Money Market Funds (MMFs) are funds that invest in short-term assets and aim to offer returns in line with money market rates and/or to preserve the value of the investment. MMFs are used by institutional investors, corporates, asset managers and financial institutions for short-term liquidity management.
MMFs will soon be subject to the new MMF regulation. This regulation will apply to existing MMFs from 21 January 2019 whereas new MMFs created after 21 July 2018 will have to comply from this date.
Currently MMF funds, either AIFs or UCITS, are subject to the ESMA guidelines (previously CESR guidelines) published in May 2010 and can be classified according to two criteria:
- The maturity of their portfolio:
- Either “short-term” with a maximum weighted average maturity (WAM) of 60 days and maximum weighted average life (WAL) of 120 days, or
- “Standard” funds with a longer maturity of assets (WAM) of 6 months and a WAL of 12 months
- Whether the shares or units of the MMF are sold or bought at a fixed price (or at constant net asset value: CNAV) or at a variable price (variable net asset value: VNAV):
- Constant NAV funds use an amortised cost accounting method to value all of their assets. To deal with negative yield they cancel shares.
- Variable NAV funds use the mark-to- market or mark-to-model method to value the assets. In case of negative yield, the dealing price or NAV decreases.
For investors, the primary differences between CNAV and VNAV funds will be national rules that apply to their investments in MMFs:
Accounting, in particular whether they are eligible for the “cash and cash equivalent” status under IFRS
While most Irish Funds and Luxembourg MMFs are CNAV funds, they do not exist in France.
Four new types of MMFs
As a result of the financial crisis, US and EU regulators have questioned the continuation of CNAV MMFs as the current constant NAV does not provide any warning in the event that the total value of the assets decrease. However the Money Market Funds Regulation, adopted on 14 June 2017 after several years of intense discussion, allows the continuation of funds with a constant NAV, provided they meet some specific conditions.
The regulation distinguishes 4 types of funds:
- Two types of VNAV funds: the short-term VNAV funds and the standard VNAV funds
- Two types of MMFs with a constant NAV which can only be short-term funds :
- Public debt constant net asset value (CNAV) MMFs which invest at least 99.5% of their assets in public debt , reverse repos secured with government debt and cash
- Low volatility net asset value (LVNAV)
On a daily basis public debt CNAV MMFs and LVNAV MMFs must calculate and disclose a mark-to-market NAV. The constant NAV of an LVNAV MMF must not deviate from its mark-to-market NAV by more than 20 basis points.
Significant regulatory changes
Regardless of the type of MMF, the new regulation introduces significant changes to the current regulatory framework to:
- Prevent any risk of contagion by prohibiting any form of financial support for money market funds
- Improve the resilience of funds with new obligations concerning:
- Eligibility of assets and risk diversification
- Minimum threshold of daily and weekly maturing assets
- Internal credit quality assessment
- Stress-testing and know your customer policy to anticipate the effects of concurrent redemption requests
- Improve transparency towards the regulators and investors
Moreover, public debt CNAV MMFs and LVNAV MMFs are subject to the obligation to monitor liquidity thresholds: weekly maturing assets must be above 30% of the total assets or daily redemption must remain below 10% of total assets. Otherwise, the governance body of the MMF must consider whether it is appropriate to apply liquidity fees on redemptions, redemption gates, or suspension of redemptions.
A main topic of concern for MMFs with a constant NAV is the European Commission’s position on share cancellation in case of negative yield. In 2017 further to the publication of its consultation paper on implementing measures, ESMA sought the views of the legal services of the European Commission regarding the practice of share cancellation, also known as reverse distribution or share destruction. On 19 January 2018 the European Commission responded with the opinion that the practice of share cancellation is not compatible with the MMF regulation as this regulation does not explicitly state this possibility.
Impacts for the Money Market Funds asset class
Changes introduced by the regulation, in particular increased transparency and more complex risk management, will make money market funds more resilient to endure another financial crisis as those changes should ensure that investors remain confident in the quality of their investment.
However costs resulting from the new requirements could further damage Money Market Funds’ returns in a low interest rate environment. Therefore the MMF regulation puts additional pressure on asset managers’ margins and could lead to a further consolidation of the number of money market funds, in particular MMFs with a constant NAV, which are subject to more constraints.
Asset managers who want to continue to fit the needs of investors by offering funds with a constant NAV have to carefully compare the pros and cons of public debt CNAV funds and LVNAV before determining their new range of funds.
The clock is now ticking.