July 23, 2014

The SEC has announced:

The Securities and Exchange Commission today adopted amendments to the rules that govern money market mutual funds.

The new rules require a floating net asset value (NAV) for institutional prime money market funds, which allows the daily share prices of these funds to fluctuate along with changes in the market-based value of fund assets and provide non-government money market fund boards new tools – liquidity fees and redemption gates – to address runs.

With a floating NAV, institutional prime money market funds (including institutional municipal money market funds) are required to value their portfolio securities using market-based factors and sell and redeem shares based on a floating NAV. These funds no longer will be allowed to use the special pricing and valuation conventions that currently permit them to maintain a constant share price of $1.00. With liquidity fees and redemption gates, money market fund boards have the ability to impose fees and gates during periods of stress. The final rules also include enhanced diversification, disclosure and stress testing requirements, as well as updated reporting by money market funds and private funds that operate like money market funds.

  • Liquidity Fees – Under the rules, if a money market fund’s level of “weekly liquid assets” falls below 30 percent of its total assets (the regulatory minimum), the money market fund’s board would be allowed to impose a liquidity fee of up to two percent on all redemptions. Such a fee could be imposed only if the money market fund’s board of directors determines that such a fee is in the best interests of the fund. If a money market fund’s level of weekly liquid assets falls below 10 percent, the money market fund would be required to impose a liquidity fee of one percent on all redemptions. However, such a fee would not be imposed if the fund’s board of directors determines that such a fee is not in the best interests of the fund or that a lower or higher (up to two percent) liquidity fee is in the best interests of the fund. Weekly liquid assets generally include cash, U.S. Treasury securities, certain other government securities with remaining maturities of 60 days or less, and securities that convert into cash within one week.
  • Redemption Gates – Under the rules, if a money market fund’s level of weekly liquid assets falls below 30 percent, a money market fund’s board could in its discretion temporarily suspend redemptions (gate). To impose a gate, the board of directors would find that imposing a gate is in the money market fund’s best interests. A money market fund that imposes a gate would be required to lift that gate within 10 business days, although the board of directors could determine to lift the gate earlier. Money market funds would not be able to impose a gate for more than 10 business days in any 90-day period.

SEC Chair Mary Jo White’s statement inadvertently explains why these measures won’t work:

During the last financial crisis, institutional prime money market funds experienced an unprecedented run when the Reserve Primary Fund “broke the buck” and declared it would no longer redeem investors’ shares dollar-for-dollar. In one week, investors pulled approximately $300 billion from prime money market funds, or 14 percent of the assets in those funds. This phenomenon, together with other events in the fall of 2008, caused the short-term financing markets to dry up, severely limiting the ability of companies to borrow funds, manage cash, and continue fueling the American economy. As part of a program of extraordinary support across the financial system, a temporary guarantee program was provided through Treasury to stop the run on institutional prime funds, and the Federal Reserve established liquidity facilities.

OK, so you’ve got a tense situation and suddenly BANG! A blue-chip company defaults leading to a run on the entire industry. But this run is actually worse than was experienced before, because not only are corporate treasurers worried about whether or not there will be default in the fund(s) that they own, but they will also be worried that the run itself will trigger redemption gates and fees on their fund – and you don’t put your corporate cash assets in MMFs so that you can pay fees and be subject to gates.

Ms. White counters this with the party line:

While many strongly favor this reform, others have expressed a concern that it could do harm by potentially triggering destructive “pre-emptive” runs. This concern is important, but addressing it need not — and should not — mean foregoing an important reform. What we have done in response to this concern is to make significant modifications to the original proposal that, while preserving the fundamental utility of fees and gates, mitigate the pre-emptive run risk and dampen the effects if they were to occur.

  • The recommendation, among other measures, increases the thresholds for imposing a fee or gate to a higher level of remaining liquid assets. A money market fund that imposes a fee or gate with substantial remaining internal liquidity is in a better position to bear those redemptions without a broader market impact because it can satisfy those redemption requests with cash, without selling assets, and this is less likely to generate a run in other funds.
  • The recommendation makes the imposition of a fee or gate more discretionary, rather than the result of strict triggers. The absence of such triggers make it less likely that informed investors will be able to “front run” the exercise of a fee or gate, thereby precipitating a run.
  • And the recommendation lessens the liquidity impact for investors of a fee or gate by, among other things, permitting only a short maximum gate. This change will also diminish the incentive of an investor to run in order to preserve liquidity.

