Cash Management

Protect Money Funds, Hurt Commercial Paper?

SEC proposals to safeguard money-market mutual funds could hamper investment in short-term corporate debt, treasurers say.
Josh HyattJuly 7, 2009

Securities and Exchange Commission proposals to ease the risk of investing in money-market mutual funds could also make it harder for companies to raise capital by issuing commercial paper, some treasurers fear.

The very idea that money funds can be risky is still new. With the $1-per-share net value they rigidly maintained, they were thought to offer safety and accessibility on par with bank savings accounts, while paying modestly better returns. Treasurers routinely parked idle cash in them. But last fall, investors were exposed to losses after some major funds that held Lehman Brothers debt “broke the buck,” or declined in value below $1 a share, after the big investment bank went bankrupt.

Aiming to reduce the risk of runs on the funds and increase their resilience to economic stresses, the SEC in June proposed prohibiting money-market mutual funds from investing in so-called “second-tier” securities. That means companies that issue second-tier commercial paper would lose a key source of investment in the instruments. (Such companies include FedEx, Kraft, Kroger, and Safeway, according to the Association for Finance Professionals.) Currently, most money funds can invest up to 5% of their assets in second-tier securities.

The proposed rule changes, for which a 60-day public comment period is currently in effect, also would require the funds to keep a portion of their portfolios in highly liquid investments and shrink their exposure to long-term debt.

Taken together, the changes would heighten the appeal of the money funds — even as they likely lower yields — to institutional and other investors, notes Thomas Deas, vice president and treasurer at FMC Corp. and a board member of the National Association of Corporate Treasurers. As a result, he claims, “the funds could suck capital away from commercial paper.”

To the extent companies were able to raise less capital from commercial paper, Deas says, they would have to turn to banks for expensive and hard-to-get backstop loans.

Many of the proposals were widely expected, according to Jay Baris, financial services partner at Kramer Levin. But, he notes, the SEC “side-stepped making recommendations on the more knotty issues.” One of the knottiest is whether the price of share funds should float, rather than be targeted at a stable net asset value of $1 a share. The SEC sought comment on that without taking a position.

Also last month, as part of its plan for overhauling financial regulation, the Obama administration called for several government agencies — including the Treasury Department and the Federal Reserve — to study whether money-market funds should adopt a floating NAV.

According to Jeff Glenzer, managing director of the Association for Financial Professionals, such a change would effectively kill the money-fund industry. “These funds have historically been managed with so little fluctuation — the change would cause our members to go with Treasuries or bank deposits,” Glenzer says.

But assuming the NAV remains stable, the safety net provided by the SEC proposals, say Glenzer and Deas, would in effect make permanent a temporary, FDIC-like insurance guarantee that the government offered last fall for investments in some money-market funds. “It was never intended to be permanent,” Glenzer says.

The program was launched after the image of money funds as glorified savings accounts was shattered last September, when the $65 billion Primary Fund, part of the Reserve Fund, announced that the value of its assets had dropped far enough that customers would lose money. The fund broke the buck after writing off  its nearly $800 million investment in debt issued by Lehman. Institutional investors rushed to pull their money out, driving the fund into liquidation. That week, investors pulled more than $300 billion out of the funds. The guarantee was intended to calm redemption-seekers and temper the outflow of funds.

Glenzer says the guarantee may be artificially inflating investments in money-market funds. According to the AFP’s 2009 Liquidity Survey, which came out last week, AFP members are allocating 32% of their cash balances to money-market funds — the highest percentage in the four years the organization has been collecting the data. Those investments are almost evenly split between pure Treasury funds (16.1%) and diversified funds (15.7%).

“There’s been a dramatic shift from emphasis on yield in short-term investment portfolios to the primary objective of preserving the safety of principle and retaining liquidity,” says Glenzer.

Meanwhile, though the proposed rule changes could hamper investment in commercial paper, they could make money funds attractive to companies that have been hoarding cash to make their balance sheets more investor-friendly.

Earlier this year, Goldman Sachs calculated that the nonfinancial firms in the S&P 500 were carrying a near-record $811 billion in cash and marketable securities on their books. The AFP survey found that almost 75% had either increased or left unchanged their U.S. cash balances in the six months leading up to May 2009. Similarly, the CFO Midcap 1500 companies have strengthened their balance sheets by boosting cash holdings from just under $100 billion in 2006 to about $125 billion last year (see the chart at the end of this article).

“Obviously, the government is trying to instill confidence in investors,” says Bradley Fox, vice president and treasurer at Safeway, the supermarket chain. “They want to see that the short-term market for borrowing and investing is functioning normally.”

But the government’s move toward increasing regulation, some argue, is an overreaction. “Money-market funds tend to be managed in the most conservative manner available,” says Ron Geffner, a partner at Sadis & Goldberg, where he oversees the financial services group. “Some people think money-market funds are broken, but I don’t think any additional regulation is required.”

Specifically, the proposed rules would require institutional money-market funds — whose investors are primarily companies and public pension funds — to keep at least 10% of their assets in cash, Treasuries, or investments convertible to cash within one day. At least 30% must be liquid within a week. (For retail funds, which have been less vulnerable to liquidity problems, the corresponding figures are 5% and 15%.)

The maximum weighted average maturity of a fund’s portfolio would be reduced from 90 days to 60 days, lessening investors’ exposure to interest-rate risks. Under another proposal, funds would be authorized to bar investors from selling their shares should their net asset value fall below $1.