Funding & Investing

MMF reform: where next?

Published: May 2022

The Ukraine crisis, inflation and rising interest rates are all affecting the investment landscape. At the same time, money market fund reform is once again on the horizon in the US and Europe – and investors have an opportunity to make their voices heard.

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Crossroad signpost pointing in multiple directions Money market funds (MMFs) continue to be a valuable short-term investment vehicle for corporate treasurers. “When you look at money market funds, they are one of the most regulated financial products globally,” explains Paul Przybylski, Head of Product and Strategy – Global Liquidity at J.P. Morgan Asset Management. “They are extremely liquid products, and have a very diversified investor base given the size of the funds. And when it comes to stability, the evidence indicates that money market funds are one of the least volatile types of collective investment schemes out there.”

Two years ago, however, the initial phase of the pandemic presented the first real test MMFs had faced since the introduction of new rules following the financial crisis. As a result of the dash for cash, precipitated by the pandemic and the subsequent economic shutdown, MMFs experienced a surge in demand for liquidity from investors.

“Short-term cash markets essentially came to a standstill,” Przybylski recalls. “There were very wide spreads between commercial paper (CP) and certificates of deposits (CDs). The banks themselves had limited capacity to intermediate in short-term markets as well, as they sought to shore up liquidity and capital, driven by the regulations that followed the financial crisis of 2008. And investors obviously de-risked, with heavy redemptions across all asset classes.”

During the most volatile period of the crisis, Przybylski notes, redemptions on J.P. Morgan Asset Management’s platform reached around 30%. However, this was relatively short-lived: “By the summer, we saw a significant return of the assets into the same exact products, actually breaching highs prior to the crisis of 2020.”

MMF reform in the US and Europe

Following the financial crisis, regulators in the US and Europe took steps to increase the resilience of money market funds in the event of future market challenges.

The US Securities and Exchange Commission (SEC) embarked on a programme of reform. The new rules, which came into effect in 2016, saw constant net asset value (CNAV) funds required to switch to a variable net asset value (VNAV) model. Other measures included the introduction of redemption gates to prevent redemptions if weekly liquid assets were to fall below 30% of the fund’s total assets, and a 1% redemption fee to be imposed if weekly liquidity falls below 10%.

Europe took a somewhat different direction with its own reforms, which came into effect in 2018-2019. The new rules included the introduction of a new low volatility net asset value (LVNAV) model, to sit alongside VNAV funds and public debt CNAV MMFs. Liquidity fees, redemption gates and suspension of redemptions can be imposed if liquidity falls below 30% and daily net redemptions exceed 10% of the fund’s total assets, with mandatory fees and gates applying if liquidity falls below 10%.

Challenges today

Fast forward to 2022, and the landscape has evolved considerably. The conflict in Ukraine has provided another shock to financial markets, with a knock-on impact on the global economy.

“The conflict hasn’t had a direct impact on the types of instruments and high-quality issuers that a well-run money fund invests in,” says Hugo Parry-Wingfield, EMEA Head of Liquidity Investment Specialists at HSBC Asset Management. “But as with any times of disruption, it leads to some adjustments being made.” For example, he says, HSBC Asset Management’s funds are currently running with higher-than-normal levels of liquidity – “which is simply a prudent discipline to follow whenever there’s any market disruption.”

Other notable developments include the prospect of further interest rate hikes, as well as the challenges brought by rising inflation, notes Beccy Milchem, Managing Director – Head of EMEA Cash Management at BlackRock. In addition, she says, few conversations with clients do not touch on the topic of sustainability.

“It’s very topical, given the backdrop around the energy crisis that’s playing out in markets,” Milchem notes. “What we are starting to see is that as investment policies are written, sustainability is front and centre of mind. That goes all the way through from a treasury perspective to cash investing, and what more clients can be doing as short-term investors.”

Return of regulatory reform?

The performance of money market funds during the unprecedented stresses of the pandemic have been identified as evidence that the recent regulatory changes have succeeded in their goals. “In our opinion, the rules that money funds have to follow in Europe and elsewhere have generally worked well,” says Parry-Wingfield.

Nevertheless, regulatory attention is once again on the agenda. “There’s been a particular focus from regulators on both sides of the Atlantic to look at how money funds managed the crisis,” Parry-Wingfield notes. “They’ve been considering whether there are any perceived weaknesses or areas where those rules could be further enhanced to improve the resilience of money funds.”

One particular focus is on the value of liquidity fees and redemption gates, which arguably incentivise investors to redeem pre-emptively during times of market stress, in order to avoid being subject to those fees and gates.

