Funding & Investing

Money market fund reform: the bigger picture

Published: Jul 2017

Jim FuellJim Fuell

Head of Global Liquidity Sales, International

J.P. Morgan Asset Management

Kerrie Mitchener NissenKerrie Mitchener-Nissen

Head of Product Development, International for Global Liquidity

J.P. Morgan Asset Management

MMFs have long been used by corporate treasurers to manage short-term cash, making it vital to understand the regulatory changes currently in the pipeline, and the steps that treasurers should be taking as a result.

State of play

MMF reform in Europe has now entered its implementation stage. On Friday 30th June 2017, the regulation was published into the Official Journal, with the regulation coming into force on 21st July 2017. All existing MMFs will then have 18 months to comply with the new rules – in other words, a deadline of January 2019. New funds must be in compliance by 21st July 2018.

The new regulation features many components that are not necessarily new, but which have been in place through other existing regulation, including broad fund regulation, industry codes of practice and rating agency requirements. The regulations bring more clarity and consistency to the MMF landscape by drawing together these elements into one consolidated regulation.

What’s changing?

At a high level, there are currently two broad categories of MMFs: short-term MMFs and standard MMFs. Under existing regulations, the standard MMF can only be run as a variable net asset value (VNAV) fund, while the short-term MMF can be run as either a constant net asset value (CNAV) or VNAV fund.

The new regulations introduce a couple of changes to the short-term MMF category. Until now, these have included government style funds and credit style funds (referred to as “prime” funds in the US). The new regulation provides optionality for investors, allowing for three new successor structures:

  • A CNAV fund option, which will be permitted for “public debt” or government style funds.
  • A VNAV fund option, which could be a government fund or a credit fund.
  • A low-volatility NAV (LVNAV) fund, which delivers a stable NAV and is also available for credit-style offerings.

As a manager, we see the developments that have come out of the regulatory process as an opportunity. The changes will give us more flexibility to deliver different options to clients, based on their specific needs.

Considerations for investors

For treasurers, it is important to understand the various structures and the underlying characteristics of those products. The topic of fees and gates is certainly sparking interest among treasurers, particularly in light of the regulatory changes that were introduced in the US, where we saw a fairly significant dislocation, with assets moving from prime or credit-style funds over to government style funds.

But in Europe, the reaction from clients to fees and gates has been very different. Given that investors in European funds tend to be familiar with fees and gates, they are simply keen to understand how the concepts will be embedded into the regulation. As a result, we are not expecting to see the same sort of dislocation in the European MMF landscape. Indeed, we are now beginning to see some of that money shift back into prime MMFs in the US.

Another important consideration for investors is whether their funds will be considered as cash and cash equivalent. It is up to each treasurer’s audit firm to determine this point, but from our perspective, very little has changed in terms of how the fund relates to the rules. In fact, the investment restrictions embedded in these regulations are a little tighter than before, so there is no reason to believe that a fund would not continue to be considered as cash and cash equivalent going forward. By the same token, our expectation is that funds will still be accessible on a T+0 basis, and that they will continue to benefit from external credit ratings.

Of course, treasurers shouldn’t look at the reforms in isolation. The investment landscape is changing, and investors have to look at all of these developments together when understanding the regulatory changes affecting MMFs. A number of other factors are influencing the short-term investment landscape, such as central bank monetary policy, which has moved rates to zero or even negative in certain currencies, as well as Basel III and its impact on banks’ appetite for liability balances.

Adapting investment policy

Our clients are actively talking to us about the changes they will need to make to their investment policies and are seeking our guidance and advice on how to structure those new investment policies. Indeed, our Investment PeerView 2017 survey found that more than half of European liquidity investors (58%) are considering changing their investment policies to meet the evolving regulatory environment. The survey, which gathered the views of treasurers, chief investment officers and senior cash decision-makers, also found that among those considering new structures, 43% ranked the risk of gating or a liquidity fee as the most important factor in their decision-making process.

When changes are required to the investment policy, these can take some time to work through. With an 18-month implementation period, clients will have plenty of time to consider their options and review their investment policies. That said, it’s important that clients think ahead about how they can prepare for the implementation of the new regulation in 18 months’ time. Corporate treasurers do not routinely change their investment policies every six months or every year. Ideally, a policy should have enough flexibility to navigate changing times without making wholesale changes. In the current market, however, it is essential to review the investment policy – not only because of European MMF reform, but because of wider market developments.

Ten years ago, many treasurers simply parked their money in a bank deposit account. More recently, Basel III has made this less feasible. A bank might have an appetite for operating balances, but non-operating balances are firmly off the agenda. It may also have a cap on the level of operating balances that it can take.

As a result, treasurers’ capacity to manage their short-term cash using bank deposits is now more constrained, motivating them to explore alternative solutions. At the same time, they are looking for ways to navigate away from negative yield in light of negative interest rates in Europe and elsewhere.

Faced with this perfect storm of factors, prudent treasurers are seeking to implement an investment policy that focuses on their highest-priority requirements — typically including capital preservation and the need for liquidity on demand. However, treasurers also need to incorporate a level of flexibility into their revised investment policy.

Keeping treasurers informed and engaged

In light of these changes, we are focused on ensuring that our clients are fully aware of the nature of the regulations. For clients, this means gaining a clear understanding of what the similarities and differences will be between the funds they are currently investing in and the funds that they will use going forward.

As a result, we are talking to treasurers about the changing landscape, the challenges that this brings and the likelihood that MMFs will continue to play a core role in helping our investors manage their short-term investments. While returns aren’t necessarily on top of the agenda for corporate treasurers, we are also talking about the challenges that these changes will bring on our ability to generate the returns they are targeting. At the same time, we are discussing the increasing importance of cash segmentation and are explaining how treasurers can generate incremental return by gaining more transparency over their investment horizons.

To support these communications, we have developed the European MMF Reform Resource Centre, which clients can access via our Global Liquidity web page. This includes a number of resources for clients and prospective customers. We also hold annual global liquidity investment forums around the world where existing and prospective clients can gain a clearer understanding of the changing environment by hearing from our market strategists, portfolio managers, credit and risk professionals and product development professionals.

With change comes opportunity

With the new regulation moving into implementation, we remain positive both about MMFs in general, and about the broader environment for MMFs. We expect that MMFs will remain a core component of the solutions that corporate investors use to manage their cash, in part due to the other changes affecting short-term investors, such as Basel III. Above all, we see regulatory reform as a positive catalyst for the evolution of this vibrant market, particularly when it comes to increasing awareness of the benefits of cash segmentation among corporate investors.

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