The European Commission recently published its long-overdue review of Money Market Fund (MMF) regulation in Europe on the adequacy of MMF regulation from a prudential and economic point of view.
Its findings paint a positive picture on the resilience of EU-based MMFs:
EU domiciled Money Market Funds comprise a huge sector, approximately €1.5 trillion at the end of 2021, with low-volatility Net Asset Value (LVNAV) MMFs accounting for just under half of the assets under management.
EU MMF reform, proposed in the aftermath of the global financial crisis which exposed certain weaknesses of financial markets, took effect in January 2019. The new regulatory framework included the LVNAV structure with which investors are now familiar, liquidity tools for investor protection such as redemption gates and fees, liquidity buffers and the banning of external support.
LVNAV MMFs replaced CNAV MMFs for investments in non-public debt. LVNAVs are allowed to use amortised cost accounting to offer a stable redemption price, but only as long as the value of the underlying assets does not deviate by more than 20 basis points from the market value of the fund’s net assets.
Professional investors account for 99% of monies in LVNAV funds. Investors cite their key criteria as intra-day/daily liquidity, preservation of capital and diversification. It also helps that shares in LVNAV and CNAV funds are considered ‘cash and cash equivalents’ under the IAS7 accounting standard due to their stable value and the possibility of intra-day redemptions.
The MMF sector was tested during the pandemic-related market dislocation of March 2020, with the spotlight on how funds managed redemption pressures when there were substantial outflows and again in subsequent years.
How did MMFs cope with market stress?
In this period of high volatility and market stress, stock markets fell sharply, corporate bond yields rose and liquidity deteriorated. EU-domiciled LVNAV funds experienced outflows of €50bn+ and faced challenges to sell their commercial papers and certificates of deposit as banks were unwilling or unable to buy back these papers, including their own. However, no EU MMFs were required to trigger redemption fees or gates or to suspend redemptions.
Russia’s invasion of Ukraine and the related geopolitical tensions again impacted financial markets. EU-based MMFs did not experience significant losses or outflows and no MMF had to introduce redemption fees or suspend redemptions.
Shortly after the announcement of the mini budget on 23rd September 2022, which saw gilt yields spike, market stress experienced in the UK also impacted MMFs with a sizeable exposure to UK assets and/or having UK investors. Some sterling-denominated MMFs saw increased outflows (five funds experiencing a cumulative outflow of more than 10%) as investors required quick access to liquidity, notably funds with liability-driven investment strategies facing increased margin calls and forced sales.
The Bank of England’s intervention to support the gilt market quickly reversed the situation. Serling-denominated EU MMFs also strengthened resilience by increasing their proportion of daily and weekly liquidity.
While one (unnamed) LVNAV fund came close to breaching the regulatory limit for NAV deviation, it appears that the sector overall held up well.
No significant impact on EU MMFs was observed after the collapse of Silicon Valley Bank. Following the takeover of Credit Suisse by UBS, EU MMFs in fact saw sizeable inflows.
In January 2022 the European Systemic Risk Board, European Securities and Markets Authority and other regulatory bodies made recommendations for further reforms to ensure MMFs do not amplify liquidity shocks in times of stress. Suggestions of removing the stable dealing price feature of LVNAV funds caused concern for investors who highly value this attribute for liquidity management.
The European Commission’s review showing that the safeguards in MMF regulation have been working in practice as intended must therefore be a relief for the industry and investors.
The Commission has identified some shortcomings to be addressed (de-linking redemption gates and fees from weekly liquidity) and there is going to be a wider review to harmonise liquidity management tools for open-ended funds across UCITS and other directives. It also calls for further assessment of the underlying short-term markets more generally, where structural issues persist.
The Commission hasn’t made any proposals for rule changes at this point, but its report is an important stage in the potential reform process. While there seems to be support for the LVNAV structure to remain largely intact, this is at odds with the proposals made by regulatory bodies in 2022, so it will be interesting to see where things go from here.
Going by past timescales for MMF reform, any changes to regulation are likely to take time before they are agreed by the relevant European bodies, not least a crowded timetable in 2024 with European Parliament elections and the selection of a new president of the European Commission.