Re-Assessing the Risks of Money Market Funds Creating More Resilient Portfolios and Coping With Client Expectations

Transcription

1 N O R T H E R N T R U S T Re-Assessing the Risks of Money Market Funds Creating More Resilient Portfolios and Coping With Client Expectations 28 th February Northern Trust Corporation northerntrust.com

2 Mind the Opinion Regulators! Inve stor Rating Agencies Investment Managers 2 Re-Assessing the Risks of Money Market Funds

3 Money Market Funds (MMFs): policy developments US 11 May June July, 2014 (SEC Focus: MMFs) SEC issues IOSCO Press Statement 3 SEC Commissioners state the IOSCO report of 27 April does not reflect the views and input of the majority of the Commission. SEC Chair Schapiro appears at Senate Banking Committee Hearing. - Defended rationale for SEC rulemaking previously signalled in Jan- Feb 12. Volcker Rule: 2 yr conformance period ends 21 July (Replaces previous 21 July 2012 effective date). - Raised issue of MMF exposure to European Financial Institutions and Eurozone market developments Jun Jul Aug Sept Oct Nov Dec Jan Feb Mar Apr RoW 14 June, August, October, November 18 Nov, 2012 (G20 / FSB Focus: Shadow Banking : including MMFs, ETFs, SPVs, Finance Cos. Related trends: EU/EEA: UCITs & S/T v s L/T labelling of MMFs Body: IMMF (Industry body) Revised Code of Practice for IMMFA members (NTGIL) issued. New provisions which limit liquidity, interest rate and credit risk and impose additional disclosure standards. Postponing of release of SEC MMF proposals 3 Commissioners, did not support proposal to reform MMF market structure. Cancelled vote was provisionally (but not formally) scheduled for 29 Aug, Encouragement by SEC Chair for other US rule making bodies to release MMF reform proposals (e.g. OCC). Final IOSCO Policy Recommendations released. Aim: act as common basis for regulation of MMFs across jurisdictions. 3 Areas of greatest impact to NTGI: (1) Valuation (2) Liquidity management (3) Disclosure to investors Review of application of recommendations to take place by FSOC proposes 3 MMF reform options: (1) floating NAV; (2) holding up to 1% capital buffer; (3) maintaining up to 3% buffer to absorb losses. Chairman Geithner reiterated SEC is best placed to regulate the MMF market. FSB Task Force Initial set of policy recommendations to reduce susceptibility of MMFs to runs 3 Re-Assessing the Risks of Money Market Funds

4 Re-Assessing the Money Market Fund Landscape Money Market Investor Risks Low Yields raise the question of alternatives most probably at a higher level of risk Complexity of measurements may disincentive contributions from less sophisticated investors Financial Instiutions Risks Rating Agency criteria can unduly affect the proper management of a fund Fees are distributed more unevenly Balance sheet management Constant NAV versus Variable NAV funds CNAV products become villains of the money market industry VNAV may exclude certain investor types Transparency Is it the ultimate answer and who foots the bill? 4 Re-Assessing the Risks of Money Market Funds

5 The Lens of an Investor The New World is one of Lesser Return and Higher Cost. It is not Transparency but Operational Effectiveness that drives Solutions. Continued Money Market Investments Consider alternatives for surplus cash Operational Effectiveness Strategic vs Tactical Cash Lower income Diversification Higher Risk Taking Higher cost Liquidity Yield 5 Re-Assessing the Risks of Money Market Funds

