Many institutional investors, including corporate treasurers, use ratings as a key selection criterion when investing short-term liquidity in MMFs. These play a central role in the short-term markets, acting as buyers of short-term debt as well as a liquid place to invest. Of the more than US$6 trillion of funds invested in them globally, more than US$3.4 trillion were invested in the US and US$1.9 trillion in Europe (as of the end of Q3 09). According to a recent survey that Fitch conducted of corporate treasurers, 40% of corporate treasurers typically invest some of their liquidity in MMFs. In many cases, such short-term investors look for ‘AAA’ ratings to determine whether or not to invest. As defined by Fitch, a ‘AAAmmf’ MMF rating indicates ‘an extremely strong capacity to achieve fund’s investment objective of preserving principal and providing shareholder liquidity through limiting credit, market, and liquidity risk’.
For the past three years, Fitch has surveyed corporate treasurers’ liquidity policies. The Treasury Policies Survey was instigated in late 2007 to investigate the effect the effect of the early stages of the economic downturn on treasurers’ management of liquid resources. At that stage there was particular concern about counterparty risk. The findings of the initial survey highlighted the robustness of treasury policies already in place – while many respondents had reviewed these policies, the overwhelming message was that broadly the policies in place among the large corporates surveyed were considered fit to address the perceived risks.
More recently, use of MMFs has been one of the areas of focus. The 2008 survey, conducted post-Lehman Brothers, showed a modest move away from MMFs as a way to hold liquid resources. Forty-five per cent of respondents who invested in MMFs reported that they had changed their allocation, and, of these, the vast majority had reduced it.
Early indications from this year’s survey, which are still being compiled, are for a reversal of this trend. Approximately a third of holders of MMFs appear to have changed their exposure in the last year, with the vast majority of these reporting an increase. The percentage of companies investing in MMFs appears to have remained steady, at around 40% – of these almost all of those that have a formalised policy to include ratings as one criterion for investment.
More broadly, respondents are continuing to change their funding strategies in response to changed markets. There is evidence that, as expected, companies are holding more liquid resources in response to greater concerns about funding sources. Many are reporting that they are seeking to diversify sources of finance, mainly from bank debt to corporate bonds, with a significant proportion considering directly tapping the retail market. The results above are initial estimates based on a subset of the full sample, so may be subject to change.
MMF Rating Criteria and Surveillance Tools
The crisis of 2008 clearly challenged confidence in MMFs. As a consequence, regulatory changes are now being considered both in the US (the Securities and Exchange Commission released a consultation in June 2009) and Europe (the Committee of European Securities Regulators consultation released a consultation in October 2009) with a global convergence of standards toward more constrained risk limits and clearer fund classifications. Further, the industry has undertaken initiatives to operate more conservatively as well.
Fitch supports these industry- and regulatory-led changes. Beyond these initiatives, however, the crisis has led investors to consider more carefully how MMFs are invested and how risks are managed. Furthermore, calls for greater transparency relating to key risk factors have grown. Fitch recently updated its criteria in a number of material ways, reflecting the need for fundamental changes in how MMFs measure and manage risk – credit, market and liquidity. Additionally, the company has launched a web-based surveillance tool for MMFs that is designed to provide additional information to investors in Fitch-rated MMFs.
Our MMF ratings are based on an evaluation of different factors including credit, market and liquidity risk, overall levels of portfolio diversifications, maturity distribution of portfolio assets (natural liquidity) and stability of the shareholder base. Additionally, they incorporate considerations as to the fund sponsor’s willingness and ability to provide support to a fund through dedicated resources, investment management oversight, and in extreme cases, financial support. The importance of the sponsor is an important lesson from the financial crisis.
The agency’s new criteria focus primarily on so-called ‘prime’ MMFs, or those rated ‘AAAmmf’ that invest in short term debt instruments issued by financial institutions, non-financial corporations and asset-backed commercial paper (ABCP) programmes. The criteria apply globally to constant as well as variable net asset value funds (CNAV and VNAV).
The establishment of a new MMF rating scale and definitions, with an ‘AAAmmf’ rating replacing the previous ‘AAA/V1+’ ratings coincided with these criteria enhancements. The new scale is intended to provide corporate treasurers and other investors in MMFs with more transparent and informative ratings that encompass the credit, market and liquidity risks that a MMF may face. They are also intended to better differentiate MMF ratings from ratings on other rated debt instruments and higher risk bond funds that may carry high ratings for credit quality but also carry significant market risk and NAV volatility.
To better gauge credit risk, the agency has introduced a matrix-based approach to evaluating overall portfolio risk in MMFs along two dimensions – credit quality and asset maturity – termed the Portfolio Credit Factor (PCF). The PCF is intended to more effectively differentiate funds that focus on high credit quality and shorter maturities from funds that exhibit higher levels of credit and/or market risk by investing in longer asset maturities and/or assets of lower credit quality. Fund diversification considers direct credit and counterparty exposure as well as indirect risk exposures arising from ABCP sponsors and liquidity providers.
Fitch has updated its rating criteria with respect to shareholder redemption risk and portfolio level liquidity. The agency has adopted baseline overnight and one-week liquidity guidelines of 10% and 25%, respectively, to provide a cushion against unexpected redemption activity. When rating a fund, the agency will undertake additional analysis, taking into consideration the shareholder profile and any liquidity stress tests conducted by the manager, which may result in adjustments to these baseline liquidity guidelines on a fund-specific basis.
The agency has also adopted a weighted average days to final maturity (WAMf) metric, which primarily measures spread risk and overall portfolio liquidity and is set at 120 days for ‘AAAmmf’ funds. This supplements the traditional weighted average days to interest rate reset (WAMr) metric, which is predominantly a measure of interest rate risk exposure.
In addition to an assessment of the fund sponsor’s operational support, infrastructure capabilities, and investment oversight, consideration is given to the sponsor’s financial standing. At the ‘AAAmmf’ fund rating level, a fund sponsor typically would be rated solidly investment grade and demonstrate an appropriate level of financial resources. In the case of small, financially weak sponsors or resource-tight investment managers, Fitch may consider mitigating factors in terms of a highly conservative investment strategy and/or a captive investor base.
A Push for Enhanced Transparency Toward Investors
Fitch meets with fund advisors on a periodic basis in order to review the policies and procedures developed to meet investment objectives, as well as the supporting organisational structure, internal controls and risk management and reporting systems. Findings are detailed in Fitch’s reports and press releases on rated funds and investors are also encouraged to contact funds’ analysts whose details are listed on all the agency’s publications.
More recently, acknowledging the importance of providing greater transparency to investors in MMFs, Fitch developed a dedicated tool accessible online that provides analytical information on a monthly basis and leverages on the agency’s surveillance data received from fund administrators. Investors and corporate treasurers can find information on rated funds as well as regularly updated data related to size, yield, assets’ breakdown, credit quality or liquidity profile.
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