With new European money market fund regulations going into effect Saturday (July 21), both Moody's Investors Service and Fitch Ratings recently commented on the changes, one in the form of a Q&A and the other via webinar. Moody's published the report, "European Money Market Funds - FAQ on new money market fund regulation," and put out a press release entitled, “Moody's: New rules for €1.3 trillion EU money market funds to reshape industry landscape and boost its resilience." The latter says, "New European Union rules to improve the transparency and resilience of Europe's €1.3 trillion money market fund industry will lead to funds being managed more conservatively, a positive for fund sponsors and investors, says Moody's Investors Service." They add, "The new rules will apply from 21 July 2018 and will introduce a new category of fund, the low-volatility (LVNAV) money market fund, while the existing prime constant net asset value (CNAV) funds will be phased out."
The report explains, “New rules designed to improve the transparency and resilience of Europe's E1.3 trillion money market fund (MMF) industry will take effect on 21 July 2018. They introduce new minimum liquidity and stress testing requirements that will make MMFs more resilient to market shocks, a credit positive for fund sponsors and investors. The rules also introduce a new category of fund, the low-volatility net asset value (LVNAV) MMF, while existing prime constant net asset value (CNAV) funds will be phased out. The rules will apply to all new MMFs from 21 July, while existing funds must comply by 21 January 2019.”
Moody's asks, “Will MMF managers alter their investment strategies?” They answer, “Yes. We expect the new LVNAV funds to be managed more conservatively than the prime CNAV funds they will replace. The same is true of short term VNAV funds, which will also attract some assets currently held in prime CNAV MMFs. Under normal circumstances, investors in LVNAV funds will be able to buy and sell their fund units at a constant share price of €/L/$1.00. The net asset value (NAV) per share will remain constant at 1, provided it does not deviate by more than 20 basis points from its market-based calculation.... This narrow share price volatility tolerance (CNAV funds currently operate within a wider 50 basis point corridor) will likely drive portfolio managers towards higher quality securities. We also expect them to increase their investment in shorter-dated securities (maturing in 75 days or less), which are valued using amortized accounting.”
Another question is, “Will MMFs impose fees and gates?” Moody’s responds, “We regard this as unlikely, absent extreme market conditions. While fees and gates would discourage potentially damaging fund withdrawals at times of high market volatility, such measures would likely deter investors from continuing to put money into any fund that applied them. We therefore believe MMF managers will maintain portfolios with high credit quality and ample liquidity in order to avoid fees and gates being triggered.... The new rules introduce specific liquidity and redemption trigger points at which LVNAV and public debt CNAV fund directors must consider applying fees and gates. However, we note that MMF boards already have the discretion to freeze redemptions at any time under current UCITS prospectuses, but have used this power only extremely rarely. The imposition of redemption gates and liquidity fees remains unlikely in practice under the new regime.”
The report also asks, “Will Moody's rate the new LVNAV funds?” They tell us, “Yes. We will rate LVNAV funds using our MMF methodology, which is designed to assess funds' ability to meet the dual objectives of preserving principal and providing liquidity. The methodology combines an assessment of the MMF’s portfolio credit profile with an evaluation of its portfolio stability. Our analysis considers portfolio risk characteristics, including credit, liquidity and market risks. It also takes into account factors such as sponsor quality, the track record of the fund managers, and any legal considerations. The MMF methodology will also apply to Public Debt CNAV MMFs and VNAV MMFs.”
Another question is, “Will the new rules prompt transfers between funds?” Moody’s replies, “Yes. As prime CNAV funds are phased out by January 2019, we expect the lion's share of their assets to flow into the new LVNAV funds. Prime CNAV MMFs currently manage about €625 billion, nearly half of the European MMF industry's total assets of €1.3 trillion. We foresee little change in the total volume of assets managed by European MMFs. We estimate that between 70% and 80% of the assets currently held in prime CNAV MMFs could transition to LVNAV funds.... Transfers will likely reach the top end of the range if the reverse distribution mechanism (RDM), which allows for the cancellation of MMF shares, continues under the new regulations. The European Commission recently issued technical guidance stating that this mechanism was incompatible with the new rules, but the industry is still consulting on the subject with the European Commission and the European Securities and Markets Authority (ESMA)."
