The End or the Beginning for Money Market Funds?
by Helen Sanders, Editor
In August 2014, the Securities and Exchange Commission (SEC) in the United States adopted reforms to Rule 2a7 funds (US money market funds - MMFs) with the aim of reducing systemic risk. Inevitably, these changes have been met with a mixed response, not least due to the uncertainty that will undoubtedly continue until full adoption of the reforms in 2016. In reality, however, are these reforms likely to mark the end of the MMF era, or conversely, given the other market and regulatory changes that are taking place in parallel, are we on the brink of a new phase in the growth of MMFs? As Jim Fuell, J.P.Morgan Asset Management highlights,
“We see two key trends in corporate investment appetite: firstly, the impact of regulation, not only MMF regulation, but wider changes such as Basel III, which in fact creates a tailwind for MMFs; secondly, prolonged low interest rates, particularly in Europe. While companies will not risk assets to avoid negative yield, the convergence of these two issues is prompting treasurers to review their investment policy and consider alternative investments.”
Regulatory impact on Rule 2a7 funds
The changes to US MMF regulation impacts on investors in a variety of ways, although these will take effect over the next eighteen months to two years (until October 2016). One of the ‘headline’ changes is the shift from constant net asset value (NAV) to variable NAV. This mandatory shift from constant to variable NAV applies specifically to institutional, non-government MMFs i.e. retail MMFs and government funds are excluded from this requirement. This has valuation, accounting, and operational implications for fund managers, as well as investors. More immediately (i.e., by February 2016) 2a7 funds can no longer be awarded credit ratings from the independent rating agencies. (The removal of external credit ratings from prime money market funds was not included in the final legislation.) The AAA credit rating that MMFs boast is often a major criterion for corporate investors, so many will need to revise their investment policy accordingly to allow for investment in unrated funds, or seek other highly rated investment options. Nick Jones, Head of Sales, Liquidity, EMEA, HSBC Asset Management emphasises,
“Changes to SEC-2a7 regulated fund structures in the US should be viewed by all corporate investors as an opportunity to engage with their global asset manager on the future implications of moving to variable NAV and the wider impact on their global investment policy in other jurisdictions. ”
Jim Fuell, Head of Global Liquidity, EMEA, J.P. Morgan Asset Management comments that while important, the reforms are unlikely to prompt an immediate change in either fund manager or investor behaviour,
“While recent regulatory announcements, such as the changes to 2a7 funds, are a concern for investors, a survey of our clients has indicated most are likely to maintain their existing cash allocation during the course of 2015 given that implementation of the new regulations will largely not take effect until 2016. Even so, investors are still keen to understand the implications and consider what changes to their investment policies may be required.”
Avoiding early adopter status
Few existing investors in 2a7 funds are likely to push their investment managers to migrate to new-style funds in the short term, bearing in mind that they are already comfortable and familiar with existing funds. Without ‘early mover’ advantage for either fund managers or investors, we would therefore not expect to see considerable activity until closer to the transition deadline in 2016. As Nick Jones, HSBC Asset Management, underlines however, regulatory change will ultimately result in innovation.
“From a bank perspective, regulatory change of this nature will lead to product innovation in fund structures. For example, off balance sheet, we could see new flavours of liquidity fund structures emerge to meet the needs of investors concerned about exposure to daily price fluctuations.”
Given that MMFs are characterised by same-day access to liquidity, and a straightforward investment and redemption process, the transition itself between existing and new funds can be more or less immediate. The primary challenge is therefore to ensure that corporate investment policies permit investment in the new, unrated, constant NAV funds, and that accounting and treasury systems support these funds. These issues will take longer to address than the investment process itself, so investors need to be well-informed and well-prepared to understand and ensure that their policies, processes and systems support the changing profile of funds in which they are investing, or that new investment arrangements are in place.