Published: November 01, 2013
The money market fund (MMF) industry is about to go through a period of significant transition driven by both impending regulatory change and a sustained period of very low interest rates. However, whilst the main options for change have been widely publicised and debated, both fund providers and investors remain unclear about precisely how they will impact the future MMF landscape. They don’t yet know which options will be implemented, when they will be introduced and how consistent they will be across US onshore and offshore funds domiciled within the EU. Nor do they know how long low interest rates will be around and how much and how quickly they will rise when this does eventually happen. In this climate it is not surprising to find that funds and investors have engaged in both short-term tactical behaviour and more long-term strategic planning to ensure that they have managed the recent difficulties as well as they could and are properly prepared for any anticipated and unexpected changes that are finally implemented. These changes inevitably have knock on consequences for MMF portal providers who have to make sure they will continue to be able to support the needs of both investors and participating funds in a changing world.
Impending regulatory change and the sustained low interest rate environment – particularly in the Eurozone – have led to a number of changes to existing funds over the past two years.
In the short term perhaps the most dramatic response was the complete (hard) closure of some EUR funds by some providers who could not see how they could continue to deliver a sustainable and attractive investment opportunity in such a difficult environment. Hard fund closures do not pose significant problems to portals as they simply require the removal of the relevant funds from market view and switching off the ability of investors to trade them through the platform. Other changes however have presented more significant challenges to the portal providers.
Many of the EUR funds that were not hard closed were subject to soft closures with either no new investments being allowed for specific periods or maximum trade values being set for new investments. This kind of dynamic investment framework creates considerably more difficulties for portals as it requires the ability to provide up to date information on changing investment guidelines for each fund as well as ensuring that investors do not inadvertently breach these, or attempt to do so, through their use of the portal. Whilst this involved some portals in new development work it probably gave all of us an insight into the more heterogeneous fund landscape that we may all be dealing with in future and hence the need for greater flexibility and configurability to adapt quickly and easily to emerging requirements.
Once the immediate pressures had been managed through hard and soft closures those fund providers who had been required to take these measures, and some others who hadn’t, began to take a slightly more strategic look at how they were going to handle what it was rapidly becoming clear was going to be a much more sustained low interest rate environment than everybody had hoped. In some cases this involved introducing new funds, not the typical AAA-rated CNAV funds, but the relatively unknown VNAV funds. In other cases more creative solutions were introduced such as what has now become almost the standard alternative to converting to VNAV, the ‘flexible distributing’ share class, a neat way to allow the CNAV status of a fund to be protected whilst avoiding the potentially damaging effects of negative yields on both investors and fund managers.
Perhaps surprisingly the change to the new flexible share type is easier for portals to handle than the change from CNAV fund type to VNAV. Whilst some portals have always been able to handle both VNAV and CNAV funds a number of them have only been used to offering the latter and hence were unable to handle the new funds, particularly given the different and varying settlement arrangements for VNAV funds. The only real issue with flexible distributing share classes is similar to that surrounding the reporting of accrued interest on portals. Investors ideally want to have daily information about their actual accrued interest month to date rather than estimated interest calculated by applying the published truncated daily dividend factors to daily account balances. In the same way, investors want to know the exact number of shares they are holding and not have an estimate of this calculated by the platform that then requires reconciliation with the fund’s own numbers at the end of each month. This can only be provided by those portals which are fully automated and receive nightly information from each fund, covering actual balances, accrued interest and share holdings.
Other slightly more strategic responses to the mounting pressures facing the MMF industry have been based on attempts to introduce new types of funds, principally focused on trying to deliver better returns in a very low interest rate environment. Obviously there are a limited number of ways to achieve such an objective, principally focused on extending the maturity profile or reducing the credit quality of a fund’s portfolio holdings.
Attempts to gain improvements from extending duration have included the development of fixed return funds where by agreeing to leave their money invested for a guaranteed period of time investors have benefited from the increased yields that fund managers were able to achieve by investing a higher proportion of assets further down the curve. However, whilst liquidity is ranked second behind security in the investment priorities for most corporate treasurers it is still ranked ahead of yield and it appears that most treasurers are still uncomfortable with sacrificing liquidity for a relatively small uptick in yield. This situation probably wasn’t helped by the fact that these types of funds could not be easily added to MMF portals given their fundamentally different operational processes and hence they were not available for electronic trading. In the case of fixed return funds it is likely that this had only a limited impact but as the use of portals continues to grow at such a fast pace there will almost certainly come a point when the ability to trade particular funds on portals will be a significant factor in ensuring the success of new offerings.
Those with a good memory will remember the rise of the ‘enhanced cash funds’ in the period running up to the 2008 financial crisis. Due to some difficulties with these funds at the time they disappeared from sight and in many cases from the fund ranges of most providers. However, the growing dissatisfaction of investors with the continuing low yields being delivered from their current investments has recently given an added impetus to the reappearance of ‘enhanced’ funds offering higher returns by investing in assets of slightly reduced credit quality and in some cases longer duration. At MyTreasury we are increasingly being asked whether we know of any enhanced funds and whether we have any plans to make them available on the platform. The answer is that we are aware of an increasing number of these funds and we bring them on board where there is sufficient client demand.
