The Future Of Money Market Funds – An Insight

By M. Isi Eromosele

While recent global economic sentiment has been somewhat positive, the financial and economic backdrop remains fragile and uncertain. The complete meltdown of the European financial system has seemingly been averted but the recessionary fire continues to burn, especially in Europe.

Across the globe, corporate profits have for the most part, been disappointing and the negative impact of rising unemployment, a reduction in both capital spending and inventories is hampering full global economic recovery.

Corporate entities are facing significant challenges in working through this exceptional period of time. Treasury teams in particular continue to navigate through uncharted waters as counterparty lists have shrunk through rating downgrades, continued concerns over the health of banks and financial institutions, liquidity headaches and fears over what assets are contained in their money market funds (MMFs).

Liquidity Management
Governments and Central Banks have alleviated some of these concerns by responding from a monetary and fiscal standpoint to recapitalize institutions and to inject fiscal liquidity into the global system to unfreeze markets and improve the price and availability of credit.

Nevertheless, dislocations are widespread across capital markets and new policies, such as quantitative easing, are making the task of managing corporate cash increasingly more complex.

Managers of AAA-rated Money Market Funds faced similar issues to those of corporate treasuries, both of which were stretched by a perfect risk storm of interest rate and credit spread widening coupled with a sharp reduction in liquidity.

To counteract these risks and ensure adherence to the core objectives of capital preservation and maintenance of liquidity, many fund managers kept investments short to reduce interest rate risk and to improve the maturity profile.

Defining Time For Market Funds
A more sobering issue is the very future of the MMF industry in the wake of potentially increased regulation, more restrictive guidelines, and the requirement for constant NAV MMFs in the U.S. to hold a special purpose banking license. The U.S. Government in particular is concerned with the role played by MMFs during the credit crisis in terms of systematic risk and financial stability.

MMFs can be defined as mutual funds that invest in short-term debt instruments. They provide the benefits of pooled investment, as investors can participate in a more diverse and high-quality portfolio than they otherwise could individually. Money market funds are actively managed within rigid and transparent guidelines to offer safety of principal, liquidity and competitive sector-related returns.

A distinction needs to be made between treasury-style products such as constant NAV MMFs and investment style funds with a variable NAV. In fact, The Institutional Money Market Funds Association (IMMFA) has worked hard to create a transparent code of practice for money market funds in Europe as a way of differentiating true AAA-rated funds from other money market vehicles.

This has proved necessary due to number of high profile European based short-dated bond funds and enhanced cash vehicles that suffered losses following the credit rout, negatively impacting the perception of the money market universe as a whole.

Ensuring The Future

The MMF industry is already moving along a path to bolster the confidence, transparency and safety of funds and safeguard the future of the industry. Actions have been proposed aimed at reducing the systemic risk that Money Market Funds posed. This include the proposal that MMFs offering a service similar to that of a bank would need to obtain special purpose banking license and submit to a higher level of regulation.

Additionally, money funds that did not convert to banks would be restricted from offering CNAV funds. In Europe, the IMMFA convened a separate working group to carry out a review on the future structure of MMFs.

The IMMFA’s working groups’ objective was to ensure that the code of practice remained similar to rule 2a-7, with the goal of keeping the global practice of AAA-rated money funds consistent, enhancing the robustness of money markets through all market conditions and potentially enabling regulators to adopt a revised code of practice.

Both working groups were keen to maintain the existing money fund structures, increase and formalize a liquidity policy, reduce credit and interest rate risk, and post greater disclosure of holdings and shareholder concentrations.

Overall, these new tighter measures, if adopted, would improve the AAA-rated MMF landscape and give investors greater comfort over the use of money funds.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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