Funding & Investing

European MMF regulation: five key talking points

Published: Sep 2016

Colourful liquid running into each other

Companies that depend upon money market funds (MMFs) for cash management may need to overhaul their approach once new regulation has been agreed by the European Union. Although the final rules are still to be decided, industry experts have highlighted a number of consequential trends that could become key talking points should we get the regulation many people are anticipating.

After much wrangling, it would appear a regulatory saga that has now dragged on for three years is finally drawing to an end. Under a plan agreed by European Union (EU) finance ministers in June this year, constant net asset value (CNAV) MMFs would, like in the US, be able to continue to operate only by investing in public debt. Alternatively, funds could – as proposed by the European Parliament (EP) – convert to a new product named the low volatility (LVNAV) MMF, which can retain a constant share price as long as shares do not deviate from the actual NAV by more than 20 basis points.

Corporate treasurers anxious for final clarity over the new rules will have to wait just a little bit longer, however. The policy process has now entered the ‘trialogue’ stage in which the EU ministers’ proposals will be negotiated with the other two parties in this, the European Commission (EC) and the EP, and it would be mistaken to conclude that, just because aspects of the Council’s proposal line up with the EP text, those proposals will be included in the final text negotiated in trialogue.

After all, a common agreement still needs to be found between the three positions. The elephant in the room is that the EP wants a five-year sunset clause applied to LVNAV MMFs, a provision opposed by much of the asset management industry. And as Carey Evans, Director, Public Policy at BlackRock, explains, that raises the question of what the EP will receive in order to give up that position. “If you started this discussion on the premise that you did not want CNAV MMFs persisting, then ruling out government CNAV MMFs altogether might seem like a more politically-attractive trade,” he says. “Whereas our opinion would be that a workable government CNAV MMF should be off limits in the discussion on the LVNAV.”

There is still very much everything to play for then. Whatever the eventual outcome of the regulatory process, though, we can be fairly certain that there are some big changes for MMFs just around the corner. Here we look at five developments industry experts expect to be key talking points in the year ahead.

Brexit uncertainty

The final outcome of the regulatory negotiations could very well be contingent upon how the politics of Brexit play out. For example, Nina Gill, the lawmaker responsible for overseeing the regulation in the EP is a UK MEP. Understandably, this has raised a few questions in Brussels in the wake of the EU referendum result in the UK.

“The politics of Brexit will almost certainly come into play somehow,” says BlackRock’s Evans. “The UK has been a very strong voice at the negotiating table to date, and the loss of influence will undoubtedly be felt. Equally, UK MEPs have played a very central role, and prolonged uncertainty over their position in the Parliament and within their political groups may change the dynamic of the trilogue’s discussions considerably.” Some in Brussels have predicted that legislative negotiations featuring so-called ‘third country issues’ (access to the Single Market by firms in non-EU countries) could become politically-charged and difficult to progress until the direction of the Brexit negotiations become clearer. While the MMF regulation does not have obvious third country issues, the concept of a government CNAV MMF, as it is constituted in the EP text, is restricted to only EU currencies – a classification that may not capture sterling in the future. While this restriction is not present in the Council text, it could become more politically charged depending on the political dynamics of Brexit.

The pivotal moment could come when the UK finally triggers Article 50 of the Lisbon Treaty, thereby officially beginning exit negotiations with the EU. At that point, there would obviously be legitimate reasons to ask UK MEPs like Gill to stand down from negotiation, given that they would be negotiating rules that, in theory, the UK would not itself be implementing.

More consolidation

The new rules that do eventually come out of these politically charged negotiations are going to – regardless of their form – almost certainly bring their associated compliance costs. These costs combined with the negative interest rate environment, will in all likelihood cause further consolidation in an already concentrated industry.

Fund managers will have to bolster their credit research and compliance oversight capabilities, and new investment will be required to comply with new operational, portfolio stress testing and disclosure requirements. All this favours scaled players that are better positioned to stomach increasing costs and can leverage the liquidity business as part of a broader strategy.

We have already seen a reduction in the number of funds, both in the US and Europe. Part of this decline can be attributed to large asset managers consolidating existing offerings, but a significant chunk has also come through acquisitions. In the past few years we have seen Federated Investors agree to acquire $1.1bn in assets from Huntington Asset Advisors, Aberdeen Asset Management purchase Scottish Widows Investment Partnership (SWIP) from Lloyds and RBS selling its MMF business to Goldman Sachs. Now in the US, the number of providers offering CNAV funds has fallen to 70 from 133 in 2008; in Europe, meanwhile, 38 fund complexes offering CNAV products have been reduced to 25 over the same period.

The politics of Brexit will almost certainly come into play somehow. The UK has been a very strong voice at the negotiating table to date, and the loss of influence will undoubtedly be felt.

Carey Evans, Director, Public Policy, BlackRock

Once the EU has agreed the new rules, we could see more money fund-managers decide to exit the business rather than make the expensive adjustments required to their offerings. “Regulation is a key factor,” Vanessa Robert, VP, Senior Credit Officer, Moody’s says. “It is weighing heavily on the already challenging landscape for money funds and it might accelerate this trend. The ability for mid-tier sponsors to thrive has been materially reduced.”

Product innovation

At the same time as corporate investors’ choice of asset manager becomes narrower, the range of short-term investment products they have to choose from may be about to get a lot bigger. First of all, a number of asset managers have already stated for the record their interest in establishing LVNAV MMFs, should the final regulation include these products as an option, of course.

