Earlier this week, S&P Global Ratings released a paper entitled, "How Has The Change In EU Regulation Affected Rated Money Market Funds?" It says, "Most EU-domiciled rated short-term MMFs have converted into short-term low volatility variable net asset value (LVNAV) funds; by contrast, in the U.S., most converted into government debt MMFs, which offer constant net asset values and enable investors to avoid fees and gates. During the past year, net assets have not significantly changed, indicating that although complying with the regulation was challenging, the industry has adapted well."
Authors Emelyne Uchiyama, Andrew Paranthoiene and Francoise Nichols write, "The journey to implementation for the EU's money market fund (MMF) regulation started over a decade ago, following the global financial crisis, when regulators reassessed the systemic risk that MMFs had on the wider financial system. Given that the industry has demonstrated good retention of assets under management, the response from investors suggests that the actual transition has been relatively low-key. The next hurdle is in July 2022, when the European Commission (EC) is scheduled to publish a review of two of the three short-term MMF categories introduced in the legislation."
They continue, "Following the 2007 disruptions and failures of short-term fixed income funds, some labelled as 'dynamic' MMFs, the EU decided to remedy its lack of common legislation for MMFs. It drafted regulations aimed at increasing transparency and harmonization, enhancing liquidity, and protecting MMF investors, while curtailing the potential for troubled funds to trigger systemic risk. CESR introduced two common definitions in 2010 with many investment guidelines very similar to those of S&P Global Ratings, for example, weighted-average maturity and final maturity limits, minimum level of credit quality, stress testing, and diversification."
S&P comments, "The EU published its MMF regulation in June 2017, with an effective date of Jan. 21, 2019 applicable to most existing EU-domiciled funds. Regulatory compliance with the new rule was later extended to March 21, 2019 for a few euro-denominated MMFs. Implementing the new regulation had no rating impact on rated MMFs."
They add, "We assign our fund ratings to approximately 600 funds globally under our principal stability fund rating (PSFR) and fund credit quality (FCQ) and fund volatility ratings (FVR) methodology. These criteria are used for funds in the three short-term MMF categories and the standard MMF category. Metrics considered include the minimum standards of credit quality, diversification, net asset value (NAV) deviation, weighted-average life, and cure periods. Our MMF criteria guidelines are mostly within those of the regulation and we apply monthly stress tests."
The S&P piece states, "Before the reform, 4% of the EU-domiciled MMFs we rated were standard MMFs -- the rest were short-term MMFs. By March 31, 2019, this had changed, so that: 70% of our rated MMFs were low volatility NAV (LVNAV); 15% were short-term VNAV (STVNAV); 11% were public debt constant NAV (CNAV); and 4% were standard VNAV. While some asset managers have launched new MMFs to complete their product ranges, others have split their core funds. We have rated 18 new MMFs since the EU published its MMF regulations in June 2017. Most of these newly rated funds were STVNAV funds, followed by public debt CNAV and LVNAV MMFs in equal numbers."
They write, "We attribute the popularity of STVNAV funds, in part, to the 'sunset' clause in the EU MMF reform regulation. This clause requires the EC to review the safety and adequacy of the public debt CNAV and LVNAV fund categories by July 21, 2022. These fund types use amortized cost accounting valuations. If the review views them unfavorably, the EC could decide to withdraw these fund types. Therefore, some fund sponsors have elected to launch STVNAV funds instead, as a pre-emptive tactic and to develop the fund's track record, because STVNAV funds will not be part of the review."
S&P goes on, "The LVNAV fund category in Europe is a hybrid between a traditional CNAV (which offers a constant NAV, for example, $1.00, £1.00, or €1.00 per share or unit) and a VNAV fund. A VNAV fund uses a full mark-to-market approach to the valuation of securities. In the past, short-term MMFs used amortized cost accounting to value securities that had maturities of up to three months and for many CNAV MMFs, the entire portfolio was valued using amortized cost. LVNAV funds take a more-conservative approach; securities in an LVNAV fund can only be valued using amortized cost accounting if they mature in 75 days or less. The LVNAV fund is thus a hybrid that uses a more conservative pricing method."
They tell us, "Over the past five years, we have seen a mixed picture among the three major currencies -- euro, sterling, and U.S. dollars. While net assets held in rated short-term MMFs denominated in sterling and U.S. dollars have trended higher, net assets in euro-denominated MMFs came under pressure as a result of negative yields and were therefore typically flat. We also saw a sharp increase in the number of U.S. dollar-and euro-denominated short-term MMFs, causing the average fund size to shrink. Meanwhile, the number of sterling-denominated short-term MMFs has been relatively stable, but it saw an increase in net assets due to organic growth and market appreciation."
S&P states, "The large increase in the number of rated short-term MMFs denominated in euros suggests that investors' interest in investing in a pooled structure and diversified investment product has not waned. In our view, investor demand for short-term MMFs may also have been supported by banks seeking to avoid holding large amounts of short-term cash on their balance sheet, as such liabilities may incur a costly capital charge."
Finally, they conclude, "The new regulation is not yet finalized. The EC is expected to undertake a review of the EU MMF regulation by July 21, 2022. It will present a report on the feasibility of establishing an 80% EU public debt quota for public debt CNAV MMFs. The report will also include the EC's assessment of whether the LVNAV MMF model has become an appropriate alternative to non-EU public debt CNAV MMFs. Given how many historical CNAV and STVNAV MMF investors have moved into the public debt CNAV and the LVNAV fund categories, it will be difficult to eliminate any of these fund categories. We will have to see if the three years before the review provide sufficient data for a full and detailed analysis."
For more Crane Data News on European Money Fund Reforms, see: "Fitch Update on European Money Funds After Reforms; Morgan Stanley" (4/1/19), "Aberdeen, Fido Make European Reform Changes; Oppenheimer Merging" (3/1/19), "Little Movement in European Money Funds; Offshore, ICI MMF Holdings" (2/15/19), "Not Done Yet: European Money Funds Continue Adjusting to Reforms" (2/6/19) and "European MMF Reforms Going Live, or Not? Economist Swipes at RDM Kill" (1/22/19).
