Last week, Fitch Ratings hosted a "European Money Market Fund Reform Teleconference," which featured Senior Director Alastair Sewell and Associate Director Evangelia Gkeka from Fitch's Fund and Asset Manager Rating Group. They discussed the "timing and implications of European money fund reform," "new fund types ... the low volatility net asset value fund," and, "inner workings of liquidity fees and redemption gates." Sewell explains, "European money fund reforms were finally agreed in December of last year. That's arguably almost 7 years after the process started, with the DeLarosierre report, which called in common definition of European money funds, or more recently, approximately 3 years after the first draft of money fund reforms in Europe were tabled."
He continues, "The reforms in Europe follow on the heels of money fund reform in the U.S., which became affective after a 2 year implementation period in October 2016. Money fund reform in the US was a big deal, over $1 trillion dollars of assets moved out of prime money market funds and into government money market funds, which caused significant funding dislocation for commercial paper issuers, and wider issues, as much as the effect on the money market industry itself. Today, we're going to talk you through the when, the what and the how of money fund reform, and above all what those questions will mean for investors, as these reforms will certainly herald changes for investors."
Fitch's Gkeka says, "The political agreement on money market reform has been reached. There is still some technical and legal work to do. But our expectation is that the reform will appear in the official website newsletter of the European Union at some point in the first half of this year. There will be an 18-month implementation period.... [I]f something is published in June of this year, the implementation period will end in December 2018. During this period, we expect to see a high level of activity from fund providers, potentially in multiple new fund launches. Some investors might face some challenges in understanding how the reforms and new products associated with it fit into their cash management practices."
She continues, "The new regulations will allow 4 different types of money market funds in Europe. Those are public debt CNAV funds, low volatility NAV funds, VNAV funds and standard money market funds. That's an increase from the current 2 forms of funds, which are short term money market funds, and standard money market funds... There are three particularly important developments. First, prime funds, meaning funds primarily investing in bank deposits and other non-government securities will no longer be able to transact at the stable unit value per share. It is a big change, because investors are accustomed to the simplicity and operational ease of using [these] funds for their cash investments."
Gkeka adds, "Government only funds will still be able to offer stable unit values per share. One interesting possibility, is whether we see the launch of government CNAV funds, investing in lower credit quality government securities, in response to the strong negative yields on core Eurozone government debt. Provided the fund manager's credit assessment of an issuer is favorable credit ... then it's possible to include it in the fund.... Whether we will see this remains to be seen, but clearly [some] may not achieve a AAA-mmf rating, typically assigned to existing MMFs. However, we think it's unlikely that there will be major flows to govie funds ... as happened in the U.S., because the normal fees and gates in the US were only associated with prime funds ... compared to the European regulations where fees and gates apply to both CNAV and MVNAV."
She also comments that, "The LNAV structure has CNAV like features.... We expect to see multiple fund launches of this type." Sewell tells us, "Now fees and gates are a headline issue in the money market reform process. You could ask the question in Europe, 'What difference does it really make?' Given that money funds in Europe already have the potential for a fee, when fees and gates being applied. To be specific about that, the vast majority of money funds reform in Europe ... already have a wide range of liquidity and management tools available to them."
See our review of Fitch's earlier piece, "Finalised EU MMF Reform Starts Implementation Clock," which was reported in our Dec. 9, 2016 "Link of the Day", "Fitch on EU Reform, Gates." It says, "Fitch Ratings published the brief, "Finalised EU MMF Reform Starts Implementation Clock - Liquidity Fees and Redemption Gates Create Uncertainty," which is subtitled, "Finalized EU MMF Reform Starts Implementation Clock Liquidity Fees and Redemption Gates Create Uncertainty."
It summarizes, "An agreement has finally been reached on European money fund regulation between the EU, Parliament and Council after three years of debate.... Low-volatility net asset value (LVNAV) funds are a workable alternative to existing constant net asset value (CNAV) funds, notably as a previously proposed sunset clause has been removed and liquidity requirements have been adjusted. It will result in LVNAV co-existing with a new form of public debt CNAV funds, short-term variable NAV (VNAV) funds and standard VNAV money funds."
The piece comments, "Public debt CNAV and LVNAV funds will be subject to liquidity fees and redemption gates, similar to US Prime MMFs, which suffered large outflows in the run-up to US reform implementation. It remains to be seen how European investors will react to such redemption limiting provisions. Some may turn to full VNAV funds but we expect the impact of the European reform to be smaller than in the US as investors accustomed to CNAV funds, which account for half of EU MMF assets, may be comfortable with LVNAV funds."
Finally, they add, "The regulation should come into effect by the end of 2018, given an 18-month implementation period after its enforcement, which is likely to be in 1H17. Fitch Ratings expects this period to be characterized by new fund launches and the adaptation of existing fund ranges into the new fund categories."
