S&P Global published a paper on "Negative Rates," which contains a section on European money funds, entitled, "Pay me to give you back less than what you gave me: the new era for money market investors." Written by Andrew Paranthoiene and Emelyne Uchiyama, it says, "Money market funds (MMFs) are well-regarded by investors as an alternative to bank deposits for short-term cash management. Investors benefit primarily from a diversified portfolio of high-credit, short dated liquid assets that seek to provide them with stability of capital, provision of liquidity and a return. Over the last eight years of ultra-low or negative interest rates, these objectives in major markets have been challenged. But for euro-denominated funds, it is business as usual, despite negative interest rates." (See Paranthoiene on CNBC Europe here and note that he'll be speaking at our European Money Fund Symposium next month in London.) We review S&P's negative rates brief below, and also excerpt from an S&P update on ABCP.
S&P writes, "Money market funds -- seeking to provide a return slightly exceeding cash but with the idea of cash-like stability -- cannot control the actions of central banks. When those banks go to negative rates, all short-term investments follow suit. So what have European funds undertaken to mitigate the effects of negative interest rates? One of the key distinguishing characteristics of European MMFs is their valuation methodology. A European fund can either be a CNAV (constant net asset value) -- which is the current basis for funds in the U.S. -- or it can be a VNAV (variable net asset value) structure. (Later this year, U.S. rules will require that institutional money market funds be more like a VNAV, though the rule will not apply to retail funds.)"
They tell us, "A CNAV MMF seeks to maintain an unchanging NAV (for example, $1, E1, or L1 per share) at all times, and uses amortized cost accounting to value all of its assets. A CNAV fund is also commonly linked to the phrase "breaking the buck," a term that references when a fund’s NAV per share falls below 0.9950, as was the case for the Reserve Primary Fund following the Lehman Brothers collapse. But a VNAV MMF generally uses mark-to-market accounting to value its underlying assets, so seeing a declining share price is not considered a momentous failure, in the same way for CNAVs. European-based CNAV funds, in order to try not to have the NAV drop below E1 in an era of negative interest rates, began in late 2013 to find ways to manage negative yields. Following shareholder approval, "share cancellation" mechanisms were introduced to a majority if not all euro-denominated CNAV money market funds."
The report explains, "Share cancellation is a method used by operators of CNAV MMFs to stabilize the NAV of the fund at 1.00 per share when a fund is encountering negative yields. The negative income rising from negative interest rates is transmitted to shareholders in the form of fewer shares.... For VNAV funds -- generally issued with a NAV per share of E1,000.00 -- such steps were not necessary, as they had always allowed for market movements to be reflected in the NAV. In an environment of negative income being "earned" by the fund, the NAV will slowly trickle down to accurately reflect that yield."
It adds, "It’s worth noting that not all MMF jurisdictions have allowed this CNAV share cancellation mechanism; regulators in the U.S., U.K and Japan have not granted approval. Many Japanese money market funds, faced with the negative interest rates in that country, either have shuttered or are set to close operations and return money to shareholders. But the flexibility provided in the VNAV structure has not protected all European money market funds. The universe of S&P Global Ratings MMFs denominated in euros has shrunk since the advent of negative yields, primarily as sponsors rationalize their product offerings or choose to have a more flexible investment approach not suited to being assessed under our money market fund criteria."
S&P also comments, "Many MMF managers believe negative rates will continue for the foreseeable future and may fall further. Investors have become more accustomed to negative yields and thus, fund managers can concentrate on providing liquidity and a diversified portfolio. Credit quality has been maintained, despite a reducing number of high credit quality short-term issuers in Europe, by diversifying into assets from around the world. The result? For those EUR-denominated rated MMFs, the average net 7-day yield is -0.25%, still a better return than a bank deposit on a relative basis."
Finally, the piece adds, "Money market funds continue to be attractive to institutional investors, despite negative yields, as investors have accepted negative market yields as a tax on savings. However, a long-term era (think “lost-decade”) of negative returns could eventually see investors realize that investments need to have a positive return and will look elsewhere. For now, it’s business as usual."