Finally, Moody's asks, “Will the new rules encourage further industry consolidation?” They state, “We believe this is a likely outcome. A combination of changing product structures, low interest rates, and higher operating expenses could put pressure on many of the remaining small-to-medium size sponsors, leading them to exit the industry. We believe there is more scope for consolidation within the unrated VNAV MMF sector, which includes a greater number of smaller providers that might struggle to comply with costly new process and transparency requirements. Although the rated industry is already very concentrated, scale will become even more crucial under the new rules.”
Fitch Ratings also commented recently during a webinar on "European money market fund reform" featuring Fitch's Alastair Sewell and J.P. Morgan Asset Management's Kerrie Mitchener-Nissen. Sewell tells us, “A couple of things for you to be aware: as of the 21st of July … all new funds will have to comply with the reforms…. The 21st of January of next year … is the deadline for all existing funds to comply with the reforms…. There is going to be a review of the reforms which is set to conclude in 2022…. There is no sunset clause in the final version of the reforms, so barring any changes from this review, there is no automatic change to any of the provisions in the reforms.”
Mitchener-Nissen comments, “We are transitioning our fund range over the weekend of 30th November. So clients, when they wake up on Monday the 3rd of December, will find themselves in our new range of products…. The [fund conversion] announcements so far indicate that that's what managers are looking to do. They're looking to give investors a choice, and I think that's one of the strengths of the regulation is that it gives really good optionality for clients. That was certainly on driving factor when we were thinking about what our fund range would look like going forward -- that ability to reflect the full range of choices that allowed us the regulation.”
Referring to a Fitch survey of the webinar audience, she says, "I think our investors have had their opportunity to review the options at hand and make some decisions. Clearly the market is getting a lot more comfortable with these concepts…. In fact it's really just … new terminology. So I think this certainly reflects what I'm hearing from clients, and I think it's showing clients continue to look for that stable NAV product. The LVNAV structure certainly delivers that step on that product still for clients that gives them that important aspect of being able to interact with the fund in the same way that they do today.”
Sewell says, “At the end of the day, liquidity fund are liquid and investors will vote with their feet. What we see on this slide is the actual distribution of investors buying … prime constant net value funds today, [they] are likely to tun into LVNAVs…. Overwhelming investor demand … is for a stable unit value per share, because of it going back to the basics of money market funds. The key utility is you put a dollar in and you get a dollar back from it…. Decision time is fast approaching. It's good to see the investors on this call seem more prepared perhaps than they were on the last one…. There are three key steps that investors focused on at the moment. The first is simply to understand the reforms. The next [is for] investors [to] ensure that their investment policy gives them appropriate flexibility to accommodate the investment options available…. Then there is going to come the decision point of actually deciding what are you going to do."
Mitchener-Nissen responds, “For us, our guiding principle here was to create and reach the clients where we are minimally impactful on them. For us, our structure involves us essentially mapping clients to what looks like the most appropriate option for them generally based on their current share class…. Mapping clients to that option and then giving them the choice of picking a different option if they feel that something else in the range is more appropriate for them. If they're happy with that proposal we've given them, they actually won't need to do anything. They will transition over that weekend and wake up on Monday 3rd of December in their new range, in their new product. So for us, we’re looking to keep this as simple as possible for clients and really to ensure that that transition is as smooth, calm, and quiet as possible.”
She also explains, "The euro denominated funds across the market really adopted a mechanism of share cancellation or reverse distribution. This is a mechanism where the traditional distribution mechanism is essentially reversed. So instead of paying out the small amount of income earned in the fund every day, the daily distributions, the fund is essentially owed; the amount of negative income.” Sewell adds, “Last year, there was issued some technical guidance on implementation of reforms, which included the suggestion that share cancellations or reverse distribution may not be possible…. I'm certainly aware that multiple groups, industry associations, provided other interested in market participants have produced or solicited opinions which universally disagree with the basis for these opinions. In short, there [is] some uncertainty here.” Finally, Mitchener-Nissen says, “I would reiterate that, for Euro investors, it is by no means a closed debate."
