A new LGIP Portfolio to open in Georgia; Financial Stability Oversight Council Action is a telltale of big changes in the financial markets.
Georgia Will Roll Out a Prime LGIP Portfolio
The Georgia Treasurer is rolling out a new LGIP for local governments that will include credit-backed money market securities in its portfolio with the objective of producing a higher yield than its existing government portfolio (Georgia Fund 1).
The offering, Georgia Fund 1 Prime, has a couple of unusual dimensions:
§ A depositor representative of a local government must undergo mandatory training before investing funds in the prime pool; and,
§ It is part of a program that will offer both government and prime fund options.
Georgia Fund 1 Prime is set to open December 4. It will be managed as a stable net asset fund with 30% invested in credit instruments (high grade commercial paper, corporate obligations, and negotiable certificates of deposit) and the balance in government obligations (including repurchase agreements).
State Treasury staff expect the new portfolio will offer an enhanced yield as compensation for the risk associated with investing in credit-backed instruments. Risk management elements include limiting the maximum weighted average maturity of the new fund to 60 days, limiting credit exposure to 30% of its assets, and employing an external investment manager. The new portfolio is expected to maintain a rating of AAAmmf from FitchRatings.
Federated Hermes will manage the new fund with oversight by the State Treasurer. The existing Georgia Fund 1 is managed internally. Treasury decided to use an external manager to bring extensive credit review/management resources to supplement the smaller, internal staff that manage and administer the government-oriented fund.
The new portfolio will operate with an expense ratio of 5.5 basis points (the same as the existing portfolio). Treasury staff that conducted an RFP for the external manager were “surprised at how aggressive the bids were.”
State Treasurer Steve McCoy is a long-time advocate of investment training. Before investing funds in the new offering, at least one depositor representative of a local government will have to undergo training on investment risks and operations. The mandatory two-hour training as a pre-requisite for using the new fund is unusual and may be unique in the LGIP space. The training will be split between risk/liquidity issues and operations issues (Federated will provide client service and operations for the new portfolio, while the State Treasury provides these services for Georgia Fund 1).
The Georgia Treasury currently has three pooled programs, including two with credit-based investments, but until now local governments were permitted only to invest in the government-oriented Georgia Fund 1 portfolio. As of June 30, 2023, Georgia Fund 1 had assets of $30.7 billion, with about 10% in bank demand deposits and the balance in government obligations. About 58% of its assets were local government assets; the balance was state and state agency funds.
LGIPs that offer both a government and a prime series are unusual, but not unheard of. Most sponsors apply a single investment policy to their portfolios. But TexPool, the State’s $42 billion LGIP, Texas CLASS, a $23 billion pool, Colotrust, a $14 billion LGIP in Colorado, and Pennsylvania’s $11 billion PLGIT, offer both government and prime options.
An Obscure FSOC Action Is a Telltale for Changes in the Financial Markets
Earlier this month the Financial Stability Oversight Council, an intergovernmental entity chaired by the Treasury Secretary, adopted a framework for assessing risk in the non-bank sector. If you are a public funds officer, you might shrug and pass quickly to the next news story. Afterall, what is interesting about an obscure Federal agency publishing a complex set of analytic rules for itself?
But this is a key sign of the extent to which non-bank banks have moved into areas of the financial markets that were once the preserve of highly regulated depository organizations. It is evidence of the changing nature of the financial markets in which state and local governments participate.
Bank consolidation is one big theme we’re following these days; a second is the rise of non-bank banks and it is the rising importance of non-banks are lightly regulated that has moved the FSOC to act.
Points to note:
§ Nowhere is the rise of non-banks more apparent than in the investment markets where money market fund assets now total more than $6 trillion and LGIP assets total at least another $700 billion. That’s nearly 40% of the level of deposits in US commercial banks. Which, incidentally, have declined this year by about $700 billion. Privately-managed institutions—or at least institutions that are not closely regulated—now are the intermediaries for almost 30% of short-term financial assets.
§ Private funds are gearing up to enter the lending markets in big way, funding business loans, financing public works, and planning to make big advances in financing mortgages.
§ Broker dealers who are active in the Treasury markets now include such firms as Citadel Securities, Jane Street and Susquehanna International Group, entities that started out as proprietary trading shops. Public agencies are likely to deal with these firms when they buy/sell securities.
§ Technology demands will expand involvement of fintech firms in the public funds investment business.
A generation ago all of this--earning interest on cash, borrowing money, buying securities, processing payments--was likely to happen via a bank, and regulators would look to bank capital and prudential regulation to manage systemic risk. The FSOC action now has focused on what it sees as a regulatory/risk gap related to the expanding role of non-banks. Designating some of these companies as Significantly Important Financial Institutions, which is the responsibility of the FSOC, could bring them under Federal Reserve supervision and lead to (higher?) risk-based capital requirements.
Investment enterprises sponsored by state/local governments are not entirely outside of the purview of this expanded analytic framework. The FSOC is actively examining the role of private funds in the financial markets. LGIPs are private funds under the securities taxonomy employed by the Securities and Exchange Commission, and LGIPs operated by external investment managers could come under regulatory scrutiny—though there is nothing to indicate they are on the FSOC radar at this point.
Bottom line: If you are a non-bank CEO, or a lawyer representing a non-bank organization, you will argue that this amounts to regulatory over-reach—that there is no evidence of recent “failures” created by the actions of non-banks.
If you are an investor, you may benefit from greater supervision and higher capital requirements for these financial organizations, but will also be affected by having to pay some or all of the costs of enhanced risk management (think costs associated with buying/settling/holding securities, processing payments, expense ratios levied by money market mutual funds, etc.)
In all events change is afoot in the financial markets. Bank consolidation, the growth of non-bank banks and the rapid rise of financial technology are altering the world for public funds investors.