Well, I guess we’ll just have to wait for the next crisis to see who’s right on this one. They come along every twenty years or so; it will give some interest to the twilight of my career. Until then I will argue that the only thing that has proved to be effective against a bank run is solvency backed up by central bank lending. And solvency in a crisis, when a certain proportion of holdings has either defaulting or is trading at stressed levels, requires capital. And these new rules ain’t got no capital.

Commissioner Kara M. Stein explained in her statement how solvency and liquidity were attained last time:

The Federal Reserve created several programs to support the liquidity of financial institutions, borrowers, and investors.[3] And the Treasury Department guaranteed nearly $2.4 trillion in money market fund assets through its Temporary Guarantee Program.[4]

[3] See, e.g., Commercial Paper Funding Facility (CPFF), Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), Money Market Investor Funding Facility (MMIF), and the Term Asset-Backed Securities Loan Facility (TALF). For descriptions of these programs, see http://www.federalreserve.gov/newsevents/reform_cpff.htm (reflecting $739 billion in CPFF loans and $738 billion in purchases of commercial paper), http://www.federalreserve.gov/newsevents/reform_amlf.htm (reflecting $217 billion in AMLF loans), http://www.federalreserve.gov/newsevents/reform_mmiff.htm (reflecting $0 in total loans as the MMIF facility was never used), and http://www.federalreserve.gov/newsevents/reform_talf.htm (reflecting $71.1 billion in TALF loans).

[4] See Press Release, Treasury Announces Temporary Guarantee Program for Money Market Funds (Sept. 29, 2008), available at http://www.treasury.gov/press-center/press-releases/Pages/hp1161.aspx.

Footnote [3] addresses liquidity, is an entirely normal feature of central bank crisis management and requires no apology or correction. Footnote [4] addresses solvency, is an unpleasant and unwelcome crisis measure by the government and reflects a situation that certainly should be corrected with new procedures and attitudes, but which is unaddressed by the new rules.

However, Ms. Stein makes some effort to redeem herself (at par):

However, after careful study, I am concerned that gates are the wrong tool to address this risk. As the chance that a gate will be imposed increases, investors will have a strong incentive to rush to redeem ahead of others to avoid the uncertainty of losing access to their capital. More importantly, a run in one fund could incite a system-wide run because investors in other funds likely will fear that they also will impose gates. I share the concerns of many commenters and economists that while a gate may be good for one fund because it stops a run in that fund, it could be very damaging to the financial system as a whole.[7]

Even further, while a run by investors in one fund may be halted when the gate for that fund is used, that does not mean the impact on the wholesale funding markets will stop. To the contrary, a fund that drops a gate likely would need to build liquidity to meet redemption requests when the gate is lifted. This means the fund is likely to stop re-investing maturing securities during the gated period, or will invest primarily in government securities, thereby cutting off funding to issuers. This effect could be amplified by investors, who likely will redeem assets from other funds if one fund imposes a gate. And if investors are not able to redeem before the gate comes down, they will be harmed as they are deprived of access to their capital.[8] Ultimately, this contagion could freeze the wholesale funding markets in much the same way as occurred during the recent financial crisis.

[7] See, e.g., Comment Letters from the Federal Reserve Bank of Boston (Sept. 12, 2013), The Systemic Risk Council (Sept. 16, 2013), Samuel Hanson, David Scharfstein, and Adi Sunderman (Sept. 16, 2013), Goldman Sachs Asset Management (Sept. 17, 2013 and July 21, 2014), Deutsche Investment Management Americas (Sept. 17, 2013), Committee on Capital Markets Regulation (Sept. 17, 2013), The Squam Lake Group (Sept. 17, 2013), and Americans for Financial Reform (Sept. 17, 2013). See also Federal Reserve Bank of New York, Staff Report No. 670, Gates, Fees, and Preemptive Runs (Apr. 2014).

