Americas related holdings decreased $​160.​1 billion to $​1.​360 trillion (​57.​5% of holdings).

The overall taxable fund Repo totals were made up of: Treasury Repurchase Agreements (down $​104.​1 billion to $​249.​4 billion, or 10.​6% of assets), Government Agency Repurchase Agreements (​up $​18.​0 billion to $​172.​2 billion, or 7.​3% of total holdings), and Other Repurchase Agreements (​up $​2.​6 billion to $​86.​3 billion, or 3.​7% of holdings). The Commercial Paper totals were comprised of Financial Company Commercial Paper (up $​15.​0 billion to $​229.​4 billion, or 9.​7% of assets), Asset Backed Commercial Paper (​down $​4.​4 billion to $​85.​1 billion, or 3.​6%), and Other Commercial Paper (​up $​1.​7 billion to $​60.​9 billion, or 2.​6%).

The 20 largest Issuers to taxable money market funds as of July 31, 2014, include: the US Treasury ($​368.​5 billion, or 15.​6%), Federal Home Loan Bank ($​217.​5B, 9.​2%), Federal Reserve Bank of New York ($​116.​0B, 4.​9%), Bank of Tokyo-​Mitsubishi UFJ Ltd ($​61.​8B, 2.​6%), BNP Paribas ($​59.​6B, 2.​5%), Credit Agricole ($​55.​7B, 2.​4%), Bank of Nova Scotia ($​55.​6B, 2.​4%), Wells Fargo ($​55.​0, 2.​3%), JP Morgan ($​54.​1B, 2.​3%), RBC ($​50.​6B, 2.​1%), Deutsche Bank AG ($​48.​8B, 2.​1%), Citi ($​47.​6B, 2.​0%), Federal Home Loan Mortgage Co ($​46.​7B, 2.​0%), Sumitomo Mitsui Banking Co ($​46.​1B, 2.​0%), Credit Suisse ($​45.​9B, 1.​9%), Barclays PLC ($​45.​6B, 1.​9%), Societe Generale ($​43.​9B, 1.​9%), Bank of America ($​43.​0B, 1.​8%), Federal National Mortgage Association ($​42.​4B, 1.​8%), and Toronto-​Dominion ($​39.​4B, 1.​7%).

In the repo space, Federal Reserve Bank of New York'​s RPP program issuance (​held by MMFs) remained the largest program (​even after its plunge) with 22.​9% of the repo market. The 10 largest Repo issuers (​dealers) (​with the amount of repo outstanding and market share among the money funds we track) include: Federal Reserve Bank of New York ($​116.​0B, 22.​9%), Deutsche Bank AG ($​38.​6B, 7.​6%), Societe Generale ($​35.​9B, 7.​1%), Bank of America ($​33.​9B, 6.​7%), BNP Paribas ($​31.​9B, 6.​3%), Barclays PLC ($​31.​0B, 6.​1%), Credit Agricole ($​24.​2B, 4.​8%), JP Morgan ($​24.​1B, 4.​8%), Credit Suisse ($​22.​1B, 4.​3%), and RBC ($​20.​5B, 4.​0%).

Crane Data shows 51 funds (​down from 82 last month) participating in the NY Fed repo program with just 2 money funds holding over $​7 billion (​the previous cap). The largest Fed repo holders include: Morgan Stanley Inst Liq Trs ($​9.​8B), Goldman Sachs FS Trs Obl Inst ($​8.​1B), Federated Trs Oblg ($​6.​0B), Western Asset Inst Lq Res ($​6.​0B), State Street Inst Lq Res ($​5.​9B), Morgan Stanley Inst Lq Gvt ($​5.​7B), Northern Trust Trs MMkt ($​5.​4B), and Dreyfus Tr&​Ag Cash Mgmt Inst ($​5.​2B).

The 10 largest CD issuers include: Sumitomo Mitsui Banking Co ($​39.​6B, 7.​1%), Bank of Tokyo-​Mitsubishi UFJ Ltd ($​38.​0B, 6.​8%), Bank of Nova Scotia ($​35.​0B, 6.​2%), Toronto-​Dominion Bank ($​33.​7B, 6.​0%), Wells Fargo ($​26.​0B, 4.​6%), Bank of Montreal ($​25.​9B, 4.​6%), Mizuho Corporate Bank Ltd ($​23.​7B, 4.​2%), Rabobank ($​22.​7B, 4.​0%), Citi ($​20.​8B, 3.​7%), and Natixis ($​19.​5B, 3.​5%).

The 10 largest CP issuers (​we include affiliated ABCP programs) include: JP Morgan ($​21.​7B, 6.​8%), Commonwealth Bank of Australia ($​16.​1B, 5.​0%), Westpac Banking Co ($​16.​1B, 5.​0%), Lloyds TSB Bank PLC ($​11.​5B, 3.​6%), RBC ($​11.​5B, 3.​6%), BNP Paribas ($​10.​7B, 3.​3%), Australia & New Zealand Banking Group ($​10.​0B, 3.​1%), HSBC ($​9.​7B, 3.​0%), FMS Wertmanagement ($​9.​2B, 2.​9%), and Caisse des Depots et Consignations ($​9.​1B, 2.​8%).

The largest increases among Issuers include: Deutsche Bank AG (​up $​21.​7B to $​48.​8B), Federal Home Loan Bank (​up $​21.​4B to $​217.​5B), DnB NOR Bank ASA (​up $​20.​0B to $​32.​3B), Societe Generale (​up $​20.​0B to $​43.​9B), Barclays PLC (​up $​15.​8B to $​45.​6B), and Credit Agricole (​up $​10.​7B to $​55.​7B). The largest decreases among Issuers of money market securities (​including Repo) in July were shown by: Federal Reserve Bank of New York (​down $​158.​5B to $​116.​0B), the US Treasury (​down $​22.​0B to $​368.​5B), Mizuho Corporate Bank Ltd. (​down $​2.​9B to $​30.​0B), ING Bank (​down $​1.​7B to $​26.​4B), and Bank of Montreal (​down $​1.​4B to $​28.​8B).

The United States remained the largest segment of country-​affiliations; it represents 48.​6% of holdings, or $​1.​149 trillion. France (​9.​7%, $​229.​4B) moved into second place ahead of Canada (​8.​8%, $​208.​6B). Japan (​7.​6%, $​180.​1B) remained the fourth largest country affiliated with money fund securities. The U.​K. (​4.​7%, $​111.​3B) moved up to fifth place, ahead of Sweden (​4.​2%, $​98.​3B) and Australia (​3.​7%, $​87.​4B). The Germany (​3.​5%, $​82.​7B) ranked 8th while Netherlands (​3.​0%, $​71.​2B) dropped to 9th place. Switzerland (​2.​7%, $​64.​4B) was tenth among country affiliations. (​Note: Crane Data attributes Treasury and Government repo to the dealer'​s parent country of origin, though money funds themselves "​look-​through" and consider these U.​S. government securities. All money market securities must be U.​S. dollar-​denominated.)

As of July 31, 2014, Taxable money funds held 24.​1% of their assets in securities maturing Overnight, and another 14.​4% maturing in 2-​7 days (​38.​5% total in 1-​7 days). Another 20.​2% matures in 8-​30 days, while 24.​4% matures in the 31-​90 day period. The next bucket, 91-​180 days, holds 12.​9% of taxable securities, and just 4.​1% matures beyond 180 days.

