Friday, September 18, 2020

Money market prime funds closing, and shadow banking system is restructuring

Money market government funds have grown in AUM this year, but the money market asset management business is again going through an existential threat from the Fed, as well as coping with the 2016 regulatory changes. The 2016 SEC changes created just two major money fund categories, government and prime that caused a major change in investor positioning. The March liquidity shock coupled with zero rates makes prime fund even less palatable to manage.

The money market fund managers have been in this position before but now managers are changing their business models. Vanguard, Fidelity, and Northern Trust are closing their prime (non-government) money funds. Fees cannot be charged on funds with such low interest rates without generating a negative return. The threat of variable NAVs is even greater when faced with large prime outflows seen earlier this year, limited liquidity in corporate short-term funding, and higher credit risks. Prime funds have come off their lows after the March outflow shocks, but the dollar inflows have not been near the increases in government funds. Prime fund AUM have not matched pre-2016 levels so this asset management sector is no long viable.

The impact of these large managers closing their prime funds cannot be understated. A major source of non-bank corporate financing will be closed and further harm the commercial paper and non-government money market.

The money fund and commercial paper shadow banking markets are just a shell of its former self, albeit the current spreads do not reflect this restructuring. Outstanding commercial paper has fallen and may reach the same lows as 2016. The Fed formed a commercial paper facility to help this market, but it was not extensively used and the blow-out in spread has made this a risky funding source as well as a risky investment. 

After a period of spread widening and high volatility, average commercial paper for A2/P2 borrowers are now on top of LIBOR, but that does not change the risk to borrowers who have to be concerned about the ability to roll-over debt. While corporate borrowers can take advantage of low rates further out the yield curve, the short-term funding market is facing a period of major restructuring. 

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