EU talks towards finalising reforms of the region’s money market funds (MMFs) sector must soak up lessons from how similar changes have played out in the US, according to Fitch.
In an 18 October statement, the ratings agency noted that recent changes to America’s MMF rules had sparked a mass exodus from ‘prime’ – ie, corporate and banking – funds, with investors migrating towards government debt in droves.
Following a mid-June internal agreement of its reform package for Europe’s MMFs, the European Council will shortly enter ‘trialogue’ negotiations with the European Commission and Parliament to finalise the continent’s new framework.
One of the most significant effects of the regulatory overhaul would be to introduce three, new MMF categories:
Europe’s MMF reforms are part of ongoing legislative efforts to strengthen the financial system against shocks, following the crisis of 2008.
Fitch pointed out: “The fact that US reforms triggered a systemic asset flow will be an important factor in the European regulatory debate.
“It may lead to slower implementation, or other measures to try and limit similar distortions in Europe. In particular, it could support the adoption of LVNAV funds.”
Those funds, the agency said, “would be able to invest in corporate and bank debt, and could offer a viable alternative to constant net asset value (CNAV) funds, if adopted as permanent – rather than the temporary solution initially proposed by the European Parliament.”
In the US, Fitch noted, “the implementation of liquidity fees and redemption gates for prime funds, but not for government funds, is the main drawback for liquidity investors, helping drive the massive shift to government assets.
“The latest European proposal would subject government funds to the same liquidity and redemption-gate mechanism as LVNAV funds, limiting the relative attractiveness of government funds.”
The agency warned: “If European reforms did prompt a similar asset switch, then returns on European MMFs could be driven even lower. With yields already negative on euro-denominated funds, further pressure could lead to investor withdrawals.”
Brexit, Fitch stressed, would form another, crucial influence in the forthcoming talks. “The regulation is in its final, ‘trialogue’ stage, during which the EU Commission, Parliament and Council need to agree a final text,” the agency said. “Brexit could prolong the process, as regulators and lawmakers will have significantly less time to devote to MMF reform.”
It added: “They may also wish to avoid implementation coinciding with the UK’s exit from the EU, which could be in the first half of 2019 if the UK implements Article 50 by March 2017. MMF regulations would probably have an 18-24-month implementation period, so a swift agreement could see the timings clash.”
In the interval, Fitch noted, MMFs on a global level will essentially operate in a two-speed world.
“A ‘prime’ fund in the US will have to operate with a variable NAV and potentially be subject to liquidity fees and gates,” it said. Meanwhile, a “Europe-domiciled dollar fund with an identical portfolio will be able to operate with a constant NAV, and investors will face less risk of fees and gates.”