Crane Data'​s Taxable MF Portfolio Holdings (​and Money Fund Portfolio Laboratory) were updated Monday, and our MFI International "​offshore" Portfolio Holdings will be updated Thursday (​the Tax Exempt MF Holdings will be released Wednesday). Visit our Content center to download files or visit our Portfolio Laboratory to access our "​transparency" module. Contact us if you'​d like to see a sample of our latest Portfolio Holdings Reports or our new Reports Issuer Module.

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Perhaps the most controversial aspect of the SEC'​s Money Market Reforms is the provision that requires prime institutional money market funds to maintain a floating net asset value for sales and redemptions based on the current market value of the securities in their portfolios rounded to the fourth decimal place (​e.​g., $​1.​0000). The requirement, which would also apply to institutional municipal money market funds, would result in the daily share prices of MMFs fluctuating along with changes in the market-​based value of the funds' investments. The amendment would not have passed without an assurance from the IRS and the Department of Treasury for tax accounting relief. (​SEC Commissioner Gallagher said that he would have joined Commissioners Kara Stein and Michael Piwowar in opposition to the reforms if the tax accounting issues weren'​t addressed.) We take a closer look at what the Floating NAV means for investors.

The SEC explains the reasoning behind the Floating NAV. "​We considered the many reasons shareholders may engage in heavy redemptions from money market funds -- potentially resulting in the dilution of share value that the Investment Company Act'​s provisions are designed to avoid -- and have tailored today'​s final rules accordingly. In particular, while many investors may redeem because of concerns about liquidity, quality, or lack of transparency -- and our fees and gates, disclosure, and reporting reforms are primarily intended to address those incentives -- an incremental incentive to redeem is created by money market funds' current valuation and pricing methods. As discussed below, this incremental incentive to redeem exacerbates shareholder dilution in a stable NAV product because non-​redeeming shareholders are forced to absorb losses equal to the difference between the market-​based value of the fund'​s shares and the price at which redeeming shareholders transact."

They continue, "For the reasons discussed below, we believe that this incentive exists largely in prime money market funds because these funds exhibit higher credit risk that make declines in value more likely (​compared to government money market funds). We further believe history shows that, to date, institutional investors have been significantly more likely than retail investors to act on this incentive. Thus, given the tradeoffs involved in requiring that any money market fund transact at a floating NAV, we are limiting this reform (​and thus the repeal of the special exemptive relief allowing these funds to price other than as required under the Investment Company Act) to institutional prime funds.... One possible reason that institutional prime funds may be more susceptible to rapid heavy redemptions than retail funds is that their investors are often more sophisticated, have more significant money at stake, and may have a lower risk tolerance due to legal or other restrictions on their investment practices."

The objectives of the Floating NAV is: "(​1) to reduce the first mover advantage inherent in a stable NAV fund due to rule 2a-​7'​s current valuation and pricing methods by dis-​incentivizing redemption activity that can result from investors attempting to exploit the possibility of redeeming shares at the stable share price even if the portfolio has suffered a loss; and (​2) to reduce the chance of unfair investor dilution, which would be inconsistent with a core principle of the Investment Company Act. An additional motivation for this reform is that the floating NAV may make it more transparent to certain of the impacted investors that they, not the fund sponsors or the federal government, bear the risk of loss. Many commenters suggested that, among the reform alternatives proposed, the floating NAV reform is the most meaningful."

The SEC continues, "Under our reform, institutional prime money market funds will value their portfolio securities using market-​based factors and will sell and redeem shares based on a floating NAV. Under the final rules, and as we proposed, institutional prime funds will round prices and transact in fund shares to four decimal places in the case of a fund with a $​1.​00 target share price (​i.​e., $​1.​0000) or an equivalent or more precise level of accuracy for money market funds with a different share price (​e.​g., a money market fund with a $​10 target share price could price its shares at $​10.​000). Institutional prime money market funds will still be subject to the risk-​limiting conditions of rule 2a-​7. Accordingly, they will continue to be limited to investing in short-​term, high-​quality, dollar-​denominated instruments, but will not be able to use the amortized cost or penny rounding methods to maintain a stable value.... Although some commenters, including some sponsors of money market funds, expressed general support for the floating NAV reform as it was proposed, the majority of commenters generally opposed requiring institutional prime money market funds to implement a floating NAV."

On fund pricing, the final rule says, "Having determined to adopt the floating NAV reform for institutional prime funds, there is a separate (​albeit related) issue of how to price the shares for transactions. Today, for the reasons discussed previously in this section, we are amending rule 2a-​7 to eliminate the exemption that currently permits institutional prime funds to maintain a stable NAV through amortized cost valuation and/​or penny rounding pricing. We are also adopting, as proposed, an additional requirement that these money market funds value their portfolio assets and price fund shares by rounding the fund'​s current NAV to four decimal places in the case of a fund with a $​1.​0000 share price or an equivalent or more precise level of accuracy for money market funds with a different share price (​e.​g., a money market fund with a $​10 target share price could price its shares at $​10.​000). Accordingly, the final amendments change the rounding convention for money market funds that are required to adopt a floating NAV -- from penny rounding (​i.​e., to the nearest one percent) to "​basis point" rounding (​i.​e., to the nearest 1/​100th of one percent), which is a more precise standard than other mutual funds use today."

It tells us, "​In considering whether to require basis point rounding or, instead, to allow 10 basis point rounding, we have looked to the potential for price fluctuations under the two approaches. Based on our staff analysis of Form N-​MFP data between November 2010 and November 2013, 53% of money market funds have fluctuated in price over a twelve-​month period with a NAV priced using basis point rounding, compared with less than 5% of money market funds that would have fluctuated in price using 10 basis point rounding. We recognize that, either way, this limited fluctuation in prices is the result of the nature of money market fund portfolios, whose short duration and/​or high quality generally results in fluctuations in value primarily when there is a credit deterioration or other significant market event."

On basis point rounding it explains, "After considering the results of the staff'​s analysis, we are persuaded to require basis point rounding. We believe that some of the institutional investors in these funds may not appreciate the risk associated with money market funds. As for this subset of institutional investors, we believe that the basis point rounding requirement may accentuate the visibility of the risks in money market funds by causing these shareholders to experience gains and losses when the funds' value fluctuates by 1 basis point or more. We further believe this may, in turn, have two potential effects that are consistent with our overall goal of addressing features in money market funds that can make them susceptible to heavy redemption. First, to the extent that some of these investors become more aware of the risks, they may develop an increased risk tolerance that could help make them less prone to run. Second, by helping make the risk more apparent through periodic price fluctuations, basis point rounding may help signal to those investors who cannot tolerate the risk associated with the fluctuating NAV that they should migrate to other investment options, such as government funds."

Regarding intraday liquidity and same day settlement, some commenters expressed concern that intraday liquidity and/​or same-​day settlement would not be available to investors in floating NAV money market funds. "We believe that floating NAV money market funds should be able to continue to provide shareholders with intraday liquidity and same-​day settlement by pricing fund shares periodically during the day (​e.​g., at 11 a.​m. and 4 p.​m.).... We believe that many floating NAV money market funds will continue to be able to provide same-​day settlement. Second, we note that under the revised retail money market fund definition adopted today, retail investors should have ample opportunity to invest in a fund that qualifies as a retail money market fund and thus is able to maintain a stable NAV. As a result, this should significantly alleviate concerns about the costs of altering these features and permit a number of funds to continue to provide these features as they do today. Nonetheless, we recognize that not all funds with these features may choose to qualify as retail money market funds, and therefore, some funds may need to make additional modifications to continue offering these features."

