The Contribution of IMMFA Funds to the Money Market
by Nathan Douglas, IMMFA Secretary General
In a world which has seen an increased volume of questions asked about the value added by certain financial transactions, what real benefit is added by money market funds? One benefit is clear to all those who use them. Money market funds provide a means through which risk can be diversified. The fact that these funds hold a large number of securities collectively held by the investors in the fund results in a spreading of risk across those securities. If an issue were to arise with one of the underlying securities, its impact upon any individual investor should be limited given the diversification within the fund. Other benefits arise through, for example, access to the professional cash management services of the fund manager.
Although this treasury management solution is undeniable, and available at a lower cost than what would be incurred if a corporate treasurer were to achieve such diversification through direct purchases, do money market funds offer any economic benefit? To answer this, the Institutional Money Market Funds Association (IMMFA) commissioned PwC Luxembourg to perform a study to assess the contribution of IMMFA funds to the money markets.
Research was performed which analysed the money markets, how they have changed over time, and the absolute and relative holdings of IMMFA funds within those money markets. The US, UK and Eurozone money markets were considered given that IMMFA funds operate in three principal currencies: US dollar, sterling and euro.
As the mid-2010, IMMFA funds held over 16% of outstanding euro-denominated paper.
Unsurprisingly, the study found that the market for commercial paper had reduced recently. The US market peaked in mid-2007, and has reduced by 45% to $2,174bn since, whereas in Europe, the market peaked in late 2008 and has declined by 27% since (to €201.5bn). These reductions reflect a more conservative investor base together with increasingly cash-rich companies which have limited need to issue commercial paper.
Although both markets have reduced in size, the amount of commercial paper held by IMMFA funds has increased in both absolute and relative terms. In the US market, the share held by IMMFA funds more than doubled between late 2005 and mid-2010 to over 5% of outstanding issuance, with material growth since the US market stabilised in early 2009. In Europe, the share held is more significant. As at mid-2010, IMMFA funds held over 16% of outstanding euro-denominated commercial paper, an increase from the 10% held in late 2005. Given that the euro-denominated commercial paper market was at similar levels in late 2005 and mid-2010, there is a notable growth in the contribution of IMMFA funds.
Activity within the asset-backed commercial paper (ABCP) market has been more varied. At the peak of the market in mid-2007, some IMMFA funds were holding significant volumes of ABCP. However, as investors became increasingly concerned with ABCP conduits and issuers in mid-2007, IMMFA funds began withdrawing from this market. Although some funds have re-entered this market, selectively purchasing high quality and supported programmes, the appetite from IMMFA funds for this type of security has been materially reduced.
The markets for certificates of deposit have experienced an altogether different story, as they have grown continually over the last five years in both the US and Europe. The US market increased by approximately 250% between late 2005 and mid-2010 to almost $1,200bn, whilst the European market grew only slightly less (215%) over the same period to €350bn. Over these periods, and in both markets, the amount and share held by IMMFA funds has grown. IMMFA funds have more than quadrupled their market share of euro-denominated certificates of deposit to over 8% in mid-2010, whilst in the US, their market share has doubled to over 6%. The growth has occurred at a time when the market on both sides of the Atlantic has increased significantly, thereby representing material growth in the amount of certificates of deposit held by IMMFA funds.
The contribution of IMMFA funds in relation to the other principal securities held within these funds – time deposits, repurchase agreements, floating rate notes and government debt – was less material. The markets for these securities all have a wider variety of investors and although the amounts held by IMMFA funds are not small, their relative values are less material than in the other security classes.
The economic impact of IMMFA funds
From this data, it is clear that IMMFA funds have assisted in developing the US and European money markets, particularly for commercial paper and certificates of deposit. The markets for these securities are likely to be deeper, more liquid and more competitive given the growing contribution of IMMFA funds. Increasing the depth of the market should encourage new entrants to the market. When this is combined with the additional interest generated in these securities by IMMFA funds, the liquidity of the market place should also be enhanced. This can only be beneficial to other market participants, whether buyers themselves or entities seeking financing by issuing such securities.
IMMFA funds are a daily source of funding to companies and govermenments, and so assist these entities to operate on a day-to-day basis.
As well as enhancing the development of these money markets, IMMFA funds effectively provide a source of funding to those entities which issue short-term debt securities. These entities include governments and companies, whether banks or non-financial institutions. IMMFA funds therefore directly contribute to the daily funding needs of companies through Europe and the US. If IMMFA funds continue to witness an inflow of investment, as has been experienced since the inception of the Association in 2000, this source of funding will become increasingly large and important.
Furthermore, with implementation of the Basel III capital requirements looming, the appetite of banks to issue commercial paper or certificates of deposit, or to acquire funding from institutional investors – such as money market funds – could be significantly reduced. The interest of IMMFA funds in the commercial paper issued by companies other than banks could increase notably. Although such paper would need to be assessed as high quality (which could require the attainment of a specific credit rating), there is likely to be an increase in appetite from these funds for such securities. This appetite is unlikely to abate if IMMFA funds continue to grow.