Time to Start Preparing for European Money Market Fund Reform
Why is it happening, what are the differences
with the US and how will it affect you?
European money market fund (MMF) reform has finally arrived1 and will herald important changes for corporate treasurers and others that use MMFs to manage liquidity. Investors will face new features and fund types, meaning more complexity, but fundamentally, the changes should be manageable once investors become accustomed to the new landscape.
Why are money market funds being reformed?
There has been a global regulatory effort to address systemic risk in financial markets. The genesis of this regulatory push was the “run” or mass redemption suffered by the MMF industry in the US following the bankruptcy of Lehman Brothers and the infamous Reserve Primary Fund “breaking the buck”. This had spill-over effects on other parts of the financial system – notably banks – which were, in part, funded by MMFs.
The primary focus of the reforms has been mitigating susceptibility to runs. The reforms have attempted to achieve this by effecting structural changes to the way funds price and operate, and by introducing additional risk limits. Structurally, the regulations have restricted funds from transacting at a constant net asset value per share (CNAV), save for government only funds and a new fund type in Europe. The risk limits are numerous, including liquidity risk, which is a critical factor for corporate treasurers and accordingly a central pillar of our rating analysis.
Based on our research,
we estimate a negligible probability of an LVNAV fund being subject to a mandatory reform-driven gate or fee.
- Alastair Sewell,
Head of Fund & AssetManager Ratings, EMEA, Fitch Ratings
What are the differences with the recent US reforms?
Around 1.3 trillion US dollars moved out of “prime” CNAV funds in the US, with the largest volumes moving in the last few months of the implementation period2. Much of this moved into government-only funds, taking the government fund share of the market to almost three quarters of the total from around a third pre-reform. Two key factors drove this shift: first, the reforms introduced liquidity fees and redemption gates to “prime” funds3. These are mechanisms to prevent (in the case of gates) or disincentivise (in the case of fees) investors from redeeming en masse. Government-only funds did not feature these mechanisms. Second, the reforms allowed government only funds to continue transacting at a CNAV per share, while “prime” funds were forced to move to a variable net asset value (VNAV) price per share.
What will the reaction be in Europe?
We do not anticipate a similar reaction in Europe because of the introduction of the new Low Volatility Net Asset Value (LVNAV) fund and the presence of reform-driven redemption gates and liquidity fees in European government-only funds. The fact that gates and fees are already well established in Europe under the Undertakings for Collective Investment in Transferable Securities (UCITS) provisions will be a factor too, as will the existing VNAV universe and investor base in Europe.
The LVNAV fund type is significant because to many investors it will look and feel much like today’s CNAV funds. It will transact at a single price per share, provided its mark-to-market price remains within a narrow corridor and it will be able to invest in the same instruments as today’s CNAV funds. The LVNAV fund type will be subject to reform-driven liquidity fees and redemption gates, but, unlike in the US, so too will European government-only funds.
How will the reforms affect European corporate treasurers?
For European corporate treasurers accustomed to CNAV funds the reform will mean that these funds will no longer exist in their current form. Some may opt for government-only funds. We anticipate that most, however, will consider the LVNAV fund type which would imply numerous fund conversions to this fund type and possible new launches too. This is likely to become the largest fund type in Europe by assets under management. However, the “standard” VNAV variant may see outflows in favour of ultra-short duration bond funds due to the minimum liquidity requirements the reforms will impose and the resulting effect on these funds’ yields.
Based on our research, we estimate a negligible probability of an LVNAV fund being subject to a mandatory reform-driven gate or fee. Clearly highly rated funds run high liquidity levels, however, the fact that liquidity levels never dipped too low tells us that fund managers have been managing in- and out-flows effectively.
We also conceive it’s unlikely that an LVNAV fund would move outside the +/-20 basis point corridor, which would force it to move to variable pricing, unless there were an extreme market shock or idiosyncratic credit event. It’s important to highlight that even if a fund did breach the corridor, but then moves back within, then it could resume stable pricing.
Looking ahead, we anticipate European fund managers adopting more conservative portfolio management practices in comparison to US counterparts.