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No Redemption for Money Markets

To bring treasurers back into the fold, money market funds may need another round of new regs.
Vincent Ryan, | US
November 14, 2011

Quick: as of today, what's your company's exposure to municipal notes and asset-backed securities through money market funds? If you don't know this minute, how long will it take your treasury staff to corral that information? The truth is, even if you can find this data about the money market fund section of your portfolio, it's as much as a month old.

Money market funds as short-term investing vehicles are under the microscope again, and transparency isn't the only problem.

Regulators are coming to a consensus that money market funds (MMFs) are still highly susceptible to credit shocks and bank-like runs from investors. Lately, they have been pointing to MMFs slashing their exposure to European bank debt. (Last week, for example, prime funds pulled $8 billion out of debt issued by Deutsche Bank.) It was probably wise, but the president of the Federal Reserve Bank of Boston called it an example of how the current industry structure makes MMFs particularly susceptible to credit shocks that can turn into liquidity problems for the whole financial industry.

Three years ago, the Securities and Exchange Commission created new rules to prevent what happened to the Reserve Primary Fund. I have to admit that when I first wrote about the regulations I was optimistic. Here were some rules that could revive what can be an important source of short-term credit and possibly restore the confidence of corporate investors.

But it didn't work out that way. According to the publication Money Fund Intelligence, money market fund assets in prime funds fell by $28 billion, or 2%, in September, and by $3 billion net for all kinds of funds. Total MMF assets are below 2010 levels, despite the piles of cash on businesses' balance sheets.

Regulators could impose additional regulations that would make MMFs a less hazardous investment vehicle. Requiring a capital-like buffer that exceeds exposure limits by a certain percentage (mentioned by Peter Crane, editor of Money Fund Intelligence) and regulating certain money funds as special-purpose banks are possibilities. Some have even suggested ending the charade that the net asset value of money market funds never drops below $1. (Treasury & Risk lays out some of the options in detail in this piece.)

In the meantime, treasurers have to be cautious. That leads us back to transparency.

At the Association for Financial Professionals's annual conference, I discussed the opacity of money market funds with Courtlandt Gates, chief executive of Clearwater Analytics and a smart guy. The problem is, under 2a-7 rules, money market funds only have to report their holdings monthly, and that data comes 5 to 7 days after month's end. (More detailed reports go to the SEC on a 60-day lagged basis.)

Gates says the money market holdings data quickly becomes useless, especially if the investor is trying to analyze its exposure across investment vehicles and marry the data from managed accounts (provided daily) with that from money market funds.

As Capital Advisors Group put in a recent paper, "Instant risk diversification, daily sweep availability, and portal technology make money market fund transactions a breeze, and a higher yield potential than that offered by bank deposits is icing on the cake." Now that the yield premiums are small, and a treasurer still can't give his or her CFO near certainty that principal is safe and risk diversified, MMFs just don't look that tasty.