Money market funds have been through the regulatory mill in the past few years. What do the changes really mean for investors? Treasury Today seeks a fund manager’s view.
The US and European market authorities have changed how money markets are regulated. By re-organising fund management into something more transparent and resilient, the theory is that investors are now in a better place than they were before.
Whether MMFs needed changing, or are any better for it, is a moot point. But from a fund manager’s perspective, compliance appears to be a welcome resetting of the rules in the direction of increased transparency, albeit heralding the death of CNAV funds.
The required switch to fund formats that use variable rates as their key measure present very little difference for the typical investor, says Natalie Cross, Senior Client Portfolio Manager, Invesco. The LVNAV funds that most CNAV investors migrated into, do however establish new coping mechanisms in the event of market instability or a credit default with a fund.
During the financial crisis in 2008, just one MMF ‘broke the buck’, its share price dropping below the sacrosanct one dollar. That the market has rarely experienced any runs on funds was not seen by the US or European authorities as a reason for regulatory inactivity following the financial crisis. Indeed, tightening up a mechanism that plays a vital role in meeting the short-term needs of many investors adds to market confidence.
So, whilst coming out the other side of change delivers products that “look and feel largely the same as before”, the efforts of the authorities bestows more structure on a largely willing market, says Cross. “It means clients have an understanding that if an event – a credit default or a huge and unexpected change in overnight interest rates – did occur, they have the backing of new procedures for unwinding affected funds.”
Of course, there are differences. Whilst the credit defaults and monumental swings in interest rates required to unsettle the money markets have been few and far between, the new rules of engagement have banned sponsor support of their funds.
The unwritten ‘agreement’ that a bank would bail out its failing fund has possibly led to a somewhat gung-ho investor attitude that MMFs are failproof. The nature of MMF portfolios tends to make them highly resilient to stress, but failproof they are not. Removing the perception that some funds are different from others, from that support standpoint, levels the playing field between bank and non-bank providers, says Cross.
With US reform, the huge shift of assets from prime into government funds was expected, though not perhaps on the scale seen, notes Cross. However, differences between US and Europe regulations were at work here. It saw the US impose fees and gates on VNAV funds but leave government CNAVs unchanged. In effect, investors simply appeared to be opting for more of what they were used to, albeit with their cash exposed to a much smaller (if quite stable) space.
The impact in Europe has been more low-key, as expected, says Cross who describes the transition into reform here as “seamless”. The most notable outcome in Europe has been the outlawing of the reverse distribution mechanism, the regulators no longer permitting funds to offset losses generated by negative euro interest rates.
In response, Invesco still offers LVNAV euro MMFs, but only as an accumulation share class. The fact that most of its clients invested in the euro markets on this basis anyway, meant little changed; LVNAV distribution share classes may be re-introduced when positive rates return, she adds.
The Asian markets are yet to see the level of reform seen in the US and Europe. One of the key differences between this and Western short-term markets – one that is perhaps keeping a lid on MMF growth – is the interest rates offered by local banks. Asian institutions are still keen to take on short-term deposits, mostly in USD, and investors can still obtain relatively attractive rates.
This suggests MMFs will remain a side-show in Asia. Not so, says Cross. The majority of corporate treasurers do not use MMFs for yield; most use them for liquidity and diversification purposes, she explains. Even where yield is available, as in Asia, it tends not to override those liquidity and diversification aims.
This is not to say that MMFs cannot offer a more attractive yield. With reform raising the profile of variable NAVs, Cross sees some investors now thinking whether all their cash needs to be in LVNAVs, with more beginning to explore either short-term or standard VNAVs to try to gain a bit more yield.
Indeed, she says some investors are using reviews of their existing MMF investments to build a better overall understanding of how the market is meeting their short-term needs. With Basel III effectively pushing banks away from taking in short-term non-fixed rate corporate cash, corporate cash holders have been facing a limited set of options. With the volume of conversation around MMF reform creating more awareness, she says interest in MMFs is rising.
Having analysed pricing variability of its own mark-to-market NAVs over a ten-year period, Cross says Invesco research reveals an appealing lack of volatility within the underlying assets of MMFs. “Presenting an investor with products that whilst transacting with a variable NAV, still have extremely low volatility and potentially a bit of extra yield, is starting new conversations.”
Need to know
For corporates that are interested in the reformed MMF space, to ensure treasury is up to speed, Cross suggests that an internal review and possible update of investment strategy may be necessary, at the very least removing reference to CNAVs.
Additionally, with transparency being enhanced by this reforming process, treasurers also need to know what data is available to them from their fund managers, from where it can be sourced, and how frequently it is published (weekly is the European minimum but some funds – including Invesco – publish daily).
With liquidity and pricing-level trigger points now set by the authorities, treasurers armed with the right data, in the right format, should be able to compare funds and ensure they have the most appropriate investments in place.