Europe's money market miracle
Tim Colyer. Global Investor. London: Oct 2002., Iss. 156; pg. 40
http://proquest.umi.com/pqdweb?did=232718991&sid=2&Fmt=3&clientId=68814&RQT=
309&VName=PQD
Abstract (Document Summary)
The size of Europe's money market fund sector has tripled in the last two years, as
investors have started to see cash as an attractive asset class in its own right. A
discussion of whether or not the market needs to be more closely regulated, is
presented. Certain considerations have led to calls for greater regulatory prescription in
Europe regarding the use of the term money market fund. In the US, the Securities and
Exchange Commission (SEC) imposes rule 2a7, which gives a rigid definition of a
money market fund that has to be met before a product can be marketed as such. Rule
2a7 requires a WAM of no more than 90 days, with a maximum 5% in any particular
security. In Europe, this is broadly mirrored by the triple-A rating, which in some ways is
even stricter, requiring a WAM of not more than 60 days, and tighter control on the
underlying assets.
Full Text (2266 words)
Copyright Euromoney Institutional Investor PLC Oct 2002[Headnote]
The size of Europe's money market fund sector has tripled in the last two years, as
investors have started to see cash as an attractive asset class in its own right. But does
the market need to be more closely regulated? Tim Colyer investigates.
JOHN MURESIANU liked cash so much it cost him his job. The manager of the $670
million Fidelity Fifty mutual fund regularly held more than 30% ofhis portfolio in cash over
the past three years, so dire did he think the outlook was for US equities. It was a
position that kept Muresianu's fund well-ahead of the S&P 500 over that period. The
problem was that Muresianu's bosses at Fidelity like their funds to do what they say
they'll do - in the case of the Fidelity Fifty, be fully invested in large cap equities, not
cash. With neither side willing to back down, Muresianu resigned from Fidelity over the
summer.
Regardless of the rights and wrongs of the case, it highlights how cash has come onto
investors' radar screens in the past three years. "We are beginning to see cash being
treated as an asset class," declares Kevin Thomson at Standard Life Investments. "Cash
products are now strategically important."
Evidence of that fact can be seen in the remarkable growth of money market funds in
Europe. Over the past two years the market has more than tripled in size, from $33
billion to $110 billion.
For investors, the attraction of money market funds is straightforward: low risk, high
liquidity, and a little extra return in comparison to bank deposits.
Marc Doman, managing director of AIM Global, argues that money market funds are
actually safer than bank accounts. "Through greater diversification, a money market fund
can achieve lower risks than a bank account," he explains. "In a bank account, you have
a single counterparty - the bank. In a money market fund there maybe 20 to 30
counterparties ofthe highest quality." It is not for nothing that most money market funds
carry triple-A credit ratings. No investor has ever lost money through a money market
fund.
Doman sees it as remarkable that many investors ignore the counterparty risk they are
exposed to through bank deposits, given that cash holdings of 5% or more are
commonplace. "It is amazing that a fund manager will be happy to have a 5% exposure
to one single counterparty in cash, when they would never consider having that level of
exposure to one counterparty in equities or bonds," he says.
Custodians have caught on to the attraction of money funds. Many now offer clients a
cash sweep service, which will sweep up any idle cash in their account and invest it over
night in a money market fund, so reducing clients' risk and giving them an extra basis
point or two in interest earned.
Lack of clarity
One factor that has hindered the growth of money market funds in Europe has been the
lack of clarity regarding the definition of a money market fund. While in the UK a money
market fund is typically rated triple-A with underlying investments all being rated Al/Pi,
and carrying a weighted average maturity (WAM) of not more than 60 days, in Germany
the WAM can be more than a year, and a fund can include short term corporate bonds
among other assets (shortterm gilts, bank certificates of deposit and repos being the
usual mix).
The issue is being further complicated bythe advent of enhanced cash products. These
attempt to bridge the gap between money market funds and short-term fixed income
funds, but in the process risk creating confusion around what the role of a money fund
should be.