See Kevin McCoy, Primary Fund Shareholders Put in a Bind, USA Today, Nov. 11, 2008 (discussing hardships faced by Reserve Primary Fund shareholders due to having their shareholdings frozen); John G. Taft, STEWARDSHIP: LESSONS LEARNED FROM THE LOST CULTURE OF WALL STREET (2012), at 2 (“Now that the Reserve Primary Fund had suspended redemptions of Fund shares for cash, our clients had no access to their cash. This meant, in many cases, that they had no way to settle pending securities purchases and therefore no way to trade their portfolios at a time of historic market volatility. No way to make minimum required distributions from retirement plans. No way to pay property taxes. No way to pay college tuition. It meant bounced checks and, for retirees, interruption of the cash flow distributions they were counting on to pay their day-to-day living expenses.”).

… and I will award Ms. Stein full marks for:

I also am not sufficiently persuaded by the argument that many investors with a low tolerance for gates will seek alternative financial products that are better aligned with their risk-return preferences. While this could happen, it seems just as likely that those same investors will continue to invest in money market funds because they believe they will be able to redeem before a gate is imposed, or that sponsor support will prevent the gate from ever being used. While the rule requires disclosure of sponsor support, it unfortunately does little to address the moral hazard that is created by it.

In addition to which, Ms. Stein is a whole lot younger and better looking than the average SEC commissioner. I wonder if she’s married, and if she’d like to meet a nice Canadian preferred share specialist.

Commissioner Michael S. Piwowar makes an argument I don’t buy:

As a threshold matter, there is no evidence that money market funds themselves pose any threat to the stability of the U.S. financial system. Rather, if there were any systemic risk related to the money markets, it would be over-reliance by financial institutions, particularly banks, on the money markets for short-term funding. In fact, it has been argued that the reason Treasury instituted the guarantee program in 2008 was to reduce financial pressure on banks that had guaranteed the commercial paper of off-balance sheet conduits established by the banks with the approval of the Federal Reserve.[5] As I have said before, if the banking regulators are concerned by banks’ over-reliance on short-term funding from money market funds, then they have the authority to address this bank regulatory shortcoming directly. Nothing in the Dodd-Frank Act weakened or repealed this authority.

[5] See Peter Wallison, Money Market Funds Were a Victim, Not a Cause, Of the Financial Crisis (May 2, 2014) available at [LINK]

Wallison’s linked article states:

It was always a bit implausible that Treasury would set up an insurance system just to protect the shareholders of MMFs against what many were calling a “run.” What interest could Treasury possibly have in whether MMF shareholders suffer losses?

But there’s another and more plausible reason for what Treasury did. By the mid-2000s, MMFs were a major financing source for $1.3 trillion in commercial paper that had been issued by off-balance sheet entities established and guaranteed by the largest U.S. banks. These entities, known as asset backed commercial paper conduits (ABCP conduits) had been set up with the approval of the Fed and had invested in prime and subprime mortgage-backed securities. Supporting long term assets like mortgages with short term commercial paper is profitable, but risky. If the mortgages begin to lose value, the financing sources may not roll over, and what would the banks do then?

These facts provide a completely different perspective than the conventional view of the of the Treasury’s action. It was not to save the shareholders of the MMFs — there was literally no reason for the Treasury to do that — but to ease the financial pressures on the banks that had guaranteed the commercial paper of their off-balance sheet conduits. It follows that in any future crisis — unless the banks are again allowed by the Fed to establish ABCP conduits — there is no likelihood that the Treasury will seek to use taxpayer funds to protect the shareholders of MMFs, even if one or more of those MMFs break the buck.

I don’t buy it. There’s been considerable commentary – reported at various times on PrefBlog, like f’rinstance in the post BIS Releases March 2009 Quarterly Review – that it was the European banks that were put at risk by a US MMF collapse, which in turn could have fed into global systemic collapse; or, if not collapse, then perhaps something even worse than what actually happened. So let’s just ignore Piwowar and his threshold matters.

