With Europe’s money market fund reform now under way, fund managers have plenty to do this year as they adjust their offerings in line with the new rules. Meanwhile, treasurers should take the opportunity to review the new fund structures, update their investment policies and check that their cash and treasury management systems are able to cater for the changes.
Europe’s money market fund reform has been in the pipeline for so many years that few are likely to be taken by surprise by the upcoming changes. With existing MMFs required to comply by 21st January 2019 – and new funds launched after 21st July 2017 already subject to the new rules – the time to act is now.
For fund managers, the new rules should not present undue challenges. “As MMF regulation has been a topic discussed within our industry for nearly a decade, I think there has been ample time to align the required resources and prepare for the forthcoming year,” comments James Finch, Head of Liquidity Management, EMEA at UBS.
Nevertheless, there is plenty of work for both fund managers and treasurers to do over the course of 2018. “We are getting ready operationally,” says Kerrie Mitchener-Nissen, Head of Product Development, International for Global Liquidity, J.P. Morgan Asset Management. “We’re also staying closely connected with our clients, ensuring they are aware of the options open to them and have updated their investment policies, looked at any changes required to their treasury workstations and trading portals, reviewed their reporting capabilities, and consulted with their tax and accounting advisers. Corporate treasurers have just under a year to get ready, but that time will pass quickly.”
The new rules
European money market fund reform was first proposed by the European Commission in September 2013, with the final rules agreed by the European Commission, European Parliament and European Council on 14th November 2016.
Three types of short-term money market fund will be available under the new rules:
VNAV MMFs calculate NAV using mark-to-market or mark-to-model prices.
Public debt CNAV MMFs will be required to invest at least 99.5% of their assets in public debt, while maintaining a constant NAV.
LVNAV funds, seen as the successor to existing CNAV funds, will use amortised cost accounting for assets with a residual maturity of up to 75 days. They will be required to maintain minimum weekly liquidity of 30%, with liquidity fees and redemption gates applicable if liquidity drops below 30% and daily net redemptions rise above 10% of the fund’s total assets.
The new rules also include one category for standard MMFs, the Standard VNAV MMF.
What fund managers are doing
For fund managers, this year will see considerable activity as providers work to convert existing CNAV funds to the LVNAV model. Hugo Parry-Wingfield, EMEA Head of Liquidity Product, HSBC Global Asset Management, outlines three key areas of change that fund managers should be focusing on: structuring the project, developing the new fund range and communicating with clients.
Structuring the project
Where the project structure is concerned, Parry-Wingfield points out that fund managers are accustomed to carrying out major formal regulatory change projects and as such are likely to have the right resources already in place.
“We launched a formal project last year specifically for this regulatory change,” he explains. “We have a dedicated project manager and team around them, and accountable executives across the different functions of the business that are responsible for the various elements within that project plan.”
Finch, meanwhile, explains that UBS has a dedicated regulatory team which “has been working closely with our Global Liquidity Management business to prepare for this year and ensure the project is scoped and resourced correctly”. He adds, “Work streams on the various reform components are already in progress and we are working towards making all our existing MMFs fully compliant with the new rules.”
Developing the fund range
For HSBC Global Asset Management, Parry-Wingfield says the key focus on the product side is the conversion of the bank’s current CNAV money market fund to the new LVNAV product. “Consistent with most providers, we believe that the LVNAV product is the most credible alternative to what investors use today,” he comments. “We also believe that is where most clients will have their preference after the rules come into place.”
At the same time, Parry-Wingfield says that HSBC Global Asset Management will be prepared for having other options available – such as CNAV government-only funds and VNAV funds. “Whilst not our base case, we would respond if there was increased demand for some of those alternatives which may be shelf-registered in the meantime,” he notes.
Communicating with clients
Also crucial for fund managers is the need to communicate the implications of the changes to investors. “I think corporate treasurers are probably as informed about the new MMF rules as the asset managers!” says Finch. “Given treasurers have always been significant users of MMFs, often using a number of providers, they have no doubt received multiple updates from each provider along the way. In addition, the rating agencies, Institutional Money Market Funds Association (IMMFA) and the press have all played their part in helping ensure that MMF reform is in focus.”