S&P Global Ratings also recently published, "Impending Reforms Will Likely Pressure Future ABCP Issuances." It comments, "Following a 20% growth spurt from historical lows, asset-backed commercial paper (ABCP) issuances have since significantly slowed in the second quarter of 2016. The accelerated growth earlier in the year was largely contingent upon transitory circumstances for the asset class, as higher financing rates for auto-related issuers temporarily increased demand for short-term financing with products such as ABCP.... As this trend faded, growth in outstanding paper related to auto securitizations tapered off.... Adding to this slowing growth, ABCP conduits could lose an additional portion of investors over the coming months if prime institutional money market funds (MMFs) continue to close shop or convert into government funds in response to regulatory reforms. This shifting demand dynamic should pressure issuance levels throughout the next two quarters."
The article explains, "Prime institutional MMFs traditionally hold a substantial amount (roughly one-third) of outstanding ABCP, making these funds a key player in conduits' placement strategy. The impending October implementation of money market reforms, though, appears to be accelerating conversions and wind-downs of prime institutional MMFs. These reforms will make structural and operational changes to prime institutional MMFs (in order to address the risk of shareholder runs) by requiring (via Rule 2a-7) floating-rate net asset values, liquidity fees, and redemption gates for these funds.... Prime institutional MMF assets are estimated to substantially decline over the course of this year, which would initially hinder conduits' ability to issue ABCP and would leave outstanding ABCP (once again) near all-time lows. At the very least, these conversions would not only affect ABCP rates and issuances but also alter the competitive dynamics for these programs."
S&P tells us, "ABCP issuances, though, can rebound from this demand shock if investors are compensated with rising spreads, or if demand from another investor group replaces that of prime institutional MMFs. Fundamentally, investors will demand a higher premium on these funds for the additional costs related to these regulatory reforms; to a certain extent, this is already occurring…. As yields for prime institutional MMFs rise, though, investor demand for these funds should eventually return (given an adequate spread). Because these funds often look to ABCP as a core investment, ABCP issuances would therefore rise as well."
They add, "However, the offered yields of these funds are inherently bound by the yield they can receive from short-term investments such as ABCP.... As such, any upward reversion in ABCP issuances due to rising MMF spreads is limited. In contrast, private liquidity funds may serve as an effective means of absorbing a decline in demand for ABCP issuances as these funds aren't required to maintain compliance with the requirements of Rule 2a-7. Their exemption means that these funds could attract short-term investors by maintaining a fixed net asset value calculation method; as of late 2015, nearly 85% of these funds did not maintain floating-rate net asset values, according to the SEC. In addition, demand for private liquidity funds could grow even further if they deviate from prime institutional MMFs' liquidity, maturity, diversification, and credit requirements. If institutional investors familiarize themselves with these new structures, and are comfortable with the differences to 2a-7 registered funds, private funds could replace part of the lost-demand in time."
S&P's ABCP piece continues, "Regardless of the level of growth in ABCP issuances, as prime institutional MMF conversions accelerate over the course of this year, the market's largest conduits will be able to use this shifting dynamic to their advantage. Conduits' reliance on prime institutional MMFs varies across the industry, with the largest conduits typically least exposed to MMF investors. According to Crane's Money Fund Portfolio Holdings, larger sponsor programs generally placed no more than 15% of their paper with prime institutional MMFs in the past year. In contrast, smaller-rated programs often placed around 50% (and sometimes more than 75%) of their paper with these clients.... All of these factors will give larger conduit programs an inherent advantage in placing paper over the coming months, so we expect their market share to rise even further throughout the rest of the year, and settle at levels visibly higher than before."
Finally, it says, "As a whole, ABCP conduits may struggle to sustain issuance levels over the coming months. With a sizeable portion of conduits' investor base dissipating, issuance volume will be sure to follow; what's more, any reversal in this trend will be particularly reliant on private liquidity funds given today's low-rate environment. Digging deeper, though, these trends should also lead to long-lasting effects on the competitive dynamics among individual ABCP programs. Conduits whose fixed costs represent a smaller portion of their overall business and those least exposed to a decline in prime institutional MMFs are best-positioned to increase their market share over the coming months. In this sense, the forthcoming demand shock will only lengthen the industry's most reliable trend since the financial crisis: consolidation."
