Treasury Today recently hosted a Q&A featuring Morgan Stanley Investment Management's Global Liquidity team on the topic of "EMEA MMF Reform." The description of the session says, "A shakeup of the European money fund industry is underway as regulatory reforms push fund providers to adjust their offerings. Whether you are an existing or potential money market fund investor you need to understand the new environment and types of funds being offered. In this podcast, Kim Hochfeld, EMEA Head of Liquidity Distribution, Douglas McPhail, Senior Portfolio Manager, and Scott Wachs, Global Liquidity Product Head for Morgan Stanley, look at the regulatory hurdles ahead and what investors can do to prepare for the change." We quote from the podcast below, and we also report on a new Consultation Paper from ESMA which requests comments on proposed European MMF Reform reporting guidelines.
Host Richard Parkinson comments, "Change is coming in the money fund industry -- long awaited legislation is now upon us in Europe. Money market fund reforms here have taken a slightly different course than in the United States, and fund managers have been working with regulators, vendors and clients over the past two years to adjust their product offerings to meet the new regulatory criteria. As a result, some fund providers are converting their money fund range to the new structures this quarter and many others will follow in the beginning of January. By 21st January 2019, all existing European funds must be adapted to the new structures introduced by the legislation. Whether you are an existing money market fund investor – or might become one, you should acquaint yourself with what is changing and the types of funds being offered."
Wachs tells us, "There are going to be three types of money market funds, all very appropriate for short term cash investing. The two that are for the most similar construct to how short term money market funds operate today are the public debt CNAV and the LVNAV options.... Something new in this new regulatory regime is trigger-based fees and gates. The LVNAV fund ... has limited use of amortized cost accounting. The fund transacts at a constant unit value again to two decimal places.... But it can only continue to price at this level as long as a portfolio NAV does not deviate by more than 20 basis points from a one unit per share. If it breaks this collar, the fund must transact at a market based NAV per share, and in that case the price would be rounded out to four decimal places [and become a VNAV fund]."
Hochfeld comments, "We believe that investors should definitely welcome the new regulations as they were created as a way to make the funds more transparent and robust for them, and they were designed specifically with the interests of investors in mind. The new regs mandate more transparency, and that includes daily publication of the fund's liquidity levels, the daily publication of the mark to market NAV on the two stable [types of] portfolios, and also more frequent dissemination of the credit profile and the maturity profile of the fund. Investors definitely need to understand the differences as to how these funds are going to operate. But broadly speaking, the new regs should definitely be welcomed."
McPhail says, "We do not intend to change our investment philosophy or strategy. We will continue to run the portfolios to comply, for example, with our rating agency methodologies. These methodologies ensure that we will maintain our AAA money market fund ratings, and the rating agency methodology actually limits our investment flexibility far more than the regulations. So capital preservation and liquidity are still paramount. Our credit process hasn't changed, and arguably could be viewed as more robust under these new regulations. We will increase daily and weekly liquidity in our portfolios due to the new requirements, especially as in the portfolios that are subject to trigger-based fees and gates. As we know, investors will be focused on these figures; we will be too. Our goal is to avoid having any fees and gates imposed at any time. Liquidity in short term VNAV funds will also be managed at levels higher than prescribed by the regulations. The regulations only prescribe 7.5% daily liquidity and 15% weekly liquidity for short-term VNAV funds. But in order to meet our investor liquidity and rating agency requirements we will continue to run the funds against our current liquidity levels."
When asked about fees and gates, Wachs responds, "I don't think investors should be particularly concerned. Importantly, fees and gates are not new to these funds, and I don't think all investors actually realize that. Under the UCITS rules, funds could choose to implement fees and gates, and those rules have been in place for a long, long time. However these UCITS rules were designed to be utilized only in extraordinary circumstances and fully based on board discretion. Our fund's board, for our Morgan Stanley Liquidity funds, has never felt the need in the history of the funds to use this type of liquidity tool. But what's new about the fees and gates under the new European money market fund reform is that they are trigger-based, and that's the new wrinkle that's been introduced."
He explains, "The first prong is that weekly assets must drop below 30%, and the second, which has to happen on the same day at the same time, is that daily net redemptions are greater than 10%. Fees and gates are discretionary, again at board discretion, at this point. But if the weekly liquidity drops below 10 percent it is mandatory to implement a liquidity measure.... We believe the funds will be managed in such a manner that the possibility of the implementation of these liquidity measures is very remote.... But we recommend that it would be prudent for investors to closely monitor a fund's weekly liquidity levels. We anticipate that fund managers will make this very easy to do by publishing this information on their websites. And it's also important to note that short term money market fund portfolios have historically been managed with weekly liquidity levels in excess of 30%, as per UCITS, IMMFA and ratings agency guidelines."
Treasury Today also asks about negative rates and share cancellation. McPhail responds, "So there's still no formal guidance from the European Commission at this point, and it's getting very late in the process. At Morgan Stanley, we are planning for both LVNAV and a VNAV option. We are certain that an accumulating VNAV structure is workable in negative interest rates. We are less clear, however, as to whether an LVNAV incorporating the reverse distribution mechanism or RDM which incorporates the share cancellation will be allowed. There may be differences in how VNAV share classes are structured, but there needs to be a number of decimal places in order to accurately reflect the interest accrual. Morgan Stanley funds have historically priced to 8 significant figures and intend to keep the structure going forward. Positive rates for Euros could be possible in 2020 or perhaps even 2021. Even if LVNAV is not workable right now, clients could still move back into an LVNAV fund with net yields returned to positive territory."
Finally, when asked about accounting treatment, Hochfeld adds, "If it walks like a duck, talks like a duck, and quacks like a duck, it has to be a duck. And we've used this metaphor to show that money funds post reform will still operate in a very similar fashion to how they do today. The argument is if structurally they still the same ... and today they are accounted for as cash or a cash equivalent, then there's absolutely no reason why there shouldn't be a cash and cash equivalent tomorrow.... The liquidity profile of the portfolio, if anything, has actually got more liquid rather than any less liquid than they are today. The fund still has the same features as cash equivalents and the fund NAV is subject to insignificant changes in value.... So why wouldn't it be classified as a cash and cash equivalent?"
In related news, the website MondoVisione posted the brief, "ESMA Consults on Future Guidelines for Money Market Funds' Disclosure," which tells us about a Consultation Paper released by ESMA, the European Securities and Markets Authority, entitled, "Draft guidelines on the reporting to competent authorities under article 37 of the MMF Regulation." MondoVisione explains, "Starting from the end of the first quarter of 2020, European money market funds will have to disclose certain information under the Money Market Fund Regulation (MMFR) to their National Competent Authorities (NCAs)."
They write, "To facilitate funds' regulatory disclosure, the European Securities and Markets Authority (ESMA) has opened today a public consultation on draft guidelines providing further specifications on how to fill-in the MMFR reporting template. ESMA's consultation paper represents the first step in the development of such specifications by setting out detailed proposals on which ESMA is seeking the views of its stakeholders."
The piece adds, "ESMA's Guidance will complement the information included in the Implementing Technical Standard (ITS), which ESMA delivered in November 2017 and which were endorsed by the European Commission in April 2018. Together with the ESMA Guidance, managers of MMFs have all the necessary information to fill in the reporting template they will have to send to NCAs of their MMF, as specified in article 37 of the MMF Regulation. MMF managers will need to send their first quarterly reports mentioned in Article 37 to NCAs in Q1 2020."