6 Objectives & Uses Institutional Short-Term Fixed Income Across the Risk/Return Spectrum Lower Yield / Greater Focus on Liquidity Higher Yield & Total Return Potential / Greater Principal Fluctuation Cash Ultra Short Short Duration Offer investors attractive options to manage their liquidity needs Sterling Government Liquidity US Dollar Government Liquidity Euro Cash Fund Sterling Cash Fund US Dollar Cash Fund Allow investors the potential to capture additional yield while accepting slightly greater levels of principal fluctuation Custom Solutions Offer investors the potential to achieve relatively higher total return while accepting greater levels of principal fluctuation Custom Solutions Capital preservation Daily liquidity $1 NAV Funds comprised of high quality securities structured to preserve principal, generate income and provide daily liquidity Weighted average maturity 0-60 day maximum Target Average quality Top Tier Short Term Search for additional yield relative to money markets Tolerant of slight principal fluctuation Total Return Portfolio invested in high quality instruments overnight to two (or three) years Duration 0.5 to 1.5 years Target Average quality AA to A Seeking greater total return Tolerant of greater principal fluctuation Accepting reduced liquidity Total Return Portfolio focusing on sector allocation, security selection and yield curve management across universe of investment grade securities in one to three years Duration 1.5 to 2 years Target Average quality A 6 Re-Assessing the Risks of Money Market Funds

7 The Lens of a Financial Institution A World of Lesser Income and Higher Cost leads to Less Offering for Investors. It is not Transparency but Customization and Education that drives Solutions. Existing Pressures New Risks Low Yields and Fee Waivers Rating Criteria vs. Prudent Management Lower income Lack of Diversification Opportunities Cost of Balance Sheet Investments Higher cost Lack of Liquidity Trend to SMAs increase management cost 7 Re-Assessing the Risks of Money Market Funds

8 S&P PSFR framework PSFR Framework Management Credit Quality Maturity Liquidity Diversification # Depth Experience Adequacy of staff Credit research and analysis Pricing Internal controls Trade ticket verification Disaster recovery/business continuity Stress-testing capabilities Pricing policies and NAV deviation procedures Minimum 'A-1+' as well as 'A-1' investments maturing within five business days (50%) Maximum 'A-1' investments maturing in more than five business days (50%) Maximum WAM(R) (60days) Maximum WAM(F) (90days) Maximum final maturity per fixed-rate investment, nonsovereign government floatingrate investment, and sovereign floating-rate investments rated below 'AA-' (397 days) Maximum final maturity per sovereign government (including sovereign government related/guaranteed) floating-rate security rated 'AA-' or higher (762 days) Limited liquidity/illiquid investments in excess of 10% of a rated fund s total assets are "higher-risk investments" Maximum per issuer (including debt guaranteed by the same issuer) (5%) Maximum per sovereign entity rated: a) AA-' or higher 100% b) A-1' or 'A+' and that matures in one business day 25% c) A-1' or 'A+' and that matures between two and five business days 10% d) A-1' or 'A+' and that matures in more than five business days 5% Maximum exposure per sovereign government related/guaranteed entity rated 'AA-' or higher (33%) The rating on a fund will be lowered by one category when any specific management actions cause the fund to breach a metric or threshold listed in this table three times over a 12-month period. 8 Re-Assessing the Risks of Money Market Funds

9 Moody s Scorecard..Composite of two factors Credit Matrix Score Fund credit profile Standardized analytical framework Asset profile Portfolio Stability Score Liquidity position Sensitivity to market risk Combining Portfolio Credit and Stability Assessments The evaluation of a money market fund is based on a composite assessment of both its Portfolio Credit Profile and its Stability Profile. However, the assessment suggested by a fund s Portfolio Credit Profile and its Stability Profile will be subject to review by Moody s rating committee, which may adjust such results upward or downward for various qualitative or quantitative reasons. The quality of individual securities and maturity of those investments Weighted Average Maturity and concentration of obligor exposure Overnight liquidity relative to investor concentrations and Fund AUM Estimating Fund s NAV under certain stress conditions 9 Re-Assessing the Risks of Money Market Funds

