Whither go European money market funds?

September 2013

On 4^th September, the European Commission (EC) released its long-awaited proposals for increasing money market fund (MMF) regulation. Treasury Today spoke to industry players to gauge their reactions, as well as understand how these proposals will affect corporates.

In a move to address financial systemic instability, on 4th September the European Commission (EC) put forward a number of proposals to regulate the European money market fund (MMF) industry, in a similar way that Basel III’s Liquidity Coverage Ratio (LCR) has put constraints on banks to ensure that they adequately manage their liquidity.

The proposed regulation, which will apply to all MMFs domiciled, managed or marketed in the EU, affecting nearly €1 trillion in investor assets, requires:

• Certain levels of daily/weekly liquidity in order for the MMF to be able to satisfy investor redemptions – MMFs are obliged to hold at least 10% of their assets in instruments that mature on a daily basis and an additional 20% of assets that mature within a week.
  
• Clear labelling on whether the fund is short-term MMF or a standard one (short-term MMFs hold assets with a residual maturity not exceeding 397 days while the corresponding maturity limit for standard MMFs is two years).
  
• A capital cushion (the 3% buffer) for constant net asset value (CNAV) funds that can be activated to support stable redemptions in times of decreasing value of the MMFs’ investment assets.
  
• Customer profiling policies to help anticipate large redemptions.
  
• Some internal credit risk assessment by the MMF manager to avoid overreliance on external ratings.
  

 

Industry frustration

In a statement, the Institutional Money Market Fund Association (IMMFA) lambasted “this ill-considered regulation”, saying it will “effectively mandate a conversion to variable NAV (VNAV) MMF to the detriment of investors, issuers and the economy in general”.

The association, which has 22 members who operate funds and a number of associate members, supports the introduction of minimum liquidity requirements, ‘know your client’ policies, enhanced transparency, and the use of trigger-based liquidity fees and gates (similar to the Securities and Exchange Commission’s (SEC) proposals, which ends its consultation period on 17th September). However, it stands firmly against a 3% capital buffer for CNAV MMF and argues that it won’t contribute towards enhancing systemic stability.

“Some of the measures in today’s EC proposal will make a positive contribution to the robustness of MMFs, but there are several which are extremely unhelpful, to investors and to the short-term debt markets in general,” said Susan Hindle Barone, Secretary General of IMMFA, in the statement. “We reject the assertion that there is a greater degree of systemic risk inherent in CNAV MMFs. The EC has not demonstrated that CNAV funds are more susceptible to run-risk than VNAV funds, and the discrimination between these two accounting techniques is unjustified.”

With the requirement for a 3% capital buffer, IMMFA expects that CNAV providers will convert their funds to VNAV, as it is uneconomic for an asset manager to hold 3% capital against an MMF. The buffer will also have a significant impact on the wider economy. The association calculates that, at 3%, the European-domiciled CNAV MMFs would have to raise €14 billion, €10 billion by banks and €4 billion by independent asset managers. Assuming banks are currently levered by 20-25 times, reassigning the capital from other business to cover the MMF buffer would withdraw €200 billion-€250 billion from the European economy.

In addition, given the SEC’s decision to reject the use of capital buffers for US MMF, the IMMFA believes that there is now a “serious risk that cross-border arbitrage opportunities will be created”. In an interview with Treasury Today, Hindle Barone says: “The SEC flatly rejected the use of capital buffers, so I can’t see them reconsidering this measure any time in the near future. Instead, they are considering a mixture of moving to VNAV and/or the use of liquidity gates and fees. European regulators don’t like to draw attention to the fact that they are going down a different path than the SEC, but they are. As an industry association, we hope that good sense prevails and the US and Europe jurisdictions become more aligned, but we continue to be disappointed.”

The proposed reforms will need to be agreed with the European Council and Parliament, a process unlikely to be completed before the May 2014 European elections. However, once the regulation is accepted into law, the transition period for these changes is only six months. This will not be feasible given the extensive operational and educational changes which would be necessary. “This is one of the biggest challenges in the proposals,” says Hindle Barone. “It is not practical to make sweeping changes and expect them to be implemented in six months.”

What about corporates?

The biggest investors in MMFs are corporate treasurers who need to hold large amounts of cash on a short-term basis and who do not want to put all of their cash in one single bank deposit account. MMFs provide a high degree of liquidity, diversification and stability of value which is combined with a market-based yield. In Europe, the split between CNAV and VNAV models is roughly 50/50, according to the EC. The 3% buffer would apply to CNAV funds, to build up a cash reserve and give the fund a buffer in the event that the value of the share dips below €1.

Mireille Cuny, Global Head of Liquidity and Investment Solutions, Société Général Corporate and Investment Banking (SGCIB), thinks that it is fair that the regulators underline the fact that there are no capital guarantees with MMFs. “Corporate treasurers are realising that, in an environment where short-term rates are very low, credit spreads are decreasing and asset managers have increasing internal costs because of incoming regulations, the return on MMFs can be very low or even negative.”

But will the proposed regulation change corporates’ investment strategy? Cuny believes that MMFs will remain attractive for those corporate treasurers that manage less cash, ie up to €50m, and who can’t develop the minimum expertise needed in-house. “If a corporate has few resources but a lot of volatility in its cash, then an MMF is probably a good investment instrument because the company can still benefit from diversification and an asset manager’s expertise. In addition, if a corporate is managing a lot more cash, it might still make sense to use MMFs for the very volatile cash between one and 30 days maturity. But for cash beyond the 30-day mark or for higher amounts where a corporate needs to monitor its diversification, then it is probably better to invest directly in commercial paper, or look for a bank deposit with some investment solution attached.”

An example of new developments in the latter space is SGCIB’s liquidity and investment solutions desk launched in 2011. Via the desk and in dialogue with its corporate clients, the bank has developed rolling deposits paying a fidelity premium, increasing at each roll. The ‘roll period’ is defined with the client according to their business constraints. The bank also offers notice call accounts and other solutions with daily liquidity, by taking into account the client’s estimate of the steadiness of the cash.
SGCIB’s rolling deposit solution has attracted more than €1 billion. “It is not only the €1 billion which is impressive, but also the fact that corporate clients all over the world are interested in this solution,” says Cuny.

What you can do

As the proposals start moving through the political process, there is still time to influence the decision-makers. The IMMFA is working together with the Association of Corporate Treasurers (ACT) to ensure that the corporate voice is heard. Each member of the association will also be reaching out to its investors to get involved in the debate.

Hindle Barone recommends pointing out directly to local MEPs, as well as representatives from the Bank of England (BoE) and the Treasury how damaging these proposals could be. “We are encouraging anyone who cares about this to make their voices heard, whichever avenue that takes,” she says. “We are trying to explain that this has a real impact on the broader economy and we struggle to get that message through.”

And input from the real economy could make a significant difference to the end result. For example, in his keynote speech at the annual IMMFA dinner in June, Sajid Javid MP, Economic Secretary to the Treasury, indicated the UK government’s strong commitment to the MMF industry. The time is nigh to get involved in the debate.