Short-term Investments: Making Sense of the Shake-up
By Eleanor Hill, Editor
As the implementation date for the new European Money Market Fund (MMF) rules approaches, it is time to cut through the noise around the new regulation, says Kerrie Mitchener-Nissen, Head of Product Development, International, Global Liquidity, J.P. Morgan Asset Management. In this interview, she dispels some of the common misconceptions about the new rules and explains what treasurers really need to consider when it comes to their short-term investment options.
Eleanor Hill, Editor, TMI (EH): Could we start with a brief recap of the regulatory change happening in the MMF space. What are the major developments here?
Kerrie Mitchener-Nissen (KMN): Designed to further strengthen the MMF industry, provide transparency of information to investors, improve regulatory reporting, and ensure consistent practices around areas such as stress testing and credit analysis, the new European MMF regulations must be fully implemented by 21 January 2019. As we head towards that deadline, asset managers are updating their product offerings in line with the new rules – and corporate treasurers must reconsider their short-term cash investments.
By way of a brief summary, the new regulations provide for two types of MMF and three structural options. Under the new rules, MMFs must be classified as either a ‘Short-term MMF’ or a ‘Standard MMF’. The former are funds that maintain the existing conservative investment restrictions currently provided under the ESMA Short-Term Money Market Fund definition, including a maximum Weighted Average Maturity (WAM) of 60 days and maximum Weighted Average Liquidity (WAL) of 120 days. Meanwhile, so-called ‘Standard MMFs’ reflect the existing ESMA Money Market Fund definition, including a maximum WAM of six months and maximum WAL of 12 months.
As for structuring, Short-term MMFs may be structured as Public Debt Constant Net Asset Value (CNAV) MMFs, Low Volatility NAV (LVNAV) MMFs or as Variable NAV (VNAV) MMFs, whereas Standards MMFs are all VNAV (see Figure 1).
Fig 1 - Comparison of Short-term and Standard MMFs
EH: What do treasurers need to be aware of around these changes? What will the impact be on their short-term investment options?
KMN: While the concept of MMFs is not changing per se, treasurers may find some of the new structures and terminology a little alien to begin with. When you look under the hood, however, things become clearer. The Short-term LVNAV MMF, for instance, is broadly similar to the Short-term CNAV MMF that treasurers have long relied on as a home for their short-term cash. Although it is worth remembering that, under the new rules, the CNAV label will be reserved for public debt MMFs only.
The Short-term VNAV MMF may be less familiar to some treasurers. While the concept of a floating NAV may seem daunting, these funds have been around in Europe for a number of years and are used by many corporates. They are able, however, to invest slightly differently to current CNAV funds, with a lower percentage of daily and weekly liquid assets (see Figure 1).
The standard money market fund, meanwhile, sits further up the yield curve than Short-term MMFs. In theory, this means that treasurers could stand to achieve a slightly higher return, but Standard MMFs also take more risk – so the return could also be lower.
EH: Could you give some examples of the level of risk inherent in a Standard MMF? And, given the additional risk, are these products really suited to the investment needs of a corporate treasurer?
KMN: A Standard MMF can invest in longer-dated instruments – up to a two-year maximum maturity, compared with 13 months for Short-term MMFs. Standard MMFs also tend to have higher liquidity risk. Moreover, funds in this category could potentially invest in non-base currencies and need to hedge back that exposure. Equally, they could invest in other funds to synthetically create liquidity, or make use of leverage to enhance their returns.
Together, these factors mean that, in my view, a Standard MMF is not a suitable product for working capital. For that segment of cash, treasurers need a low-risk product that offers instant access to their cash – like a Short-term MMF. That’s not to say that Standard MMFs do not have a role to play in the short-term investment landscape, but that they are perhaps better suited to strategic cash.
In other words, investors need to fully understand the risk they may be taking with the corporation’s short-term cash if they simply invest according to basic regulatory classifications. Standard MMFs are not really MMFs as treasurers currently know them, and it would be a mistake to invest in one based on the assumption that all MMFs are low-risk.
EH: Speaking of understanding risk, what do treasurers need to know about labels like ‘enhanced cash’ and ‘cash plus’ that are attached to some MMFs today?
KMN: That’s a great question because there is currently no consistent definition of these kinds of terms. They can mean different things to different people. As such, treasurers would do well to be even more cautious than usual whenever such terms are used – there is a definite need to dig below the surface to understand what is causing the fund to be ‘enhanced’ and what that means from a risk and reward perspective.
Fortunately, I think we may see less usage of such terms in the future as the new MMF rules will make it more difficult for such labels to be applied – which is positive for investors and the industry.