The Current State and Future Potential of European Offshore MMFs
The European money market funds (MMFs) industry can not only feel satisfied with the continued growth in assets under management but also with the growing recognition and awareness of MMFs. The industry’s trade body, the Institutional Money Market Funds Association (IMMFA), can take the credit for creating a widely accepted definition of ‘treasury-style’ institutional funds, achieving significant success in lobbying regulators, and for building the Code of Practice to position the industry for future possible regulation. The European MMFs industry is in excellent shape and can continue to be a major success story.
Assets under management are showing further impressive growth in 2007.1 Both US dollars and pounds sterling are showing double digit percentage growth, but the euro funds have seen a phenomenal 40% growth year to date. The total value of euro funds is half the size of sterling, and it is evident that it is the euro market that has the potential for the greatest growth.
From 2000 onwards, a combination of factors fuelled the phenomenal growth as European offshore money market funds under management grew rapidly from US$70bn in 2000 to US$496bn today. The key growth factors were a combination of corporates building up unprecedented cash reserves as they rebuilt their balance sheets and a relatively stable, historically low interest rate environment. In addition, MMFs finally were in the spotlight highlighting cash as the ‘forgotten asset class’. UK corporates, who are historically in the vanguard when it comes to new financial instruments, embraced money market funds faster than the rest of Europe. Many of the factors that led to this growth have now dissipated and whilst the euro funds target the corporate sector in Europe, it is the prospect of financial institutions investing directly into funds that has captured the market’s imagination.
To date, the sizeable new investment flows expected from regulatory changes, such as the risk weighting changes under the European Commission Basel II inspired Capital Requirements Directive, have yet to fully materialise. Although Basel II came into effect on 1 January 2007 its implementation needs to be viewed as a process as the regulators allow financial institutions to gradually release capital, for example a 100% capital floor for the Internal Ratings Based (IRB) Advanced Approach does not come into effect until 2010. Large banks that were fully Basel II compliant on 1 January 2007 are starting to investigate MMFs, but it will require a change of investment behaviour driven by the balance sheet management area before funds can expect to see significant inflows from banks. Funds will also need to address the effect of these ‘super-investors’ as their investment decisions will be more performance driven and may change the dynamics of the funds.
The European MMFs industry has not had the equivalent benefits that the US industry has enjoyed. In the US, Rule 2a-7 of the Investment Company Act of 1940 has been the clear guiding regulatory framework. There is no equivalent in Europe and this lack of clarity has forced the industry to develop its own Code of Practice using the IMMFA, as well as looking to the rating agencies to fill the void. It is, however, possible that within a few years’ national regulators, such as the Financial Services Authority in the UK, will regulate for money market funds to be launched onshore.
As European regulation continues to gather pace, consultation and the resulting lobbying is critical. The key role for IMMFA is to ensure that a European regulatory framework fully accommodates money market funds. The Undertakings for Collective Investment in Transferable Securities (UCITS) Directive now accommodates money market funds and legitimises the use of amortised accounting. This has been a step towards the goal of an integrated market, and if European regulators can remove the administrative and regulatory frictions that slow down cross-border market access a functioning pan-European integrated market may yet be achievable. However, it is disappointing to learn than only three countries to date have actually completed full implementation of the markets in financial instruments directives (MiFID). The European Commission is concerned about member states not meeting the November 2007 deadline, and it will be interesting to see if infringement proceedings (court action) are forthcoming.
As competition becomes fiercer, fees are driven lower, and the market becomes more innovative it could be argued that the European MMF industry has officially come of age and is now a ‘mature’ market. The ‘treasury-style’ MMFs have firmly established themselves and are considered a major liquidity management tool. The future growth will now be driven by more ‘investment-style’ enhanced funds, as investors in continental Europe have historically demanded higher yielding products.
There are currently over 440 offshore MMFs and there are still new entrants, but the entry cost is ever increasing, initial fund launch size is now significantly larger today than five years ago. The winners in the MMFs business are the providers that have achieved critical mass. The bigger will get bigger as smaller players are forced to ‘white label’ their funds or ultimately merge.
MMF portals have become an important part of the European MMF industry as they clearly offer the right service for some clients. Portals will continue in importance as institutional investors are likely to be more performance driven than retail investors and they will utilise portals as they demand speed of execution, transparency, larger size tickets, lower transaction costs, later cut-off times, and straight through processing.
The European MMF industry has achieved a great deal in a relatively short space of time but to emulate the success of the US it will need to continue product innovation, expand investor diversification and continue to work for a European Rule 2a-7 equivalent regulatory framework.
1Source: Offshore Money Fund Report™ May 2007, a service of iMoneyNet