Doman has steered clear of developing enhanced cash funds at AIM Global. "In gaining
yield beyond market movement, an investor invariably sacrifices either liquidity or a
degree of safety," he explains.
Indeed, rating agency Standard & Poor's (S&P) refuses to classify these enhanced funds
as money market funds at all. Instead of using the suffix M, which accompanies money
market funds, enhanced cash funds are given an F suffix, bringing them into the same
category as fixed income funds. S&P's Gordon Wright says: "In our eyes these funds are
more like bond funds, because they can no longer promise a return of principle."
Mark Hannam, head of European cash management at Barclays Global Investors (BGI),
disagrees. He has championed the cause of enhanced cash products, taking a "horses
for courses" approach. BGI offers three different types of liquidity products, as they
choose to call them - the typical triple-A(M) rated, constant net asset value fund; a cashplus fund, with weighted average maturities of 75-to-110 days; and select funds, which
are more enhanced still.
Hannam's approach is to trade off liquidity for return, rather than credit or market risk. By
allowing bonds to run to maturity, all Hannam needs is investors who are prepared to
lock their cash up for longer, and accept a lower level of liquidity. And he's against such
funds being treated as short-term bond products. "Short-term bond funds are managed
against different types of benchmark, and bonds are often bought with the intention of
selling. That is almost never the case when we buy securities for cash products."
Standard Life's Thomson suggests that the trade-off can never be as simple as just
liquidity for yield, because investors are gambling on an upward sloping yield curve for
the maturity of that security. As he points out: "The yield curve does not always have a
positive gradient."
Regulation
Considerations such as these have led to calls for greater regulatory prescription in
Europe regarding the use of the term money market fund. In the US, the Securities and
Exchange Commission (SEC) imposes rule 2a7, which gives a rigid definition of a
money market fund that has to be met before a product can be marketed as such.
Rule 2a7 requires a WAM of no more than 90 days, with a maximum 5% in any
particular security. In Europe, this is broadly mirrored by the triple-A rating, which in
some ways is even stricter, requiring a WAM of not more than 60 days, and tighter
control on the underlying assets.
But with the emergence of enhanced funds have come calls for regulatory tightening.
Peter Crane, editor of iMoneyNet, an industry resource for comparing money funds,
says: "People are beginning to think that more rigorous regulation may be required. A
rating doesn't carry the weight of a regulation."
AIM Global's Doman wonders how much longer regulators will be able to ignore money
market funds. "The money market fund industry is still in its infancy. Once it reaches
$500 billion, regulators may take a closer look as far as specific regulation is concerned."
If the growth rate of the past couple of years continues, that should happen by 2006.
But regulation can often be a double-edged sword, as experience in the US has shown.
In the spring of 1994, more than two dozen money market funds had to be bailed out by
parent companies after losses were incurred in money market derivatives. For one, the
Community Bankers Government Securities Fund, the problems were so severe that it
was liquidated. Only generous bailouts prevented investors from losing their money.
BGI's Hannam argues that, far from providing a compelling case for greater regulation,
these US examples provide evidence of the strength of the European system."Rule 2a7
has become a security blanket for some investors in the US. It is taken to imply that one
can't lose money in a money market fund. No matter how tight the regulations, that will
never be guaranteed."
Hannam obviously has ulterior motives for supporting the status quo in Europe, since
any rule 2a7 equivalent would inevitably rule out BGI marketing its cash plus and select
products as money market funds. But his point has some validity.
What is important is not that investors are protected by regulations against risky
investment vehicles, but that they are aware ofthe risks involved before they invest. As
Hannam points out: "People think that you can never lose your money in a bank
account, but that isn't true."
Indeed, this oft-ignored risk has been one of the selling points for money funds in
Europe. In 2000, a leading investment consultant in the UK wrote aletter to its pension
fund clients warning them of the risk they were taking by holding cash on the books of
US-based custodian banks.
"If you are a European account holder at a US bank, in order of priority, US investors get
paid out first before foreign creditors in the event of a bank default," explains Doman at
AIMGlobal. This realization prompted many pension funds to take their first look at
money funds. But even Hannam concedes that one advantage of the 2a7 regulation is
that it means money funds are straightforwardly comparable.
