Funding & Investing

Getting to grips with VNAV

Published: May 2015
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New regulatory proposals set out for money market funds (MMFs) by the European Commission (EC) earlier this year are set to radically reshape the trillion dollar industry. But perhaps not in the way that a lot of people anticipated.

Over the last several years the money fund industry in Europe has been shrinking. Every year since 2012, data has shown the total number of funds to be in decline. With far from universally favoured regulatory proposals in the offing, together with the negative interest rate environment, many in the industry thought that that this decline would accelerate further still in the coming months and years. They may have spoken a bit too soon.

Conversations Treasury Today has recently had with European asset managers indicate that the coming regulatory shake up may well preclude a growth in MMF products, albeit by means of the assets already held in prime CNAV MMFs being reallocated into various smaller funds.

Retail and government constant net asset value (CNAV) MMFs will remain on the menu for the time being. The big news, however, is that an entirely new category of fund will be established subject to a five year sunset clause: Low Volatility (LVNAV) MMFs that will be required to publish their mark-to-market daily and remain within a 20 bps range. As asset managers endeavour to establish new funds compliant with the regulations, treasurers may soon have much more to choose between when it comes to investment vehicles for their cash investments.

“What is clear is that MMF providers will have the abilty to offer a wider range of products to suit their client base”,” says Ian Lloyd Senior Business Manager for Liquidity at Legal and General Investment Management (LGIM). “I think it is clear that all managers running CNAV’s will be considering LVNAV and government MMF’s. The current product offering is very commoditised, as we move forward I expect to see a wider range of products. Where we’ve got a flagship sterling fund – which today stands at circa £23bn, it is likely that this could end up split into a Government fund, a LVNAV and a VNAV product. The ultimate size of the respective funds will be based on investor appetite.”

Any new funds that are established may very well, in the current environment, be attractive propositions for corporates relative to bank deposits (depending, of course, on how security, liquidity and yield are prioritised). Contrary to expectations, neither regulatory uncertainty nor free-falling interest rates have precipitated substantial outflows from the industry. “You need to be careful looking at combined asset flows in euro terms because of the euro depreciation, but the actual flow into CNAV MMFs in sterling, euro and dollar terms over the last year have all been positive,” says James Finch, Head of Global Liquidity Management, EMEA at UBS. “Even in the US asset levels have actually been higher since their regulatory measures were announced. Everyone was slightly pessimistic, saying that it would lead to outflows from the industry but it hasn’t – it has, in fact, been the reverse.”

Like many other corporates, we are not currently using euro denominated money funds due to the yield, rather than the new regulation issues.

Andy Nash, Senior Vice President and Group Treasurer, Ahold

Like LGIM, there are already plans in place at UBS to grow their liquidity fund product range. Initially, they plan to launch a range of traditional CNAV funds in Ireland to complement the VNAV funds they are running already in Switzerland and elsewhere in mainland Europe. Once the regulation is agreed these newly established CNAVs will be amended accordingly. “At UBS we are going to be building out our product range in the short-term MMF space,” says Finch. “If you look at ourselves – and the other providers – we want to have a range of solutions from potentially CNAV retail or government only, through to LVNAV and VNAV funds. From the client’s perspective, they are going to have a range of different products to choose from. The demand is still going to be there for high-quality short-term MMFs that settle on a same day basis, so we will be trying to take the things that investors find most attractive about CNAV MMFs and deliver them in a new regulatory environment.”

Even the impact of negative yields, which many treasurers cite as a greater concern than regulation, appears to be more nuanced than some anticipated.

Less than zero

Corporates are facing an exceptionally challenging investment environment in Europe at the moment – one which actually has little to do with the forthcoming regulatory changes being imposed upon the money market fund industry. The recent monetary policy stance of the European Central Bank (ECB), in particular the decision to slash its deposit rate to minus 20 basis points is driving yields on virtually all euro-denominated MMFs into negative territory. Treasurers, none of whom are feeling overly enthusiastic about the idea of paying for their liquidity (which thanks in part to the recent bond issuance frenzy is at extraordinarily high levels), have been re-considering their options.

“Like many other corporates, we are not currently using euro denominated money funds due to the yield, rather than the new regulation issues,” says Andy Nash, Senior Vice President and Group Treasurer at the Dutch international retailer Ahold. Compounding the problem is that, in Europe at least, there are almost no other liquidity vehicles able to provide a positive yield without sacrificing the other two elements of that impossible short-term investment trinity, security and liquidity. It’s of little surprise, then, that those who are able to are keeping their cash elsewhere.

Ahold is quite fortunate in the respect that 60% of its business is in the US and has US dollar cash which can be invested in a better yield environment including dollar money market funds. It is also possible to manage the FX risk from dollars to euros but this entails taking a different approach to asset liability management. “Normally you would be much more focused on having a balance between dollar assets and liabilities. But in today’s environment it is much better to actively manage the FX and keep more dollar cash, ensuring the FX is managed for euro needs. It also means being very strong on cash flow forecasting and understanding how far you can term out.”

Nowhere to turn

Why have those expected outflows not materialised? After all, IMMFA estimates that a majority (57%) of all euro area MMF assets are held in CNAV funds. These are evidently very popular investment vehicles, and given that regulation means they are set to vanish from the European market one might expect some investors to take their liquidity elsewhere.

One of the problems with that reasoning is that it works on the assumption that there are plenty of other viable vessels out there waiting for corporate liquidity. There simply are not. In reality, the alternatives on the market are few and far between. Although bank deposits might serve as a feasible option, for some (if they can stomach the even more negatively yielding deposit rates), the introduction of Liquidity Coverage Ratio has seen to it that non-operational deposits are now being actively discouraged by some institutions. Segregated mandates have some benefits for exceptionally cash rich corporates, but are more or less impractical for everyone else. Another possibility might be an Exchange Traded Fund (ETF), but any treasurer who goes down that route would have to be willing to tolerate longer durations and, by extension of that, higher levels of risk.