10 Credit Matrix Score Date: March 30, 2012 Money Market Fund Credit Matrix Fund: NTGF-EUR Each security is assigned an expected loss factor based on two parameters, namely long-term credit quality and maturity. Securities Enter Par Amount Invested Prime - 1 Prime - 2 Prime - 3 Not-Prime Maturity Ba1,Ba2,Ba3,B1,B2,B3,C No. Days Dates Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 aa1,caa2,caa3,ca Total Mar - 14-Apr-12 1,529,440,000 35,000, ,000, ,000, ,887,492 $2,431,327, Apr - 29-Apr ,219, ,000,000 $228,219, Apr - 14-May ,010,000 $26,010, May - 29-May ,000,000 $62,000, May - 13-Jun-12 39,000,000 $39,000, Jun - 28-Jun-12 53,000,000 35,000,000 $88,000, Jun - 13-Jul Aug - 14-Sep Sep - 15-Oct Oct - 15-Nov Nov - 16-Dec Dec - 16-Jan Jan - 16-Feb Feb - 19-Mar Mar - 19-Apr-17 Total $1,761,669,000 $35,000,000 $450,000,000 $343,000,000 $284,887,492 $2,874,556,492 % 61.3% 1.2% 15.7% 11.9% 9.9% 100% Rank Credit Rating Analysis Top 3 Expected-Loss (EL) Positions Aaa Aa A Rank Rating Date Amount Port % % Aaa EL % Aa EL % A EL Meets Benchmark (Yes/No) YES YES YES 1 A1 14/04/ ,887, % 14.3% 1.0% 0.07% % of Allowable Expected-Loss 35.3% 2.5% 0.2% 2 Aa3 29/04/ ,000, % 4.9% 0.3% 0.02% Summary Analysis The portfolio can take on additional credit risk, and increment the expected loss by another 64.7% and still achieve a rating of Aaa as the expected loss of the portfolio at 100% would be equal to 100% of the allowable expected loss. 3 Aa3 14/04/ ,000, % 4.8% 0.3% 0.02% Total 592,887, % 24.1% 1.7% 0.1% Enter securities in long-term credit rating and maturity cells. For floating rate securities use final maturity, put option date or ABS ex pected finial. Total Par Amount (000): $2,874,556,492 No long-term rating, use the follow ing: P1 = A2, P2 = Baa2, P3 = Baa3. Risk (Expected-Loss): 1.10E-06 * Estimated Credit Weighted Av erage Maturity is calculated from mid-periods. Estimated Credit WAM*: 13 days Portfolio risk divided by Benchmark risk (expected loss factor at 12-months) Country: National Scale Rating: US Aaa sum of the product of the par amounts of each of the securities held in the fund and their corresponding idealized cumulative expected loss 10 Re-Assessing the Risks of Money Market Funds

11 Date: March 30, 2012 Money Market Fund Credit Matrix Fund: NTGF-EUR Securities Enter Par Amount Invested 11 Re-Assessing the Risks of Money Market Funds Prime - 1 Prime - 2 Prime - 3 Not-Prime Maturity Ba1,Ba2,Ba3,B1,B2,B3,C No. Days Dates Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 aa1,caa2,caa3,ca Total Mar - 14-Apr-12 1,462,700,000 35,000, ,740, ,000,000 95,000, ,887,492 $2,431,327, Apr - 29-Apr-12 92,219,000 13,000,000 83,000,000 40,000,000 $228,219, Apr - 14-May ,010,000 $26,010, May - 29-May ,000,000 $62,000, May - 13-Jun-12 39,000,000 $39,000, Jun - 28-Jun-12 70,000,000 18,000,000 $88,000, Jun - 13-Jul Aug - 14-Sep Sep - 15-Oct Oct - 15-Nov Nov - 16-Dec Dec - 16-Jan Jan - 16-Feb Feb - 19-Mar Mar - 19-Apr-17 Total $1,681,929,000 $35,000,000 $331,740,000 $153,000,000 $253,000,000 $135,000,000 $284,887,492 $2,874,556,492 % 58.5% 1.2% 11.5% 5.3% 8.8% 4.7% 9.9% 100% Rank Credit Rating Analysis Top 3 Expected-Loss (EL) Positions Aaa Aa A Rank Rating Date Amount Port % % Aaa EL % Aa EL % A EL Meets Benchmark (Yes/No) NO YES YES 1 A3 14/04/ ,887, % 95.8% 6.7% 0.46% % of Allowable Expected-Loss 140.5% 9.9% 0.7% 2 A1 14/04/ ,000, % 11.8% 0.8% 0.06% Summary Analysis Credit Matrix Score with downgrade impact 3 A2 14/04/ ,000, % 8.9% 0.6% 0.04% Total 614,887, % 116.6% 8.2% 0.6% Enter securities in long-term credit rating and maturity cells. For floating rate securities use final maturity, put option date or ABS ex pected finial. Total Par Amount (000): $2,874,556,492 No long-term rating, use the follow ing: P1 = A2, P2 = Baa2, P3 = Baa3. Risk (Expected-Loss): 4.35E-06 * Estimated Credit Weighted Av erage Maturity is calculated from mid-periods. Estimated Credit WAM*: 13 days Country: National Scale Rating: Note: the above incorporate the potential bank downgrades by Moody s The portfolio needs to reduce the expected loss by another 40.5% to achieve a rating of Aaa as the expected loss of the portfolio at 100% would be equal to 100% of the allowable expected loss. US Aa1 Lloyds TSB and Citibank

