A publication entitled, "2017 Outlook: Money Market Funds" was put out by Fitch Ratings yesterday, which reviews the impact of both U.S. and European regulatory changes on money funds in the coming year. The report says, "Following a tumultuous two-year implementation period, money fund reform in the US is now in place. More than USD1trn has shifted from prime to government money funds, but asset levels have now stabilised and are expected to reverse to a degree over 2017. As fund managers and investors begin to feel more comfortable with the new equilibrium, funds are beginning to revert to a more normal portfolio strategy." We excerpt from Fitch's update below, and also review a BlackRock paper on new European money fund reforms.
Fitch also comments on European reforms, explaining, "The European Commission, Parliament and Council announced agreement on European money fund reform in November 2016. The new regulation will make low volatility net asset value (LVNAV) funds a viable alternative to existing constant NAV (CNAV) funds, notably as a previously proposed sunset clause has been removed from the agreed regulation. Given the 18-month implementation period, reforms will likely be fully effective in 2H18."
The Outlook continues, "Under the new regulatory regime in the US, prime and municipal money funds now have the ability to impose liquidity fees or redemption gates on investors. Fund managers will be carefully managing their portfolios to avoid these scenarios, but will be pressured to balance liquidity with the search for higher yields. Fitch views the potential for a run on a fund with low or declining levels of liquidity as the biggest risk to the industry. European reform will likely include similar provisions."
Fitch adds, "Alternative products to prime money funds, including private money funds, ultra-short bond funds, and separate accounts, have been growing. In the US, after the initial big move from prime to government, investors are likely to re-evaluate their cash needs and the range of available liquidity products and move money out of government funds.... Low and negative yields in euro and sterling have been a strong driver of growth for ultra-short bond funds. In the US fund managers have been aggressively re-positioning prime funds and alternatives as higher yielding than government money funds to quickly win back investors. The differences in yields across the various liquidity products will be a key determinant for investors' cash allocation decisions."
On Supply, they comment, "A silver lining of the US shift from prime to government funds is the markedly improved supply-demand dynamics for the remaining assets in prime funds. Conversely, government money funds are in a more difficult position, given the significant inflows they have experienced. So far the larger asset base of government funds has been absorbed by the market rather smoothly, but participants are concerned with the future availability of dealer repo, US Treasuries, and Agencies. One bright spot is the expanded capacity of the Fed's reverse repo program."
Fitch also writes, "Recently agreed European money fund regulation could further shake up demand for short-term corporate and bank debt. However, we expect the impact to be smaller than in the US because investors accustomed to CNAV funds may be comfortable with the proposed LVNAV funds, which will still be able to hold non-government debt. Liquidity fees and withdrawal gates will also apply to government CNAV funds under the European regulation, which might make these funds less attractive to investors."
In other news, BlackRock sent out an update to International and offshore money fund investors explaining the recently approved (but not detailed) "European Money Market Fund Reform." It says, "European Money Market Fund Regulation (EMMFR) is nearing finalization with a political agreement reached between the European Parliament, Council and Commission, and the technical drafting now complete. The final rules are unlikely to change significantly from what has been agreed in recent weeks: an agreement that importantly, preserves Constant Net Asset Value (CNAV) for government funds, and introduces a new type of fund, the Low Volatility NAV (LVNAV) fund."
Co-Heads of International Cash Management Bea Rodriguez and Damien Donoghue, and Head of Government Affairs & Public Policy Joanna Cound, explain, "LVNAV is intended to replicate some of the utility of CNAV funds, with greater sensitivity to market pricing, and additional safeguards and controls built into the fund structure. This should mean that investors will continue to have a range of fund options and investment strategies to meet their needs. With the details now finalized, the formal sign off process will likely be completed by early next year via a full vote of the European Parliament."
They tell us, "The transition period for existing funds to comply with regulations is expected to be 18 months, however the timeline only begins when the regulation is formally adopted, translated and is officially published, meaning final rules are likely to come into force near the end of 2018."
BlackRock describes the LVNAV fund, saying the "Fund can price to 2 decimal places if the full mark-to-market price does not deviate from 1.00 by more than 20 basis points (bps), essentially rounding up to 1.00. If the 20 bps tolerance is breached the fund will price to 4 decimal places using the full mark-to-market NAV, essentially rounding down to the nearest basis point." It also, "Can use amortized cost for assets <75 days, however the mark to market price must be used if this deviates by >10 bps from the amortized cost price" and is "`Mandated to hold 10% in daily maturing assets and 30% in weekly maturing assets," and is "Subject to liquidity fees & gates."
Finally, the piece says, "For internal credit the Money Market Funds must establish, regularly review and maintain internal credit assessment procedures. Sponsor support is prohibited for all Money Market Funds including Government CNAV and LOW-Volatility NAV (LVNAV).... Low-Volatility NAV (LVNAV): As well has mandatory stress testing, enhanced Know Your Customer (KYC) rules, public disclosure rules. Also the fund is not subject to sunset clause."
