Fixed Income Division
The Impact from Regulatory Reform:A New Era of Cash Management
March 2011
For institutional client use only© 2011 FMR LLC. All rights reserved
Not FDIC insured. May lose value. No bank guarantee.
2
Agenda
I. Industry Overview
II. The Impact From Regulatory Reform
III. European Debt Crisis Overview
IV. Investment Process
V. Post-Crisis Observations
3
Industry Overview
Pre-Crisis Observations
Clients may have become less sensitive to investment risks inherent in cash investments
Some fund sponsors failed to maintain appropriate client investment objectives and required resources to meet those objectives
Technology/portals increased “ease of use” for MMF investors
With decades of virtually loss-free investing, investors were lured to “highest yielding” product offering
4
5
Money Market Industry Assets Under Management
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$3,500
$4,000
De
c-8
6
De
c-8
7
De
c-8
8
De
c-8
9
De
c-9
0
De
c-9
1
De
c-9
2
De
c-9
3
De
c-9
4
De
c-9
5
De
c-9
6
De
c-9
7
De
c-9
8
De
c-9
9
De
c-0
0
De
c-0
1
De
c-0
2
De
c-0
3
De
c-0
4
De
c-0
5
De
c-0
6
De
c-0
7
De
c-0
8
De
c-0
9
De
c-1
0
($B
illi
on
s)Money Market Fund Assets Stabilize, Remain Historically High
Source: iMoneyNet and FMR as of 12/31/2010
6
Yield Differentials Drive Flows
-3
-2
-1
0
1
2
3
4
5
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
-3
-2
-1
0
1
2
3
4
5
Net New Cash
Flow1
Interest Rate Spread2
Money Market Fund Flows Versus Interest Rate Spread to Banks
1 Net new cash flow is a percent of previous month-end taxable retail money market fund assets and is shown as a six-month moving average 2 The interest rate spread is the difference between the taxable retail money market fund yield and the average interest rate on money market deposit accounts Sources: Investment Company Institute, iMoneyNet, and Bank Rate Monitor
7
Bank Deposits Offer Negative Real Yield in Long Run
MMF vs. MMDA Real Yields
-3.00
-2.00
-1.00
0.00
1.00
2.00
3.00
4.00
5.00
Dec
-90
Dec
-91
Dec
-92
Dec
-93
Dec
-94
Dec
-95
Dec
-96
Dec
-97
Dec
-98
Dec
-99
Dec
-00
Dec
-01
Dec
-02
Dec
-03
Dec
-04
Dec
-05
Dec
-06
Dec
-07
Dec
-08
Dec
-09
Dec
-10
Yie
ld (
%)
Average MMDA Yield- Real Average MMF Yield- Real MMDA Yield- Real MMF Yield- Real
Source: iMoneyNet, BankRateMonitor, Bloomberg as of 12/31/09
8
The Impact from Regulatory Reform
9
1Estimated yield impacts represent annual reductions in annual fund yield in a normalized rate environment over time. Reductions show impact to fund that is running at or near current Rule 2a-7 limits. Yield impacts differ among rated, institutional, and retail funds. Sources: FMR and Securities and Exchange Commission
Regulatory Changes Impacting Portfolio Management
Old Rule 2a-7 Current Rule 2a-7Estimated Yield
Impact (bp)1 Implementation Date
Daily Liquidity – Taxable None 10% 0 May 28, 2010
Daily Liquidity – Municipal None None None None
Weekly Liquidity – Taxable None 30% (9 – 12) May 28, 2010
Weekly Liquidity – Municipal None 30% 0 May 28, 2010
Weighted Average Maturity (WAM)
90-days 60-days (0 – 8) June 30, 2010
Weighted Average Life (WAL)
None 120-days (1 – 3) June 30, 2010
Illiquid Securities 10% 5% (1 – 3) May 28, 2010
Second Tier Securities
5%
1% per issuer
397-day limit
3%
0.5% per issuer
45-day limit
(0 – 3) May 28, 2010
Total (11 – 29)
10
Presidents’ Working Group Report-Potential Options for Money Fund Reform
