Transcript: Prime money markets funds are in trouble

This is an audio transcript of the FT News Briefing podcast episode: ‘Prime money markets funds are in trouble’

Sonja Hutson
Good morning from the Financial Times. Today is Friday, April 12th, and this is your FT News Briefing.

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A federal investigation into Morgan Stanley just got a lot bigger. And new regulations could force billions of dollars out of prime money market funds. Plus, Russian oligarchs have found a way to challenge EU sanctions. I’m Sonja Hutson, and here’s the news you need to start your day.

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Three more US regulators are investigating Morgan Stanley’s wealth management division. They’re looking into how the company vets potentially risky clients. The Federal Reserve already had the business in its sights over money laundering controls, and now the Securities and Exchange Commission, the Office of the Comptroller of the Currency and the Treasury are also involved. Morgan Stanley has grown its wealth management division considerably over the past several years, but it’s been lagging during this period of high interest rates. News that this federal investigation has widened in scope isn’t helping. Morgan Stanley’s share price fell more than 5 per cent after it was first reported.

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Money managers are planning to shut down or convert more than $200bn worth of US money market funds. It’s in response to a new rule from the Securities and Exchange Commission that goes into effect later this year. This is potentially bad news for both investors and the banks and companies that issue short-term commercial debt. I’m joined now by the FT’s Harriet Clarfelt to discuss. Hi, Harriet.

Harriet Clarfelt
Hi.

Sonja Hutson
So, Harriet, before we get into the implications of this new SEC rule. Can you first explain to me the type of money market fund that is gonna be impacted by it and just how important that is?

Harriet Clarfelt
Yes. So taking a step back, money market funds, a vehicle that holds very short-term securities that offer daily access. They hold a mixture of cash and short-dated instruments like short-dated government debt. But the type of money market fund that will be directly affected by these new rules are called prime institutional money market funds. They can also hold something called short-dated commercial paper, which can include short-term bank debt and company debt. They therefore do carry a little more risk, arguably, but they can offer greater yields to their investors. And money market funds broadly become really attractive to investors as interest rates have gone up, because the returns that investors can get on these short-dated vehicles have also gone up quite drastically.

Sonja Hutson
OK, let’s get back to this new SEC rule. How is it gonna affect these prime money market funds?

Harriet Clarfelt
So this rule, which was announced last summer, will mean that institutional prime funds will need to impose a fee on departures whenever net redemptions from that funds exceed 5 per cent of total net assets in a single day. So the idea is that if you’re an investor and you’re trying to leave one of these funds, you’ll have to pay a fee. There have been moments in the past when we’ve had investors stampedes out of asset classes, including money market funds, that they’ve basically trying to avoid a repeat of that by imposing a fee on the investors who choose to leave.

Sonja Hutson
So why are these money managers so worried about this new rule? And what are they doing in response?

Harriet Clarfelt
So I wouldn’t say it’s that they’re hugely worried. It’s actually that they’re having to introduce the structural changes to their funds. Those changes can be costly. And for some managers, I think there’s a sense that this isn’t necessarily worth it for them. And actually the small increase in terms of return that you get on a prime fund versus a government-focused money market fund, maybe the stakes aren’t worth it in terms of all the administrative work and costs that would have to go into implementing these changes.

Sonja Hutson
So they’d rather just use a traditional money market fund, which uses short-term government debt rather than short-term commercial debt. How significant of a shift is this? I mean, I mentioned earlier that we’re talking about $220bn here. That seems like a lot of money.

Harriet Clarfelt
It is, and proportionately it’s a lot. So the sector is set to shrink by at least one-third this year, based on what we know now about the funds, who are choosing not to continue providing some of their vehicles or, you know, choosing to convert them to a government fund instead. And other managers say they’re still deciding what to do, I should say, but there is a prediction among some industry executives that we’ll see more closures and conversions as the deadline comes closer.

Sonja Hutson
So that’s a really significant shift. What kind of impact could that have on investors themselves?

Harriet Clarfelt
So there’s an argument that the shrinking of the institutional prime money market funds universe could reduce the diversification of investors’ short-term cash portfolios. But there’s also another concern here, which is the shrinkage of the pool of buyers for the $1.3tn commercial paper asset class. So, as we’ve explained, prime funds can hold something called commercial paper, which includes short-term company and bank debt. So there is a question arguably for the issue is of commercial paper, which is: Is there a world in which we lose a big chunk of our pool of buyers? And what does that mean? Do we turn to other buyers instead? There may be a bit of a rethink, essentially. What I would say is that, you know, we still have six months left until the early October deadline, and so we’ll have to watch this very closely to see whether we do see more big managers say, actually, it isn’t worth it for us or whether they decide to push ahead.

Sonja Hutson
All right. Still a little bit of time for some wheeling and dealing before this rule goes into play. Harriet Clarfelt is a US capital markets correspondent for the FT. Thanks, Harriet.

Harriet Clarfelt
Thanks very much.