In conclusion, the new rules add, "We are providing a two-​year compliance date (​as proposed) for money market funds to implement the floating NAV reform. A long compliance period will give more time for funds to implement any needed changes to their investment policies and train staff, and also will provide more time for investors to analyze their cash management strategies."

​

In our continuing in-​depth coverage of the SEC'​s Final Rules on Money Market Fund Reform, we take a closer look at the fees and gates provisions. Specifically, we examine the benefits, the impact on fund flows, the size of fees, when they should be imposed, and how often, among other things. Explains the final rules, "While we recognize that there is risk of pre-​emptive redemptions, the benefits of having effective tools in place to address runs and contagion risk leads us to adopt the proposed fees and gates reforms, with some modifications. We believe several of the changes we are making in our final reforms will mitigate this risk and dampen the effects on other money market funds and the broader markets if pre-​emptive redemptions do occur." (Note: Late Thursday, Fidelity Investments also published its most recent communication in a new "`​Regulatory Reform educational series," a piece entitled, "Redemption Restrictions for Money Market Mutual Funds: Liquidity Fees and Redemption Gates.")

On the impact of imposing as fee or gate, the SEC'​s final rule states, "​Commenters have suggested that once fees and gates are imposed, they may not be easily lifted without triggering a run. Similarly, other commenters warned that imposing a fee or gate would not help a fund recover from a crisis but rather force it into liquidation because investors would lose trust in the fund and seek to invest in a money market fund that has not imposed a fee or gate. We acknowledge that there is a risk that investors may redeem from a fund after a fee or gate is lifted. We believe this is less likely following the imposition of a fee, however, because investors will continue to have the ability to redeem while a fee is in place and, therefore, may experience less disruption and potentially less loss in trust. We think it is important to observe that whenever a fee or gate is imposed, the fund may already be under stress from heavy redemptions that are draining liquidity, and the purpose of the fees and gates amendments is to give the fund'​s board additional tools to address this external threat when the board determines that using one or both of the tools is in the fund'​s best interests.... Even if a fund ultimately liquidates, its disposition is likely to be more orderly and efficient if it previously imposed a fee or gate. In fact, imposing a fee or gate should give a fund more time to generate greater liquidity so that it will be able to liquidate with less harm to shareholders."

On the potential effects on liquidity, it states, "In our view, however, these reforms should not unreasonably impede the use of money market funds as liquid investments. First, under normal circumstances, when a fund'​s liquidity is not under stress, the fees and gates amendments will not affect money market funds or their shareholders. Fees and gates are tools for funds to use in times of severe market or internal stress. Second, even when a fund experiences stress, the fees and gates amendments we are adopting today do not require money market funds to impose fees and gates when it is not in the best interests of the fund."

How often will they be imposed? "​We believe gates (​as well as fees) will rarely be imposed in normal market conditions. In our view, in those likely rare situations where a gate would be imposed, investors would (​in the absence of the gating mechanism) potentially be left in worse shape if the fund were, for example, forced to engage in the sale of assets and thus incur permanent losses; or worse, if the fund were forced to liquidate because of a severe liquidity crisis. Thus, we believe that allowing fund boards to impose gates should not be viewed as detrimental to funds, but rather should be viewed as an interim measure boards can employ in worse case scenarios where the alternative would likely be a result potentially more detrimental to investors' overall interests.... While we recognize these commenter concerns regarding liquidity, we believe that the overall benefits and protections that are provided by the fees and gates amendments to all investors in these money market funds outweigh these concerns.... Moreover, to the extent an investor wants to invest in a money market fund without the possibility of fees and/​or gates, it may choose to invest in a government money market fund, which is not subject to the fees and gates requirements."

On flows out of money funds it states, "Some commenters expressed concern that the possibility of fees and gates being imposed could result in diminished investor appeal and/​or utility of affected money market funds, and could cause investors to either abandon or severely restrict use of affected money market funds. For example, commenters suggested that fees and gates would drive sweep account money out of money market funds. Commenters warned that fees and gates may cause investors to shift investments into other assets, government money market funds, FDIC-​insured accounts and other bank products, riskier and/​or less regulated investments, or other alternative stable value products. Conversely, other commenters predicted only minor effects on investor demand and/​or that investor demand would decrease less under the proposed fees and gates alternative than under the proposed floating NAV alternative. We recognize that, as suggested by certain commenters, our amendments could cause some shareholders to redeem their prime money market fund shares and move their assets to alternative products that do not have the ability to impose fees or gates because the potential imposition of a fee or gate could make investment in a money market fund less attractive due to less certain liquidity. We agree with one commenter that suggested it is difficult to estimate the extent to which assets might shift from prime funds to government funds or other alternatives."

The rules also commented on factors that a fund'​s board should consider when deciding whether or not to impose a fee or gate. "​The "​best interests" standard in today'​s amendments recognizes that each fund is different and that, once a fund'​s weekly liquid assets have dropped below the minimum required by rule 2a-​7, a fund'​s board is best suited, in consultation with the fund'​s adviser, to determine when and if a fee or gate is in the best interests of the fund.... We agree with the commenter who suggested an exclusive list of factors could be counter-​productive.... Instead, we believe a fund board should consider any factors it deems appropriate when determining whether fees and/​or gates are in the best interests of a fund. Nonetheless, we believe it is appropriate to provide certain guideposts that boards may want to keep in mind, as applicable and appropriate, when determining whether a fund should impose fees or gates and are providing such guidance in this Release.... These may include, but are not limited to: relevant indicators of liquidity stress in the markets and why the fund'​s weekly liquid assets have fallen (​e.​g., Have weekly liquid assets fallen because the fund is experiencing mounting redemptions during a time of market stress or because a few large shareholders unexpectedly redeemed shares for idiosyncratic reasons unrelated to current market conditions or the fund?); the liquidity profile of the fund and expectations as to how the profile might change in the immediate future, including any expectations as to how quickly a fund'​s liquidity may decline and whether the drop in weekly liquid assets is likely to be very short-​term (​e.​g., Will the decline in weekly liquid assets be cured in the next day or two when securities currently held in the fund'​s portfolio qualify as weekly liquid assets?); for retail and government money market funds, whether the fall in weekly liquid assets has been accompanied by a decline in the fund'​s shadow price; the make-​up of the fund'​s shareholder base and previous shareholder redemption patterns; and/​or the fund'​s experience, if any, with the imposition of fees and/​or gates in the past.... Other commenters proposed that boards should be permitted to reasonably determine and commit themselves in advance to a policy to not allow a fee or gate to ever be imposed on a fund. We disagree. A blanket decision on the part of a fund board to not impose fees or gates, without any knowledge or consideration of the particular circumstances of a fund at a given time, would be flatly inconsistent with the fees and gates amendments we are adopting today, which, at a minimum, require a fund to impose a liquidity fee when its weekly liquid assets have dropped below 10%, unless the fund'​s board affirmatively finds that such fee is not in the best interests of the fund."

Regarding the size of fees, the rules say, "Today'​s amendments will permit a money market fund to impose a discretionary liquidity fee of up to 2% after its weekly liquid assets drop below 30% of its total assets. We are also adopting a default liquidity fee of 1% that must be imposed if a fund drops below 10% weekly liquid assets, unless a fund'​s board determines not to impose such a fee, or to impose a lower or higher fee (​not to exceed 2%) because it is in the best interests of the fund. As proposed, the amendments would have required funds to impose a default liquidity fee of 2% after a fund'​s weekly liquid assets dropped below 15% of its total assets, although (​as under our final amendments) fund boards could have determined not to impose the fee or to lower the fee.... We note that fund boards should not consider our 1% default liquidity fee as creating the presumption that a liquidity fee should be 1%. If a fund board believes based on market liquidity costs at the time or otherwise that a liquidity fee is more appropriately set at a lower or higher (​up to 2%) level, it should consider doing so.... The amendments we are adopting today incorporate substantial flexibility for a fund board to determine when and how it imposes liquidity fees. As long as funds' weekly liquid assets are above the regulatory threshold (​i.​e. 30%), fund shareholders should continue to enjoy unfettered liquidity for money market fund shares. The likely limited and infrequent use of liquidity fees leads us to believe exemptions are generally unnecessary."

