Funding & Investing

VNAV: time to get acquainted

Published: Apr 2016
Woman jumping barefoot over a puddle

The regulation of money market funds (MMFs) is already changing in the US, and Europe is not too far behind. But some corporate investors are not waiting until the new rules arrive before testing out new short-term investment products.

“Never test the depth of the river with both feet,” the legendary real-estate investor Warren Buffett once cautioned. It is pertinent advice, perhaps, for those treasurers now acquainting themselves with new money fund products ahead of the coming regulatory shake-up.

One corporate cash investor that has been familiarising themselves with something new recently is the treasury department at UK postal company Royal Mail. Last year treasury tentatively began using funds with a floating (VNAV) rather than a fixed (CNAV) net asset value.

“I guess you could say we tip-toed into it,” says Auna Dunlevy, Head of Liquidity and Investments at Royal Mail. “We had a limit on how much we can do to begin with, and the first VNAV funds we looked at were the ones that were more similar to CNAV.”

Many of Dunlevy’s treasury peers, on both sides of the Atlantic, are also likely to be looking to acquaint themselves with the VNAV MMF product too in the coming months. The trouble is that ever since the term ‘shadow banking’ began to enter the vernacular of central bankers and other financial regulators, the CNAV MMF’s days have seemed to be numbered. Citing the need to prevent run-risk, regulators in both the US and Europe indicated, post-crisis, their support for a mandatory conversion of all funds to VNAV.

Now after years of consultation and argument and counterargument, the much debated reforms to the regulation of money market funds is beginning to take effect. In the US, new SEC rules mean that since April 2016 funds, are now required to disclose daily and weekly asset levels, market based net asset values (NAVs), net shareholder flows and the occurrence of sponsor support. More structural changes will come into effect later this year, including a requirement for all prime institutional funds to switch to VNAV. Similar regulation is expected to be introduced in Europe in the not too distant future.

For treasurers investing short-term liquidity in MMFs, the rules around disclosure of information US MMFs are now subject to are particularly significant, since they now have access to new data with which to assess the risk of their investments. But asset managers argue that the disclosures might also help treasurers decide where they will invest once institutional prime MMFs are mandated to convert to VNAV. Even those treasurers not actively experimenting with VNAV now have, with the additional data at their fingertips, a means to “test the depth of the river” without fully taking the plunge.

Analysing VNAV

“It has been clear from our conversations with investors over recent weeks that they think the release of this information is going to help them decide what they will do in the future,” says Barry Harbison, North American Head of Liquidity Product, HSBC Global Asset Management. Being able to see “how much that NAV is likely to move” over the next six months, adds Harbison, should assure treasurers concerned about the volatility of the VNAV structures prime MMFs have to apply.

HSBC recently carried out its own study to better understand how the NAV of a MMF might behave over time. Analysing market data from January 2001 through to January 2016, the bank considered how the NAVs of four hypothetical MMF portfolios with different strategies might move. What the bank found was that both the magnitude of movement in NAVs and the time taken to recover was closely linked to maturity of the portfolio. But even in funds with more aggressive risk parameters, there were only negligible declines in the NAVs of the four hypothetical portfolios.

“Our analysis shows that the NAV is not likely to move as much as some previously considered,” he says. “Even in that worst-case scenario, in which we considered taking the maximum duration permitted across the entire period we analysed, the average price fall was still around a basis point.”

Moving to govies

So where does this leave the value proposition of prime institutional MMF products once the implementation of the new rules is completed in October? Will there still be the big exodus from prime MMFs into the government funds that can still apply CNAV?

Analysts at the ratings agency Moody’s have said previously it may not be a question of ‘if’ but ‘when’ such a shift in assets from prime funds to government takes place. They note that market pundits estimate that between $400bn and $800bn of the $1.2trn in US prime fund assets could flow out before October 2016; a migration driven by both existing prime funds converting to government status and, additionally, investors switching to avoid the new rules. The latter, they add, could account for in excess of 25% of total institutional prime assets under management (AUM).

Our Government funds today are yielding roughly 20 bps, while our prime funds offer around 40 bps. Right now investors are staying to capture those extra 20 bps, but expect some of them to move prior to conversion.

David Fishman, Managing Director; Co-Head, Goldman Sachs Asset Management’s Global Liquidity Management Business

Goldman Sachs Asset Management say the flight from prime to government MMFs has already begun, albeit driven more so far from prime retail funds converting, like the Fidelity Cash Reserves Fund, than investors making the transition themselves.

“There will be a number of clients for whom the path of least resistance will be switching to government funds,” says David Fishman, Managing Director; Co-Head of Goldman Sachs Asset Management’s Global Liquidity Management Business.