Floating the NAV of money market funds
Mandatory redemptions-in-kind
Private liquidity facilities
Insuring money market funds
Two-tiered system of money market funds of stable NAV and floating NAV funds
Regulating stable NAV funds as special purpose banks
Regulating non-2a-7 cash management products
11
Basel III – Additional Consideration for 2a-7 funds
On September 12th, the Basel committee reached agreement on key elements of the capital reform process
Capital» Minimum Tier 1 common ratio of 4.5%
» Capital conservation buffer of 2.5%, yielding 7% effective T1 common floor
» Additional countercyclical buffer of 0-2.5%
» Minimum Tier 1 leverage ratio of 3% effective 2018
» Capital requirement phase-in period from 2013 - 2018
» Hybrids phased out over 10yrs beginning 2013
Liquidity» Liquidity coverage ratio effective 2015
» Net stable funding ratio effective 2018
Source: FMR
GSE Reform- White Paper from the U.S. Treasury
The U.S. Treasury proposed three options to wind down the GSEs while agreeing to honor all outstanding GSE obligations» Option 1 would incorporate a full shutdown of the GSEs in which the only
government support for the mortgage market would be through the Federal Housing Administration (FHA), the Veterans Administration (VA) and the US Department of Agriculture (USDA)
» Under Option 2, the GSEs would be completely wound down but include a government backed mechanism to support the mortgage market in times of crisis
» Option 3 would include a reinsurance mechanism from private mortgage guarantee companies to guarantee MBS with strict underwriting standards
The Treasury’s intentions are to:» Bring private capital back to the market
» Phase in increased pricing at Fannie Mae and Freddie Mac
» Reduce conforming loan limits
» Phase in a 10% down payment requirement
» Wind down Fannie Mae and Freddie Mac’s investment portfolios
13
Regulation Creates Opportunity
Source: Morgan Stanley
Money Market Fund and Bank Regulations
Yield Curve Steep Beyond Six Months
LIBOR and Treasury Yield Curves
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1-D
ay
1-M
on
2-M
on
3-M
on
4-M
on
5-M
on
6-M
on
9-M
on
1-Y
ea
r
2-Y
ea
r
Yie
ld (
%)
LIBOR 2/28/10LIBOR 2/28/11Treasury 2/28/10Treasury 2/28/11
Source: Bloomberg as of 2/28/11
Past performance is no guarantee of future results. It is not possible to invest directly in an index. Index performance is not meant to represent that of any Fidelity mutual fund.
15
Federal Funds Target Rate and Fed Funds Futures
0.0
0.51.0
1.5
2.0
2.53.0
3.5
4.0
4.55.0
5.5
6.0
Feb
-05
Au
g-0
5
Feb
-06
Au
g-0
6
Feb
-07
Au
g-0
7
Feb
-08
Au
g-0
8
Feb
-09
Au
g-0
9
Feb
-10
Au
g-1
0
Feb
-11
Au
g-1
1
Feb
-12
Yie
ld (
%)
Fed Funds Target Rate
Fed Funds Futures
Source: Bloomberg as of 2/28/11
Recovery Underway, Fed Tightening Unlikely in 2011
16
Source: Bloomberg as of 2/28/11
3-Month LIBOR vs. 3-Month Treasuries
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
Feb
-08
May
-08
Au
g-0
8
No
v-08
Feb
-09
May
-09
Au
g-0
9
No
v-09
Feb
-10
May
-10
Au
g-1
0
No
v-10
Feb
-11
Yie
ld (
%)
3-Month LIBOR
3-Month Treasuries
TED Spread High10/10/08: 449 bps
TED Spread Low: 3/16/10: 11 bps
TED Spread Current:2/28/11: 17 bps
Short-Term Credit Spreads Remain Near All-time Lows
Past performance is no guarantee of future results. It isnot possible to invest directly in an index.Index performance is not meant to represent that ofany Fidelity mutual fund.