Stability by other means

For corporate investors, however, MMFs remain the preferred option. The fact that a large slice of the market could be obliged to convert to VNAV – albeit over a long period – may in fact be immaterial to many. Investment policies may need to change in some cases; tax and accounting treatment may for some prove more challenging, but even so the anecdotal evidence suggests that most treasurers understand now that VNAV does not necessarily equate to volatility.

It all depends on how the fund is managed. Anybody who still doubts this should take a look at the liquidity fund offerings of Aviva Investors which were converted to VNAV back in the aftermath of Lehman Brothers. “The valuation of our daily sterling liquidity fund over the past seven years has never moved away from one,” says Matthew Tatnell, Head of Liquidity at Aviva Investors. “If a cash fund is managed in accordance with its stated objective of maintaining a £1 share price then there should be little or no volatility in normal market conditions. The term VNAV can in fact be used as a label for a very wide range of different ‘cash’ investment styles that certainly don’t all set out to provide a stable asset value, high amounts of liquidity and low credit risk.”

Investment policies may need to change in some cases; tax and accounting treatment may for some prove more challenging, but even so the anecdotal evidence suggests that most treasurers understand now that VNAV does not necessarily equate to volatility.

Aviva has been able to achieve this share-price stability simply by managing their funds in a more conservative fashion, prohibiting the purchase of higher yielding floating-rate notes, for example where historically prices can be volatile, preferring instead to offer this type of product in a separate AAA-rated fund that doesn’t target a stable asset value. Of course, in extremely stressed market conditions the value of the fund’s portfolio could decline and that would show in the share price. That would happen to any investment fund though, regardless of what label one puts on it. The difference is that, when faced with such conditions, the ability of the share price to fluctuate helps to keep the fund open for business.

In contrast, when a CNAV MMF is faced with such market conditions it could, in the absence of sponsor support, be forced to wind down. In this extreme situation, the investor could potentially experience a long, nervous wait to see how much of the investment will be repaid as the fund sponsor attempts to sell off the portfolio into a market that, in all likelihood, is already stressed. “I actually think this whole VNAV and CNAV differentiation is irrelevant,” says Colin Cookson, Managing Director of Liquidity at Aviva Investors. “Just because you put a label on something doesn’t mean it’s immune. Instead investors should be thinking about how the sponsor is managing the portfolio to minimise the probability of a potential for a move in the NAV.”

Decisions, decisions

As noted earlier, treasurers in the post-regulation European MMF landscape are likely to have considerably more choice in terms of products. But what type of fund will ultimately end up being the most popular choice for the corporate investor? With the expectation being for so long that it would be VNAV or nothing for European MMFs, some of those who formerly invested in the other category of fund have been busy readying themselves for VNAV, considering how such investments and removing any potential obstacles ahead of time. Many of them may also be looking at the more stable incarnations of VNAV MMFs, as run by the likes of Aviva and Northern Trust, and reaching the conclusion that this type of product, if managed in the right way, might not be so incompatible with their investment needs after all.

On that basis, LGIM’s Lloyd believes that the bulk of corporate liquidity may eventually end up heading in the VNAV direction. “It may well be that VNAV over time becomes the preferred choice for corporate treasurers, especially given the LVNAV sunset clause. If that is indeed the case, how does Lloyd see all of those CNAV-only fund investors adjusting? “To begin with investors will have to get used to the mechanics of a VNAV but given the underlying investment guidelines are unlikely to change dramatically it is likely that over time corporate treasurers will become comfortable with this product.”

UBS’s Finch agrees, adding that the now-visible volatility will also entail changes in accounting methodologies and, possibly, updates to TMSs and other relevant systems. “If treasurers are used to CNAV funds then changes in the underlying NAV will make it somewhat different in terms of the accounting or how they book it into their systems.” Providing the introduction of LVNAV MMFs is confirmed in legislation later in the year, however, treasurers will at least have time on their side. “That should be a kind of stepping stone product,” he says. “It will look and act like a CNAV product and will provide clients with similar benefits.”

Straightforward, easy to book and report on a tax basis; it is not difficult to understand why prime CNAV MMFs have long been popular investment vehicles, for corporate treasurers especially. However, ever since the bankruptcy of Lehman Brothers caused the Reserve Primary Fund to “break the buck”, regulators have had the industry in their crosshairs. Now, rightly or wrongly they have decided that in the interests of financial stability they should be phased out. That is the reality facing investors. For those who prefer their NAVs fixed at a price of one it is not an ideal reality, yet in the current environment it is hard to see many corporates discontinuing or even reducing their use of MMFs once the regulation is finally passed into law.

Just because you put a label on something doesn’t mean it’s immune. Instead investors should be thinking about how the sponsor is managing the portfolio to minimise the probability of a potential for a move in the NAV.

Colin Cookson, Managing Director of Liquidity, Aviva Investors

Even when the HSBC Euro Liquidity Fund became the first multi-billion fund in Europe to post a negative yield back in April it proved to be very much a storm in a teacup. Moody’s said at the time that even though it expected more of the MMF sector to turn negative in the weeks ahead, this would likely only result in reallocations within the sector, not outflows.

That should give everyone an idea of prospects for the industry going forward. If the notion of paying to deposit liquidity proved insufficient to drive investors out of the MMF space, it seems somewhat unlikely that changes to how funds account for capital and income, and value their underlying investments, will.

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