While corporate treasurers have been enjoying the period of higher interest rates, they are also keeping a close watch on how these rates will move over the rest of the year. Therefore, in this current economic environment, corporate treasurers remain motivated to explore low-cost ways to generate return on cash.
Money market funds (MMFs) continue to play a critical role for treasury professionals with a growing awareness that MMFs are not just a holding station for cash but can offer significant benefits including daily liquidity to meet their short-term cash management needs, shelter from market volatility in equity or longer-term bond investments and, crucially, in a higher interest rate environment, still deliver compelling yield.
Over the last nine months, investors in UK MMFs have typically received a return comfortably above the return on two-year UK gilts, representing an attractive premium for corporate treasurers over bank deposits, without the relative capital risk.
MMFs also are increasingly attractive to a wide range of other investors including the public sector, higher education and charities, issuers, and those who benefit from the activities of both the public and private sector entities that access the short-term funding markets. In particular, low-volatility net asset value (LVNAV) MMFs are valued products that have served investors, issuers, and markets incredibly well since their inception.
As a result, globally, MMFs, whether sterling, euro, or dollar-denominated, have gained sizeable inflows over the last couple of years on the back of the sharp rise in interest rates, with US MMFs reaching an all-time high of more than US$6tn earlier this year. This asset class growth has, understandably, attracted the attention of regulators.
Since the 2008 Financial Crisis, the EU has adopted a dedicated regulatory regime for MMFs that enhanced the safety and resilience of UK and EU MMFs and provided immediate and observable benefits during the turbulent markets of March 2020, caused by the COVID-19 liquidity crisis.
Although the short-term funding markets experienced significant challenges then, UK MMFs and EU MMFs proved incredibly resilient; no MMF in the UK or EU needed to suspend redemptions or impose fees and/or gates, nor when facing a raft of other once-in-a-lifetime market dislocations, such as Russia’s invasion of Ukraine with its cataclysmic effects on energy prices, global inflation and rising interest rates.
Notwithstanding the successful management of MMFs in the UK and EU, the data does support the argument for specific reform enhancements that could be implemented to enhance the safety and resilience of MMFs. To this end, the Financial Conduct Authority (FCA), in close cooperation with the Bank of England (BoE) and HM Treasury (HMT), proposed several new provisions in a consultation paper on 6 December 2023 (FCA CP23/28, Updating the regime for Money Market Funds).
In particular, the FCA proposed to remove the link between minimum liquidity thresholds and the imposition of liquidity management tools. It is widely understood that this link accelerated investor redemption activity as certain MMFs approached liquidity thresholds during the Liquidity Crisis. This regulatory constraint also necessitated MMFs’ need to divest longer-dated securities for securities that qualified as weekly liquid assets.
The delinking of minimum liquidity thresholds and the imposition of liquidity management tools will allow MMFs to utilise all their available liquidity as intended
As a general matter, while MMFs hold highly liquid assets, MMF managers do not typically sell assets to meet redemptions. Redemptions are generally satisfied from cash balances and the use of proceeds as short-term securities mature. As such, although UK MMFs held sufficient liquidity to meet all redemption requests during the liquidity crisis, sales were nevertheless made purely to ensure weekly liquidity levels remained above the 30% weekly liquidity asset requirement.
The delinking of minimum liquidity thresholds and the imposition of liquidity management tools will allow MMFs to utilise all their available liquidity as intended. Indeed, each of the FCA’s proposed measures, including its proposal to increase the minimum liquid asset requirements for all MMFs, should be analysed with the understanding that the improper linkage will be removed.
As a result, Federated Hermes does not believe it is necessary to mandate higher levels of liquidity for LVNAV MMFs. Removing the link between liquidity requirements and the potential imposition of fees and gates provides an additional 30% liquidity (and more in practice) effectively rendered unavailable during the liquidity crisis.
In our view, the FCA’s proposal to require an additional 20% weekly liquid asset requirement, on top of the soon-to-be-unencumbered 30% weekly liquid requirement, would unnecessarily reduce the spread in yield for UK LVNAV MMFs, reducing yields to investors, shrinking the UK MMF industry, and increasing the costs of funding to private companies and financial institutions. In our opinion, unduly impacting investors and increasing borrowing costs are not warranted or supported by any data.
We are supportive of a data-driven approach to regulation that will enhance the safety and resilience of MMFs and welcome the FCA’s decision to allow the existing MMF structures to continue, including the stable NAV feature of LVNAV and public debt MMFs. Further, we welcome any additional proposals to improve stress testing, know your client, and transparency throughout the marketplace.
The FCA’s proposed provisions would be included as a new MMF sourcebook in the FCA’s Handbook, revoking parts of the UK MMF Regulation. It is critically important that the FCA, together with HMT, the BoE, and other relevant stakeholders, seek a balanced approach that allows UK investors to maintain their access to UK MMFs while at the same time guaranteeing a level-playing field between EU and UK-domiciled MMFs.
Regulatory developments for MMFs are not limited to the UK: in the EU, policymakers also are calling for a comprehensive assessment of the EU regulatory framework for MMFs. We welcome this assessment and look forward to engaging with policy-makers to ensure MMFs continued resilience both in the UK and in the wider EU market, as corporate treasurers continue to value MMFs’ ability to deliver market-based rates of return, while offering the flexibility which sets them apart from other fixed income and equity investments.
Debbie Cunningham is CIO global liquidity markets and Dennis Gepp is head of European regulatory affairs at Federated Hermes