S&P Global Ratings published the paper, "EU Money Market Reform: The Wait Is Finally Over," which discusses the pending money market fund reforms in Europe. Written by Andrew Paranthoiene, Francoise Nichols, and Joseph Giarratano, it says, "After years of contested debates about the pros and cons of regulation for European money market funds (MMFs) and 10 years after the start of the global financial crisis, the EU finally has its own MMF legislation, approved by the European Council on May 16, 2017. This third and final step in a very lengthy regulatory process, will see the "Regulation of the European Parliament and of the Council on Money Market Funds" come into force." (See our May 30 News, "ESMA Publishes Consultation on European MMF Regs; Fitch on European," our May 18 News, "More on Passage of European Money Fund Reform; Impact on Corporates," and our May 17 Link of the Day, "Law360 on EU Money Fund Rules.")
The new paper explains, "S&P Global Ratings rates European domiciled MMFs mostly denominated in U.S. dollars, British pound sterling, and euros, collectively totaling approximately E630 billion in assets under management as of March 2017. In this article, we provide our views on the newly published EU MMF reform and what it means for those MMFs that we rate. We also offer our view on the future of the industry, particularly how the reform provides sound policies and practices for MMFs to follow, and the effects of the explicit nature of the reforms on the industry."
S&P's "Overview" tells us, "In our view, the increased transparency, enhanced liquidity, and investor protection outlined in the new regulations are positive developments for the industry. Notably, we anticipate that the introduction of new rules in Europe will not affect European domiciled MMFs assessed under our PSFR criteria. The explicit nature of the reforms will likely create a pool of homogenous MMFs, which could then result in further fund mergers reducing competition in the marketplace."
They write, "With regulatory uncertainty now out of the way, the E1.2 trillion EU MMF industry, from its more humble beginnings in France in the 1980s, can finally move forward. In recent years, and since the first EU MMF reform proposal in 2013, the industry has been treading water due to political inaction and significant lobbying and campaigning efforts from opposing sides. For more than 40 years prior to these regulatory changes, numerous countries such as France, Spain, Italy, Germany, Luxembourg, Ireland, and the U.K. each maintained their own guidelines for MMFs."
Paranthoiene says, "In 2009, the Committee of European Securities Regulators (now known as the European Securities and Markets Authority or ESMA) proposed guidelines and two common definitions of MMFs. Some viewed these proposals as positive developments for the EU MMF industry because they clarified how the market should operate, considering the philosophical differences between a U.S.-styled MMF offering a constant net asset value (CNAV) and the continental (French) style MMF offering a variable net asset value (VNAV). However, the guidelines failed to create a minimum level playing field for MMFs in the EU, since more than half of the EU countries did not apply the guidelines."
Regarding the "Key Aspects Of The Reform," S&P comments, "The new regulation provides investors with a degree of optionality for investing their short-dated cash, by offering two types of MMFs: Short-term MMFs with the objective of offering money market rate returns, while ensuring the highest possible level of safety for the investors; and Standard MMFs with the objective of offering returns slightly higher than money market returns, and they therefore invest in assets that have an extended maturity."
They continue, "In addition, the regulation introduces three new structural options, within the short-term MMF category: Public debt CNAV: A MMF that seeks to maintain an unchanging net asset value (NAV) per unit or share and invests 99.5% of its assets in government debt instruments, reverse repos collateralized with government debt, and cash. Low volatility net asset value (LVNAV): A MMF permitted to maintain a constant dealing NAV, provided that certain criteria are met, including that the fund's market NAV does not deviate from the dealing NAV by more than 20 basis points. Variable NAV: A MMF that prices its assets using market pricing and therefore offers a fluctuating NAV."
In addition to diversity, credit quality, valuation and maturity guidelines, the new rules also include liquidity guidelines. S&P says, "The new EU MMF reform contains newly introduced metrics for MMFs to observe daily and weekly liquidity amounts. The introduction of such metrics is consistent with other global regulators who have also introduced such measures.... Both public debt CNAV and LVNAV MMFs need to maintain at least 10% of their investments in overnight investments and 30% in a weekly allocation. Short-term VNAVs are required to maintain these amounts at 7.5% and 15%, respectively."
The report states, "The final European MMF regulations include a ban on external support. External support is defined as cash injections, asset purchase at an inflated price or with the purpose to provide liquidity, the issuance of an implicit or explicit guarantee, or any action to maintain the liquidity profile of the NAV.... Under the regulation, know your client (KYC) is one of the key aspects a MMF needs to incorporate as part of its risk management practices.... To provide that liquidity to its shareholders, a MMF should have a solid understanding of the investor's redemption pattern."
S&P says, "We support the efforts made to introduce regulation that focuses on increasing the safety and liquidity of the EU MMF industry. In our view, the increased transparency, enhanced liquidity, and investor protection outlined in the new regulations are positive developments for the industry. Notably, we anticipate that the introduction of new rules in Europe will not affect European domiciled MMFs assessed under our PSFR criteria. We believe the steps taken since reform was first announced in 2013 have resulted in an improved and more focused legislative framework that placates both sides of the political and industry debate, namely CNAV advocates (supporting U.S.-style MMFs) and VNAV advocates, generally found in continental Europe (i.e., French-styled MMFs)."
They tell us, "We expect fund providers will favor the LVNAV product amongst the rated universe of funds. Unlike what occurred with the U.S. reform in 2016, it's likely there will be very little investor appetite for the public debt CNAV funds, considering that such funds are not exempt from the application of fees and gates. We don't estimate many existing VNAV funds switching to LVNAV structures as their underlying investors are already cognizant with the mechanics of investing in VNAV MMFs. As investors digest the changes and asset managers engage with their stakeholders, it's quite possible that certain asset managers could offer all three types of "short-term MMFs," but such a product offering could be subject to challenges relating to a fund's critical mass."
S&P continues, "Some of the positive market reception on the final regulations revolved around the exclusion of most of the contentious issues originally proposed from the final reform, notably the 3% capital buffer, a ban on MMF ratings, the mandatory conversion to VNAV, and the removal of asset-backed commercial paper (ABCP) as an eligible asset. Certain aspects of the final regulations were consistent with the original proposal, such as the WAM/WAL limits, while certain aspects were slightly adjusted (for example, credit research requirements and liquidity requirements from the original 2013 proposal). The daily and weekly portfolio liquidity requirements will now apply to both "short-term" and "standard" MMFs, where there were no such requirements under ESMA guidelines."
Finally, they add, "In our view, the new EU MMF reform provides sound policies and practices for MMFs to follow into the future, especially considering their systemic importance and important funding role to local economies. The explicit nature of the reforms will create a pool of homogenous MMFs, which could then result in further fund mergers reducing competition in the marketplace--a fairly common activity since 2009. Worryingly though, a reduced marketplace only increases the size of the remaining funds and their heightened systemic importance within the EU capital markets."
