Last week, the U.K.-based Association of Corporate Treasurers' James Winterton hosted a webinar entitled, "European MMFs at a Crossroads," which featured Fitch Ratings' Alastair Sewell and Minyue Wang discussing pending European and global money fund regulations. Sewell asks, "So where are we? To summarize, the major global regulators are looking at money market regulation. As of the time of our speaking, we do not have final regulatory proposals yet. So, the SEC in the U.S. completed a consultation in April of this year. It intends to publish ... policy proposals by April of next year. ESMA in Europe has completed a consultation, and it expects to publish its final decision in the second half of this year.... The Financial Stability Board, which is the collective of regulators, consulted in August of this year and published a final report in October of this year."

He tells us, "To summarize that report very briefly, it is scrupulously neutral in the proposal it discusses. Our interpretation is that the FSB believes that material changes are needed to address the vulnerabilities in money market funds. Our interpretation is that the FSB is not in favor of tinkering with money market funds. It is in favor of more wholesale change. So, therefore, it is important to be aware now that change is coming, to be aware of the direction of travel and to begin getting prepared, with the caveat ... that we don't actually know yet what Europe will decide. But we do have a sense."

Sewell continues, "I think the key takeaway here is that there is a relatively high level of overlap between the different regulatory bodies' proposals.... You can also see that ESMA has gone out on a little bit of a limb compared to some of the other bodies with some of its proposals, particularly in terms of the way that ratings can be used among money market funds, which is, of course and subject dear to our hearts.... Probably the most important topics to think about are ... the removal of ties between liquidity and fees and gates ... changes to what constitutes weekly liquid assets, potentially moving all funds to a floating NAV [and] potentially introducing swing pricing or asset dilution levies."

He says, "First, most of the public respondents disagreed with ESMA's view on reassessing money market fund ratings.... Public respondents agreed very strongly with decoupling regulatory thresholds from suspensions and liquidity fees.... There's now a very wide body of academic evidence and industry ... commentary indicating that this [outflows in March 2020] was an unintended consequence of this feature of the regulation, which of course, was designed to stop a shock in the money market fund sector from spilling over to other sectors by cutting off the risk. But clearly, there seems to be a fairly-strong consensus that this needs to be addressed and this needs to be removed."

Sewell states, "The other one here is the disagreement with the creation of a Liquidity Exchange Facility (LEF) ... available to all MMFs to support in some period of future stress. Now, obviously the main issue with this is that it would require funding and for it to be truly effective at significant scale.... For this liquidity facility to be effective, you need to be both large, immediately available and funded. The bottom line is that this would come at a potentially significant cost.... The last one I'll mention ... is that respondents disagreed with eliminating LVNAV funds."

He also says, "Let's talk a little bit about timing, and this is really important. The first point to make is that we think it's highly unlikely that re-regulation is a 2022 event. At the earliest, it will be 2023. Let's work through the steps how we get to that. First of all, we know that ESMA has indicated it will publish its opinion and money market fund review in the second half of 2021, just under a month to that. So this could be coming out any day. We know that in July 2022, ESMA will be reviewing MMF regulations, their scheduled 5-year review.... You add that together with some kind of implementation period, then it really can't be any earlier than 2023.... If we look back at what happened the last time around, that timeline was really quite long. The regulation was signed into law in June 2017, took effect for new funds in July 2018 [and] became effective [for others in] March 2019."

On whether money funds are "cash equivalents," Sewell says, "If you are a U.S. investor or you're a domestic French investor, then your treatment is extremely clear because it is set out in regulation [that] money market funds are cash or cash equivalents.... Outside of France and the U.S., it is less clear.... From our perspective as a ratings agency, we would see money market funds as cash in terms of our corporate rating criteria."

He explains, "What's interesting about France is French money market funds are primarily VNAV. So, if there were a regulatory scenario in which LVNAVs were eliminated and more funds were VNAV, then for a French investor it is plausible that they would remain cash. Now we know in other jurisdictions, VNAV and LVNAV can be seen as a differentiating factor. But in principle, from a European regulatory perspective, since the precedent is set in France, that this is not the distinction. The distinction really is between the quality of the underlying portfolio, which are of course, invested in instruments which would qualify as cash [under] regulation."

Finally, Sewell comments, "The last point I wanted to make is to talk briefly about Brexit, which many of us have forgotten about with Covid. But Brexit did indeed happen a few years ago.... [The question is] whether we might see the U.K. begin to diverge from Europe. Now the sense I have is that divergence would [only] happen if it were triggered by something. We do have a trigger. We know that European Money Market Fund regulation is being reviewed. We think it's probable that there are going to be changes, potentially some quite material changes. So therefore, it's ... to the point at which the UK might seek to diverge from Europe."

He adds, "If you read [comments from the Bank of England] back in May of this year, it would seem to be opening the door to precisely this possibility. One of the reasons it seems plausible is that most of the money market funds to use are heavily represented by UK domestic investors in EU money market funds. So, there is a disconnect there. There are a few money markets funds in the U.K. Most of them, with one or two exceptions, are quite small.... [Their] domestic industry [may] instead chooses to import the European mutual funds.... So that's something to watch."

In related news, Fitch Ratings also published a "3Q21 U.S. ESG Money Market Fund Update," which comments, "Fund managers continue to expand offerings of environmental, social, and governance (ESG)-focused money market funds (MMFs), according to Fitch Ratings' new report. Most recently, State Street Global Advisors (SSGA) announced a new money market fund share class, the Opportunity Class, which SSGA says will benefit philanthropic organizations whose values align with State Street's commitment to racial equity and social justice. SSGA will donate at least 20% of its annual net management fee received from the Opportunity Class shares to such organizations."

They add, "As of Sept. 30, 2021, total U.S. ESG MMF assets under management (AUM) were $9.0 billion. The AUM marginally decreased by $4 million in 3Q21, or 0.05%, compared to a 3.1% decrease in overall prime MMF AUM. Gross yields of ESG MMFs had averaged 15 bps during 3Q21, 2 bps lower than non-ESG MMFs, due to ESG MMFs' reduced investable universe. ESG MMFs' net yields averaged 5 bps during the quarter, which is 2 bps higher than comparable non-ESG MMFs due to lower expense ratios at the ESG funds. These gross and net yield spreads between ESG MMFs and non-ESG MMFs were the same in 2Q21."

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