EC’s money-market reforms to trigger seismic shift
The European Commission’s onerous clampdown on money-market reforms will likely ‘kill off’ constant net-asset value funds and potentially encourage investors and corporate treasurers to place excess cash in bank deposits instead, say analysts.
While corporate treasurers tend to invest most of their short-term cash in bank deposits, many do so in conjunction with money-market funds (MMFs).
According to a liquidity investment survey published by JPMorgan Asset Management, as of June 30, 2011, bank deposits accounted for 56% of treasurers’ surplus cash, while MMFs took second place with 21%.
However, corporate treasurers might be rethinking this strategy in light of new rules proposed yesterday by the European Commission (EC).
MMF reform has been on the cards since the start of the financial crisis, when the collapse of Lehman Brothers prompted a run on MMFs. Since then, regulators on both sides of the Atlantic have focused their attention on making MMFs more robust.
In particular, the changes under discussion have tended to focus on constant net-asset value (CNAV) funds, which maintain a constant share price of £1, $1 or €1 – unlike variable net-asset value (VNAV) funds, the prices of which can fluctuate, at least in theory.
While regulators believe CNAV funds are more susceptible to runs than VNAV funds, this is disputed by many within the industry.
A spokesperson from HSBC Global Asset Management says: “Our analysis does not support the view that CNAV funds have a greater propensity to run risk compared to VNAV funds.”
The EC’s proposal includes several key components. One of the most significant is the announcement that CNAV funds will be required to hold a 3% capital buffer to “support stable redemptions in times of decreasing value of the MMFs’ investment assets”.
This represents a different approach to the SEC in the US, which issued its own proposals in June. The SEC is considering two options: requiring CNAV funds to convert to a VNAV model, and/or restricting redemptions during times of stress.
Other changes proposed by the EC include required daily and weekly liquidity levels, customer profiling and the use of internal credit risk assessments by fund managers to “avoid overreliance on external ratings”.
At one level it is positive news for CNAV fund managers that CNAV funds have not been banned outright. A question-and-answer section on the EC’s website points out that CNAV funds represent half of the European MMF market and that some investors would stop investing in MMFs altogether if CNAV funds disappeared.
“For this reason, there was the need to find an intermediate solution that takes the form a buffer imposed on CNAV MMFs,” states the EC.
In reality, however, the introduction of the 3% capital buffer is expected to have the same effect.
“The cost of capital for fund providers to provide that 3% liquidity buffer when they are only charging 10 basis points – the economics don’t make sense,” says Colin Cookson, managing director of global liquidity at Aviva Investors.
“The 3% liquidity buffer will probably kill off CNAV funds. Our understanding is that many of the main CNAV fund providers have VNAV funds sitting in the wings ready to be rolled out.”
The question is whether the expected shift from CNAV to VNAV funds will result in a mass exodus among investors. Surveys have repeatedly indicated that many of those investing in CNAV funds would exit MMFs entirely if the funds were required to shift to a VNAV model – largely because of the more straightforward accounting treatment associated with CNAV funds.
Shortly before the proposals were announced, Jennifer Gillespie, head of money markets at Legal & General Investment Management, said: “Should the proposed reforms force money-market funds to convert from CNAV to VNAV, corporate treasurers would need to consider several key impacts – firstly, whether they are permitted to hold VNAV funds as cash or near cash instruments on balance sheet.”
Life after CNAV
While CNAV fund managers will be disappointed by the proposals, the changes are not unexpected – and indeed, some funds have already made the leap from CNAV to VNAV. Aviva Investors converted its CNAV funds to VNAV in 2008, prompted by the collapse of Lehman Brothers.
“We have built assets since then,” says Cookson. “I was told by a very senior member of an industry body that we would be out of business within four weeks – but here we are five years later. We’re growing assets and all of our clients understand why this is appropriate for them.”
Nevertheless, others believe the impact on the industry will be more significant, and that many investors will pull their money out of MMFs, choosing instead to place excess cash in bank deposits.
“Money market fund assets under management are likely to fall initially and I would expect volumes to recover as VNAV takes hold,” says an industry commentator. “Whether or not AUMs will regain current levels is moot.”
It is possible that the proposed changes could prompt corporate treasurers to revisit their cash-management practices. Some might decide to move their cash out of MMFs and into bank deposits – but this course of action comes with its own problems.
With corporate cash reserves continuing to be high, many corporate treasurers are approaching their counterparty limits, which restrict the amount they can deposit with a particular bank.
If a company decides to move a substantial amount of cash out of MMFs and into bank deposits, it might find it needs to spread its deposits among a larger group of banks – which could involve placing deposits with lower rated banks.
Investors might be willing to embrace VNAV funds – but it is also possible that product innovation could lead to the development of new instruments enabling corporate treasurers to manage excess cash in a diversified way.