On the duration of gates and fees it says, "We are adopting, as proposed, a requirement that any fee or gate be lifted automatically once the fund'​s weekly liquid assets have risen to or above 30% of the fund'​s total assets. We are also adopting, with certain modifications from the proposal as discussed below, a requirement that a money market fund must lift any gate it imposes within 10 business days and that a fund cannot impose a gate for more than 10 business days in any 90-​day period.... We also recognize commenters' concerns regarding the application of fees and gates in the context of sweep accounts. We note that during normal market conditions, fees and gates should not impact sweep accounts' (​or any other investor'​s) investment in a money market fund. We also note that, unlike our proposal, the amendments we are adopting today will allow a fund boards to institute a fee or gate at any time of the days. To the extent a sweep account'​s daily investment is made at the end of the day, we believe this change should reduce concerns that the sweep account holder will find out about a redemption restriction only after it has made its daily investment and may lessen the difficulty and costs related to developing a trading system that can ensure an account has sufficient funds to cover the trade itself plus the possibility of a liquidity fee."

Finally, the SEC writes, "We believe the floating NAV requirement may encourage those investors who are least able to bear risk of loss to redirect their investments to other investment opportunities (​e.​g., government money market funds), and this may have the secondary effect of removing from the funds those investors most prone to redeem should a liquidity event occur for which fees or gates could be imposed."

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The August issue of Crane Data'​s Money Fund Intelligence was sent out to subscribers on Thursday. (Sorry about the delay; we had some e-​mail issues Thursday.) The latest edition of our flagship monthly newsletter features the articles: "SEC Passes MMF Reform on Split Vote: Combo is Coming," which discusses the adoption of money market fund reforms by a count of 3-​2; "Chair White'​s Statement on New MMF Reforms," which excerpts SEC Chair Mary Jo White'​s discussion of the reforms; and, "Modest Outflows Expected from Reforms; 3 Questions," which examines the implications of the MMF reforms on fund flows. We also updated our Money Fund Wisdom database query system with July 31, 2014, performance statistics and rankings late last night, and we also sent out our MFI XLS spreadsheet this a.​m. (MFI, MFI XLS and our Crane Index products are available to subscribers at our Content center.) Our July 31 Money Fund Portfolio Holdings data are scheduled to go out on Monday, August 11.

The latest MFI newsletter'​s lead article comments, "By a vote of 3-​2, the SEC adopted long-​awaited and much discussed reforms for the $​2.​6 trillion money market industry on July 23rd. "​The amendments make structural and operational reforms to address risks of investor runs in money market funds, while preserving the benefits of the funds," stated the SEC in a press release. We distill the SEC'​s 869-​page reform proposal down to the highlights. Chair Mary Jo White, along with Commissioners Luis Aguilar and Daniel Gallagher, voted in favor of the reform package. Commissioners Kara Stein and Michael Piwowar voted in opposition. Here'​s what they adopted."

The article explains, "Floating NAV -- Institutional Prime MMFs (​including Inst Muni MMFs) are required to maintain a floating net asset value for sales and redemptions based on the current market value of the securities in their portfolios rounded to the fourth decimal place. The requirement would result in the daily share prices of the money market funds fluctuating along with changes in the market-​based value of the funds' investments. These funds no longer will be allowed to use the special pricing and valuation conventions that currently permit them to maintain a constant share price of $​1.​00. Also, the U.​S. Dept. of ​the Treasury and the IRS proposed new regulations to allow floating NAV MMF investors to use a simplified tax accounting method to track gains and losses."

Our monthly "​profile" says, "At the Open Meeting of the Securities and Exchange Commission on July 23, the SEC voted to adopt its proposal to reform money market funds. Here are excerpts from Chair White'​s statement." White said: "Today'​s reforms will fundamentally change the way that most money market funds operate. They will reduce the risk of runs in money market funds and provide important new tools that will help further protect investors and the financial system in a crisis. ​Together, this strong reform package will make our financial system more resilient and enhance the transparency and fairness of these products for America'​s investors."

She continued, "Over the last several decades, money market funds have become a critical part of the American economy, providing an important source of short-​term financing for issuers, including American businesses, state and local governments, and other market participants. ​Today, nearly $​3 trillion is invested in money market funds, much of it in institutional prime funds held by investors such as pension funds and corporations. ​Issuers and investors now rely daily on money market funds, and the benefits of such funds are significant."

The August MFI article on `​Modest Outflows Expected from Reforms; 3 Questions asks, "How much money could leave Prime Institutional money funds? How likely is a 30% (​or 10%) liquidity buffer breach (​and how likely will boards be to use gates and fees at these points)? Will the floating NAV actually float? These are what we see as the 3 most important questions fund companies and investors are asking as the money fund industry begins preparing for the SEC'​s Money Fund Reforms in August 2016. We examine these below."

Crane Data'​s August MFI with July 31, 2014, data shows total assets decreasing by $​19.​8 billion (​after decreasing by $​13.​4 billion in June, rising $​10.​9 billion in May, and falling by $​59.​5 billion in April) to $​2.​461 trillion (​1,​238 funds, 10 fewer than last month). Our broad Crane Money Fund Average 7-​Day Yield and 30-​Day Yield remained at a record low 0.​01% while our Crane 100 Money Fund Index (​the 100 largest taxable funds) yielded 0.​02% (​7-​day and 30-​day). On a Gross Yield Basis (​before expenses were taken out), funds averaged 0.​13% (​Crane MFA, unchanged) and 0.​16% (​Crane 100) on an annualized basis for both the 7-​day and 30-​day yield averages. (Charged Expenses averaged 0.​12% and 0.​14% for the two main taxable averages.) The average WAM for the Crane MFA and the Crane 100 were 42 and 45 days, respectively, increasing 1 day from the prior month for the Crane 100. (​See our Crane Index or craneindexes.​xlsx history file for more on our averages.)

Finally, the final agenda was sent out to subscribers for our European Money Fund Symposium, which will take place Sept. 22-​23 in London at the Hilton London Tower Bridge. Though there has been no word from European regulators and the newly elected European Parlaiment has yet to even commence, we expect them to eventually craft legislation similar to the SEC'​s. This will be a main topic of discussion at Euro MFS, along with other issues impacting Euro, Sterling, USD and "​offshore" money market funds domiciled in Dublin, Luxembourg and other European and global financial centers.

​

As we'​ve mentioned in our News coverage over the past 2 weeks, the SEC included a host of enhanced disclosures and reporting requirements in its Money Fund Reform package, adopted July 23. The new rules, when they go into effect 18 months from this month (​the rules have yet to be published in the Federal Register, so the effective date has not been set yet), will require funds to disclose daily on their web site daily and weekly assets, inflows/​outflow, and market NAVs per share, as well as whether there has been any imposition of gates and fees, or any use of affiliate sponsor support. It will also remove the delay in disclosing monthly portfolio holdings via Form N-​MFP, among other stipulations. Thankfully, the SEC pared back its exhaustive list of new disclosures from its 2013 proposal, though the list is still extensive. Below, we take a closer look at the disclosure requirements straight from the SEC'​s 869-​page Money Market Fund Reform Final Rules. (​See the SEC'​s "​Money Market Funds" page here too.)

