EU Money Market Fund Regulation and Share Cancellation: A Last-Minute Threat to Stable-Price MMFs?

Just as European corporate treasurers were starting to prepare for the entry into force of the EU Money Market Fund (MMF) Regulation and to understand the implications of the changes brought by it, a new obstacle has emerged that might put into question some of the fundamental aspects of the Regulation. The European Commission is indeed currently assessing whether share cancellation fits into the new EU legal framework and whether the practice should be banned altogether. It is highly uncertain whether negative-yielding funds that seek to maintain a stable asset price would survive a prohibition of the share cancellation practice. 

The MMF Regulation is entering into force in January 2019 and will bring about major changes to the MMF industry. Among the most important is the reshaping of MMF types: the current CNAV fund model will be replaced by CNAVs that are only allowed to invest in government debt, and a new fund type, called Low Volatility NAV fund, that are also allowed to show a stable NAV, will appear. Since the start of the legislative process and debate concerning the MMF Regulation back in 2013, one of the main concerns for the EACT has been the continuation of a CNAV or CNAV-like structure, which were put into question by the original proposal for Regulation. The MMF Regulation was subject to intense debates by the EU legislators, and in the end a result was reached that provides for a broadly satisfying outcome. One might therefore be surprised that once again stable-priced funds are under threat, this time by a question raised by EU authorities on whether the practice of share cancellation is allowed under the MMF Regulation.

Share cancellation

Share cancellation is used by MMFs offering a stable-NAV to deal with the distribution of negative income due to negative yields, meaning the reduction of the amount of an investor’s shares corresponding to the amount of negative yield. For a stable-NAV fund, the options to deal with negative income are limited: share cancellation, invoicing investors for negative yield, and converting to a floating NAV. Of these options the mechanism of share cancellation was chosen at the time as the only operationally viable one. 

Share cancellation was not a major topic of debate during the legislative process. It was only early in 2017 in an ESMA consultation on the so-called ‘level 2’ measures (Regulatory and Implementing Technical Standards) that the topic surfaced. In its consultation paper, ESMA stated – to the surprise of many - that it considered that the destruction of shares is not allowed under the MMF Regulation, as the Regulation does not explicitly state the possibility of a fund cancelling shares. The European Commission has since taken over  the issue from ESMA and is now analysing whether ESMA’s assessment is indeed justified. ESMA and the Commission seem to have a concern about whether the process of share cancellation could be used by fund managers for  purposes other than dealing with a situation of negative yield, for instance to reflect a change in the mark-to-market value of their portfolio (this concerns in particular LVNAV funds where the MMF Regulation obliges an LVNAV fund to convert to a VNAV fund if the mark-to-market value of its portfolio diverges by more than 20 basis points from the net asset value displayed by the fund). Our position in a nutshell is that prohibiting share cancellation would do more harm than good for corporate investors, and any concerns that authorities may have can surely be addressed by other means.

Alternative mechanism

If MMFs can no longer use share cancellation as the mechanism to deal with negative yield, the alternative is to make investors deal with it by making payments corresponding to the amount of negative yield. On an operational and administrative level, this would shift the burden to corporate investors to set up systems and processes to deal with potentially daily payments, and the level to which this could be made automated would be different depending on the type of investor. From an investor perspective, it is difficult to see any advantage in taking over tasks that belong to the fund manager or to the transfer agent. 

More fundamentally, the risk is that fund managers will not be able to offer CNAV and LVNAV funds that bear a negative yield without the ability to use share cancellation. In the current environment this puts the future viability of euro and yen-denominated CNAV and LVNAV funds into question, but it is of course difficult to predict how yields develop in the future for other currencies.  

The EACT has continuously defended the view that corporates need access to a range of options for investing their cash, especially in the post-Basel III world where banks are careful to consider how corporate cash influences their regulatory ratios and are therefore less ready to accept cash deposits. MMFs, even with negative yields, offer a valuable diversification tool for corporates to place their cash and support corporates in their need for capital preservation and easy access to liquidity. We continue to think that the availability of both stable and variable NAV funds going forward is critical for treasurers.

Such regulatory uncertainty is of course very unhelpful at this stage, as corporates are preparing for the upcoming changes. We would hope that in the end the Commission privileges the importance of maintaining the fund types and structures agreed in the legislative process and avoiding potentially very heavy disruption for corporates investing in these funds. The EACT will continue to monitor the developments closely and to defend an outcome that provides all corporate investors with viable and usable MMF structures.