State Street Global Advisors' latest Cash Market Podcast discusses European Money Market Reforms and features Portfolio Strategist Will Goldthwait and Portfolio Managers Sean Lussier and Nick Pidgeon. (See the transcript here.) Goldthwait explains, "We are going to be talking about European money market reform, but specifically the markets and portfolio positioning in light of reform." He asks, "How is this European reform different from what happened in the US?" We review the podcast and the latest on European MMF Reforms below. (Note: We'd like to again remind readers about our upcoming European Money Fund Symposium, which will take place Sept. 20-21 at the London Tower Bridge Hilton. We hope to see you in London next month!)
SSGA's Lussier explains, "European Money Fund reform is currently not stirring up the same reaction that US money fund reform received prior to the US deadline of Oct 2016. Let me remind our listeners of two key reasons why that is the case. First in the US, all institutional prime money market funds had to convert to a variable Net Asset Value pricing model or VNAV. Only Retail Prime funds had the option to value assets using amortized cost accounting or Constant Net Asset Value pricing or CNAV. Secondly, US Government and US Treasury funds had the option to decline the use of liquidity gates and redemption fees.... Both of these factors weighed heavily in clients choosing government funds as their preference."
He continues, "As for European reform, first, the regulators have listened to investor and investment manager feedback and are allowing a new pricing structure for prime funds -- the Low Volatility NAV (LVNAV). This structure will support a Constant NAV price valued at $1.00, as long as the 'shadow price,' or mark to market price of the fund, remains within a 20 basis point range, called a 'collar'.... Secondly, European reform did not give Sovereign or Government funds and or their providers the option to decline the use of liquidity gates and redemption fees for these funds."
Lussier adds, "Regardless, the feedback we have received is that European clients are pleased with the rule changes and that their preference is to remain in the strategies they are currently invested in. Now, of course, significant regulatory change such as this will create some market volatility and uncertainty, but the short end credit markets have proven that they are dynamic and flexible enough to accommodate telegraphed regulatory changes."
When asked how he is positioning the USD "offshore" funds, Lussier answers, "It has made sense to naturally position the funds during this [Fed] hiking cycle with a shorter duration and concentrated maturities around FOMC meeting dates in order to reinvest into higher rates. This natural market positioning will also coincide with the regulatory deadline of January 2019, and should provide the funds with increased liquidity and Net Asset values at or near par as we get closer to the fund specific regulatory transition date. Given the increase in U.S. Treasury bills and repurchase agreement collateral that market has experienced, in combination with attractive short date credit offerings, the supply available to the market should accommodate this cautious positioning ahead of the reform."
On the Sterling money funds, Pidgeon tells us, "It seems to be business as usual regarding money fund reform from a Sterling perspective. Like Sean mentioned there will be some exceptions but I don't think enough to see significant sterling flows. In fact, our sterling fund has seen some robust growth over the past year and we would hope this remains on track."
He also says, "The biggest adjustment will be to liquidity ratios with some minor tweaks elsewhere as most of the rules are pretty much in line. We already run the fund to a minimum 10% overnight and 30% one week liquidity, which is in line with the new regulations. But the new rules are more stringent, however, around processes and the chain of events that could be affected if liquidity falls below theses limits. So the tighter regulation will require an up-lift in liquidity provisioning to ensure ratios are maintained. This aligns with use of amortized accounting within the context of pricing for an LVNAV fund."
Pidgeon explains, "Although we will still aim to create a robust maturity ladder on investments, only securities that are less than 75 days to maturity can use amortized accounting. Therefore, you should expect a higher ratio of 75 day or less to maturity securities, which both assist in stable fund pricing and assist in higher liquidity ratios in a laddered portfolio. I still wouldn't expect a huge difference in the Weighted Average Maturity & Weighted Average Life over time of the fund though against the daily average of the current CNAV offering."
He adds, "Sterling Repo investments can be tricky at quarter ends and year ends. We have seen huge swings in yields offered over these periods and generally yields have turned negative. You could see less reliance on repo this yearend though and more reliance on UK sovereign debt."
When asked by Goldthwait about a conversion date for the new funds, Lussier responds, "We have heard from some fund companies that they will be converting in the 4th Quarter.... We continue to discuss the date that we will be converting our funds. It's possible we transition all 4 of our funds at once or stagger the transitions over a series of dates. Regardless, you can be sure the transition dates will be fully vetted with our internal and external partners to ensure a smooth and seamless conversion."
The SSGA PM adds "If what is expected actually occurs, very little AUM movement, then the conversion date should not mean much to the shareholders of the funds. Although we know the final rules or end state of Euro funds has not been determined due to the negative interest rates in that currency, those clients in European funds could be forced to choose a variable NAV instead of the constant NAV if ESMA's decision on Reverse Distribution Mechanism or RDM, is not appealed."
Finally, Pidgeon states, "The door for Reverse Distribution Mechanism funds is still slightly open, with options for the RDM still being discussed by competent authorities to see if they are able to agree a possible way forward. As it stands, however, ESMA has directed that the RDM will not be allowed for CNAV and LVNAV funds because those funds are negative yielding, as you said. Therefore current Euro CNAV MMF investors could have fewer options open to them, whilst we remain in a negative rate environment in the Eurozone."
He adds, "We do know the rule changes around RDM and conversion to VNAV is more significant for some investors, but others feel comforted by the lack of liquidity gates and fees. We do have a robust process to identify what each client of the fund will do with their balances, and while liquidity requirements for the STVNAV funds are slightly lower than what is required for LVNAV, I suspect the main change we will see in managing the fund will be liquidity. This is likely to be elevated going into the conversion date, and until we get more comfortable with the client positioning under new reforms. That aside, we will look to continue managing a well laddered liquid portfolio in line with current ECB outlook for markets."
For more on European Money Market Fund Reforms, see these recent Crane Data News stories: Goldman on Repatriation, European Reforms; Federated Plans; Assets (8/24), BlackRock Details European Money Fund Reform Plans; Love the LVNAV (8/17), SEC Shows Private Liquidity Funds Up in Q4; HSBC's European MF Plans (8/14), Morgan Stanley European MMF Reform Plans; Offshore Port Composition (7/17), JPMAM European MMFs Plan for Nov 2018 Conversion; MF Assets Plunge (3/16), and JP Morgan To Offer All European Fund Options; ICI MMF Holdings Update (11/16/17).
