Regulatory Change and Unintended Consequences

The MMF industries in the US and Europe are highly regulated, particularly following the global financial crisis of 2008. The funds have required liquidity levels, and investors can face additional costs and fees if their movement of cash out of a fund has a detrimental impact upon it. The first significant test of these rules came in March 2020’s short sharp liquidity shock. Every area of the financial system witnessed extreme drawdowns on liquidity. And yet, as ICD analysis in May 2020 found, MMFs did not ‘break the buck’ despite this intense pressure.

Regardless, regulators on both sides of the Atlantic are again considering regulatory reforms for MMFs in ways that could challenge the viability of certain MMFs should the proposals become law.

As François Masquelier, CEO, Simply Treasury, and Chair of EACT and the Luxembourg Corporate Treasury Association (ATEL) remarks:

“Overregulation is the enemy of good intentions. You might make the product very resilient by ring-fencing it but risk turning it into a fortress that nobody wants to enter.”

A swing and a miss in SEC proposals

In the US, the Securities and Exchange Commission’s (SEC’s) proposed amendments would increase liquidity requirements for MMFs to provide a more substantial liquidity buffer in the event of rapid redemptions. The proposals also would remove provisions requiring an MMF to impose liquidity fees or to suspend redemptions through a gate when a fund’s liquidity drops below an identified threshold. Certain reporting requirements would also be amended to enhance the transparency of funds.

Most controversially, the proposals require institutional prime and institutional tax-exempt MMFs to implement swing pricing policies and procedures that would require redeeming investors, under certain circumstances, to bear their redemptions’ liquidity costs.

Daniel LaRocco, Director, Money Markets, Northern Trust Asset Management (NTAM) comments: “The biggest point of consternation for the money market industry is the introduction of swing pricing for US institutional prime and municipal MMFs. How it’s designed creates a mass of complexity and new mechanics for investors to understand. These complexities will not be palatable for the typical money market investor.”

He continues: “Our philosophy for all investment asset classes is to ensure investors are compensated for the risks they take. One of the risks with swing pricing is, on any given day, if there are net redemptions on that day, then the fund is obligated to implement a swing price that is supposed to represent the liquidity profile of that portfolio. Effectively, investors will not know the exact dollar price they are getting out of that liquidity fund until the end of the day.”

In this scenario, a treasurer may have a sale order early in the morning, only to find at the end of the day that the fund had a net redemption, meaning a swing price would have to be implemented. That creates the possibility of confusion around the precise level of liquidity a treasurer is going to get on any given day. In turn, this makes cash forecasting much more difficult.

“The swing price is designed to benefit those investors that stay in the fund, but it makes their lives even more difficult,” notes LaRocco. “The usual ‘dollar in, dollar out’ constant NAV [net asset value] that the money market industry has thrived on for five decades would fall by the wayside because all these new complexities will make that fund much less predictable. Swing pricing will ultimately kill the institutional prime and municipal part of the market.”

At the end of July 2022, the US MMF industry was worth approximately $4.5tr., of which only about 10% was in prime strategies. The complexity added by swing pricing, which presents risk because corporates may not have enough liquidity to meet their liabilities or obligations, means treasurers are not being compensated for that risk.

“When we ask corporate treasurers if there is a level where they are compensated for that navcomplexity, many say there isn’t a price,” reveals LaRocco. “If performance is 30 basis points better going to a credit fund with swing pricing, is that enough? Those treasurers we are speaking with will not be compensated for that level of complexity, specifically with swing pricing.”

European stable NAV funds feel the heat

In Europe, there are two critical targets for the proposals being weighed up by the European Commission (EC). One addresses liquidity by ensuring the mandatory availability of at least one liquidity management tool for all MMFs. It also suggests amendments to the daily liquid asset/ weekly liquid asset ratios and the inclusion/ reinforcement of the possibility of temporarily using liquidity buffers in times of stress.

The other main target of the reform proposals is to address the threshold effects for constant net asset value (CNAV) MMFs by decoupling regulatory thresholds from suspensions, gates, and redemption fees for low volatility net asset value (LVNAV) and public debt CNAV (PDCNAV) MMFs, and removing the possibility of using amortised costs for LVNAV MMFs.

Veronica Iommi, Secretary General, Institutional Money Market Funds Association (IMMFA), comments: “The effective prohibition of the stable NAV component of the LVNAV fund type is something that IMMFA strongly opposes on the basis that it’s not evidentially supported and that it would have deeply negative implications for investors such as treasurers who value the utility of the stable NAV LVNAV. It’s imperative to preserve investor choice, and we do not feel that the experience of funds during the crisis warrants the effective suppression of the LVNAV fund type.”

The current ability for an LVNAV MMF to round the NAV per share to one offers investors operational utility. That utility is offset by the product’s higher daily and weekly requirements compared with the other regulatory structures introduced in 2019. This fund construction is popular with treasurers and other cash investors.

“The ability to trade in and out at an agreed price of 1.00 is a vital part of the utility of the LVNAV – it is predictable, which means that the fund type can be designated ‘cash or cash equivalent’ for accounting purposes,” comments Iommi. “Converting to a floating or variable NAV would greatly increase uncertainty around the accounting treatment.”

Industry rallies to advise regulators

While potential regulatory changes seem a long way off, the critical time to engage with regulators is now. Stakeholders from treasurers to fund providers and MMF portals have already been stating their cases.

“We were the first large money fund complex to file a comment letter with the SEC about the proposals,” recalls LaRocco. “Over the years, we’ve strived to be ahead but also to be balanced with the pros and the cons of different approaches. This resonated well because we’ve had the opportunity to engage with various regulators about the markets and put some context around potential unintended consequences. That ability to represent our investors’ views gives us a lot of pride.” Masquelier adds: “The EC is interested in hearing from treasurers because we are the real economy. They’re keen to know what our views are.”

Iommi agrees: “If treasurers want to preserve the utility of MMFs and investor choice, the key time to speak out about this is right now. I strongly encourage treasurers and issuers to engage actively and ensure their voices are heard loud and clear by key regulators and policymakers.”

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