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Supplements » Irish Report 2013

MONEY MARKET FUNDS: How to run money markets

RunnerInvestors' liquidity needs may be enough to support money market funds, a major industry in Ireland, but one that is challenged by rates and regulation. Nicholas Pratt talks to several key players about their hopes for the industry's future.

Ireland is the dominant centre for money market funds – a sector rocked during the 2008 financial crisis and recoiling still as regulatory change affecting them evolves.

The trouble with money market funds is reflected in Ireland, which has experienced a decline in assets under management from €357 billion at the market’s 2010 peak to €291 billion in March 2013. During this period the market has seen consolidation and fund closures.

Deborah Cunningham, chief investment officer for money market funds at Federated Investor, says the biggest challenge for the sector is the low interest rate environment across almost all currencies. There is also a lack of supply because interest rates and regulation are providing incentives to potential money market issuers to raise funding in other ways.

Yet demand for money market funds remains, she says. “Offshore Ucits assets have held steady at the $1 trillion [€770 billion] mark and from the US market there is roughly $2.6 billion in assets. There has not been much change in the last two years.”

Investors may well be frustrated at the low interest rate environment, but the dominant influence in the use of money market funds, especially among corporate treasurers, is a desire for liquidity, diversification and capital preservation – and these are still difficult to find anywhere else, says Jon Boyle, chairman of Fidelity's Institutional Liquidity Fund and head of treasury at FIL.

“The reality is that we are in a low interest rate environment but people still need liquidity.”

For money market fund promoters, the supply is still generally very manageable, says Boyle. The most pressing issue, as always, is to maintain quality and liquidity within the fund. It is still possible to do that, although within euro-denominated funds, providers have commonly been waiving part of their management fees for some time in order to continue to produce a positive yield for investors.

And then there is regulation. Ever since the collapse of Lehman Brothers, regulators have been concerned about a possible run on liquidity funds in the event of another market shock. The European Commission has proposed a regulation on money market funds that should be discussed in depth during the Lithuanian presidency of the EU in the latter half of 2013 and then finalised and implemented in the first half of 2014.

A recent report issued by Moody’s Investor Services, Money Market Funds and Regulatory Reform: A Business Model Hangs in the Balance, predicts that changes in the money market sector will continue due to the twin pressures of unfavourable market dynamics and unhelpful regulatory changes.

“Due to the changing product dynamics, we expect industry consolidation to accelerate combined with a significant impact on the overall liquidity product landscape and investor preferences,” says Yaron Ernst, managing director of Moody’s managed investments group.

The regulatory changes cover a whole raft of initiatives in both the US and Europe, many of which could threaten the traditional constant net asset value (CNAV) structure of the funds by insisting on a variable net asset value (VNAV) structure. For Ireland, which is home to roughly 90% of the CNAV funds, this is an especially important issue.

Moody’s outlines three possible scenarios for the money market fund industry based on possible regulatory changes.  The first of these is that VNAV money market funds will replace CNAV funds entirely, though this is deemed unlikely.

A second scenario is that only government/treasury money market funds are allowed to retain CNAV status, while a third scenario imagines that capital buffers will be required for all CNAV money market funds. This is considered the most likely outcome for Europe.

Boyle says that, from a treasurer's perspective, regulatory proposals are seen to improve liquidity and reduce other risks within the money market sector. But concerns have been expressed, in particular that the proposal for a capital buffer could kill the industry.

“The regulators' concern is the risk of runs on money market funds and they see so-called CNAV funds as more susceptible than VNAV funds, although this has been challenged by industry bodies on the basis of historical experience during the credit crunch approximately five years ago,” says Boyle.

“A CNAV fund offers very high levels of resilience even to exceptionally high levels of redemptions, and in Europe now generally includes a mechanism to be able to pass on a negative yield if such is being generated by the high quality instruments in which it invests, although this has never yet been required,” says Boyle.

“A compromise based upon other proposals would be likely to be more workable, perhaps involving increasing liquidity, reducing maturities, redemption gates and stress testing.”

Although VNAV funds are widespread in Europe, making them mandatory would be a big change, says Cunningham, especially for the large institutional buyers that use a money market fund as if it is a current account. “If you are using a CNAV structure, this does not create any accounting issues, but by being forced to use a VNAV structure the slightest fluctuation would create a huge paper trail.”

The gating proposal, where directors can put up a temporary gating structure, is also supported by Cunningham as a more workable option than changes to the NAV structure.

“The concern for all the regulators is to avoid a run on liquidity if there should be a market shock. A variable NAV doesn’t seem to help in that regard. If you were going to stem a run then gating may help. It is a mechanism rather than a systemic change and it will give management time to think of a game plan.”

Despite the current challenges, there is an air of resilient optimism among money market providers. And Boyle says that money market funds continue to meet investors’ requirements, especially from a treasurer’s perspective.

“The constitution of a money market fund is a very good one and it will continue to be good provided that regulators allow the product to continue to be effective. The yield is not the main attraction with money market funds, it is liquidity, diversification and capital preservation.”

A potential opportunity for money market funds is that they are used as collateral to serve the growing interest in high quality collateral as a result of new margin requirements for centralised clearing of over-the-counter derivatives and the concern that there might be a shortage of high quality collateral. Various exchanges, such as the London Stock Exchange, are allowing broker/dealers to post money market funds as acceptable collateral.

Post-trade services provider Clearstream has been promoting the use of funds as collateral for more than two years, including money market funds. “For money market funds we have plenty of initiatives, driven by asset managers that are interested in using money market funds as an alternative to cash in terms of collateral,” says Bernard Tancré,  executive director, head of business solutions at Clearstream.

But Clearstream has not been helped by the European Securities and Markets Authority’s rules on the technical standards for European market infrastructure regulation (Emir), which excludes money market funds as acceptable collateral for the central clearing of OTC derivatives. “The Emir rules say that investors are too dependent on the liquidity of money market funds for them to be used as collateral and the preferred position would be to have a secondary market for money market funds.

There are other collateral takers out there that are not governed by the Emir rules, however the current market conditions allied with the Emir rules have lessened the interest in using money market funds as collateral. Interest in the market for money market funds is not great, concedes Tancré. “We are a bit dependent on the economic conditions and we need money market funds to be less questioned by market participants and then the interest will filter down.

“The current conditions will not last forever and we will continue to talk to people.”

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