New regulations came into effect in July 2018 for new European money market funds (MMF). They will come into force for existing funds on 21 January 2019.
Money market funds offer investors liquidity, preservation of capital, and yield. Regulatory reforms for money market funds have been on the table since the 2008 financial crisis and regulators have been chiefly focused on systemic risk mitigation in the form of enhanced prudential oversight and control for systemic risks in the financial marketplace.
Regulators in the US and Europe responded to the events of the 2008 financial crisis with reforms to money market funds in 2010, with additional new rules in the US coming into force from 2016. The European Commission proposed new rules for money market funds back in 2013. After a lengthy gestation, these rules have now been agreed by the various regulatory bodies, but there are still some areas that require further clarification – specifically, the practice of using share cancellation to keep the value per share constant.
As discussed in my previous article, “European Money Market Funds Choose the Middle Ground,” prior to the new MMF Regulations there were two broad categories of money market funds: short-term money market funds and standard money market funds. The new regulations introduce changes to the short-term money market fund category, including increasing the number of structures available to investors from two to three:
- A public debt CNAV MMF (public debt constant net asset value)
- A VNAV MMF (variable net asset value)
- A LVNAV MMF (low volatility net asset value) – the units or shares may be issued or redeemed at a constant NAV providing the fund does not deviate from the NAV by more than 20 basis points otherwise the NAV must be used
The practice of share cancellation allows money market funds to keep the value per share constant under negative interest rates. The practice has been accepted and is commonly used for funds denominated in currencies with negative interest such as we have seen with euro and yen. While the new European regulations do not include any explicit references to share cancellation, it is unclear whether money market funds will be able to continue with the practice.
Last month, the European Securities and Markets Authority wrote to the European Commission asking for legal clarity as money market fund managers remained unsure about how to prepare for the January deadline. According to the Financial Times, the European Commission confirmed to ESMA last month [i.e. August] that share cancellation would breach provisions of the new regulations.
If the practice of share cancellation is prohibited, funds will have limited options to deal with negative income, other than converting to a variable net asset value (VNAV) fund. The alternative would be to place the onus on the investor by invoicing them for negative yield. This practice may not be viable, not least due to the operational and administrative complexities.
From discussions with our money market funds manager clients, the new LVNAV appears to be a popular choice. However, while uncertainty remains on the continued use of the share cancellation practice, money market funds managers may have to consider other options.
Investors and corporate treasurers may take different views on the attractions of LVNAVs and the potential loss of the share cancellation practice. There are still several months before the compliance date and it is possible we will see some fund managers altering their initial plans as they see competitors testing their strategies.
The views expressed herein are those of the author only and may not reflect the views of BNY Mellon.
