London – The probability of a discretionary or mandatory liquidity fee or redemption gate being imposed on European money market funds (MMFs) post-reform is low, absent a systemic shock or idiosyncratic credit event, says Fitch Ratings in a new report.
Based on observations of the Fitch-rated constant net asset value (CNAV) MMF universe in the last five years, albeit a benign credit environment, there were no incidents of weekly liquidity (ie the percentage of portfolio assets maturing within one week) dropping below 10%; and instances of weekly liquidity dropping below 30% occurred in less than 10% of cases. Under the July 2017 EU MMF reform measures, weekly liquidity below 10% triggers a mandatory redemption gate or fee; and the combination of a daily net outflow greater than 10% of fund net assets, and weekly liquidity dropping below 30% triggers a discretionary redemption gate or fee for CNAVs.
The already low probability of large outflows is even less when factors such as pre-planned investor movements are excluded. Along with minimum weekly liquidity thresholds, assessing factors such as net redemptions is a critical metric under the reforms in determining whether extraordinary actions must be taken by a fund’s board.
Fund boards must decide if liquidity fees or temporary suspension of redemptions should be activated in the unlikely event of a fee and gate trigger. Therefore, the reforms put more emphasis on the role of MMF Board of Directors and their independence.
Fitch expects the new Low Volatility Net Asset Value (LVNAV) funds introduced by the European MMF reforms will have very high overnight and weekly liquidity. Public Debt CNAV and LVNAV funds must maintain minimum overnight and weekly liquidity level of 10% and 30%, respectively; liquidity limits have also been introduced for the first time in Short-term and Standard Variable Net Asset Value (VNAV) MMFs.
Today’s report also notes that ‘AAAmmf’ rated smaller funds hold 5%-7% more weekly liquidity than their larger equivalently-rated counterparts to manage liquidity risk. The risk of a fund’s liquidity deteriorating below the discretionary threshold remains low despite smaller funds being more vulnerable given their size and possible concentrations. The risk is expected to be further mitigated by fund managers increasing their weekly liquidity levels, as was the case in the US following its fee and gate reform – where Prime funds now hold about 10% more weekly liquidity on average than at pre-reform levels.
Today’s report, “Reform Gate Risk Low for European Money Funds” is available at www.fitchratings.com.
