Money market funds (MMFs) are a key cash-management tool for corporate treasurers at a time of negative interest rates on deposits and a vital source of liquidity for small firms that have difficulty accessing capital markets directly.
However, even this type of mutual fund – benefiting as it does from low-risk portfolios of short-term securities – has not escaped regulatory scrutiny.
In the aftermath of the Lehman Brothers bankruptcy, when money market managers were retaining cash for withdrawals instead of investing in commercial paper – securities sold by corporations to fund short-term obligations such as wages – short-term corporate borrowing ground to a halt.
| The market appreciates that suspending redemptions during investor runs ought to protect the fund and its sponsor. However, this could affect a money market fund investor suffering from liquidity challenges.|
Olga Cileckova, PwC
European regulators are concerned that the failure of an MMF could destabilize Europe’s financial system and believe that requiring each fund to set aside a percentage of its capital as a buffer would make such an occurrence less likely.
However, as with many other issues that require pan-European consent, progress towards regulation of MMFs has been characterized by delay and compromise.
In March, the European parliament’s economic and monetary affairs committee abandoned a vote on a proposal that funds should be forced to hold a cash buffer equal to 3% of their assets, with opponents claiming that funds’ low margins would make such a buffer unsustainable.
The committee is scheduled to vote on the issue again this month ahead of a full European parliament vote in March, but opposition to the regulation remains despite the European Commission (EC) suggesting a compromise that would require funds to hold capital proportionate to the risks on their books rather than a fixed 3% of assets.
The European Association of Corporate Treasurers (EACT) has acknowledged the EC’s concerns that some funds could be systemically important or too big to fail, a point taken up by Olga Cileckova, a director in the treasury team at PwC.
“In general, the market appreciates that suspending redemptions during investor runs ought to protect the fund and its sponsor,” she says. “However, this could affect a money market fund investor suffering from liquidity challenges.”
According to the EACT, while funds need to be rigorous in their assessment of the credit quality of instruments in which they plan to invest, the implication that without regulation funds might take a casual attitude to investment risk stretches credulity. The association is also critical of the proposal to prevent funds soliciting or paying for a rating from a credit rating agency.
Where a fund is no longer provided with an external credit rating, investors will need to strengthen their internal counterparty risk-management procedures and approach, Cileckova continues.
“One of the main concerns continues to be the accounting classification of the money market fund investment, for instance for investments to be continued to be classified as cash and cash equivalents,” she says. “The regulatory change may also require system updates to manage investment in a floating net asset value fund.”
A bar on credit ratings would affect large corporates with sizeable liquidity positions which have embedded counterparty credit policies in place, explains Sreekar Periketi, principal consultant at business and technology consultancy Capco.
“Treasurers would have to change current policies and possibly turn to internal models in order to determine counterparty credit risk,” he says.
“However, this can vary considerably depending on the corporate’s capability in this area, in addition to the level of investment required. SMEs that do not have such capabilities – and those that rely on credit agency ratings – would have to reassess short-term investment policies, which could see funds diverted away from money market funds into rated institutions.”
Moving from constant to variable net asset valuations would also have implications for treasurers, Periketi says, adding: “The move from amortized cost to fair-value-based valuation would drive up volatility, especially during systemic market events. Whilst it would increase transparency on valuations, the primary advantage for treasurers using constant net asset valuations is the stability this has on their balance sheet.
“Predictability is key for treasurers and introducing volatility into their balance sheets will not be appealing. Therefore, they could seek to divert away from money market funds, driving up the cost of funding.”
Jan Vermeer, founder of Belgian treasury consultancy firm Treasury Services, also refers to the likely cost impact of proposed changes to MMFs regulation.
“There are some organizations that are looking for alternatives to these types of products, but these alternatives are becoming increasingly difficult to find,” he concludes.