12 Moody s Scorecard Score Asset Profile: Enter Data: Score Weight WAM % < 60 Days < 90 Days < 120 Days >= 120 Days Top 3 obligor concentration / Fund AUM 23% 2 10% < 15% < 30% < 50% >= 50% Fund Liquidity: Overnight liquidity / Largest 3 investors 51% 3 20% > 90% > 75% > 25% <= 25% Overnight liquidity / Fund AUM 28% 1 20% > 20% > 10% > 5% <= 5% Fund exposure to market risk: NAV stress % > > > <= Portfolio Stability Score 1.5 Credit Matrix score SCORECARD RESULT Aaa Aaa-mf Aaa Aa A Baa Ba Portfolio Stability Score: Scorecard Aaa-mf Aaa-mf Aa-mf A-mf Baa-mf Aaa-mf Aa-mf A-mf Baa-mf B-mf Aa-mf A-mf Baa-mf B-mf C-mf A-mf Baa-mf B-mf C-mf C-mf All NTGF funds are rated Aaa-mf based on the current Moody s credit ratings Note: the above is based on current ratings 12 Re-Assessing the Risks of Money Market Funds

13 Moody s Scorecard with downgrade Impact Score Asset Profile: Enter Data: Score Weight WAM % < 60 Days < 90 Days < 120 Days >= 120 Days Top 3 obligor concentration / Fund AUM 23% 2 10% < 15% < 30% < 50% >= 50% Fund Liquidity: Overnight liquidity / Largest 3 investors 51% 3 20% > 90% > 75% > 25% <= 25% Overnight liquidity / Fund AUM 28% 1 20% > 20% > 10% > 5% <= 5% Fund exposure to market risk: NAV stress % > > > <= Portfolio Stability Score 1.5 Credit Matrix score SCORECARD RESULT Aa1 Aaa-mf Aaa Aa A Baa Ba Portfolio Stability Score: Scorecard Aaa-mf Aaa-mf Aa-mf A-mf Baa-mf Aaa-mf Aa-mf A-mf Baa-mf B-mf Aa-mf A-mf Baa-mf B-mf C-mf A-mf Baa-mf B-mf C-mf C-mf Notes on NAV stress The stress tests applied to a money market fund s portfolio are:» Yield curve shift (100 bps curve shift applied to all securities)» Credit spread shift (100 bps increase in spread applied to Aa2 or lower rated securities)» Outflows (50% overnight redemption rate) The first two stresses are applied to the value of the assets held by a fund, which are then re-priced. The last stress of a 50% redemption rate simulates the need to sell at least 50% of a fund s assets in order to meet investor redemptions. The fund s NAV is then re-calculated and the resulting stressed NAV is the basis for the market risk score on the scorecard. The above stress tests are based on historical observations of actual stress events and on certain assumptions related to the impact of such events on the fund s NAV. Note: the above incorporate the potential bank downgrades by Moody s 13 Re-Assessing the Risks of Money Market Funds

14 Constant NAV or Variable NAV The New World still has a place for CNAV and VNAV. Its not VNAV that creates Transparency but Effective Controls. Constant Net Asset Value Variable Net Asset Value Operational Effectiveness More accurate/ transparent pricing? Lower effort First mover advantage? Timing Challenges Higher cost Implicit company support? Operational burden for investors 14 Re-Assessing the Risks of Money Market Funds

