Treasury Today Country Profiles in association with Citi

Euro LVNAV MMFs hang in the balance

Balanced rocks in front of a waterfall

The European Commission’s outlawing of money market funds using ‘share cancellation mechanisms’ puts euro LVNAV funds in doubt.

The ability for fund managers to offer euro-denominated Low Volatility Net Asset Value (LVNAV) money market funds is in doubt.

This comes after the European Commission (EC) stated that fund managers would no longer be able to use share cancellation mechanisms under the new regulatory regime that applies to new funds from 21st July 2018 and existing funds from 21st January 2019.

Share cancellation is a technique used by fund managers that offer constant net asset value (CNAV) funds. It allows them to maintain a share price of €1 in a negative interest rate environment – one of the most appealing features of the funds for investors.

With the usage of this mechanism now outlawed, euro LVNAV funds – which the majority of euro CNAV funds were going to transition to – will not be viable in a negative interest rate environment. Because of this, fund managers offering euro CNAV funds will have little option but to convert to variable net asset value (VNAV) money market funds, impacting €100bn of assets under management.

This would not be the case if short-term interest rates turned positive to the extent that they could deliver positive yields. However, ratings agency Fitch predicts this is unlikely and expects the ECB policy rate to stay at 0% this year and rise to only 0.5% in 2019.

It is worth noting that sterling and US dollar LVNAV funds do not face the same risk, given the higher short-term rates for these currencies.

Corporate concern

This news may create concern amongst corporate investors in euro MMFs. Many have stated that LVNAV style MMFs are their preferred option in the new regulatory environment because they can offer a stable price-per-share for investors.

VNAV funds meanwhile utilise a floating NAV, meaning that they do not maintain principal stability as their primary investment objective. With VNAV funds, assets are marked to market daily and unrealised gains and losses are translated directly into the share price, something that not all corporate investors are comfortable with.

VNAV: a viable alternative?

That being said, Aviva Investors has been offering VNAV funds since 2008 and has had success marketing this product to corporates.

“The collapse of Lehman Brothers and the run on Northern Rock, almost a decade ago, systematically changed the environment for stable net asset value money market funds,” explains Matthew Tatnell, Head of Liquidity at Aviva Investors.

“Corporate investors that once considered cash investments as a risk-free asset class could no longer do so. In 2008 we took a bold decision to change our stable net asset funds from CNAV to VNAV but continued to target a stable net asset value. This was the right decision for our investors and we have continued to deliver a stable net asset fund.”

Treasury Insights has also heard first hand from corporates using VNAV MMFs. One is Auna Dunlevy, Head of Liquidity and Investments at Royal Mail, who has recently been testing VNAV funds as part of the company’s investment portfolio.

Despite initial reservations, her experience has been positive, saying that: “What we found was that VNAV funds are not as scary as we thought. We also found that there is quite a range of funds with slightly different strategies, whereas sometimes CNAV funds all seem to be investing in the same thing.”

Dunlevy is also satisfied with the results, noting that VNAV funds tend to provide “an extra pick up in terms of return”.

An evolving landscape

This news adds an extra layer of unwelcome uncertainty for corporates already striving to understand the new MMF regulatory environment and what this means for their investment portfolio.

Treasury Today will continue to keep you abreast of developments as they emerge and we are keen to hear your views.

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