Fishman adds that the yield differential between prime and government since the rate lift off could be the factor keeping some investors in prime funds, for now. “Our Government funds today are yielding roughly 20 bps, while our prime funds offer around 40 bps,” he says. “Right now investors are staying to capture those extra 20 bps, but expect some of them to move prior to conversion.”

But most asset managers in the US market believe that institutional prime MMFs will continue to be a valuable tool for liquidity management. Treasurers should be careful not to get too distracted by what happens to AUM around the time of the switch, since such shifts might not necessarily be reflecting the sentiment of their peers.

“I think a lot of investors would agree with the idea that we are putting forward that there is still value in these products,” says Harbison. “There has been a transition from retail and some other institutional investors from prime to government funds, and the risk is that leads corporate investors to think that this flow is being driven solely by other treasurers so they need to go along with it.”

Harbison is not the only person in the asset management world who thinks that many investors will continue to use MMFs that switch to VNAV. “We have not seen a large scale shift into government funds yet,” says Tom Callahan, Head of Global Cash Management at BlackRock. “Through our conversations with clients we know there are certainly a number who may switch to government funds in the first instance as they assess the new landscape but we at Blackrock remain bullish on the value of prime MMFs for corporate investors in the longer term.”

European MMF regulation: the latest

While the US is already advancing with the implementation of its amendments to rule 2-a7, new MMF regulation is still some way from being settled on the other side of the Atlantic.

“There are quite a number of people involved in the EU legislative process” explains a top institutional global liquidity asset manager. “There are multiple legislative institutions that play a part in writing this legislation, whereas in the US, there is just one body that writes and enforces the rules. This can sometimes slow down the rule-making process in Europe.”

As it stands, we await the input of the EU’s Council of Ministers, having now heard proposals from both the European Commission and the European Parliament. Aspects of the latest version of the rules from the European Parliament, published in March 2015, were welcomed by the asset management industry. Like in the US, retail and government constant net asset value (CNAV) MMFs would continue to operate under the proposals. In addition, an entirely new category of fund would be established subject to a five year ‘sunset clause’: Low Volatility (LVNAV) MMFs that would be required to publish their mark-to-market daily and remain within a 20 bps range.

“There are some positive elements to the Parliament’s proposal, including the concept of LVNAV,” says Tom Callahan, Head of Global Cash Management at BlackRock. But as is often the case with such things, the devil will be in the detail. “Theoretically, the structure could deliver some of the key CNAV features that investors value – such as same day liquidity, intraday liquidity and a stable net asset value. But the technical details of the structure, including the sunset clause, trigger threshold and NAV calculation, are still under debate and will ultimately determine whether an LVNAV product is operationally feasible.”

How much of the European Parliament’s proposed changes will make it into the final version of the rules remains to be seen. First, EU Member States in the Council will offer their suggestions, and then the legislation will enter the so-called ‘trialogue’, stage in which the EC, EP and Council come together to agree a compromise. The Council rotates its presidency every six months. Currently the Dutch hold the Council Presidency; the next two Presidencies reside with Slovakia and Malta.

“If the Dutch Presidency manages to reach an agreement between Member States in the Council by July then a trialogue agreement by the end of the year is a possibility,” says the manager.

Time to act

Those treasurers who, making use of the new information funds have to disclose, to analyse how those NAVs behave may reach a different conclusion from those who move into government funds. But with the much talked about changes now becoming a reality, treasurers need to decide soon.

“Some investors probably feel there is a lot of time before October 2016,” says Fishman. “I will tell you that there is not.” Treasurers need to begin thinking now about what their investments will look like after the changes come into effect. Systems may have to be updated to be able to account for a variable NAV; investment policies may have to be amended. “If they are able to handle those things then there will be an incremental yield in prime MMFs that investors can capture,” says Fishman. “If they can’t then they will need to prepare to move to a government fund.”

HSBC’s Harbison agrees that now is the time to act: “We think now is the right time to start thinking about this. Investors still have time between now and October to figure out what their investment line-up is going to look like after the regulation has been fully implemented. Now, at least, they have all the available information to make that decision.”

So while VNAV was initially perceived as a ‘show-stopper’ by many corporate investors, asset managers seem confident that comfort levels will increase over time. Further, as treasurers become acquainted with the new product – either through experience or simply by monitoring the published NAVs of their funds – they too should become more comfortable.

Getting used to how such funds behave is undoubtedly a critical exercise for MMF users. Large companies will often invest cash in a wide, diversified portfolio of assets and instruments: from treasury bills to commercial paper and short-dated corporate bonds. But for daily liquidity, that cash put aside for day-to-day operational needs, MMFs continue to be the favoured instrument for many treasurers. In both the US and Europe, regulation is coming that is going to change the MMF landscape drastically. Now is the time to prepare.

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