MMFs: A Regulatory Concerto?
by Helen Sanders, Editor
There have been few times in recent decades where the closing weeks of the year have brought such uncertainty and controversy as the dying song of 2010. While the potential fortunes of the euro and risk of contagion in the European debt markets continue across Europe and Basel III are amongst the most pertinent issues for treasurers, another issue worthy of consideration is changing regulation in the money market fund (MMF) industry.
Why MMFs, why now?
MMFs are discussed regularly in the treasury media, so why raise this topic at a time when there are so many other challenges? While treasurers have many issues to consider in the present discordant environment, one is the security of cash. Leaving cash in with a bank in a vulnerable country could be considered careless at the least. Government securities, the traditional bastion of investment security, are no longer seen to be ‘risk free’. Consequently, a diversified approach to investment would seem to be essential, but few treasuries have the resources or appetite to construct an investment portfolio that provides the security and access to liquidity that they require. While no instrument is ‘risk-free’ the diversified collection of high-risk assets that comprise a AAA-rated MMF should prove increasingly attractive, illustrated by the continuing growth of these instruments in Europe.
While treasurers have many issues to consider in the present discordant environment, one is the security of cash.
Since Lehman Bros collapsed, and the Prime Reserve Fund ‘broke the buck’ in September 2008, regulatory changes to MMFs have been widely expected and anticipated, and individual associations such as IMMFA have already updated their Code of Practice. As Kathleen Hughes, Co-Head of Global Liquidity Distribution, Goldman Sachs Asset Management (GSAM) explains,
“Today’s challenges and uncertainties in the MMF industry continue to be largely caused by the regulatory changes we see in the United States and Europe. Tightening Rule 2a-7 is positive for investors and fund managers alike by creating a level playing field. In Europe, we see CESR defining MMFs in Europe more clearly, which again is positive for investors.”
Some of these changes have now taken effect, such as in the United States, and European guidelines have also been published. So what are the potential outcomes of these changes, and what other issues are influencing the MMF market today? In many respects, new regulatory stipulations have been received positively, not least because they create a level playing field for fund managers, and investors can have greater confidence in the fund in which they are investing. This is not to say, however, that a fund in which a company is already investing will necessarily need to change, particularly IMMFA AAA-rated MMFs which effectively demonstrate the characteristics of a Short-Term Money Market Fund according to the CESR definition.
In the United States, many of the new and amended requirements for the 2a-7 fund (figure 2) are already in effect, with the remaining provisions due by end 2010. In Europe, CESR (Committee of European Securities Regulators) has published new guidelines which will take effect in 2011 (figure 3). Fund managers and investors alike recognise the need for greater transparency as well as management of risk, and many individual fund managers, and associations such as IMMFA had already enhanced transparency over the fund portfolio. Kathleen Hughes, GSAM describes:
“Fund transparency continues to be important to investors. In Europe, MMFs already provided 60-day WAM and WAL, which are effective ways of measuring fund risk. In addition, portfolio holdings must also be made available to investors through a website. For IMMFA funds, managers also have a policy for investor concentration and the maturity profile of the portfolio.”Colin Cookson, Head of Liquidity - Business Development, Aviva Investors agrees,
“We pre-empted the demand for greater transparency over funds, and for nearly two years have provided a weekly breakdown of the portfolio, a daily mark to market valuation plus WAM and WAL calculations.”
The CNAV – VNAV debate
Fund managers and investors alike recognise the need for greater transparency as well as management of risk.
While many of these changes are positive, one major cause of controversy is that while constant net asset value (CNAV) funds form the backbone of today’s AAA-rated MMF industry, only certain types of funds will be able to be valued in this way in the future, in favour of variable net asset value (VNAV). Specifically, as described in figure 3, European money market funds will be designated either as Short-Term MMFs or Money Market Funds. Short-Term MMFs can be constant NAV (as with today’s IMMFA AAA-rated MMFs) but other types of Money Market Fund such as some of today’s continental MMFs, must be VNAV. In some countries, such as the Czech Republic, few if any existing funds will be able to adhere to these restrictions. While ultimately this may be positive in terms of investment security and transparency, in the short term, investor choice and opportunities for investment may be limited.
Kathleen Hughes, GSAM emphasises that both CNAV and VNAV funds have their place,
“The value of IMMFA-style, AAA-rated CNAV MMFs is well-accepted, in addition to the potential advantages of VNAV funds, particularly for retail investors with a different risk profile to the institutional investors who are currently attracted to CNAV funds.”