15 Risk Management for Money Market Funds The Original Goals for Investor Protection, Simplicity and Profit Generation can be met when Transparency is viewed from all angles Education Investors Financial Institutions Create robust risk framework to anticipate investor s risks Simplicity and Risk Assurance Programs Supporting the need for operational effectiveness Transparency Offering Customization and Education costs money Understanding your client s needs Allow for controls rather than defining structures Regulators Protect investors and manage systematic risk Build a link between Financial Institutions and Rating Agencies 15 Re-Assessing the Risks of Money Market Funds

16 Important Information Northern Trust Corporation, Head Office: 50 South La Salle Street, Chicago, Illinois U.S.A., incorporated with limited liability in the U.S. The Northern Trust Company, London Branch (reg. no. BR001960), Northern Trust Global Investments Limited (reg. no ) and Northern Trust Global Services Limited (reg. no ) are authorised and regulated by the Financial Services Authority. The material within and any linked material accessed via this communication is directed to eligible counterparties and professional clients only and should not be distributed to or relied upon by retail investors. For Asia Pacific markets, it is directed to institutional investors, expert investors and professional investors only and should not be relied upon by retail investors. Northern Trust (Guernsey) Limited, Northern Trust Fiduciary Services (Guernsey) Limited, and Northern Trust International Fund Administration Services (Guernsey) Limited are licensed by the Guernsey Financial Services Commission. Northern Trust International Fund Administrators (Jersey) Limited and Northern Trust Fiduciary Services (Jersey) Limited are regulated by the Jersey Financial Services Commission. Northern Trust International Fund Administration Services (Ireland) Limited, Northern Trust Securities Services (Ireland) Limited and Northern Trust Fiduciary Services (Ireland) Limited are regulated by the Central Bank of Ireland. Northern Trust Global Services Limited has a Luxembourg Branch, which is authorised and regulated by the Commission de Surveillance du Secteur Financier (CSSF). Northern Trust Luxembourg Management Company S.A. is regulated by the Commission de Surveillance du Secteur Financier (CSSF). Northern Trust Global Investments Limited has a Netherlands branch, which is authorised by the Financial Services Authority and subject to regulation in the Netherlands by the Autoriteit Financiële Markten. Northern Trust Global Services Limited has a Netherlands Branch, which is authorised and regulated in the Netherlands by De Nederlandsche Bank. Northern Trust Global Investments Limited has a Sweden branch, which is authorised by the Financial Services Authority and subject to regulation in Sweden by the Finansinspektionen. Northern Trust Global Services Ltd (UK) Sweden Filial is authorised by the Financial Services Authority and subject to regulation by the Finansinspektionen. Northern Trust Global Services Limited operates in Abu Dhabi as a Representative Office. Our registered office is authorised and regulated by the Central Bank of the United Arab Emirates. The Northern Trust Company operates in Australia as a foreign authorised deposit-taking institution (foreign ADI) and is regulated by the Australian Prudential Regulation Authority. The Northern Trust Company has a branch in China mainly regulated by the China Banking Regulatory Commission, People s Bank of China and State Administration of Foreign Exchange. The Northern Trust Company of Hong Kong Limited is regulated by the Hong Kong Securities and Futures Commission. Northern Trust Global Investments Japan, K.K. is regulated by the Japan Financial Services Agency. The Northern Trust Company has a Singapore Branch, which is a foreign wholesale bank regulated by the Monetary Authority of Singapore. The Northern Trust Company operates in Canada as The Northern Trust Company, Canada Branch, which is an authorised foreign bank branch under the Bank Act (Canada). Trustee related services in Canada are provided by the wholly owned subsidiary The Northern Trust Company, Canada, an authorised trust company under the Trust & Loans Companies Act (Canada). Deposits with The Northern Trust Company and its affiliates and subsidiaries are not insured by the Canada Deposit Insurance Corporation. IRS CIRCULAR 230 NOTICE: To the extent that this message or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. For more information about this notice, see 16 Re-Assessing the Risks of Money Market Funds