State of play in the short-term fixed income markets

1. State of play in the short-term fixed income markets Demystifying regulatory reform, interpreting implications and offering solutions

2. Contents • Reform update • Market, issuer and portfolio implications • Client implications

3. Reform update

4. Current industry climate A debate is on in the money market fund industry concerning the need for additional regulatory reforms. “ I believe additional steps should be taken to address the structural features that make money market funds vulnerable to runs. Mary SchapiroChairman, SEC ” “ ” Money market funds play a critical role in the U.S. economy. David HirschmannU.S. Chamber of Commerce “ It’s disappointing that the success of the 2010 amendments is ignored in pursuit of changes that will compromise core features of money market funds. Paul StevensPresident, Investment Company Institute ” “ Europe doesn’t have any (money market funds), and they have a financial system. Ben BernankeChairman, Federal Reserve ”

5. How strong are money market funds today? Money market funds have shown great resiliency since significant reforms were enacted in 2010. Still, the SEC is proposing additional regulations with varying impact on systemic risk. Prime Money Market Funds accommodated large outflows during U.S. debt ceiling and Eurozone debt crises Source: Investment Company Institute

6. The current regulatory environment Regulators, think-tanks and industry organizations are working on a wide range of potential solutions. Status quo Capitalideas Gatingprovisions Two-tier regulatory system Structuralchange With revisions to current 2a-7 rules Sponsor capital Mandatory redemptions in kind Split retail frominstitutional Floating NAV Shareholder funded Redemption fee Split credit fromgovernment funds Subordinated share class Escrowed shares Unresolved systemic risk in the market? Minimal risk of impact to short-term markets while addressing systemic risk concerns? Implications for theshort-term markets?

7. Potential SEC money market fund reform • SEC writing proposal — expected April – May • Two commissioners oppose additional reforms — one undecided • Commissioner Aguilar on the fence • 3 votes of 5 needed to pass proposal • Potentially get 90 – 120 days to comment • Industry and investors — “Rare Alignment”

8. Capital buffers This proposal requires funds to maintain dedicated capital for covering losses in times of trouble. Capital buffer Redemption holdback Resources to address significant falls in a fund’s value + = SEC position: A capital buffer, in combination with the holdback proposal, would mitigate the incentive for investors to run since there would be capital to address potential losses.

9. Redemption restrictions This proposal requires funds to hold back a percentage of a shareholder’s redemption proceeds for a set period of time. Example: (Assumes a 5% holdback) Investor owns shares worth $100and redeems entire amount Receives $95today Receives remaining $5in 30 days… …UNLESS a crisis happens, in which case the first losses would be funded by the fund’s capital buffer and then by that $5holdback SEC position: Discourages a run on the fund as shareholders redeeming the full amount of their investment would bear the first loss in the event that a fund broke the dollar.

10. Floating the NAV This proposal requires funds to stop using the amortized cost method of valuation and let their share prices float. SEC position: A floating NAV reflects a fund’s true market value, demonstrates that money market funds are not free from risk and helps reduce large redemptions during periods of financial stress. A historic look at market NAV fluctuations, 2000 – 2010Prime money market funds

11. Market, issuer and portfolio implications

12. Market Implications • Restructuring of intermediation in the short-term fixed income markets • AUM shift to offshore MMFs, LGIPs, STIFs and short/ultra-short bond funds • Transfer of systemic risk from one market segment to another • Yield curve implications unclear • shift to Tsy/Govt sector would pressure curves lower • demand for shorter, liquid credit product would steepen the credit curve beyond 3 months • Dodd-Frank and Basel III – supply challenges • Shift to bank deposits. Wholesale deposits neither desirable, nor economical for banks and FDIC insurance on non-interest bearing accounts may not extend past 2012 • deposit fees? • funding shift to the Fed?

13. Market Implications Is bank deposit growth sustainable? Source: BofA Merrill Lynch Global Research, Haver, Federal Reserve

14. Market Implications Banks unlikely to invest excess liquidity at current market levels Source: BofA Merrill Lynch Global Research

15. Issuer Implications MMFs are a vital source of short-term funding to a variety of issuers Sources: Investment Company Institute, Federal Reserve Board, U.S. Treasury Department, Fannie Mae, Freddie Mac, Federal Housing Finance Agency, Federal Reserve Bank of New York, Municipal Securities Rulemaking Board, Municipal Market Advisors

16. Issuer Implications Systemic risk reduced as short-term funding markets have contracted *Data for 2010 are through October. Sources: Investment Company Institute and Federal Reserve Board

17. Portfolio Implications Redemption Restrictions Floating NAV • Unique liquidity considerations: how to account for and • Manage the “hold back”. An additional liquidity requirement. • Shorter WAM and WALs – first mover liquidity risks • NAV “arb” liquidity risks • Pricing considerations – premium on most liquid and easily- • priced securities. Avoiding pricing “surprises”. • Increased levels of Tsy/Gov’t holdings in credit MMFs • Credit decisions become more conservative. Credit specific • stress => NAV and cash flow implications Capital Buffer Common Themes • Existing supply challenges exacerbated. Demand for shorter, • less volatile assets will not be met with issuer supply. • Shorter, more liquid and less credit-sensitive portfolios • More opportunity to add value in SMA structures? • Sponsors with deeper capital resources attract a greater share • of industry AUM. Consolidation drives supply challenges. • Greater flexibility in regulatory framework if capital exists? • Consolidation impact on market liquidity. More concentrated • buyer bases.

18. Client implications

19. Corporate reactions Investors and issuers of money market funds express concerns about the potential reforms. “ We rely upon the convenience and simplicity that the stable NAV provides for accounting, recordkeeping and tax treatment of cash balances. New Jersey Association of Counties ” “ Money market mutual funds are a reliable source of direct, short-term financing for millions of businesses, non-profits, and others, including colleges and universities. American Association of State Colleges and Universities ” “ Holding back a portion of an investor’s money to guard against changes in share value would drive investment away from the funds. The Pennsylvania League of Cities and Municipalities ”

20. Capital Buffers A capital reserve is an interesting idea, but there are limits on the amount of capital that could be raised.

21. Redemption Restrictions This proposal eliminates the very attribute investors value most in a money market fund – daily liquidity.

22. Floating the NAV This proposal eliminates the very attribute investors value most in a money market fund — a constant NAV. Investment Policy Impact

23. Appendix – Slide 14 Footnotes

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