Cash Sweep Scrutiny Poses Risks to Wealth Managers’ Credit Ratings, According to Moody’s Report by Reuters

By Niket Nishant

A recent wave of regulatory investigations into cash sweep programs employed by wealth managers could negatively impact their credit ratings, according to a warning from Moody’s Ratings. This poses a significant risk to the high-margin operations of firms such as Morgan Stanley and Wells Fargo.

Importance of the Situation

A potential downgrade in ratings could increase operational costs for wealth managers, especially amid growing concerns about the economy, with forecasts suggesting a possible downturn due to tight monetary policies.

Background Information

Cash sweep programs enable wealth managers to transfer un-invested cash from brokerage accounts into partner banks, allowing clients to earn some returns on idle funds. However, these programs have led to disputes since the interest offered by these partner banks tends to be lower than what clients could achieve through alternatives like money market funds.

To address these issues, wealth managers have begun providing clients with more options. Customers can choose to place their un-invested funds in tax-exempt accounts or other investment vehicles instead of directing them to partner banks.

In response, Morgan Stanley, Wells Fargo, and Bank of America have also increased the interest on select brokerage accounts.

Despite these adjustments, the ongoing regulatory scrutiny remains a concern. Both Wells Fargo and Morgan Stanley have revealed that their cash sweep programs are currently under review by the SEC, while Bank of America has identified it as a potential risk factor in its latest quarterly report.

Moody’s indicated that larger firms with diversified revenue streams may better withstand these challenges. However, private-equity-backed wealth managers with high debt levels and less varied business models are likely to face more significant impacts.

The investigations may also compress profit margins across the financial industry by necessitating that firms boost interest rates on brokerage accounts, the ratings agency noted.

Key Insight

"Increased competition could propel consolidation in this space, depending on how many sweep accounts are affected and how much revenue is lost," stated Gabriel Hack, assistant vice president at Moody’s Ratings and the report’s lead author.