What treasurers should be doing
For corporate treasurers, likewise, there is plenty to do to prepare for the changes, from understanding the changes to reviewing investment policies and systems.
Engage with providers
Firstly, treasurers should engage with fund managers in order to gauge how prepared their fund providers are for the changes and what approach they are planning to take. “We are speaking to our funds and understanding what changes they will make and how this will affect our return,” says Auna Dunlevy, Head of Liquidity and Investments at Royal Mail. “It seems like most of the funds we deal with as CNAV will become LVNAV, although we haven’t got ‘official’ confirmation yet. It also seems that as the funds we deal with are at the high end of the quality scale, the impact should not be significant.”
Review available fund structures
Likewise, treasurers should take the time to understand the types of structure available under the new rules. “The new regulation offers great optionality for cash investors,” says Jim Fuell, Head of Global Liquidity Sales, International, J.P. Morgan Asset Management. “But to minimise any disruption, corporate treasurers will need to look closely at the fund structures available to them, and carefully consider the implications of each option.” Fuell notes that certain fund structures have the ability to offer a more attractive return – “but what level of risk are those managers taking in order to deliver additional yield?”
Review investment policies
Treasurers will also need to review and update their investment policies and risk policies. “Obviously a lot of these policies get approved by boards and have to fit into the relevant approval cycles, so this should not be left to the last minute,” says Parry-Wingfield. “Corporates should be thinking about timings and working backwards from when they need to submit papers or make decisions.”
François Masquelier, Vice Chairman of EACT agrees that it may be useful for treasurers to revisit their asset management policies to make sure they are compliant with the reform. “Furthermore, it is important to get validated by treasury committees the types of products we will be authorised to invest in,” he says.
Technology is another consideration. Parry-Wingfield points out that treasurers may need to update their cash and treasury management systems and processes. “Treasurers need to ensure that whatever systems they are using, including investment platforms and portals, cater for any new features in the products and any changes that will take place,” he says.
Engage with auditors
Treasurers will also need to engage with their auditors about the treatment of LVNAV funds from a cash equivalent point of view. “We expect the new LVNAV product to continue to be cash and cash equivalent from an auditor’s point of view in most cases – however, it’s for individual auditors to evaluate that and give the relevant advice,” says Parry-Wingfield. “And like everything else, the sooner the better.”
Aside from these practical considerations, treasurers may be asking whether they should take the opportunity to consider other investment options. “I feel this is a good opportunity to look again at the wider range of MMF solutions available, understanding if in addition to LVNAV MMFs, Variable NAV MMFs could also be used as part of a tiered liquidity management strategy,” says Finch.
However, Finch adds that he doesn’t really see the new rules fundamentally changing the way that corporate treasurers use MMFs. “Over the years, treasurers have become very familiar with the use of MMFs, valuing their liquidity, security, yield and operational simplicity and I don’t believe the new rules fundamentally alter any of these benefits,” he explains. “In addition, with banks continually looking to reduce the amount of short term deposits they take onto the balance sheet, traditional alternatives are become more limited.”
Parry-Wingfield says that the new rules are designed to improve the security and consistency of the products concerned. “We believe that the fundamental reasons why corporates have used money funds as a short-term cash product in the past will not change specifically because of these new regulations,” he says. “Coupled with our confidence that LVNAV is a very credible alternative to the existing CNAV product, it’s reasonable to think investors will continue to value these kinds of products. Investors may separately evaluate alternatives – but should not lose focus on the fundamental benefits money market funds can provide for the element of the cash that is short-term in nature.”
Nevertheless, it’s worth noting that the regulatory reform is not the only issue affecting money market funds in Europe. Masquelier comments, “I am more worried about the potential longer-term period of negative EURIBOR rates than the reform itself.” He adds that treasurers may be tempted to propose other longer duration products to their CFOs in order to avoid booking losses with negative returns, or to mitigate negative impacts on the P&L: “It is a perfect opportunity to at least try to suggest to management to open doors to alternative products with higher volatility, longer time horizon but potentially better return,” he says.
