Europe’s money market fund regulation reaches final stage

The Council of the European Union’s (EU) proposed revised regulation for the €1.2 trillion European money market fund (MMFs) industry would achieve its objective of making MMFs safer, through portfolio diversification and liquidity rules, according to Fitch Ratings’ assessment.

In its newly-published report, entitled ‘European MMF Regulation Enters Final Stage’, the credit ratings agency (CRA) says that the new rules would make low volatility NAV (LVNAV) MMFs a viable alternative to existing constant NAV (CNAV) funds, although liquidity requirements could be an obstacle.

The Council’s agreement represents a significant step towards European MMF regulation, almost three years after the European Commission’s (EC) initial proposed text, illustrating the difficulties in reaching a commonly agreed approach for the broad European MMF industry.

The Council’s proposal would see LVNAV cohabiting with a new form of government-only CNAV funds, short-term variable NAV (VNAV) funds and standard VNAV MMFs.

The regulation draft is now entering its final trilogue stage whereby the EU Commission, Parliament and Council need to agree on a final text. It remains to be seen how the UK’s vote to leave the EU will affect the regulatory debate. It could notably prolong the trilogue process, which is to be followed by an implementation period of a proposed 18-24 months. The reform would therefore not be effective before 2019 at the earliest.

The new rules on LVNAV funds would make them a workable alternative to existing CNAV funds, notably as the sunset clause has been removed. This is in contrast to the European Parliament’s (EP) 2015 proposal, which first introduced the LVNAV concept but with a five-year sunset clause, a strong drawback for the conversion of existing CNAVs that represent half of European MMF assets.

However, the new liquidity requirements for government CNAV and LVNAV, if introduced as is with limits on the eligibility for portfolio liquidity buckets of government-related securities that benefit from strong market liquidity, would be challenging to implement. This is due to the scarcity of ultra-short-dated asset supply, notably from banks, due to their own prudential regulatory requirements.

Across European MMFs, the proposal achieves the objectives of making funds safer and investors better protected through portfolio diversification rules and minimum liquidity standards. This is particularly true for most standard VNAV MMFs that would have to raise their portfolio liquidity. Liquidity practices vary greatly among this segment of the market. The proposed portfolio diversification and liquidity rules are close to existing investment practices of most CNAV and some short-term VNAV MMFs. Fitch’s MMF rating criteria goes beyond the proposed rules in some areas in identifying and measuring key risks.

New fund valuation rules would raise an operational challenge for fund administrators, fund managers and investors. The introduced focus on mark-to-market pricing would require adjustment to current pricing policies. The amortised cost valuation method, which is currently authorised for CNAV assets in its entirety and up to three months for VNAV assets, would see its usage substantially reduced.

The proposed mandatory application of liquidity fees or redemption suspensions for LVNAV and government CNAV funds would lead to more careful portfolio liquidity management and stronger interaction with investors. No such measures have been defined for VNAV MMFs, aside from the usual available Undertakings for Collective Investment in Transferable Securities (UCITS) provisions.

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