Will Europe Become the Global Hub for Triple-A Rated Money Market Funds?
Over the last 10 years, investment in European triple-A rated institutional money market funds has been nothing short of remarkable. Since their inception, funds under management have grown to a figure of around US$300bn1 – making it one of the fastest growing investment products on the market over this period.
Yet, in comparison to its US counterpart, the market in Europe is still in its infancy. Over a period of 35 years, monies invested in US money market funds have grown to around US$2 trillion, acknowledging the huge appetite for funds of this type in both the institutional and retail markets. One of the major reasons for their success has been the existence of a regulated environment specific to these types of fund (known as SEC Rule 2a-7). Whether similar success can be achieved in the European market remains to be seen, with regulation also having a major part to play in shaping how the European institutional money market fund industry develops.
Triple-A rated institutional money market funds provide investors with the usual benefits of pooled investments and are actively managed within rigid guidelines. They offer a combination of capital security, liquidity and competitive sector-related returns, as evidenced by the triple-A rating award from recognised credit agencies. As such, these funds usually appeal to those entities that have significant surplus liquidity cash balances to manage but need same day access to their funds if required for business reasons, such as investment funds, corporate treasurers and local authorities, who form the majority of their client base. Investors tend to regard these funds as an attractive alternative to traditional money market call deposit accounts.
Before considering the raft of regulatory changes that may have a significant effect on funds operating cross-border, including triple-A rated institutional money market funds, it might be useful to consider the general environment in which they function. This will help explain some of the issues currently impeding the growth of institutional money market funds in Europe.
Firstly, the absence of a tailored regulatory regime for triple-A rated institutional money market funds has led to a general lack of awareness of the product among European treasurers and other potential clients who remain unfamiliar with the characteristics of this particular type of fund. To compound matters, there are actually two fundamentally different styles of money market funds currently operating in Europe, both of which meet the needs of their specific investors. These are often referred to as ‘investment-style’ money market funds and ‘treasury-style’ institutional money market funds.
Investment-style institutional money market funds have been available in continental Europe for over 30 years. These funds have a primary investment objective to achieve an ‘all-in-return’ (i.e. combined capital plus income growth). In many ways they have similar characteristics to short-dated bond funds.
On the other hand, treasury-style institutional money market funds were only introduced to Europe in the mid-1990s. They have proved very popular with liquidity cash managers as their main investment objective is capital preservation. As such they have a unique characteristic when compared to other funds in that they operate on a constant net asset value per share basis (i.e. £1.00 in/£1.00 out). They are also very similar to treasury money market call deposits in the way they operate.
So, here we are with two products in Europe that both call themselves ‘money market funds’, one with the characteristics of a short-dated bond fund, the other with the characteristics of a treasury call deposit account. Both of these have a role to play as they are intended to be used for different purposes by investors.
To address this anomaly, the Institutional Money Market Funds Association (IMMFA) was established in 2000 as the trade body for ‘treasury-style’ institutional money market funds, both to raise awareness and to actively promote the product throughout Europe – with an ultimate ambition to establish Europe as a global hub for the management of triple-A rated money market funds.
There is little doubt that, like other collective investment schemes, the growth of treasury-style institutional money market funds in Europe is currently impeded by the marketing and promotional regulatory requirements that exist within the EU.
In principle, the Undertaking of Collective Investments in Transferable Securities Directive (UCITS III) should have created a level playing field for cross-border sales since a fund would be authorised by the regulator in its country of domicile and then ‘passported’ into other host member states. This would involve notifying the relevant authorities and furnishing them with, among other things, the fund’s full and simplified prospectus, its annual report and any subsequent half-yearly reports, along with its fund rules or its instrument of incorporation.
However, it has long been known that the reality is somewhat different. As each member state implemented the UCITS III guidelines to comply with their own specific marketing legislation requirements, it became apparent that local regulators applied their own interpretation of the ‘passport’ requirements. This resulted in a wide range of onerous information peculiarities that go far beyond those stipulated in the Directive. For example, member states impose different waiting times for registrations, ranging from 12 days to over 100 days. Such delays can prove expensive in the competitive world of fund management.
In addition, many member states require that financial reports be sent to the regulator in their local language, although this is not included as a requirement in the Directive itself. Most also require all prospectus material to be translated into the local language, although there is a dispensation to allow other major languages to be offered as well. On top of this, there are the cumulative costs and effort associated with maintaining registration and any registering alterations to funds, such as a change in investment strategy.
Specific to Germany, the regulators require letters from both the German paying agent and the information agent confirming their roles as well as requesting proof of payment of the initial registration fee. In addition, a special partial German prospectus needs to be submitted showing only the funds made available in Germany. There is also a requirement for all ongoing dividend payments to be verified by an independent party.
These disparate requirements have proven to be costly and time consuming and have definitely inhibited cross-border activity. Much of the problem stems from the fact that primary legislation changes would be needed to support a standard pan-European approach.
Of particular concern is that any additional costs incurred in the notification process are borne directly by the funds and therefore the investors. This, in turn, can restrict investor choice and reduce returns.
It is generally felt that if one country is able to register a fund quickly and without any additional requirement to those stipulated in the European UCITS III Directive, then there is no sound reason why others cannot. As such, simplification of the notification procedure is now accepted as being one of the main priorities that the European Commission wants to address.
The good news is that the European Commission is now taking action to resolve this issue. In June 2006, the Committee of European Securities Regulators (CESR) issued its second consultation paper on simplification of the notification procedure in which it acknowledged some of the key issues hindering the development of a standard pan-European approach. These included the duration of the registration process, the management of its timing and the language regime affecting the notification procedure.
CESR’s revised guidelines go a long way to simplifying the process. However, its recommendations will only become effective if individual member countries are prepared to pass primary legislation to bring their marketing regulations in line with the best practice benchmark standards that CESR has outlined.
Continuing on a positive note, earlier this year CESR recognised treasury-style institutional money market funds and now takes them into account in their advice to the European Commission on clarification of definitions concerning eligible assets for investment of UCITS.
Under UCITS III, the list of eligible assets was extended beyond the traditional investments of shares and bonds to include broader investments such as derivatives, bank deposits and money market instruments. The final advice from CESR was particularly favourable for the institutional money market funds industry as it makes clear that money market instruments are eligible investments for UCITS funds.
A further piece of European legislation that has had a positive impact on institutional money market funds is the Markets in Financial Instruments Directive (MIFID). This legislation, due to be implemented in 2007, explicitly recognises the security of the money market funds industry by making provisions for client money to be invested in triple-A rated funds for the first time, a move away from the traditional bank deposits that are currently used.
Going forward, the recognition of these instruments and associated funds at European level will greatly assist the cross-border sales effort.
While we still need wider recognition of the benefits of treasury-style money market funds, recent legislation will undoubtedly assist further growth in funds under management. There can be no doubt that the future success of the product is dependent on the implementation of a simplified but robust pan-European regulatory regime that does not stifle innovation. Provided this can be achieved, there is no reason why money market funds cannot become as big an industry in Europe as they are in the US.
1Source: iMoney Net, Inc. as at 31 July 2006.