New US institutional money market fund rules will come into effect over a couple of years. But expect funds and investors to change much faster than that. And we have new rules to look forward to in Europe in due course. Non-financial corporates have opposed new money-fund rules. But now they have to live with them.
The prime or liquid funds, offering daily liquidity of investments, with dollar for dollar redemptions (“constant net asset value” – CNAV) that companies mostly use are affected. The Rules are effective in two years.
The first big change in the US is that redemption values must float.
In normal circumstances, floating redemption values (“variable net asset value” – VNAV2) would be very close to dollar for dollar. So, over time, for a steady level of investment, it may even out. But life is not like that – and people value losses more highly than gains… However, the US tax man has promised to bring in sensible tax treatments (and UK tax advisors generally say they expect similar sense in the UK). And European offices of the big accounting firms say that under IFRS the expectation that cash will be returned dollar for dollar means that shares in money funds will still be able to be treated as cash equivalent.
So, if all that’s confirmed, I’d say the biggest issue with floating values is the treasurer’s need to explain them to their board in the context of their investment policy. Come on guys, time for those communications skills.
The second change is that if liquid assets (up to one week liquidity) make up less than 30% of assets, the fund may suspend redemptions (“gates”) for up to ten days and impose a redemption fee of up to 2%. Not likely in “normal circumstances”, but a risk. And if liquidity falls to less than 10% the fund must generally impose a fee of 1%.
Actually, funds could always suspend redemptions – but then had to go into “orderly” liquidation. So we can see the new rules as a relaxation here. But more explaining to Boards and investment policy amendments needed by corporates.
Corporates tend to use money funds as a way to spread their risk in a convenient way over a portfolio of banks (few funds hold much if any corporate commercial paper) rather than the few banks they know and (?) love. If one or two banks get into trouble, a company invested in a fund would probably lose a little. If it had any significant concentration in one of the failed banks in direct investment, it might lose rather more.
Investing in a fund, though, it risks liquidity as well as value while the fund sorts itself out. So there is an incentive for investors to bail out from a fund, before it needs to impose restrictions – adding to the risk to other investors as the fund uses up liquid assets to make the repayments. A great incentive to be first out. It does seem that the objective of making runs on money funds less likely has been totally overlooked.
The new rules also require more disclosure by funds (notably, daily, of NAV) and stronger diversification and stress testing that investors will appreciate. And rules will be brought in to eliminate the requirement for money funds to use credit ratings in portfolio selection – to which investors are likely to be indifferent as investment policies are unlikely to change.
Some companies will live with the changed risks – more explicit in future but probably not much different from those they currently run. Others may spread investment over more funds – but how different would those funds’ portfolios be? Maybe they will seek to reduce the risk of loss of access to their money by having fund managers run segregated funds (“liquidity funds” – essentially private, unregistered money funds) for them alone.
Some treasurers may shift more liquid funds investment to banks directly – but they are not really bank credit analysis specialists and they have a lot of risk with the banks they deal with on a daily basis anyway. More firms may look to secured deposits (reverse repos3). Some may start to buy more corporate commercial paper. They may start to buy more government bills for their own account where that’s possible.
The financial services industry being what it is, expect some new products to be designed for offer to treasurers, though there is some worry about the future attractiveness to managers of running some money funds.
All treasurers will have to review their investment policies. They have had a couple of year’s notice of changes in the pipeline. The new rules are not applied instantly. No panic.
And what about the pending new European rules? Well the new Parliament and Commission will deal with proposals carried over from earlier this year.
The US explicitly keeps types of CNAV funds representing 54% of US current prime CNAV funds and 75% of CNAV fund assets. European rules under discussion are mostly similar to the new US rules though they would apply to all funds. They may allow CNAV funds if they start to hold capital (3%) as a buffer against valuation fluctuations. Needing to earn a return on that capital just about kills the CNAV model anyway - especially at present interest rates. Note that sovereign-only funds have not really developed in Europe and it is very difficult for corporates to buy government bills directly.
New regulations make short-term wholesale deposits generally less attractive to banks. UK companies face the issue of getting banks to accept their liquid funds in any form, at all or at a reasonable or even any rate and especially over month, quarter and year ends. Negative interest rates on cash with banks seem a real possibility. In Europe too. Probably the real cost of carry of cash is not that much different from that in the recent past. But until rates become significantly positive, it is more noticeable.
So cash management will remain a live topic – on both side of the Atlantic.
Footnotes
1. US funds investing just in US federal government obligations are unaffected – though funds can adopt the new rules if they wish. In the past, corporates have used them little. Maybe they will use them a bit more – but supply is limited. And retail and retail related funds are exempted too. Funds investing in US municipal obligations, though, are caught.
2. Some of the press has newly started to use “FNAV”, for “Floating NAV”. Time will tell if it catches on.
3. See ACT Repo briefing note: http://tiny.cc/fqqhow.
External link
The US AFP has ten tips for reviewing use of US money funds (registration required): http://www.afponline.org/mbr/reg/res/reg_news/10_Steps_Every_Treasurer_S...
