Europe’s money market fund (MMF) reform was intended to protect investors from risks that were highlighted during the financial crisis. Among the changes was the replacement of constant net asset value (CNAV) funds with a new low volatility net asset value (LVNAV) model, with liquidity fees and redemption gates to be applied in certain circumstances. As of 21st January 2019, existing MMFs were required to comply with the new rules – so how well have fund managers and investors adjusted to the new landscape?
“We think it’s been a success,” says Hugo Parry-Wingfield, EMEA Senior Liquidity Product Specialist at HSBC Global Asset Managements. “It’s not without its challenges – as with the implementation of any new regulation – but we’re perfectly happy with the flows we’ve seen in our funds since then, and investors are still able to access the products they need.”
Natalie Cross, Senior Client Portfolio Manager at Invesco, agrees that investors have reacted positively to the new structures, adding that the changes “have had relatively limited impact, and day-to-day activity continues smoothly with minimal shifts in AUM.” She adds that the enhanced regulations have improved consistency across the industry, “due to the common guidelines which providers now have to ensure their MMFs adhere to.”
According to Cross, the impact of the new rules has brought little change to Invesco’s MMFs: “Minimum liquidity levels had been previously established and implemented, combined with our robust credit research process which was already in place.” However, she notes that the introduction of enhanced reporting requirements has brought investors greater insight into the structure, positioning and underlying market value of the funds they invest in.
End of the reverse distribution mechanism
That’s not to say there have been no changes. Cross says that funds have continued to deliver a solution that – subject to regulatory requirements being met – transact at 1.00 every day and settle on a T+0 basis. The exception, she says, are euro-denominated MMFs, where the regulators have banned the use of the reverse distribution mechanism (RDM) – a mechanism introduced by the industry to enable investors to use CNAV MMFs efficiently during periods of negative yield.
“LVNAV MMFs adapted to this ban by limiting the share class offering to accumulation classes only,” notes Cross, adding that accumulation classes “roll up the negative income into the fund daily prices, thus decreasing the share value instead of ‘distributing’ the negative returns though decreasing the number of shares held.” She adds, “Investors have responded relatively well to these changes although it is fair to say, there are some that, due to system restraints, have been unable to continue investing in Euro MMFs.”
In addition, while the new rules have improved consistency, Parry-Wingfield says that one unintended consequence is that fund managers are approaching the trigger points for introducing liquidity gates and fees differently. Under the new rules, liquidity fees and redemption gates may apply if weekly liquidity falls below 30%, and if daily net redemptions exceed 10% of the fund’s total assets.
“There are two required triggers in play, that leads to the board of the fund needing to consider whether to put in place fees and gates,” says Parry-Wingfield. “So it’s not mandatory at that point.” Nevertheless, he says, some managers are managing the 30% weekly liquidity level as an artificial hard threshold, while others, like HSBC Global Asset Management, are not.
“We actually don’t think that’s in the best interest of the shareholders,” he says, noting that doing so can have an impact on yield. “Our belief is that if you’re confident in your liquidity risk management process, you don’t need to manage to that 30% level in a black-and-white way.”
MMFs and ESG
With the new rules now a reality, what else could be on the horizon for money market funds? Parry-Wingfield says that one area of interest could be the growing focus on environmental, social and governance (ESG) issues. “It’s a hot topic in general, and in particular the money fund industry,” he says. “A number of managers are looking at ways to integrate ESG into their investment processes, and we have been integrating ESG within our investment processes since 2007.”
In practice this could involve screening or excluding issuers, as well as incorporating ESG considerations into specific investment decisions and credit analysis. “Without a doubt, ESG is a critical focus area for treasurers and managers, and that landscape is going to develop and evolve this year and beyond,” Parry-Wingfield concludes.