A summary of the "Amendments to Disclosure Requirements" (​starting on page 281) says, "​We are amending a number of disclosure requirements related to the liquidity fees and gates and floating NAV requirements adopted today, as well as other disclosure enhancements discussed in the proposal. These disclosure amendments improve transparency related to money market funds' operations, as well as their overall risk profile and any use of affiliate financial support. In the sections that follow, we first discuss amendments to rule and form provisions applicable to various disclosure documents, including disclosures in money market funds' advertisements, the summary section of the prospectus, and the statement of additional information ("​SAI"). Next, we discuss amendments to the disclosure requirements applicable to money market fund websites, including information about money market funds' liquidity levels, shareholder flows, market-​based NAV per share (​rounded to four decimal places), imposition of liquidity fees and gates, and any use of affiliate sponsor support."

On revising the disclosure statements it says, "​We are adopting amendments to rule 482 under the Securities Act and Item 4 of Form N-​1A to revise the disclosure statement requirements concerning the risks of investing in a money market fund in its advertisements or other sales materials that it disseminates (​including on the fund website) and in the summary section of its prospectus (​and, accordingly, in any summary prospectus, if used).... We believe that enhancing the disclosure required to be included in fund advertisements and other sales materials, and in the summary section of the prospectus, will help change the investment expectations of money market fund investors, including any erroneous expectation that a money market fund is a riskless investment. In addition, without such modifications, we believe that investors may not be fully aware of potential restrictions on fund redemptions or, for floating NAV funds, the fact that the value of their money market fund shares will, as a result of these reforms, increase and decrease as a result of the changes in the value of the underlying securities."

Money markets that maintain a stable NAV must include the following statement in their advertisements, sales materials, and in the summary section of the prospectus: "You could lose money by investing in the Fund. Although the Fund seeks to preserve the value of your investment at $​1.​00 per share, it cannot guarantee it will do so. The Fund may impose a fee upon the sale of your shares or may temporarily suspend your ability to sell shares if the Fund'​s liquidity falls below required minimums because of market conditions or other factors. An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Fund'​s sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time." Funds with a floating NAV will be required to replace the second sentence of the above statement with: "Because the share price of the Fund will fluctuate, when you sell your shares they may be worth more or less than what you originally paid for them."

The Amendments also provide guidelines on the additional disclosures in the SAI or prospectus. "​We anticipate that funds generally would consider the following disclosure to be appropriate for the prospectus, as disclosure regarding redemption restrictions provided in response to Item 11(​c)(​1) of Form N-​1A: (​i) means of notifying shareholders about the imposition and lifting of fees and/​or gates (​e.​g., press release, website announcement); (​ii) timing of the imposition and lifting of fees and gates, including (​a) an explanation that if a fund'​s weekly liquid assets fall below 10% of its total assets at the end of any business day, the next business day it must impose a 1% liquidity fee on shareholder redemptions unless the fund'​s board of directors determines that doing otherwise is in the best interests of the fund, (​b) an explanation that if a fund'​s weekly liquid assets fall below 30% of its total assets, it may impose fees or gates as early as the same day, and (​c) an explanation of the 10 business day limit for imposing gates."

Further, it adds, "The DERA Study analyzed the distribution of weekly liquid assets and found that 83 prime funds per year, corresponding to 2.​7% of the prime funds' weekly liquid asset observations, saw the percentage of their total assets that were invested in weekly liquid assets fall below 30%. The DERA Study further showed that less than one (​0.​6) fund per year, corresponding to 0.​01% of the prime funds' weekly liquid asset observations, experienced a decline of total assets that were invested in weekly liquid assets to below 10%. Of those 83 funds that reported a percentage of total assets invested in weekly liquid assets below 30%, it is unclear how many, if any, would have attempted to keep the percentage of their total assets invested in weekly liquid assets at or above 30% to avoid having to report this information on their SAI (​assuming they were to impose, at their board'​s discretion, a liquidity fee or gate)."

On website disclosure, the final rules read: "We are adopting, as proposed, amendments to rule 2a-​7 that require money market funds to disclose prominently on their websites the percentage of the fund'​s total assets that are invested in daily and weekly liquid assets, as of the end of each business day during the preceding six months. The amendments we are adopting would require, as proposed, a fund to maintain a schedule, chart, graph, or other depiction on its website showing historical information about its investments in daily liquid assets and weekly liquid assets for the previous six months, and would require the fund to update this historical information each business day, as of the end of the preceding business day."

The SEC explains, "We believe that daily disclosure of weekly liquid assets and daily liquid assets ultimately benefits investors and could both increase stability and decrease risk in the financial markets. As mentioned above, while there is a potential for heavy redemptions in response to a decrease in liquidity, the increased transparency could reduce run risk in cases where it shows investors that a fund has sufficient liquidity to withstand market stress events. We also agree with commenters and believe that daily disclosure will increase market discipline, which could ultimately deter situations that could lead to heavy redemptions.... Finally, we note that several funds have already voluntarily begun disclosing liquidity information on their websites."

The SEC is also requiring funds to disclose "​prominently on their websites" the fund'​s "​daily net inflows or outflows as well as the fund'​s current NAV per share (​calculated based on current market factors), rounded to the fourth decimal place in the case of a fund with a $​1.​0000 share price or an equivalent level of accuracy for funds with a different share price (​the fund'​s "​current NAV") as of the end of the previous business day during the preceding six months."

Regarding the new Form N-​MFP Reporting Requirements, the rules state, "​We are requiring the reporting of certain new information that will be useful for our oversight of money market funds.... We are not changing the requirement that funds continue to file reports on Form N-​MFP once each month (​as they do today), but are adopting a requirement that certain limited information (​such as the NAV per share, liquidity levels, and shareholder flow) be reported on a weekly basis within the monthly filing.... We are also adopting, with some changes in response to comments, certain amendments to Form N-​MFP'​s investment categories for portfolio securities.... We have revised the final investment categories to better align the categories with typical industry categorizations and provide a more precise description of fund investments."

The investment SEC'​s revised categories will include the following selections: "​U.​S. Treasury Debt; U.​S. Government Agency Debt; Non-​U.​S. Sovereign, Sub-​Sovereign and Supra-​National debt; Certificate of Deposit; Non-​Negotiable Time Deposit; Variable Rate Demand Note; Other Municipal Security; Asset Backed Commercial Paper; Other Asset Backed Securities; U.​S. Treasury Repurchase Agreement, if collateralized only by U.​S. Treasuries (​including Strips) and cash; U.​S. Government Agency Repurchase Agreement, collateralized only by U.​S. Government Agency securities, U.​S. Treasuries, and cash; Other Repurchase Agreement, if any collateral falls outside Treasury, Government Agency and cash; Insurance Company Funding Agreement; Investment Company; Financial Company Commercial Paper; Non-​Financial Company Commercial Paper; or Tender Option Bond. If Other Instrument, include a brief description."

Note that Crane Data will revise its Money Fund Portfolio Holdings collection to reflect the new categories once funds begin using the new scheme. (​The main change is the addition of "​Time Deposits", though we will also utilize more of the Form N-​MFP data instead of the website disclosures once the time lag on the former is removed.) We also will continue publishing the "Market NAV" or MNAV in our Money Fund Intelligence Daily, and this will switch to a live NAV for Prime Institutional funds. We will be adding Daily and Weekly Liquidity statistics to MFI Daily as they become available. (​Currently, only a handful of funds publish these, but we will add the fields in coming weeks. We currently offer Daily and % Maturing in 7 Days fiellds, as well as percentages in Treasury and Govt agency securities, in our monthly `​MFI XLS.)

