It Ain’t Over Till Its Over – European Money Market Fund Reform Continues

Fund managers implementing money market fund (MMF) reforms are having to deal with last-minute changes requested by regulators. The reforms were meant to be concluded by January this year, but have now been pushed back to March.

If investors shy away amid any potential resulting disruption, this would be negative for the industry given that fees are largely based on assets under management. However, the impact on individual funds should be limited as this is a short-term operational issue and liquidity levels are generally strong.

The reforms were originally due to be applied from January 21. They have now been delayed for two months after regulators in Ireland and Luxembourg, which oversee the bulk of European MMFs, announced on January 11 that applications for funds to operate under the new rules would have to be resubmitted. The regulators now want the applications to give details of how funds will cease the use of share cancellation by March 21 2019. Share cancellation is routinely used by euro-denominated MMFs to maintain a stable net asset value per share while short-term euro interest rates are negative. US dollar and sterling-denominated MMFs have not used share cancellation, given the positive short-term rates for these currencies.

This was short notice for many MMFs given that some reform conversions had already occurred and many more were scheduled for mid-January 2019. Fitch Ratings estimates that the conversion of more than EUR280bn of European short-term prime MMFs will now be delayed. About 25% of this is euro-denominated.

A number of non-euro conversions unaffected by share cancellation went ahead in January as planned. BlackRock and Aberdeen Standard Life converted their non-euro MMFs, and Federated converted its sterling and US dollar funds. Barings and BNY Mellon also converted their USD funds. Fitch Ratings affirmed the ratings of converted funds following confirmation there had been no adverse investor movements applying pressure on rating criteria metrics.
The decision to end share cancellation by March 21 means there are fewer choices for investors in euro-denominated funds than in funds denominated in other currencies. While investors in sterling and dollar funds have full optionality of distributing and accumulating share classes, euro investors will have access only to accumulating share classes in low volatility net asset value (LVNAV) funds, at least while short-term interest rates stay negative. Fitch Ratings estimates 80% of euro-denominated short-term prime MMFs are awaiting conversion. The vast majority of their assets under management relate to distributing share classes – a clear sign that euro investors prefer stable net asset values.

Several fund managers have published plans for their euro short-term MMFs. Some are opting to have only accumulating shares in LVNAV funds (perhaps better described as decumulating, while rates are negative). Some others are planning LVNAVs with distributing share classes that switch to accumulating in a negative yield environment.

Euro funds experienced outflows at the start of the year, but we at Fitch Ratings think it would be wrong to attribute these to the late change of position by regulators. MMFs show seasonal flow patterns and January’s flows were similar to those at the same time last year. What’s different, however, is the positioning of the funds. Portfolios this year are more conservatively positioned, with high liquidity levels – no doubt in readiness for conversion.