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Sonja Hutson
The European Central Bank kept interest rates unchanged yesterday. They’re still sitting at 4 per cent, but the ECB did signalled that it could start to cut rates at the bank’s next meeting in June. ECB president Christine Lagarde said a small minority of policymakers had argued for an immediate cut, but most of them wanted to wait until they were sure that inflation had stabilised. Lagarde also pushed back against the idea that the ECB was going to wait for the Federal Reserve to cut rates first.

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A top court for the European Union threw out a bunch of evidence that tied two oligarchs to Russia’s full-scale invasion of Ukraine. That connection was used to place sanctions on the two tycoons after the war started. The ruling now opens the door for hundreds of others with links to the Kremlin to also challenge sanctions against them. Here to talk to me about it is the FT’s Henry Foy. Hey, Henry.

Henry Foy
Hey, Sonja.

Sonja Hutson
So walk me through the details of this case. Who’s involved and what exactly was decided?

Henry Foy
So this was a case brought by Petr Aven and Mikhail Fridman to Russian business partners who made their fortune in oil and banking, various other businesses who were sanctioned in the days following Vladimir Putin’s full-scale invasion of Ukraine in February 2022. They were sanctioned as part of a massive wave of measures that were brought by Brussels in those first few days that hit hundreds of Russian individuals and companies, and indeed oligarchs such as them who were seen as close to the Kremlin. Now, what these two men have brought to the court is evidence and their counter-evidence saying, look, the reasons that you sanctioned us were not fair, were not valid and don’t hold up to legal scrutiny. And the court found in their favour.

Sonja Hutson
And what kind of evidence are we talking about here that was dismissed?

Henry Foy
So the evidence includes news reports, one even dated back to 2005, which of course is a long, long time before the invasion took place. We also know that it includes an open letter written by a dozen or so academics and former journalists, sort of criticising these two men being invited to a dinner in America. Not sort of classified information, stuff available in the public domain and as the judges found in this case, stuff that wasn’t solid enough to connect these two men to Putin. Now, it’s important to say right now that the court only threw out the evidence used against these two men from February 2022 to March 2023. After March ‘23, Brussels brought in different justification to sanction these two men. So the sanctions still apply but it’s unclear at the moment as to what redress could be given to the two men, given that they were sanctioned for 13 months on the grounds that this court has now said was invalid.

Sonja Hutson
And, Henry, I just wanna take a quick step back here. What is generally the process that the EU uses to determine who is gonna be targeted for sanctions?

Henry Foy
So what happens is one of the EU’s 27 member states has to propose a name. They propose a name and normally propose evidence or intelligence supporting that proposal. It’s done in a secret closed-door manner, and multiple countries can obviously submit the same names. The commission, the European executive, then collates that information and draws up a list of people. And then those names have to be agreed by all 27 members in a council meeting. From what we understand, from talking to officials here who look back on that process who were involved at the time, this stuff was done at a speed that had never been done before the pressure on Brussels. But also on London and Washington and other G7 partners to sanction people as soon as possible, meant that some of these people were not fully vetted.

Sonja Hutson
So does this ruling then mean that the bar for establishing credible links to the war is now higher than it was before?

Henry Foy
That’s exactly right. This is what legal experts are telling us. Essentially now, many, many, many oligarchs who’ve been sanctioned could come to the court with the same request, which is look at the evidence that was presented by the EU, merely shows that I knew Putin, that perhaps I met him a few times, that my business was involved in somehow linking me to the Kremlin. But that doesn’t mean that I support the invasion. The question now is, what the EU do in response? Does it try to argue that the evidence was valid? Does it try to appeal this ruling? Or does it say, OK, those grounds were insufficient and then they have to go back and replace the grounds on many, many, many other oligarchs who may claim the same mispractice.

Sonja Hutson
So, Henry, what will this ruling do to future sanctions policies in the EU?

Henry Foy
I think this is something of a reminder to the officials in Brussels and in member-state capitals of the EU, that they need to have a higher bar when it comes to evidence presented against oligarchs when they’re applying these sanctions, which essentially freeze all assets held in the EU and ban these people from travelling around the EU. It’s been made clear that the court is willing and is able to strike down evidence that it deems insufficient, and so they’ll do more research and more studies done into these people that they want to sanction, to make sure that the evidence against them is watertight.

Sonja Hutson
Henry Foy is the FT’s Brussels bureau chief. Thanks, Henry.

Henry Foy
Thanks a lot.

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Sonja Hutson
Before we go, the FT Weekend Festival is coming to Washington, DC on May 4th. Former US House Speaker Nancy Pelosi will be there. So will National Security Adviser Jake Sullivan. And hey, I will also be there. You can find out how to register by clicking the link in our show notes and podcast listeners get 10 per cent off by using the code: weekendpodcast. 

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This has been your daily FT News Briefing. Make sure you check back next week for the latest business news. 

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The FT News Briefing is produced by Kasia Broussalian, Fiona Symon, Marc Filippino and me, Sonja Hutson. Our engineer is Monica Lopez. We had help this week from Zach St Louis, Ethan Plotkin, Cara Schillenn, Sam Giovinco, David da Silva, Michael Lello, Peter Barber and Gavin Kallmann. Our executive producer is Topher Forhecz. Cheryl Brumley is the FT’s global head of audio, and our theme song is by Metaphor Music.

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