​

As part of its July 23rd Money Market Fund Reform package, the SEC re-​proposed amendments for the "​Removal of Certain References to Credit Ratings" which would eliminate the credit ratings requirements for money market funds. The biggest change is the SEC eliminating its "​First Tier" and "​Second Tier" definitions and replacing these with a single but more amorphous "​minimal credit risk" standard. The proposals are open to a 60-​day comment period (​once they'​re published in the Federal Register), and comments may be submitted to rule-​comments@​sec.​gov (​include File Number S7-​07-​11 on the subject line). Below, we take a deeper dive into the proposal, which is posted on the SEC'​s web site. We believe these proposed changes should have little impact on fund'​s current investment policies (​once finalized and implemented), but we believe they will reduce even further the already mimimal amount of "​Second Tier" securities purchased by money funds. Note that the SEC'​s proposal only involved mandates for the ratings of money market securities, and does not involve or impact triple-​A ratings on money market funds (​which will still be permitted).

According to the proposed new rules, a money market fund could invest in a security "​only if the fund'​s board of directors (​or its delegate) determines that it presents minimal credit risks, and that determination would require the board of directors to find that the security'​s issuer has an exceptionally strong capacity to meet its short-​term obligations," states the SEC'​s money market reform press release. They also proposed amendments to Form N-​MFP. "Currently money market funds report their portfolio holdings and other information to the Commission each month on Form N-​MFP, including certain credit ratings assigned to each portfolio security. The re-​proposed amendments to Form N-​MFP would require that a money market fund disclose any credit rating that the fund'​s board considered in determining that a portfolio security presents minimal credit risk," says the release.

The Proposal'​s summary says: "The Securities and Exchange Commission is re-​proposing certain amendments, initially proposed in March 2011, related to the removal of credit rating references in rule 2a-​7, the principal rule that governs money market funds, and Form N-​MFP, the form that money market funds use to report information to the Commission each month about their portfolio holdings, under the Investment Company Act of 1940. The re-​proposed amendments would implement provisions of the Dodd-​Frank Wall Street Reform and Consumer Protection Act. We are issuing this re-​proposal in consideration of comments received on our March 2011 proposal. In addition, we are proposing to amend rule 2a-​7'​s issuer diversification provisions to eliminate an exclusion from these provisions that is currently available for securities subject to a guarantee issued by a non-​controlled person."

Here'​s some background on the amendments. The SEC writes, "Section 939A of the Dodd-​Frank Act requires each federal agency, including the Commission, to "​review any regulation issued by such agency that requires the use of an assessment of the credit-​worthiness of a security or money market instrument and any references to or requirements in such regulations regarding credit ratings." That section further provides that each such agency shall "​modify any such regulations identified by the review ... to remove any reference to or requirement of reliance on credit ratings and to substitute in such regulations such standard of credit-​worthiness as each respective agency shall determine as appropriate for such regulations.""

The proposal explains, "As a step toward implementing these mandates, in March 2011 we proposed to replace references to credit ratings issued by nationally recognized statistical rating agencies ("​NRSROs") in two rules and four forms under the Securities Act of 1933 and the Investment Company Act, including rule 2a-​7 and Form N-​MFP under the Investment Company Act The 2011 proposal preceded other amendments to rule 2a-​7 and Form N-​MFP that we proposed last year as part of our broader efforts to reform money market funds. At that time, we noted that we were not rescinding our 2011 proposal to remove ratings references from certain rules and forms under the Investment Company Act, but that we intended to address the matter at another time."

The Proposal adds, "We received several comments on the 2013 Money Market Fund Proposing Release suggesting that we act on credit ratings as part of our broader money market fund reforms. And today in another release, we have adopted certain amendments to rule 2a-​7 and Form N-​MFP that we proposed last year. We also received comments on the 2011 Proposing Release that raised a number of concerns with respect to the proposed amendments and suggested alternative rule text for some provisions. We have determined to re-​propose amendments to replace references to credit ratings in rule 2a-​7 and to modify provisions in Form N-​MFP that reference credit ratings, in consideration of the mandate of Dodd-​Frank Act section 939A, the comments on the 2011 Proposing Release, and the broader money market fund reforms we have adopted today."

It continues, "Rule 2a-​7 contains "​risk limiting" provisions designed to minimize the amount of risk a money market fund may assume.... Among these conditions, rule 2a-​7 limits a money market fund'​s portfolio investments to "eligible securities," or securities that have received credit ratings from the "requisite NRSROs" in one of the two highest short-​term rating categories or comparable unrated securities.... Rule 2a-​7 further restricts money market funds to securities that the fund'​s board of directors (​or the board'​s delegate) determines present minimal credit risks, and specifically requires that determination "​be based on factors pertaining to credit quality in addition to any ratings assigned to such securities by an NRSRO." A money market fund is required to invest at least 97 percent of its total assets in eligible securities that have received a rating from the requisite NRSROs in the highest short-​term rating category for debt securities ("​first tier securities") or unrated securities of comparable quality."

It outlines the details of the proposal. "​To implement the mandate of Dodd-​Frank Act section 939A, we are re-​proposing amendments to remove references to credit ratings in rule 2a-​7. The re-​proposed amendments would affect five elements of the rule: (​i) determination of whether a security is an eligible security; (​ii) determination of whether a security is a first tier security; (​iii) credit quality. The re-​proposed amendments to rule 2a-​7 reflect our consideration of commenters' concerns and suggested modifications to our 2011 proposal, as well as the broader money market fund reforms we have adopted today. These re-​proposed amendments are designed to remove references to, or requirement of reliance on, credit ratings in rule 2a-​7 and to substitute standards of creditworthiness that we believe are appropriate."

Further, it states: "​After consideration of the comments and the statutory directive to eliminate references to ratings in our rules, and to seek consistent standards of creditworthiness to the extent feasible, we are re-​proposing amendments to rule 2a-​7. The re-​proposal would combine the two risk criteria into a single standard, which would be included as part of rule 2a-​7'​s definition of eligible security. As re-​proposed, an eligible security would be a security with a remaining maturity of 397 calendar days or less that the fund'​s board of directors (​or its delegate) determines presents minimal credit risks, which determination includes a finding that the security'​s issuer has an exceptionally strong capacity to meet its short-​term obligations."

"Thus, under our re-​proposal, a money market fund would be limited to investing in securities that the fund'​s board (​or its delegate) has determined present minimal credit risks, notwithstanding any rating the security may have received. In addition, fund boards would no longer be required to designate NRSROs. The re-​proposed determination is designed to retain a degree of credit risk similar to that in the current rule by allowing for gradations in credit quality among securities that meet a very high standard of credit quality, while limiting a money market fund'​s investments in second tier securities to those the fund determines do not diminish the overall high quality of the fund'​s portfolio. As a result of the single standard and elimination of the distinction between first and second tier securities we are re-​proposing, we also are re-​proposing to remove the current prohibition on funds investing more than 3 percent of their portfolios in second tier securities."