This particular development has been reinforced by a substantial increase in the number of approaches we have received from providers of other types of funds that have typically not appeared before on any MMF portals. Particularly interesting is the fact that the pending regulatory change in Europe has encouraged the providers of the unrated French Fonds Commun de Placement (FCPs) to consider putting them onto MMF platforms for the first time to take advantage of what they see as the possible break up of the hegemony of AAA-rated CNAV MMFs for institutional investors outside France. There is a perception amongst many fund providers in the offshore space that a combination of both regulatory change and the continuing low interest rate environment is encouraging investors to look more widely for improved performance whilst reducing the perceived barriers to considering anything other than the AAA-rated CNAV funds. The growing interest in ultra-short bond funds and even some ETFs are other examples of this shift in thinking. There is a long and sometimes difficult path between investors commencing market research on alternative fund offerings and securing board approval to begin investing in new types of funds with different risk profiles. However, the emerging view amongst investors appears to be that if they are going to have to secure board approval for using the new version of their traditional MMFs they might as well look at alternatives and seek approval for these as well.
Whatever the outcome of the current developments, MMF portal providers have to be prepared for significant changes that may come along and investors want to select portals that are going to be fit for purpose in a few years’ time and not just today. In view of this the MMF portal industry is currently awash with technology and business development activity designed to allow a broader range of fund types to be offered. It has already reached the position where it doesn’t really matter what the outcome of regulatory change will be as investors have already started to look at broader potential investment opportunities and now have alternative fund types firmly in their focus.[[[PAGE]]]
The implications of regulatory uncertainty and low interest rates have also led many investors to look beyond funds to other types of investment opportunities. These have included standard products such as term deposits and certificates of deposit, and recently tri-party repo has been increasingly investigated as an alternative low-risk option offering the potential for obtaining better yields coupled with secured lending. Not surprisingly this trend has also led to some of the portals entering the race to deliver a single gateway to multiple investment products. The overriding objective for investors is rapidly becoming to be able to rationalise their portal use from single product and sometimes single fund/bank offerings to just one platform that provides global access to all products and all liquidity providers as well as a single integration ‘pipe’ into their own back-office systems. This means that the shelf life of niche MMF portals is rapidly diminishing and all of them will either be required to evolve to meet these challenges of diversification or disappear.
Despite the changes introduced by the funds, the impact of sustained low interest rates in the Eurozone and for US Treasuries has resulted in the widespread need for funds to waive their management fees either in part or in whole to avoid negative net yields for investors. Although the portals have historically been paid fixed fee rates by the funds, the strong downward pressure on their own management fees has led many funds to renegotiate the portal fee structure towards a variable fee based on an agreed percentage of the actual management fee received by the fund after fee waivers. The introduction of MyTreasury as a low cost portal into the MMF market has already led to a reduction in the historically high level of fees charged to the funds by some of the early entrants into the market, and the emergence of fee waivers has further reinforced this trend, particularly in the case of EUR and USD Treasury Funds where fees reached zero in many cases some time ago.
The net effect of this has been that the funds mainly, and to a lesser extent the portals, have effectively borne the ‘cost’ of reduced yields to avoid this impacting investors. In the same way that fund providers have been encouraged to explore innovative ways to address this issue through the introduction of flexible share classes and VNAV funds, there may come a point when MMF portals also have to examine alternative ways of getting paid for the services they provide to investors. Historically trading portals of all kinds have been offered to investors free of charge with the funds paying the portal fees. Whilst the portals were only providing basic trading functionality and a normal interest rate environment prevailed this has been a sustainable business model, albeit not particularly popular with the funds themselves.
However, as low interest rates have continued and the services provided by portals have extended beyond simple trading into areas such as risk management, consolidated reporting, portfolio analytics, back office integration and auto-settlement there has been growing pressure for at least some of the revenue raised by the portals to come from investors rather than only the funds. There is an argument that, if corporates are prepared to pay for their treasury management and other back office systems, why should they not also pay for the added value they increasingly receive from trading portals above and beyond the ability to simply communicate a trade. Whilst this view may be shared by one or more of the portal providers, the reality is that it would be extremely difficult for any platform to act unilaterally in this way. There is a well documented example in the FX market of a portal attempting to introduce fees on the corporate side, unwittingly generating the most significant and rapid rise in the number of customers ever experienced by its closest competitor. But whilst it may be difficult to see this happening in the foreseeable future the inability of the funds to carry on paying sustainable fees to the portals as their own management fees continue to come under pressure may eventually force portal providers to look to their users to fund the development and delivery of the increasingly sophisticated range of added-value services they are constantly striving to provide. Alternatively, an increase in interest rates may come about before the current portal business model becomes unsustainable and this issue will be put back in the cupboard for the time being at least.
In combination all the factors identified above are leading to a process of consolidation across the three major parties involved.
Consolidation on the investor side is coming about in terms of the rationalisation of their use of trading portals as investors increasingly move from using single fund/bank, single product portals to multi-fund/bank multi-product portals. This process will continue until investors can first trade all their standard investment products electronically via a single platform and then gain access to more complex voice-brokered trading capabilities through hybrid platforms as well as having a range of additional services such as market data analysis and OTC derivatives trade portfolio reconciliation capabilities being delivered via their portal.
On the fund side we have already seen significant consolidation since the financial crisis of 2008 and the impact of regulatory uncertainty and low interest rates has seen some more recent M&A activity. Two of the major UK bank fund managers have been acquired very recently. As the risk and cost of running these funds increases whilst the return from doing so continues to decrease it may be inevitable that we see further fund consolidation.
And finally some of the niche MMF platforms are lagging behind in the race to deliver multi-product multi-bank/fund at the moment: it appears highly likely that there will be a rationalisation in the portal market to mirror the one that is taking place in the fund market. The likely outcome will be the emergence of a smaller number of large, global, multi-product multi-bank/fund platforms that meet all the needs of their users, including FX as well as MMF and other money market instrument trading.
It is not yet clear who will be the winners in this race but for obvious reasons it is highly likely that they will be already large global organisations with existing activities across the full range of product and service offerings which these ‘super-portals’ will be providing.
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