And even PrefBlog’s favourite whipping boy, Commissioner Luis A. Aguilar, had a useful link, although I can’t say he actually proved his point:

Some observers, including staff at the Federal Reserve Bank of New York, have suggested the possibility that fees and gates may themselves cause pre-emptive runs, by encouraging investors to redeem their shares before fees and gates are imposed.[29] However, as discussed at length in today’s release, the Federal Reserve staff’s conclusion that fees and gates may cause pre-emptive runs is based on a model whose assumptions and features are different than the reforms we are adopting today.[30] Accordingly, as noted in the release, the Federal Reserve paper’s findings regarding the risks of pre-emptive redemptions are not likely to apply.[31]

[29] See, e.g., Federal Reserve Bank of New York Staff Report, Gates, Fees, and Preemptive Runs (Apr. 2014), available at http://www.newyorkfed.org/research/staff_reports/sr670.html.

[30] Id. For example, the Federal Reserve Bank of New York Staff Report relies upon a model that assumes that fees or gates are imposed only when a fund’s liquid assets are fully depleted. In contrast, under today’s reforms, fees or gates may be imposed while the fund still has substantial liquid assets, and thus investors may be dissuaded from pre-emptively redeeming from funds with substantial internal liquidity because the fund is more likely to be able to readily satisfy redemptions without adversely impacting the fund’s pricing. Adopting Release, supra note 1, at 63-66. Another important difference is that our reforms include a floating NAV for a significant portion of money market funds, which may have the effect of altering the behavior of investors under a model that took such a combination of effects into account. Id. at 65. Another significant difference is that our reforms include a floating NAV for institutional prime money market funds, which constitute a sizeable portion of all money market funds, but the model assumes a stable NAV. The floating NAV requirement may encourage those investors who are least able to bear risk of loss to redirect their investments to other investment opportunities (e.g., government money market funds), and this may have the secondary effect of removing from the funds those investors most prone to redeem should a liquidity event occur for which fees or gates could be imposed.

[31] Adopting Release, supra note 1, at 65-66.

Isn’t the US system great? You never see anything like this in Canadian regulatory discussion. The banks wouldn’t approve.

There has been a mass rebranding of the DEX bond indices to FTSE TMX Canada bond indices.

Has anyone here ever seen anything like this? Concrete paviors with a 3:1 plan ratio. I took this picture on Yorkville Avenue between Yonge and Bay.

All the stuff I can find on the internet merely talks about the aspect ratio – that is, the longest dimension divided by the vertical length, what I would call the depth, but what they call the thickness, noting only that 3:1 or less is required for vehicular traffic.

All I can find regarding the plan ratio simply notes that 2:1 or 3:1 can be set in an interlocking herringbone pattern … fine, but why not a 4:1 plan ratio? Would that make the aspect ratio silly, or unsafe, or uneconomic, or what? Certainly if a plan ratio of 4:1 was to be used for vehicular traffic, and therefore requiring a maximum 3:1 aspect ratio, then the depth would be greater than width and the installers would feel pretty silly. But are there other reasons?

And are there any advantages or disadvantages to a 3:1 plan ratio relative to a 2:1 plan ratio?

2014-07-23 18.00.19
Click for Big

It was a good day for the Canadian preferred share market, with PerpetualDiscounts up 10bp and both FixedResets and DeemedRetractibles gaining 7bp. Volatility was anemic. Volume was average.