On second tier securities, it states, "By eliminating the rule'​s current limitations on investments in second tier securities, funds theoretically could invest in second tier securities to a greater extent than permitted today. The re-​proposed standard, however, is designed to preserve the current degree of risk limitation in rule 2a-​7 without reference to credit ratings by requiring a fund'​s board (​or its delegate) to determine that the issuer of a portfolio security has an exceptionally strong capacity to meet its short-​term obligations, a finding that some boards or fund advisers may determine can be met by second tier rated securities (​but only of the highest quality).... We request comment on consolidating the credit quality standard and eliminating the distinction between first and second tier securities. Do commenters believe that the re-​proposed standard is an appropriate standard of creditworthiness for rule 2a-​7?"

On stress testing it says, "​Our re-​proposed stress testing amendments would require that money market funds stress test for an event indicating or evidencing credit deterioration of particular portfolio security positions, each representing various exposures in a fund'​s portfolio." Finally, regarding Form N-​MFP it proposes, "​We have carefully considered these comments and are re-​proposing instead to require that each money market fund disclose, for each portfolio security, (​i) each rating assigned by any NRSRO if the fund or its adviser subscribes to that NRSRO'​s services, as well as the name of the agency providing the rating, and (​ii) any other NRSRO rating that the fund'​s board of directors (​or its delegate) considered in making its minimal credit risk determination, as well as the name of the agency providing the rating." The anticipated compliance date for these new rules is 18 months after the reforms are effective.

​

The U.​S. Treasury'​s Financial Stability Oversight Council met late last week to discuss the SEC'​s recent money fund reforms, and indicated that they won'​t act until they'​ve had a chance to monitor the impact, which would be well over two years from now. FSOC'​s release states, "​During the meeting, the Council discussed its ongoing assessment of potential industry-​wide and firm-​specific risks to U.​S. financial stability arising from the asset management industry and its activities. The Council directed staff to undertake a more focused analysis of industry-​wide products and activities to assess potential risks associated with the asset management industry. The Council also discussed the Securities and Exchange Commission'​s (​SEC'​s) final rule on money market mutual fund (​MMF) reform. The Council recognizes the SEC'​s work to adopt a significant set of structural reforms of MMFs, in particular a floating net asset value (​NAV) for institutional prime MMFs. These structural reforms, along with enhanced transparency and diversification requirements as well as strengthened rules for government MMFs, are intended to reduce the risks to financial stability posed by MMFs."

The release continues, "​Since the financial crisis, MMFs have represented an unaddressed source of risk to the financial system. MMFs proved susceptible to destabilizing runs that necessitated extraordinary government support during the financial crisis. Since then, the Council has highlighted this risk and recommended that the SEC undertake structural reforms of MMFs. In 2012, the Council used its authority under Section 120 of the Dodd-​Frank Wall Street Reform and Consumer Protection Act (​Dodd-​Frank Act) to propose specific recommendations to the SEC for reform. The SEC proposed reforms in 2013 and adopted them last week. While not proceeding at this time to a final Section 120 recommendation, the Council intends to monitor the effectiveness of the SEC'​s reforms in addressing risks to financial stability. In particular, the Council believes it will be important to better understand any unintended consequences of liquidity fees and gates, as well as the treatment of retail funds."

The FSOC statement adds, "After these measures have been implemented, the Council will report on the effects of these reforms and their broader implications for financial stability. During the meeting, the Council continued its discussion of nonbank financial company designations under section 113 of the Dodd-​Frank Act. Consistent with the Council'​s rule and guidance, the Council will not name any company under review in this process until a final designation has been made. This discussion also included an annual review of two nonbank financial companies designated in July of 2013, American International Group, Inc., and General Electric Capital Corporation. The Council did not rescind either company'​s designation."

FSOC also release the minutes from its June 24, FSOC meeting, where the Council discussed "Short-​term Wholesale Funding Markets. The minutes state, "​The Chairperson introduced the first agenda item, a presentation on risks in short-​term wholesale funding markets. He introduced Mark Van Der Weide, Deputy Director of the Division of Banking Supervision and Regulation at the Federal Reserve, and Susan McLaughlin, Senior Vice President at the Federal Reserve Bank of New York. Mr. Van Der Weide discussed certain reforms to date, including increased bank capital requirements, reduction of liquidity risk in the banking system, and efforts to reduce structural risks in the market through tri-​party repo reforms. With respect to tri-​party repo reforms, he noted that although much has been accomplished, significant risks remain for potential fire sales of collateral held by lenders in the event of a large dealer default. He then discussed regulatory options to reduce residual risks by discouraging reliance on short-​term wholesale funding and reducing lenders’ incentives to run. Ms. McLaughlin then discussed global and national initiatives to collect data to monitor securities financing transactions. After the presentation, members of the Council asked questions and had a discussion about topics including the global nature of the risks identified, the potential timing for implementing regulatory reforms, and proposed money market mutual fund reforms."

The Wall Street Journal wrote about FSOC on Friday, "Asset Managers Notch an '​Important' Win." Writes Andrew Ackerman: "After months of lobbying, large asset managers such as BlackRock Inc. and Fidelity Investments won a battle in their fight against tighter regulation Thursday. A panel of top financial regulators agreed to revamp their review of asset-​management firms to focus on potentially risky products and activities rather than individual firms. The shift by the Financial Stability Oversight Council lessens the likelihood individual asset managers will be labeled "​systemically important" -- a designation that would draw them in for greater oversight by the Federal Reserve."

In other news, Fitch Ratings says that SEC money fund regulations "​represent a dramatic overhaul for the liquidity management industry." According to a Fitch report, "the operational changes necessary to continue using institutional prime and municipal money funds will likely prove too burdensome for many users of NAV-​money funds, which are heavily represented by corporate and public sector cash managers. In surveys conducted by both Treasury Strategies and the Association for Financial Professionals, a majority of cash investors who use money funds have indicated that they will stop using, or reduce usage, of money funds with a floating NAV. Many investors in institutional prime and municipal money funds are expected move cash into government money funds exempt from the new rules, and/​or bank deposits, assuming there is capacity to absorb the inflows. Corporate and public sector cash managers will likely also explore alternative liquidity management options like separately managed accounts, or increase their direct investments in the short-​term markets."

Adds Fitch, "Many institutional investors will need to re-​examine and update their written investment policies to be able to use the new money fund structures or access alternative liquidity management solutions.... For example, some policies specifically dictate that money funds must have a stable NAV, and corporations and municipalities will have to determine whether they would be comfortable investing cash in a floating NAV fund. In addition, fund managers are expected to introduce new liquidity products, but these may need to be added as approved investments to treasurers' policies."

The reforms will also create problems for local government investment pools (​LGIPs), states Fitch in a July 31st release. "The SEC'​s reforms could mean that many LGIPs will no longer be able to price their shares at a stable $​1.​00 net asset value (​NAV) as they have done in the past. Potential changes to the way LGIPs operate as a function of the new rules could also impact investors. Many LGIPs are "​money market fund-​like" investment pools that are required by state law, and under generally accepted accounting principles to operate consistently with the Securities and Exchange Commission rule governing money market funds (​Rule 2a-​7)."

Fitch continues, "LGIPs are governed by the Governmental Accounting Standards Board (​GASB), which allows LGIPs to use amortized cost as long as their policies and operations are consistent with Rule 2a-​7. However, given the SEC'​s new rules, it is unclear whether LGIPs will now need to adopt floating NAVs if they invest in nongovernment securities (​including municipal securities). GASB is aware of the ambiguity and has identified it as an agenda item to address in 2014, although LGIPs will remain in limbo while new rules are being written. Subject to GASB'​s interpretation, it'​s possible that LGIPs could continue to offer stable NAVs and maintain amortized cost accounting by investing in government and agency securities. However, while LGIPs generally operate with low expense ratios, investing exclusively in government securities may not cover operating expenses for the pool. Finally, the costs of making changes to systems and operations to comply with a floating NAV, as well as fees and gates, may also be prohibitive for LGIPs run by municipalities."