“That is something we might be interested in adding to our product portfolio,” Paul Mueller, Senior Portfolio Manager, Sterling and Euro MMFs at Invesco, said in a recent interview with Treasury Today. “In principle, it could have a lot of appeal to clients, not least because of the fact it can still trade at a share price of one. But there are some practical operational details that could have a meaningful impact on how viable this product might ultimately be, for example, what investment securities will be allowable in the liquidity bucket. Also it is crucial that the five-year ‘sunset clause’ set-out in the EP’s proposal is not in the final text because we do not think that this product would be viable if that were to be included.”

Applying similar caveats, J.P. Morgan Asset Management also expects to see an evolution in its portfolio of funds once the new rules have been implemented. “When we finally see the details of the forthcoming regulatory changes in Europe it is very likely that we will need to look again at the funds we offer to investors in the region. That could include the proposed LVNAV MMF. Should LVNAV MMFs indeed become a reality, we could look at launching or even converting our existing funds to be able to offer the product.”

The changes are unlikely to stop with the introduction of LVNAV MMFs either. Even now, while the new rules are still being negotiated, we are seeing an ongoing evolution in asset managers’ portfolio of products, driven by the negative interest rate environment and clients searching for additional yield. Both Invesco and J.P. Morgan Asset Management, for instance, note a growing interest in products with longer investment relative to MMFs, such as managed reserve funds (MRFs) and, especially, separately managed accounts (SMAs).

New policies

Given the likely emergence of more new investment products in the coming years, evaluating and updating existing investment policies to better reflect such market trends might be a necessary exercise. In fact, such exercises are already on the agenda for many treasurers. Last year’s, J.P. Morgan Global Investment PeerViewSM survey, for example, found that just under half (46%) of the treasurers surveyed in Europe plan to make changes to their investment policies, an unsurprising finding given that the same survey also discovered that only 44% of the same group of companies allowing for the use of variable net asset value (VNAV) MMFs.

“Upcoming US MMF reforms and eventual updates in Europe are prompting many corporate clients to review their investment policies,” says Beccy Milchem, Director, BlackRock Cash Management, noting the growing demand for alternatives to MMFs amongst the client base. “Those that are able to bucket stickier portions of operational and core cash balances have looked for additional solutions to add to their investment toolkit.”

Treasurers need to work closely with the Board to build an updated policy document detailing a full list of permissible instruments and counterparties. This could mean minor tweaks or a total revamp, depending obviously on the nature of the existing policy and the investment objectives of the corporate in question. For most companies, though, the undertaking would appear to be closer to the latter. Of those respondents in J.P. Morgan’s PeerViewSM survey that said they were planning changes to investment policies, only 18% said the changes would require a minimal level of effort. Meanwhile, 82% described the effort involved in making the necessary policy amendments as ‘moderate’ or ‘significant’.

Time on your side

Given the time consuming nature of identifying the changes that need to be made and then seeking board level approval, it is therefore advisable that treasurers – especially those at corporates that rely heavily on MMFs – to begin the process of review at the earliest opportune moment.

Many treasurers may, of course, want to wait until a final agreement is reached by European policymakers on the future regulation of MMFs before setting anything in stone. That would mean holding off until early 2017, at the earliest and, after the point of agreement, there should be an interim period (anywhere between six months and two years, based on the current proposals). However, it might be sensible to work ahead of that schedule. Indeed, many corporate treasurers have, sensing the general direction of regulation in both Europe and the US, already made the necessary policy changes in order that they can begin familiarising themselves with the new products gradually and at their own pace. That way, once this protracted regulatory saga is eventually concluded – which it surely will be in the coming months – they will be as prepared as they possibly can be.

Best practice: investment policies

All of a company’s investments should be governed by pre-determined criteria, designed to balance risk and return in a way which meets the company’s risk appetite: in other words, by an investment policy.

The investment policy sets out who has permissions to carry out certain investments, which funds, banks and other counterparties are permissible and in what amounts (percentage limits can be set), the credit ratings, returns and maturity lengths which are acceptable and how the policy may be updated in future as the company’s risk profile changes, new investment products become available or counterparties change. Rules like Sarbanes-Oxley (SOX) and IFRS place responsibility for internal controls on the senior management team. In line with this, the board, CFO or a specially constituted treasury committee may have roles in determining the investment policy and keeping it up-to-date. It is generally approved at a senior or board level.

If a treasury investment policy has not recently changed to reflect the ‘new normal’ of regulatory reform, market volatility and low interest rates, then it will almost certainly need to in the near future. There are three areas treasurers may wish to focus on when revising policy, says Hugo Parry-Wingfield, EMEA Head of Liquidity Product at HSBC Global Asset Management. These are:

  • Are policies still fit for purpose? Companies should not simply adjust their criteria downward in response to ratings agencies reviewing – and downgrading – banks, says Parry-Wingfield. “Rather there should be a deep analysis to decide whether they have the right – and sufficient – counterparties.”

  • Are new investment instruments needed? If the ability to place some short-term deposits with banks is becoming limited, then perhaps treasury needs to explore if other instruments are needed, such as those listed above.

  • How much liquidity is needed to run the business? In light of Basel III and the introduction of the LCR, corporates should also be thinking about how their investment policies define their liquidity profile. “The treasurer should now be reviewing what liquidity they really need to run the business. There is always an opportunity cost to holding too much liquidity but we believe that is going to be accentuated in the months to come,” says Parry-Wingfield.

Source: Treasury Today Short-Term Investments and Money Market Funds 2016

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