PerpetualDiscounts now yield 5.09%, equivalent to 6.62% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.2%, so the pre-tax interest-equivalent spread is now about 240bp, unchanged from July 9.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
(at bid)
Mod Dur
Issues Day’s Perf. Index Value
Ratchet 3.07 % 3.06 % 19,911 19.52 1 0.0000 % 2,584.9
FixedFloater 4.19 % 3.41 % 30,232 18.61 1 1.4752 % 4,145.6
Floater 2.85 % 2.94 % 46,485 19.87 4 0.3412 % 2,785.5
OpRet 4.00 % -9.33 % 80,344 0.08 1 0.0000 % 2,733.9
SplitShare 4.25 % 4.00 % 48,216 4.01 6 0.1197 % 3,120.5
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0000 % 2,499.9
Perpetual-Premium 5.52 % -4.81 % 83,982 0.09 17 -0.0139 % 2,429.9
Perpetual-Discount 5.23 % 5.09 % 109,792 15.21 20 0.0958 % 2,584.9
FixedReset 4.40 % 3.59 % 203,446 8.57 77 0.0702 % 2,559.6
Deemed-Retractible 4.98 % -0.29 % 123,904 0.09 43 0.0713 % 2,554.3
FloatingReset 2.66 % 2.12 % 95,384 3.82 6 -0.1834 % 2,520.8
Performance Highlights
Issue Index Change Notes
MFC.PR.F FixedReset 1.17 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.29
Bid-YTW : 4.00 %
BAM.PR.G FixedFloater 1.48 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-07-23
Maturity Price : 22.78
Evaluated at bid price : 22.70
Bid-YTW : 3.41 %
Volume Highlights
Issue Index Shares
TD.PF.A FixedReset 97,601 RBC crossed 25,000 at 25.36. Nesbitt bought 10,000 from TD at 25.30.
Maturity Type : Limit Maturity
Maturity Date : 2044-07-23
Maturity Price : 23.24
Evaluated at bid price : 25.30
Bid-YTW : 3.61 %
ENB.PF.E FixedReset 57,200 Recent new issue.
Maturity Type : Limit Maturity
Maturity Date : 2044-07-23
Maturity Price : 23.10
Evaluated at bid price : 24.97
Bid-YTW : 4.11 %
GWO.PR.P Deemed-Retractible 53,510 TD crossed 50,000 at 25.80.
Maturity Type : Call
Maturity Date : 2020-03-31
Maturity Price : 25.25
Evaluated at bid price : 25.72
Bid-YTW : 5.07 %
BNS.PR.Q FixedReset 47,000 RBC crossed 29,900 at 25.45. Desjardins crossed 15,000 at the same price.
Maturity Type : Call
Maturity Date : 2018-10-25
Maturity Price : 25.00
Evaluated at bid price : 25.43
Bid-YTW : 3.17 %
PVS.PR.D SplitShare 35,234 Recent new issue and ticker change.
Maturity Type : Hard Maturity
Maturity Date : 2021-10-08
Maturity Price : 25.00
Evaluated at bid price : 24.40
Bid-YTW : 4.95 %
BNS.PR.P FixedReset 33,400 RBC crossed 30,000 at 25.48.
Maturity Type : Call
Maturity Date : 2018-04-25
Maturity Price : 25.00
Evaluated at bid price : 25.45
Bid-YTW : 2.83 %
There were 30 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
BAM.PR.G FixedFloater Quote: 22.70 – 23.70
Spot Rate : 1.0000
Average : 0.6944

Maturity Type : Limit Maturity
Maturity Date : 2044-07-23
Maturity Price : 22.78
Evaluated at bid price : 22.70
Bid-YTW : 3.41 %

FTS.PR.F Perpetual-Discount Quote: 24.52 – 24.82
Spot Rate : 0.3000
Average : 0.2092

Maturity Type : Limit Maturity
Maturity Date : 2044-07-23
Maturity Price : 24.23
Evaluated at bid price : 24.52
Bid-YTW : 5.06 %

FTS.PR.H FixedReset Quote: 21.45 – 21.82
Spot Rate : 0.3700
Average : 0.2874

Maturity Type : Limit Maturity
Maturity Date : 2044-07-23
Maturity Price : 21.45
Evaluated at bid price : 21.45
Bid-YTW : 3.51 %

GWO.PR.H Deemed-Retractible Quote: 24.10 – 24.40
Spot Rate : 0.3000
Average : 0.2263

Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.10
Bid-YTW : 5.37 %

PWF.PR.G Perpetual-Premium Quote: 25.40 – 25.58
Spot Rate : 0.1800
Average : 0.1132

Maturity Type : Call
Maturity Date : 2014-08-22
Maturity Price : 25.00
Evaluated at bid price : 25.40
Bid-YTW : -14.46 %

IFC.PR.C FixedReset Quote: 25.77 – 25.94
Spot Rate : 0.1700
Average : 0.1103

Maturity Type : Call
Maturity Date : 2016-09-30
Maturity Price : 25.00
Evaluated at bid price : 25.77
Bid-YTW : 2.88 %

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