Looking further ahead, Masquelier says that the current situation could push MMF providers towards another stage of consolidation in the industry. “I would not be surprised to see fewer players but at a larger scale,” he says. “We could end up with few very large players, and small specific boutiques, like the French funds.”
In light of these changes, Masquelier predicts that corporates will “adapt their strategies, slice their excess cash into layers with different time horizons in order to adjust product to each bucket and all-in try to limit as far as possible negative impacts/results”.
MMFs in Switzerland
Finch argues that the domestic Swiss cash market will be interesting for MMFs going forward. “Historically, there has been a preference for Swiss treasurers to use bank deposits for cash management, with MMFs not gaining significant market share,” he says. “However, given low and negative interest rates, combined with the pressure on banks to reduce their short-term deposit books, off-balance sheet alternatives such as MMF are starting to gain traction with corporate treasurers.”
Finch says there are currently a limited number of Swiss domiciled MMFs focused on institutional investors (he notes that investing in a Lux or Irish domiciled MMFs can attract a stamp tax for Swiss investors). However, he adds, “we expect this to change and are actively working on developing and expanding our existing range of Swiss domestic MMFs to cater for an institutional client base.”
He notes that from a regulatory perspective, Swiss domiciled MMFs are not directly impacted by the new EU rules. “But we could see the Swiss regulator look to adopt certain, if not all of the new EU MMF rules.”
With the new rules already coming into effect, treasurers should expect to see plenty of communications from their fund providers over the course of this year. However, it’s important to note that fund providers aren’t the only ones who will need to make changes. From updating investment policies to engaging with auditors, treasurers will also need to make sure they are ready for the new funds – while keeping an eye on the impact of wider market conditions on this type of investment.
Preparing for the new rules
Assistant Treasurer, Front Office
What steps will you be taking this year to prepare for the new MMF regulations?
The protracted discussions on European MMF Reform and the associated uncertainty led us to make a number of changes to our investment policy ahead of the Final Regulation being published. We challenged ourselves to segment our cash more, and diversify our cash investments to include other investments, such as tri-party repos. It is our continued intention to use MMFs for our core liquidity needs. In order to prepare specifically for the new MMF regulations, we will seek approval from the Risk Committee to invest in the LVNAV.
Are there any particular challenges that you will need to overcome?
We will write a detailed paper outlining the key changes, including the need for the NAV to be within 20 basis points, and the potential for fee and redemption gates. We expect to be challenged on how such funds would behave under times of market stress, and therefore will need to present back testing on how a CNAV and their shadow funds would have performed during the 2008/09 financial crisis. It will be important to highlight the subtle differences between a CNAV and LVNAV that should reduce the LVNAV’s volatility.
We are also aware that a LVNAV may not be viable in a negative yield environment, but fortunately we currently only invest in USD funds. Determining whether a LVNAV will be classified as cash and cash equivalents will be an important consideration, particularly as we are looking to use LVNAVs for our core liquidity. As we currently hold investment grade securities directly, our investment policy already allows us to invest in securities that need to be marked-to-market.
Do you expect to replace CNAV funds with LVNAV funds, or will you be considering other options?
We expect to be investing into LVNAV funds so long as the back testing analysis and investment profile seems in line with expectations. As mentioned above, our investment policy and current infrastructure has enabled us to switch into alternatives if required. We have in the past used government-only MMFs, and will continue to have this as our risk-averse option. We acknowledge that the regulations surrounding the percentage of overnight and one-week paper on LVNAVs may lower the yield compared to previously, but these still earn in excess of the CNAV government funds.
How effectively are fund managers communicating with you about the new rules?
All our managers maintain a good line of communication with us, particularly when there are any developments surrounding the reforms. We have started to see some back-testing analysis now, with accompanying seminars and workshops on the issues.