Published: November 15, 2011
According to a recent report for Q2 2011 jointly compiled by the European-based European Fund and Asset Management Association (EFAMA) and US based Investment Company Institute (ICI), investors held some $4.9tr of assets under management around the world in products described as ‘money market mutual funds’. These assets were held in a range of product types and currencies and domiciled in 42 countries around the world.
The three largest markets as stated in the report for money market fund products are firstly, the US with $2.7tr (55%), secondly, funds adhering to the Code of Practice of the Institutional Money Market Funds Association (IMMFA) with $648bn (13%), and lastly the French money market funds industry with $532bn (11%). French and IMMFA funds are registered as UCITS under European Union regulation with the latter principally domiciled in Ireland ($452bn) and Luxembourg ($192bn).
While the markets described above hold the greatest share of global money market fund assets, smaller but thriving money market fund industries exist in many countries around the world. As securities industry and banking regulation has evolved in developing countries such as China, India and Brazil, so have new domestic industries for money market funds and many global asset managers are excited by the prospect of providing investment solutions to cash investors in the years to come.
The money market funds industry in the US is mature and well-established with products following a blueprint mandated by the Securities & Exchange Commission (SEC) and enshrined in Rule 2a-7 of the Investment Company Act of 1940. US-based money market funds seek to maintain a stable $1.00 constant net asset value (CNAV) per share at all times. IMMFA funds are typically offered as CNAV products closely resembling Rule 2a-7 money market funds but often with two types of share classes – the majority, known as ‘distributing’ classes declare daily income as dividends which is then paid out as cash or re-invested in new shares on a monthly basis, and a smaller proportion termed ‘accumulating’ classes which add daily income to principal thereby resulting in a steadily increasing share price.
In contrast money market funds offered outside the US and IMMFA industries can be relatively diverse in structure. For example, the largest single domestic market for money market fund products outside the US is France where all funds regulated by the Autorité des Marchés Financiers (AMF) have a variable net asset value (VNAV) per share. In the French market, money market funds follow rules introduced by European Union regulation in 2011 which now define two types of money market funds that can be classified as UCITS – ‘short-term money market funds’ and ‘regular money market funds’. The former follow more conservative guidelines than the latter, for instance with shorter instrument and portfolio maturities.
To understand the differences between the products offered in today’s major markets it helps to understand their evolution. In the US CNAV funds were first offered in the 1970s and steadily grew in popularity for both institutional and retail investors over the following decades culminating in their peak in early 2009 at a little over $4tr in assets under management. Initially US money market funds became popular with retail investors as an alternative to bank deposit products providing portfolio diversification, stability of principal, liquidity and money market rates of return. Over time money market funds became widely adopted by institutional investors as vehicles that could hold significant cash balances while providing diversified alternatives to single credit exposure via banking products. Today institutional money market funds comprise some 65% of US money market fund industry assets under management.[[[PAGE]]]
In France the industry grew rapidly in the 1980s in response to banking regulation which prevented banks from paying investors interest on deposits. While this changed in 2004 the industry had by then become well-established and at its peak at the end of 2009 stood at just under $700bn in euro-denominated assets under management.
In other European countries including Italy, Switzerland, Germany and Spain domestic funds have almost invariably been offered as VNAV products. While it could be said that US money market funds are relatively homogeneous, the sector in Europe has shown great diversity with European asset managers following relatively complex and ‘sophisticated’ strategies to achieve competitive returns. These could include using derivatives to hedge duration and currency, investing in fixed income securities with a wider range of credit quality and maturities than permitted in Rule 2a-7 or IMMFA funds, and seeking to achieve performance returns relative to a variety of European market benchmarks such as EONIA or EURIBOR.
International or IMMFA funds have for the most part been offered by asset managers familiar with managing portfolios within the constraints of Rule 2a-7. A high proportion of cash invested in IMMFA funds is sourced from subsidiaries of multinational corporations or ‘global’ corporations headquartered in many locations including North America, Asia, Europe and Latin America. In recent years and largely due to concerted efforts by asset managers to raise investor awareness CNAV funds have steadily grown in popularity with domestic institutional investors in many countries around the world.
