Security for All Seasons
5 May 2009 Kathleen Hughes
AAA-rated money market funds offer valuable liquidity and security throughout different stages of the economic cycle and even during extraordinary events such as the current financial crisis, explains IMMFA’s Kathleen Hughes.
Recent events in financial markets have had a large impact on the money market sector, bringing the money market funds industry very much into the spotlight. While the initial stages of the crisis placed significant stress on the whole global financial system and had a negative impact on some individual money market funds in the US, more recent developments have been positive for money market fund providers given the high level of security that money market funds offer.
The US money market fund industry was shaken in September 2008 by the failure of the reserve primary fund, which was a large independent US-based money market fund. Unlike J.P. Morgan and other providers of Institutional Money Market Funds Association (IMMFA) style funds in Europe, the fund was not rated by any of the ratings agencies. Under the IMMFA Code of Practice, all IMMFA style funds must be AAA-rated.
Indeed, the turmoil of the financial crisis prompted a surge in investor interest in European-domiciled money market funds. As investors became increasingly risk averse and cautious, the flows into money market funds actually increased. What is most striking, however, is that European money market investors have shown a clear preference for the more conservative IMMFA funds.
According to Feri-FMI, which classifies money market funds as funds investing at least 80% of their assets in money-market instruments with a short average maturity, funds under management in money market funds (excluding IMMFA fund assets) increased by 4% between 31 August 2007 and 31 December 2008, from $943.6bn to $982bn. However, during the same time period IMMFA funds experienced a 29% increase from $440.9bn to $569bn.
Money market funds have also helped to play another important, and often overlooked, role during the financial crisis. One of the defining problems has been the seizure of credit markets as liquidity dried up. As large buyers of bank issuances of commercial paper, money market funds have helped to provide liquidity in the CP market.
IMMFA is the trade association for providers of AAA-rated, constant net asset value, money market funds domiciled in Europe. Established in June 2000, IMMFA’s primary aim is to ensure a high standard of quality and service provision for investors. All J.P. Morgan money market funds domiciled in Europe are IMMFA style funds.
IMMFA’s main objectives are to maintain a Code of Practice for the European money market funds industry, provide generic information and performance data about funds, lobby governments and regulatory bodies for appropriate treatment of institutional money market funds and support the formal recognition of institutional money market funds in the UK, Europe and elsewhere.
The role of IMMFA is clearly appreciated, with over €440bn under management with IMMFA’s 33 members, as at 20 February 2009. The financial landscape is constantly changing and evolving, and the board of IMMFA is dedicated to ensuring that its members continue to provide the best quality of service possible for investors.
US money market fund guidelines
In the US, money market funds must adhere to the Securities and Exchange Commission (SEC)’s rule 2a-7. Under these rules, money market funds must aim to preserve principal at all times and maintain value day-after-day, not just seek to perform well over time. Furthermore, the securities themselves that are held within 2a-7 money market funds must be ‘first tier’ and a portfolio must have a weighted average maturity (WAM) of 90 days or less, while individual securities must have a maturity of less than 13 months. Finally, a money market fund may only hold a maximum of 5% of its holdings with any one issuer.
In Europe, there is no single piece of legislation comparable with the SEC’s rule 2a-7, and a broader array of funds can be termed money market funds, ranging from the highly conservative IMMFA style funds, which are consistent with the US SEC 2a-7 rules, to enhanced cash and even short term bond funds. However, all European money market funds are authorised under the UCITS Directive, which allows funds to ‘passport’ into other European member states without seeking authorisation in each individual jurisdiction.
In addition, the Eligible Assets Directive was issued in 2007 and allows a money market fund to value assets on an amortised cost basis. This helps to insulate money market funds from minor, temporary market movements and reflects their investment strategy of holding short-dated debt instruments to maturity, rather than making sales at a gain or a loss before the maturity date.
The IMMFA Code of Practice
In 2002 IMMFA introduced its own Code of Practice to establish European industry standards of best practice in the absence of any SEC 2a-7 comparable legislation. All members are required to adhere to the Code of Practice, which includes the following rules:
• Money market funds are required to monitor and limit any deviation between amortised and market value on at least a weekly basis, and implement an escalation policy to act upon material discrepancies (which commences at ten basis points at fund level).
• Money market funds must have a WAM of not more than 60 days.
• Money market fund managers must ensure that each instrument held by the fund presents appropriate risk for the period during which it is held by the fund.
• Money market funds must provide same-day liquidity with no penalty applied to redemptions and; no fees are charged to enter the fund or on redemption.
One of the key objectives of IMMFA is to ensure the security of assets invested in money market funds. As such, IMMFA money market funds must be rated AAA and highly diversified. Furthermore, the assets within the fund are held in a separate legal entity from the investment manager to ensure that they would not be impacted by problems affecting the investment manager, including solvency issues.
Even in the worst case scenario of an investment manager becoming insolvent, investors within the fund would just need to transfer their investment management mandate to another manager.