Money Funds Cheer Reverse-Repo Shift

By DAISY MAXEY

NEW YORK—The New York Federal Reserve has at least three—and probably many more—willing potential partners as it plans to expand the tools used to control liquidity in financial markets.

Vanguard Group, Fidelity Investments and Federated Investors on Monday welcomed the New York Fed's announcement that it will expand the counterparties, starting with money funds, with which it conducts reverse-repurchase agreements.

"We would enthusiastically want to take a look at these transactions for our portfolios," said David Glocke, manager of the Vanguard Group's money funds. "It's a great alternative to other transactions that we already do."

A spokesman for Fidelity Investments said it is always seeking investments that will help protect its money funds' stable $1 net asset value, provide liquidity and offer a market return.

Federated is currently reviewing the Fed's eligibility criteria for money funds and anticipates submitting an application. "We do view this as a positive step for cash markets," a spokeswoman said.

Money-market funds applying to act as counterparties must have net assets of no less than $20 billion for six consecutive months, have been in existence for at least one year and be a consistent investor in the tri-party repo markets, according to the New York Fed's eligibility criteria.

Applicants also must be able to execute reverse repos with securities margined at 100% with terms of up to 65 business days or longer, and applicants must be able to submit minimum bids of $1 billion or greater.
A Trusted Counterparty

Other companies in the $3.1 trillion money-fund industry are likely to be cheered by the prospect of deals with a party as trusted as the Fed. The supply of safe assets in which money-market funds can invest has dwindled during the financial downturn, and plans for tighter regulations on just how money-market funds can invest are likely to make liquid assets even more scarce.

Access to the "reverse repos" will actually help money funds comply with the new Securities and Exchange Commission rules, said Peter Crane, president of Crane Data LLC.

"As those go into effect, there's going to be even more of a thirst for liquidity," he said of the new regulatory rules.

Money-market funds have been pinched by low rates and have had to waive fees to keep investors. Additional supply will likely boost interest paid on investments and provide welcome relief.
Draining Liquidity

The Fed will use reverse repos as a way to drain some of the $1 trillion it pumped into the financial system during the economic crisis.

In a reverse-repo transaction, the Fed lends securities such as Treasurys, which drains cash from the system, with the promise that it will buy them back at a later date.

The Fed typically conducts reverse repos with primary dealers, the 18 major banks that deal directly with the central bank and underwrite Treasury auctions. But it said Monday that it will expand that to money-market funds, and expects to include a broader set of counterparties over time.

How quickly and how much the Fed will do for money funds is still uncertain. The expansion "is a matter of prudent advance planning, and no inference should be drawn about the timing of any prospective monetary policy operation," the Fed said in its announcement.

Vanguard's Mr. Glocke said he doesn't expect any transactions with the Fed to take place until May.

Vanguard's prime money-market fund has $109 billion in assets, and "we would certainly be interested in participating early," Mr. Glock said. He noted, too, that the Fed intends to modify the requirements at some point in the future, which could potentially mean that more portfolios would be eligible.

Federated has two funds large enough to meet the Fed's criteria, the firm's spokeswoman said.

Some 29 out of 329 taxable money-fund portfolios are currently larger than $20 billion, according to Crane Data. These 29 portfolios represent about $1.36 trillion in assets, or 52.2% of the total taxable assets outstanding, Crane Data said.

Money funds held about $540 billion in reverse-repurchase agreements as of Jan. 31, according to the Investment Company Institute. That accounts for about 19.1% of taxable money-fund assets, and makes repos the funds' second-largest holding behind certificates of deposits, Mr. Crane said.

"Repos may even grow to become the largest holding as the new liquidity mandates are implemented," he said.