17
European Debt Crisis Overview
First Dimension of Contagion
European Response was Significant
Permanent Liquidity Measures from the European Central Bank (ECB)» Main Refinancing Operation (MRO)
» Long-Term Refinancing Operation (LTRO)
Recent Measures by European Authorities» Expanded collateral eligibility
» Reinstituted central bank swap lines
» ECB targeted bond purchases
Sovereign Support Programs» Initial Greek package of EUR110 billion
» Financed 2/3 from EMU and 1/3 from IMF
» European Financial Stabilization Fund – EUR 750 billion» EU/EC Balance of Payments Facility – Increased to EUR110 billion
» Eurozone Loan Guarantees of EUR440 billion
» IMF Loan Facility up to EUR250 billion
Peripherals Highly Dependent on ECB Funding
Source: Morgan Stanley, Bloomberg, ECB and Central Bank of Ireland as of 2/15/2011
Sovereign Risk Remains Volatile
Source: Bloomberg as of 1/31/2011
5-Year Credit Default Swaps of PIIGS
0
200
400
600
800
1000
1200
Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11
Bas
is P
oin
ts
Greece Ireland Portugal Spain Italy
Two Rounds of Bank Stress Tests
The Committee of European Banking Supervisors (CEBS) conducted the first European Bank Stress Test in July 2010
Only seven banks failed with a €3.5bn total capital shortfall» Failed banks included one German, one Greek and five Spanish banks
The market blamed the low number of failures due to a lack of rigor in macroeconomic stresses and that sovereign haircuts were applied only to trading books and not to accrual books
Hence, another stress test is scheduled with CEBS expected to be published in June» Similar to 2010, the banks tested will cover 65% of EU banking system total assets and at
least 50% of the national banking sectors in each EU member state» Haircuts for sovereign debt will still not be taken in the accrual book, but there will be better
disclosure (e.g. the sovereign holdings by maturity buckets) » The test will include a baseline and adverse scenario for the periods of 2011-12
Baseline scenario: sovereign exposures are subject to an “interest rate” stress Adverse scenario: sovereign exposures are subject to further specific sovereign rate shocks with
haircuts differentiated by the maturity of the assets
» The methodology states a more stringent approach to the definition of core tier 1 capital compared to the 2010 exercise
Risks Lie Ahead
Sovereign crises are likely to be with us for some time
They could expand into other, larger and more systemic countries including Spain, UK, Japan and even the United States
The Greek rescue package does not address solvency issues and as such only buys some time – it is important for other countries to get in order
Large sovereign crises are likely to have major systemic implications, especially given the close linkages between sovereigns and their banking systems
The transmission from sovereign to financial system crisis could be rapid given how much sovereign debt banks hold
Higher counterparty risk, swap spreads and LIBOR-OIS spreads make it more difficult for banks to fund themselves
Austerity and higher funding costs could undermine economic growth and increase the risk of double dip into recession
24
Investment Process
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Identify and Measure Relevant Risk Parameters
Investment Risks
Significance of Risk ExposureBenefits of a Multi-Dimensional
Research Process
Credit RiskPrincipal depreciation through price volatility or default
Non-reliance on Nationally Recognized Statistical Rating Organizations
Interest Rate RiskPrincipal depreciation through rising interest rates and widening spreads
Quantitative Risk Management Framework
Liquidity Risk Lost access to cash holdingsThorough analysis of underlying liquidity provisions
Structural RiskComplex documentation contains embedded risks
Dedicated legal team with specialized securities knowledge
26For Institutional Use Only
ConsistentRisk-Adjusted
Alpha
Multi-Dimensional Investment Approach
Bottom Up Foundation» Fundamental Analysis
Fundamental foundation Relative value assessment
» Quantitative Analysis Proprietary risk modeling Security and portfolio level
» Structured Analysis Capital structure analysis Complements fundamentals
» Value Added Trading Relative value assessment Across curve and structure Macro trends/technicals
Top Down Perspectives» Macroeconomic Inputs
Federal Reserve expectations Sovereign landscape Tail risk/scenario modeling
» Sector Basis call: transparency Fundamental and relative value
» Yield Curve Breakeven analysis Slope and volatility Relative value opportunities
» Interest Rate Duration views Volatility perspectives
Bottom-up, fundamental Investment platform complementedby top-down inputs, results in a robust and durable process
Objective:
ConsistentRisk-Adjusted
Returns
201101-8963
548129.11.0 - 22
27
The recent and future regulatory environment have given rise to a new era of cash and liquidity management
Investment goals and objectives are independent of current market conditions» Capital Preservation
» Liquidity
» Returns
Cash Management is a time consuming, resource intensive multi-dimensional process» Develop a Risk vs. Return profile
» Understand all aspects of the investible universe
The guiding principle of credit research is minimal credit risk
Money market funds are more resilient than ever before
Conclusion: Post-Crisis Observations
Important Information
Not NCUA or NCUSIF insured. May lose value. No credit union guarantee.
The views expressed in this statement reflect those of the portfolio manager only through the end of the period of the report as stated on the cover and do not necessarily represent the views of Fidelity or any other person in the Fidelity organization. Any such views are subject to change at any time based upon market or other conditions and Fidelity disclaims any responsibility to update such views. These views may not be relied on as investment advice and, because investment decisions for a Fidelity fund are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity fund.
Past performance is no guarantee of future results. Investment return will fluctuate, therefore you may have a gain or loss when you sell shares.
Diversification does not ensure a profit or guarantee against a loss.
An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund. Interest rate increases can cause the price of money market securities to decrease.
Before investing, have your client consider the funds’ investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Have your client read it carefully.
For Institutional Investor Use only.
Fidelity Investments & Pyramid Design is a registered service mark of FMR LLC.
Fidelity Investments Institutional Services Company, Inc., 100 Salem Street, Smithfield, RI 02917
Not FDIC Insured. May lose value. No bank guarantee.
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