- Charlotte Quiniou
- CFA, Director, Fund and Asset Management, Fitch Ratings
by Charlotte Quiniou, Director, Fund and Asset Management, Fitch Ratings and Li Huang, Associate Director, Fund and Asset Management, Fitch Ratings
In December 2015, the China Securities Regulatory Commission (CSRC) announced new rules on money market funds, showing some convergence with international standards, notably with the introduction of liquidity requirements.
The new regulations strengthen industry practices, foster greater investor protection and lower risk through the introduction of liquidity requirements, broaden their investment scope, implement liquidity fees and gates, and specify the actions expected in the event the net asset value (NAV) deviates from predetermined limits. Nonetheless, regulations still permit Chinese money funds more latitude in taking investment risk than European and US money funds.
Until now, the Chinese regulation had not set out specific liquidity requirements. The new rules require Chinese money market funds to hold a minimum of 5% of assets in cash, government bonds, central bank bills and policy bank bonds and a minimum of 10% in the above-mentioned assets plus assets maturing within five trading days. Furthermore, non-tradeable assets maturing in more than 10 business days should not exceed 30% of the portfolio. In comparison, money funds operating in the US are currently required to maintain 10% of their portfolios in assets that mature overnight and 25% in assets that mature weekly; similar practices are followed by constant NAV European money funds.
The CSRC has also reduced the funds’ leverage ratio to 20% from 40%. Leverage is rarely used by money funds in developed markets - it is not allowed in the US and limited to 10% under the European UCITS (Undertakings for Collective Investment in Transferable Securities) regulation. The regular use of leverage by money funds is inconsistent with Fitch’s rating criteria for ‘AAAmmf’ on the international scale and similarly for ‘AAAmmf(chn)’ rated funds on the Chinese national money fund rating scale. As such, no money fund rated by Fitch in China currently employs leverage.
Permitted investment in NCDs
From February 2016, Chinese money funds may invest in negotiable certificates of deposit (NCDs), which should provide the funds with greater issuer diversification and access to an instrument that is tradeable in the secondary market. The market is, however, relatively new, and the ability of funds to effectively trade these securities, notably during periods of market stress, remains untested. Nonetheless, unlike most instruments typically held by Chinese money funds, NCDs are marketable securities, which would support a portfolio’s secondary-market liquidity. NCDs are eligible investments for Fitch-rated Chinese money funds if the certificates meet the agency’s criteria set out in its ‘National Scale Money Market Fund Rating Criteria’, dated 24 April 2015. Chinese money funds’ ability to invest in NCDs also grants them access to a broader universe of issuers.
Money funds’ use of NCDs is unlikely to have a material effect on credit quality despite a broader issuer pool, as the primary issuers of NCDs are banks with which money funds already transact. The new regulations do allow money funds to invest in lower-quality corporate bonds more than it used to. Fitch takes into account issuer credit quality in its assessment of a money market fund’s rating. Under Fitch’s criteria for ‘AAAmmf(chn)’ funds, issuers must be rated at least ‘A-’ by Fitch or another international rating agency. [[[PAGE]]]
New rules require the asset managers to set up an internal liquidity risk management system and charge a 1% fee in case a single shareholder redeems more than 1% of the fund’s assets when the five-day liquid assets (cash, government bonds, central bank bills, policy bank bonds and assets maturing within five trading days) on that day are below 5% of the fund and the NAV deviation is negative.
Asset managers may partially meet or delay the redemption if a single shareholder redeems more than 10% of the fund on a single day. The liquidity fee and gates should be specified in the fund purchase contract.
The CSRC shortened the maximum weighted average maturity (WAM) to 120 days from 180 days, and for the first time set a maximum limit on the weighted average life (WAL) of 240 days. In comparison, European and US money funds operate with maximum WAM and WAL of 60 days and 120 days, respectively. Concentration limits are updated as well. For example, aggregated time deposits should not exceed 30% of a fund.
Although current regulations still permit Chinese money funds more latitude in taking investment risk than European or US money funds, we believe this is a positive step and the new regulations will strengthen industry practice and reduce risk.