Further, Fitch states, "We believe that the new rules also create uncertainty for LGIP investors, whether captive or voluntary, because of the potential changes to LGIP structures. Captive investors are typically required by state law to invest in LGIPs, and in some cases specifically in those that transact at a stable NAV. Absent statutory or accounting relief, this change will leave some municipalities with limited or no alternative cash management options. For example, there is limited appetite from banks to accept institutional deposits given changes to bank regulations. Voluntary LGIP participants may elect to invest their cash elsewhere, but have historically favored LGIPs as a low-​cost investment alternative."

They add, "​Moreover, municipal treasurers' investment policies will need to be updated to account for the change to floating from stable NAV, a potentially time-​intensive endeavor. While investment policies are usually updated on a yearly basis, this can be a complicated and costly process that will require a careful, strategic approach. We understand many investors have been waiting for clarity on the new regulations before making investment policy changes. The SEC set the implementation period for the main aspects of reform at two years, giving LGIP managers and participants time to adjust to the new rules. However, while private sector money fund managers and their clients can begin to respond to the new regulatory regime, LGIPs and their investors must still wait for guidance from GASB or statutory authorities. Without further guidance from various constituents, LGIPs are unable to make the necessary changes, causing uncertainty in the near term."

​

On Wednesday, ICI released its latest "Trends in Mutual Fund Investing, June 2014," which tells us that total money fund assets decreased by $​17 billion in June to $​2.​56 trillion after increasing $​3.​8 billion in May, decreasing $​57.​9 billion in April, and dropping $​29.​6 billion in March. For the 12 months through 6/​30/​14, ICI'​s monthly series shows assets down by $​23.​3 billion, or 0.​7%. Month-​to-​date through July 30, money fund assets have declined by $​11.​4 billion, but Prime Institutional assets, which are the most impacted by the SEC'​s recent Money Market Fund Reforms have increased by $​3.​0 billion in July, according to Crane'​s Money Fund Intelligence Daily. (​In the week since the SEC adopted reforms, total money fund assets are down $​6.​3 billion. But Prime Institutional Money Funds increased by $​736 million over the last 7 days and by $​1.​9 billion on Wednesday.) Below, we review ICI'​s latest monthly and weekly assets survey, as well as their June Portfolio Composition totals.

ICI'​s June "​Trends" says, "The combined assets of the nation'​s mutual funds increased by $​221.​08 billion, or 1.​4 percent, to $​15.​67 trillion in June, according to the Investment Company Institute'​s official survey of the mutual fund industry. In the survey, mutual fund companies report actual assets, sales, and redemptions to ICI.... Bond funds had an inflow of $​10.​6 billion in June, compared with an inflow of $​11.​1 billion in May. Taxable bond funds had an inflow of $​8.​3 billion in June, versus an inflow of $​7.​6 billion in May. Municipal bond funds had an inflow of $​2.​3 billion in June compared to an inflow of $​3.​5 billion in May."

It adds, "Money market funds had an outflow of $​17.​15 billion in June, compared with an inflow of $​3.​19 billion in May. Funds offered primarily to institutions had an outflow of $​4.​59 billion. Funds offered primarily to individuals had an outflow of $​12.​56 billion." Money funds represent 16.​3% of all mutual fund assets while bond funds represent 22.​0%.

ICI'​s latest weekly "​Money Market Fund Assets" release says, "Total money market fund assets decreased by $​8.​79 billion to $​2.​55 trillion for the week ended Wednesday, July 30, the Investment Company Institute reported today. Among taxable money market funds, Treasury funds (​including agency and repo) decreased by $​6.​58 billion and prime funds decreased by $​870 million. Tax-​exempt money market funds decreased by $​1.​34 billion." Note that ICI'​s weekly survey shows Prime Institutional funds flat, down a mere $​110 million (​compared to Crane Data'​s numbers cited above, which showed a slight increase).

ICI also released its latest "Month-​End Portfolio Holdings of Taxable Money Funds," which verified our reported jump in Repo and plunge in CDs in June. (​See Crane Data'​s July 14 News, "July MF Holdings Show Jump in Fed Repo; CD, TD Drop; Europe Plunges.") ICI'​s latest Portfolio Holdings summary shows that Holdings of Repos rose by $​63.​9 billion, or 12.​5%, (​after rising $​33.​5 billion in May, plunging $​38.​4 billion in April, and jumping by $​41.​7 billion in March) to $​573.​4 billion (​24.​9% of assets). Repo became the largest segment of taxable money fund portfolio holdings in June, bumping Certificates of Deposits out of first place, according to ICI'​s data series.

Certificates of Deposits decreased by $​60.​7 billion in June (​after jumping $​9.​9 billion in May, $​50.​3 billion in April and declining by $​54.​1 billion in March) to $​541.​6 billion (​or 23.​5% of taxable MMF holdings). CDs are the second largest composition segment. Treasury Bills & Securities, the third largest segment, fell $​3.​6 billion in June (​after plummeting $​29.​7 billion in May, plunging $​52.​7 billion in April, and increasing $​1.​6 billion in March) to $​376.​8 billion (​16.​3%).

Commercial Paper, which decreased by $​9.​8 billion, or 2.​7%, remained the fourth largest segment just ahead of U.​S. Government Agency Securities. CP holdings totaled $​346.​9 billion (​15.​0% of assets) while Agencies grew by $​10.​2 billion to $​333.​1 billion (​14.​4%). Notes (​including Corporate and Bank) fell by $​11.​7 billion to $​67.​5 billion (​2.​9% of assets), and Other holdings dropped by $​9.​1 billion to $​48.​7 billion (​2.​1%).

The Number of Accounts Outstanding in ICI'​s Holdings series for taxable money funds decreased by 180.​6 thousand to 23.​644 million, while the Number of Funds decreased by 3 to 375. Over the past 12 months, the number of accounts fell by 1.​0 million and the number of funds declined by 16. The Average Maturity of Portfolios stayed the same at 44 days in June. Over the past 12 months, WAMs of Taxable money funds declined by 6 days.

The latest numbers from our Money Fund Intelligence Daily show that total money fund assets are $​2.​45 trillion, down $​11.​4 billion month-​to-​date and down $​155.​2 billion (​6.​0%) year-​to-​date (​through July 30). The Crane Money Fund Average, which tracks all taxable funds, has dropped $​13.​0 billion month-​to-​date to $​2.​20 trillion through July 30. Year-​to-​date, the Crane Money Fund Average is down $​141.​1 billion; over the last 7 days it'​s down $​5.​0 billion. The Crane Retail Money Fund Index has declined $​4.​4 billion over the last 7 days, $​2.​7 billion MTD to $​758.​4 billion and $​34.​7 billion YTD through July 30. The Crane Institutional Money Fund Index is down $​555 million over 7 days, $​11.​0 billion to $​1.​4 trillion MTD and $​106.​3 billion YTD.

Note: Crane Data updated its July MFI XLS to reflect the 6/​30/​14 composition data and maturity breakouts for our entire fund universe on July 14. Note again too that we are now producing a "Holdings Reports Issuer Module," which allows subscribers to choose a series of Portfolio Holdings and Issuers and to see a full listing of which money funds own this paper. (​Visit our Content Center and the latest Money Fund Portfolio Holdings download page to access the latest version of this new file.)

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