Most investors in the money market fund (MMF) space will be aware that changes are afoot in this industry. With the SEC having laid out its plans in July for the US, and its European counterparts currently debating along similar lines (but yet to declare its hand), these changes are likely to shake things up quite a bit.

Many investors – certainly those anchored in the world of corporate treasury – will also be aware that regulatory reform could impact them indirectly, as the likes of Basel III and CRD IV reach the financial services sector, casting a shadow over the desirability for banks of very short maturities and reducing the supply of eligible assets in the process. It will be a rare investor too who has not witnessed interest rates fall away to almost zero and, in Europe, even stray into negative territory.

These observations serve as the backdrop to a significant change by one global asset manager to the way it approaches its euro MMF. When in August 2014, Northern Trust Asset Management launched its variable net asset value (VNAV) Euro Liquidity Fund it was taking a somewhat vanguard position (most funds remain focused on the constant net asset value, or CNAV, model). But the significance of the change for the market will not translate into client upheaval.

The impact of moving to a VNAV fund should be minimal for our clients,” comments David Blake, Director, International Fixed Income, Asset Management for Northern Trust. “We have a core belief of how a MMF should be run; our investment philosophy in terms of liquidity policy, eligible investments, portfolio diversification all remain the same,” he adds. “To us a VNAV fund is identical to a CNAV fund in terms of its underlying investments, so effectively it is just a change of accounting treatment, from amortised cost accounting to variable price accounting.”

Northern Trust did a lot of “road-testing” over a two-year period before launching its VNAV fund. The reaction, Blake reports, was mostly favourable. Acceptance in certain cases was “a journey”, with some clients hanging on to the idea of ‘CNAV with a positive return’. But the reality of the situation is that interest rates are negative in Europe – and likely to remain in this territory for some time – and there is a fundamental incompatibility between a CNAV structure and a negative rate of return. For Blake, change was inevitable.

Although ‘breaking the buck’, where the price drops below the fixed rate of ‘1’, is a cardinal sin in the money market world, he is at pains to mark the distinction between asset impairment or default (as happened to the now infamous Reserve Fund in the US), and simply being forced to endure a negative central bank rate. A negative rate is not a failure, “just the price of doing business in euros at the moment”.

This distinction aside, in a negative rate environment, holding cash is expensive. However cash is held by some clients because they need to, notes Blake. And whether it’s for operational needs or to satisfy investment or asset allocation decisions, money funds remain an effective vehicle for that cash. Whilst positive returns cannot be produced out of nothing (or less than nothing), Northern Trust’s investment philosophy steers all of its funds towards the preservation of capital and same-day liquidity first and foremost; only then will it seek to maximise return. “We position ourselves at the more conservative end of the spectrum,” he comments. Whereas some managers may dabble with increased risk to try to extract yield, where it is simply not possible to go out on the curve (and you would have to go some way out these days for notably better yield) he advocates “facing up to reality” by changing accounting structures; a change for Northern Trust made concrete by its VNAV Euro Liquidity Fund.

Challenges had to be overcome on the journey into VNAV. “Our investment guidelines and holdings are the same and our cut-off times and payment instruction deadlines are the same too. But there has been a lot of work behind the scenes to make that happen at a transfer agency and fund accounting level,” Blake explains. He adds that adoption of VNAV was never a foregone conclusion as the most appropriate alternative accounting mechanism to deal with negative interest rates. The team considered the reverse distribution mechanism (also known as ‘CNAV with unit cancellation’). In this model, instead of varying the price of the fund as in VNAV, the price is maintained at a steady ‘1’ but shares are necessarily redeemed to cover any negative accruals. “Economically it is identical to VNAV but the transparency of variable pricing seems greater to us than not knowing how many units are held in a fund,” he explains. But perhaps even more persuasively, with the likelihood that European regulators will follow the SEC down the VNAV line, he adds that it made little sense to adopt anything else.

With clients being closely involved in the ‘design’ process of its VNAV fund, Northern Trust has been able to provide a euro-based vehicle – alongside its existing sterling and dollar CNAV funds – that can operate effectively in the current environment and pre-empt likely mandatory market changes without stepping outside of its own and indeed most treasurers’ core values of transparency, security and liquidity. The time for VNAV seems to have arrived.