Nevertheless, Crane at iMoneyNet is confident that his system provides investors with a
means of comparing like with like. "We think that it is a fair comparison. On occasion, if a
fund is beating the competition by a long way, then we will look at the portfolio. What is
interesting is that in Europe, everyone is interested in yield. In the US, a high yield is
often considered to be a bad thing."
Poor technology
Given that cash management is an integral part of their service, it is surprising that
global custodians haven't tried to make more of a play for money market fund related
business.
State Street has just upgraded the money fund trading function on its Global Link
platform, which goes under the name of FundConnect. Caroline Hutchings, vice
president with Global Link, bemoans the lack of technology in cash fund trading. "This is
one of the least efficient areas of financial services and one of the last to fully embrace
on-line trading and STP," she says. "It is very paper based."
FundConnect integrates the pre-trade, trade and post trade requirements ofmoney
market funds, allowing comparison ofthe funds, electronic trading of cash products, and
automatic monitoring ofthe fund. It also automatically records which clients are doing
what with their money market funds, so that clients can meet regulatory requirements
imposed to prevent the use of money funds for laundering ill-gotten gains.
To date, much of the growth of the money fund market in Europe has been down to
increased institutional involvement. But as individual investors become more aware of
the low interest rates their cash gets on deposit, so they may gravitate towards money
market funds.
If banks choose to ignore the money market fund option, then they may find themselves
losing retail business just as has been the case in the US, where the cash market is split
evenly between retail and institutional business.
BNY SCORES OUTSOURCING SUCCESS WITH ING
The Bank of New York has signed a major new outsourcing agreement with ING, which
will outsource it international cash equities clearance and settlements operations in
London, New York, Hong Kong and Singapore to BNY. The deal represents a quantum
leap for the bank's outsourcing operations.
Hot on the heels of its disappointment at losing the US part of its asset management
outsourcing agreement with JPMorgan Fleming Asset Management, the deal is a new
direction for the bank's outsourcing strategy, and the largest deal to be announced
between a custodian and a broker-dealer. BNY's decision to attack the sell side as well
as the buy side is a significant one.
Francis LaSalla, president and chief operating officer, BNY Clearing Services, says:
"The transaction, coupled with our outsourcing agreement with the retail clearing
platform of Tilney Investment Management, enhances our position as the pre-eminent
global correspondent clearing firm."
The broker-dealer outsourcing is organized under a different part of the company to the
investment manager outsourcing, with separate staff and technology under BNY
Securities. BNY is taking on around 100 ING staff.
BNY has also announced that it is consolidating its institutional agency brokerage and
correspondent clearing businesses into a single unit, BNY Securities Group. The new
group will comprise of five business units including BNY Brokerage, BNY Direct
Execution and transition management.
GLOBAL INVESTOR IT SURVEY AWARD WINNERS LUNCH
Maybe it was because they are all from the same side of the business. Perhaps it is
because they are the best at what they do. Whatever the reason, there was a surprising
degree of agreement between participants at Global Investor's IT Survey award winners
lunch. While the main purpose of the event was to celebrate the firms' achievement,
there was broad discussion around some of the key issues facing the suppliers of thirdparty solutions for asset managers.
The most obvious pressing issue is to how to deal with the downturn in the market and
the impact on client profitability. Everyone agreed that clients were now increasingly
focussed on maintaining and improving existing systems, rather than looking to add new
ones. The demise of the 'black boje solution was a point of unanimity with widespread
acceptance that open architecture is a better pitch at present.
Asset managers' improved efficiency in attempting global systems integration was also
noted, bringing in its train the rise of the internal sourcing department, with most also
believing that the compliance officer plays an increasingly important role in system
selection. But the greatest level of agreement (and volume) was reserved for the topic of
the independent consultants. It is only in the interests of diplomacy that we note that
there was near unanimity that they provide little value, are of questionable independence
and have a tendency to pass the blame at the first opportunity.