Standard & Poor's Ratings Services released two papers last week on the current realities in the European money market fund industry. One is called, "European Money Market Funds Display Resilience in Tough Times," while the other is on "What the Evolving Regulatory Landscape for Banks Means for European Money Market Funds." The former looks at how the industry is surviving the challenges it has faced in Europe. S&P writes, "In the first half of 2015, managing short-term money market funds (MMFs) became that much harder. Obstacles for fund managers in Europe include low or negative yields, declining net assets, a shrinking supply of investments that offer high credit quality, and ongoing uncertainty regarding regulation in the future. In response, many MMF managers have increased their weighted-average maturity and geographic diversification. Despite the difficult environment, the managers of Europe-domiciled MMFs have maintained the 'AAAm' rating." (Note: S&P and experts on European money funds will present on many of these topics at this week's Crane's European Money Fund Symposium in Dublin, which takes place Sept 17-18 in Dublin, Ireland.)
The first piece explains how investors are adapting, saying, "Faced with such low fund yields, liquidity investors are reassessing their options. If they can, they are increasing their allocation to higher-yielding assets. Most of those who invest in MMFs in Europe are institutional clients -- primarily insurance companies and pension funds -- who use MMFs to meet their investment cash needs. These investors can choose to reallocate some of their assets and invest in longer-dated assets that provide a higher yield. However, MMF managers cannot. MMFs are short-duration in nature due to a weighted-average maturity restriction of sixty days, limiting the amount that can be invested in longer-dated securities. Corporate treasurers are also known to invest in short-term MMFs for their operational cash needs. However, we understand from our rated fund sponsors that corporate treasurers are re-evaluating their cash requirements by segmenting their cash balances into those for immediate use and those for later use, in an attempt to mitigate the impact of negative yields. This means that they are making less use of liquidity funds as a short-term cash investment."
S&P adds, "Most short-term MMF managers started to cancel shares in April 2015, affecting investors in constant net asset value (CNAV) EUR MMFs further, with many investors looking for alternative investment options. The industry has been able to absorb negative yields and still maintain a E1.00 constant NAV per share by cancelling shares that an investor holds. CNAV EUR MMFs that were able to incorporate this feature in their prospectuses have passed on the negative yields and, in many cases, fees to investors. As a result, most CNAV EUR MMF investors will end up with fewer shares than originally received."
The paper continues, "Since the end of January 2015, low yields, asset reallocation, changes in business strategy, fund liquidation, and the withdrawal of fund ratings have led to a decline in the net assets of 'AAAm' rated MMFs in the three major currencies, especially EUR MMFs. The primary reason for the large decline in EUR MMFs is the rating withdrawal of a large fund that represented 18% of total net assets. Excluding this large fund, net assets declined by 15% instead of the 32%. Similarly, the rating withdrawal of a large fund caused net assets to decline by an additional 8% for USD MMFs. Excluding this fund, net assets declined by 7%, instead of 15%. The recent net asset trend of GBP MMFs was not subject to significant fund additions or withdrawals and reflects general market demand. Despite the above challenges, our ratings on the MMFs managed in Europe have remained stable."
On MMF regulations, it says, "Although the final shape of the European MMF reforms remains unclear, some details have emerged. According to the proposal that was voted on in the European Parliament in March 2015, the final proposal is unlikely to require MMFs to hold a 3% capital buffer. Requiring a buffer would have made short-term CNAV MMFs, which currently offer negative yields or yields of only a few cents per E1.00, economically unsustainable. Instead, we expect regulators to implement liquidity fees and redemption gates that would be activated during times of stress. It is hoped that these measures would address the risk of an investor run on an MMF. They are similar to the rules the U.S. Securities and Exchange Commission (SEC) plans to adopt for regulated U.S. MMFs in October 2016. More importantly, short-term CNAV MMFs will be allowed to coexist with variable net asset value (VNAV) MMFs as long as CNAV MMFs are provided under the banners of public debt MMF and retail CNAV MMF or low-volatility NAV short-term MMFs. CNAV MMFs would continue to exist for a predetermined period of time and reassessed for future risk."
On banking regulations, S&P writes, "In Europe, the supply of highly rated eligible investments has declined since 2012 as several regions in the Eurozone fell back into recession. Furthermore, regulatory developments in the banking sector may continue to affect the supply of high credit quality issuers, especially highly rated global commercial banks, which are an important source of investment for European MMFs. This segues into the second S&P release, "What the Evolving Regulatory Landscape for Banks Means for European Money Market Funds."
This report begins, "How important are financial institutions, banks in particular, to European MMFs as an investment option? At the end of June 2015, 75% of sterling-denominated, 67% of U.S. dollar-denominated, and 55% of euro-denominated MMFs' portfolio holdings were in bank-related short-term investments such as bank deposits, certificates of deposit, cash held with a custodian bank, bonds, floating-rate notes, and reverse-repurchase agreements (repos). In our view, the predictability of extraordinary government support for banks' senior creditors is likely to diminish across Europe.... In June and July, we took various rating actions on systemic banks in these countries to reflect the removal of ratings uplift for government support, as well as, in many cases, the recognition of ALAC (the additional bail-in capacity that banks already hold or that we expect them to build up in the future)."
Standard & Poor's Ratings explains, "We have lowered a number of long-term bank ratings over the last three years, but the number of banks with the highest short-term ratings of 'A-1' or 'A-1+' has declined only slightly, indicating their resilience to changing market conditions and regulatory environment. This is especially important to European MMFs, which rely on and use the short-term rating, a key part of our principal and stability fund ratings criteria, when determining credit quality and investment strategy."
It concludes, "We still see pressure on bank ratings in many of the remaining European jurisdictions that have yet to implement the BRRD or equivalent legislation, and in North America and Canada as global bank regulation evolves. Banks continue to adjust to the evolving regulatory landscape that has emerged since the financial crisis, as market conditions remain unsupportive and sometimes volatile in certain regions. As a result, we expect that European MMFs will continue to invest cautiously, seeking to maintain the extremely high quality and liquidity of their investments, and we anticipate further changes in bank creditworthiness."
In other news, both Fitch and Moody's also announced European money market fund ratings actions. Fitch assigned 'AAAmmf' ratings to two short-term money market funds managed by BlackRock -- BlackRock ICS Institutional Euro Liquidity Fund and BlackRock ICS Institutional Euro Government Liquidity Fund. The press release says the funds are "sub-funds of the Irish-domiciled umbrella fund, BlackRock Institutional Cash Series plc." Fitch says the key drivers of the ratings are, "The portfolios' overall credit quality, diversification and short maturity profile; Minimal exposure to interest rate and spread risks; Overnight and one-week liquidity profiles consistent with Fitch's rating criteria; The capabilities and resources of BlackRock as investment manager."
Also, Moody's withdrew the Aaa-mf money market fund rating of Federated Short-Term Sterling Prime Fund. The Fund is managed by Federated Investors (UK) LLP. The release says, "Moody's has withdrawn the rating for its own business reasons."