In essence, all money market funds aim to achieve the same end result to greater or lesser degrees – portfolio diversification, high levels of credit quality, relatively low to zero price volatility, and same (T+0) or next day (T+1) liquidity for the end investor. Differences in product form have evolved in the various markets due to a variety of factors including local market perceptions and tolerances around risk, investor preferences for income or capital gains due to differing rates of taxation, operational simplicity and accounting regulation.
The key difference between funds offered as CNAV or VNAV products is in their income distribution accounting policies. Typically CNAV funds account for capital and income separately and treat income as a daily declared dividend accruing to the shareholders of a fund and which are distributed or paid out to investors in the form of a cash dividend or re-investment in new shares at the end of each month. In contrast VNAV funds roll up daily income into the share price which changes in value on a day to day basis as a result.
For some investors such as multinational corporations, the accounting and operational simplicity provided by CNAV funds makes their use more attractive than VNAV products. In particular, the lack of price volatility in CNAV shares avoids the need to track and reflect a daily gain or loss in a firm’s accounting records.
Another difference closely linked to their income policies is the extent to which CNAV and VNAV funds use amortised cost or mark-to-market accounting. CNAV funds will generally use amortised cost for all securities within their portfolios. Amortised cost allows a security to be valued on a straight line basis from its initial purchase price to par value at maturity ensuring that there is an even and predictable change in its daily valuation, provided the price remains within certain tolerances. In contrast, VNAV funds will, for the most part, follow mark-to-market accounting whereby securities are valued at the market price at which they could be sold.[[[PAGE]]]
In practice many VNAV funds follow hybrid models whereby securities maturing within a certain time period i.e. three months might be valued at amortised cost, whereas those maturing later than three months would need to be priced at their market value.
Today Rule 2a-7 is arguably the most comprehensive body of regulation governing any component of the global money market funds industry. While it has become more substantive in recent years, pan-European regulation has historically allowed for greater scope for money market fund product descriptions and diversity in investment guidelines.
Following the credit crisis of 2007-2009 regulators in both the US and European markets have focused on money market funds for a variety of reasons. For instance, in the US, money market funds have been perceived by regulators as representing a source of systemic risk. This has led to changes in the SEC Rule 2a-7 which has both introduced new rules around areas such as liquidity and transparency and also tightened existing parameters around, amongst other items, maturity, credit quality and reporting.
European-based money market funds are generally UCITS funds which means they have to follow both European Union regulation as set out in UCITS legislation [Directive 85/611/EEC] and any additional rules which the local market regulator requires to be followed. As a result of the credit crisis, the European Securities and Markets Authority (ESMA) introduced new guidelines for money market funds domiciled within the European Union which asset managers will need to comply with by the end of 2011.
ESMA also introduced two categories of money market funds – ‘short-term money market funds’ which are required to follow more restrictive investment guidelines and ‘money market funds’ which have greater investment flexibility. IMMFA CNAV funds fall into the short- term category and as mentioned earlier in this article, French VNAV money market funds are offered as both ‘short-term money market funds’ and ‘money market funds’.
Since IMMFA is not a regulatory body, its Code of Practice is voluntary. However, changes in the Code of Practice made post the credit crisis of 2007 to 2009 are largely consistent with those made by the SEC to Rule 2a-7 and the new classifications introduced by ESMA.
In France and other jurisdictions around the world, regulators have continued to review how money market fund products are classified and what investment parameters need to be followed to hold the designation.
The credit crisis of 2007 to 2009 changed the perception of risk that regulators and investors held for many sectors of the investing markets. The money market fund sector in particular has been subject to scrutiny by regulators around the world as the extent to which their activities as lenders to financial and non-financial institutions in the short-term credit markets around the world have become more widely understood. In 2010 changes which were principally enacted in the US and European Union markets have, according to many commentators, strengthened the risk framework for both CNAV and VNAV money market funds. While these changes have been welcomed by the industry and investors, regulators have continued to seek ways to minimise the systemic risk which they believe money market funds present to the markets. At the time of writing, several regulatory bodies including the SEC, ESMA, FSB and IOSCO continue to assess the need for additional changes to regulatory frameworks, in particular for CNAV funds.
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