In the US, the SEC voted in December 2021 to propose a new round of changes, with the goal of improving the resilience and transparency of MMFs, and reducing the likelihood of future runs on MMFs during periods of stress. The proposed changes include higher liquidity requirements, as well as the removal of liquidity fees and gates. Instead, funds would be required to implement swing pricing arrangements, under which redeeming investors would bear the liquidity costs of redemptions.

In Europe, meanwhile, the EC is already scheduled to review the adequacy of the structures introduced in the 2017 regulation by July 2022. In February, the European Securities and Markets Authority (ESMA) issued a report outlining its opinion on proposed reforms to the regulatory framework for EU MMFs. The proposed measures include decoupling regulatory thresholds from suspensions, gates and redemption fees, as well as other actions such as removing the possibility of using amortised costs for LVNAV MMFs.

Impact of future changes

The question is to what extent further regulatory changes will affect the appeal of money market funds for investors. Przybylski recalls the significant impact of the 2016 US reforms: “As a result of that action, US$1.1trn equivalent of prime assets shifted into government money market funds. The prime space has definitely shrunk – the overall industry is now about US$600bn, from a number that was close to US$1.3trn in the past. So the challenge is regulation that by design limits choice for investors.”

In Europe, likewise, industry players are looking closely at the impact of future changes on investors. “The ESMA proposal calls for the ability to round to one to be removed, which would effectively eliminate the LVNAV money market fund – instead, you would end up with a third variable NAV structure,” explains BlackRock’s Milchem.

She adds that it is only three years since investors spent a considerable amount of time and resources building policies, controls and oversight of the new product structures that were created under the 2017 policy framework. “So we think that corporate treasurers will share our position that a policy response eliminating this structure is not really appropriate, absent some clear evidence that the structure itself resulted in this vulnerability in March 2020 – which we think is hard to evidence.”

Investor voices

While the proposed changes could have significant repercussions if they come to pass, however, this could take some time to materialise. “In terms of where we are at this stage in Europe, it’s important for investors to be clear that no rule changes have yet been determined,” says Parry-Wingfield. “Secondly, it’s still not known when that would be, or what any implementation period would be.” He points out that during the previous reform, this was a process that took many years to complete. “So I think it’s very important for investors to keep up-to-date with what’s going on – but this isn’t something that’s about to happen in the next few months.”

In the meantime, says Parry-Wingfield, it is important that investors take part in the conversation so that their voices are heard – for example, by responding to the European Commission’s public consultation, which is open until 13th May.

Milchem, likewise, notes “there is still time to help shape that landscape, and the value placed on the utility of money market funds needs to be conveyed to policy makers. One aim that we at BlackRock have – and I know that the Institutional Money Market Funds Association (IMMFA) has as well – is around bringing investor voices to the table to help influence the debate.”

Portrait of Stuart Fitzsimmons, Treasury Manager, Whitbread

Stuart Fitzsimmons

Treasury Manager

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How does Whitbread use MMFs?

It’s part of the toolkit that we have for our surplus cash. At the moment, the options that we use are either bank deposits, savings accounts with the group of banks that provide us with a revolving credit facility, or MMFs. We have a small group of relationship banks, and we have a fairly restrictive treasury policy around how much we can invest with any given counterparty.

We like MMFs because they give us same-day access. We like the yield when we can get it, but it’s not our main focus – it really is about security and liquidity, and it enables us to diversify our investments far more than we could do on our own.

How has your use of MMFs changed over the last couple of years?

We’ve ended up with far more cash, mainly because of things we did to strengthen our balance sheet. In June 2020, the business raised approximately £1bn for a rights issue. Then in early 2021, we went through the bond markets and raised £550m. Some of that was used to retire existing debt, but it also added to the amount of cash on our balance sheet.

We heard about concerns at the time the pandemic started around the possibility of fund liquidity levels and demands on the funds, so we’ve always kept a close eye on assets under management and liquidity levels. But we haven’t used MMFs any differently.

What do you see as the pros and cons of MMFs in today’s environment?

The pros are same day liquidity, preservation of capital and diversification of risk. These funds are far better able to diversify the risks than we are – they are invested in several dozen different counterparties and types of instruments, which we wouldn’t have the infrastructure to do on our own. They are also very easy to use. When we started out, we were trading over the phone, but now we use the Goldman Sachs Mosaic platform, which is integrated with our treasury management system, Reval. I can’t think of any cons – we haven’t had any negative experiences with them.

Is the prospect of further MMF regulation on your radar?

Yes, I took part in a round table that one of our MMF providers arranged for corporates with the UK authorities last year. It seems like a long way off, and by that stage our cash balance might have come down considerably. But we are looking at alternatives – I imagine it would be hard for me to get sign-off to invest much, if any, of our cash in VNAV instruments.

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