Treasury Today Country Profiles in association with Citi

MMFs: what’s next after CNAV?

European Parliament

This week Europe’s stable NAV money market funds received a temporary stay of execution after the planned European Parliament vote on new regulatory proposals was postponed. Industry stakeholders say a mass exodus from MMFs could ensue if the legislature votes to adopt the proposals as currently drafted. But where will all that liquidity go? In this Insight, we take a look at the alternatives.

Earlier this week, European lawmakers delayed a vote on proposals to regulate money market funds (MMFs), after splits began to appear within the European Parliament’s economic affairs committee on the best way to proceed. The decision means that industry stakeholders now have an extra two weeks to voice their concerns on the proposals before MEPs cast their votes.

Enough has already been written on the reasons why certain aspects of Europe’s MMF regulatory proposals are so misguided that there is no need to run through it all again here.

But there is one remaining area that has not yet been sufficiently explored that perhaps deserves some attention now, given the impending vote at the European Parliament. The issue is: what will happen if the regulation is indeed approved as it has been drafted? What alternatives are there to MMFs for corporate investors if a switch to VNAV is not feasible?

A recent survey by Treasury Strategies, which was included in an open letter sent to the European Parliament ahead of this week’s vote, offers a hint. In Europe, 61% of corporate treasurers invest cash in CNAV funds only, while 30% use a combination of CNAV and VNAV. If all funds are compelled to switch to VNAV, the survey indicates that 69% of CNAV fund investors will reduce or discontinue using MMFs.

Back to bank deposits

According to this survey, bank deposits represent the preferred alternative for a majority (72%) of CNAV MMFs users. But not everybody is convinced this is the right move. Like many of his treasury peers in continental Europe, François Masquelier, Risk Manager and Head of Treasury and Corporate Finance at RTL, uses both types of fund. He believes that even VNAV funds are a better option than bank deposits. After all, moving money away from MMFs and into bank deposits will only result in more risks being concentrated on non-triple A rated financial institutions.

“That does appear the best strategy especially given the rates being offered and the abundance of liquidities on the market,” he says. And he makes a persuasive case. Switching to VNAV will inevitably require treasurers to learn the nuances of a new accounting treatment, and perhaps even changes to investment policy. But the funds do have the advantage of a cash equivalent which usually offers better returns compared with a bank.

That is of vital importance. – and in fact is the main reason most treasurers favour CNAV MMFs, one UK-based treasurer for a well-known frozen foods company told Treasury Today. She is optimistic, however, that Europe’s MMF industry can weather the storm if CNAV funds do die out. Of course, the regulation will require treasurers to look again at their investment policies and there may be a few hoops to jump through to ensure investments are still classified as cash equivalent on the balance sheet. But, assuming that challenge can be overcome, she thinks VNAV MMFs still look a better option than bank deposits or repos.

“As a first port of call, if we can use the VNAV funds on our balance sheet then we will,” she says, adding that the question had been put to the firm’s auditors but had yet to receive an answer. Returns on bank deposits have for some time now been negative in real terms but, like Masquelier, that is not what concerns her most. The problem is that a lot of banks now simply do not reach the investment criteria. “In terms of going to a VNAV fund I have heard that it doesn’t fluctuate that much,” she adds. “You are exposing yourself a bit more, perhaps. But really the issue is whether you can get over that accounting classification.”

Susan Hindle Barone, Secretary General of the Institutional Money Market Fund Association (IMMFA) agrees that depositing cash directly in a small number of relationship or ‘national champion’ banks does not represent an ideal alternative. On the one hand, it is not good for the investor who should want to avoid the concentration of risk, but it is not good for banks either as they do not want a lot of very short-term cash. “On those grounds, one could argue that this regulation has potential to increase systemic risk, rather than reduce it,” she observes.

Segregated mandates

The problem is that besides bank deposits there is very little else in the way of options for the corporate investor. One possibility that has received a lot of attention of late is separately managed accounts. These individually managed investment accounts have been around since the 1970s, but with all the uncertainty surrounding the future of MMFs, interest has clearly been growing. Figures from the US-based Money Management Institute indicate that the total separate account sector – retail and institutional – posted a 3% asset gain during the third quarter of 2013.

But do separate accounts really represent a viable alternative for corporates? For some, they may be an option worth considering. There are advantages, such as the ability to customise accounts to exclude certain securities or industries. However, the investment minima are often much higher than with MMFs, therefore excluding all but the largest corporates. “One issue with segregated mandates is that they have to be quite big to make them worth doing,” says Hindle Barone.

Those corporates with enough cash to run as a segregated mandate will find that this option provides less flexibility than an MMF, particularly from a liquidity perspective. In an MMF, investors benefit from the collective liquidity of all the investors in the fund, whilst with a segregated mandate there are no funds other than your own. The portfolio of assets is invested with a range of maturities, some very short, but some longer. It may not be possible to access all of your funds at very short notice – i.e. next day. “That is the liquidity benefit of being in a fund,” she adds.