Any treasurer with a European domiciled money market fund (MMF) will know that established MMFs have until 21 January 2019 to comply with European Regulation (EU) 2017/1131 on MMFs (the MMFR).
An excellent overview of the MMFR changes to fund types was provided by David Passarinho, Huawei Global Finance UK.
Of the three types of product funds, low volatility net asset value (LVNAV) funds will effectively report a stable net asset value (as with public debt constant debt net asset value (CNAV) funds), but will have to convert into variable net asset value (VNAV) when the mark-to-market value per unit deviates by more than 20bps from the constant asset price.
In a negative interest rate environment, CNAV funds currently use an operational mechanism to maintain a stable net asset value. Known as the reverse distribution mechanism (RDM), it is basically a standing redemption request from the investor to the fund manager to redeem and cancel the required number of their shares to offset the negative interest rate. Conversely, in a rising interest rate environment, income is paid out to maintain the stable net asset value.
The European Commission’s view is that RDM is not compatible with the legal framework established by the MMFR. This was first raised as an issue by the European Securities and Markets Authority (ESMA) in May 2017 and, after an extended period of uncertainty, the Commission and ESMA have only recently clarified (late November 2018) that the widely accepted practice of RDM will not be allowed under the new regulation.
No RDM means that euro currency funds cannot be LVNAV (with a distributing, ie, stable value share class) once the regulation becomes effective. Whether the regulators and ESMA will give fund managers an extension of time post the 21 January 2019 date to adjust their fund ranges remains to be seen. LVNAV funds may be possible in euros, but with accumulating (‘decumulating’) share classes only, rather than the distributing share classes most treasurers prefer.
Corporate treasurers who currently invest in EUR CNAV funds and who were planning on transferring to a EUR LVNAV fund will need to consider their investment options: potentially switching to LVNAV that has an accumulating share class; switching to a VNAV fund; or finding an alternative investment product.
For those who go down the VNAV route, remember to check: does the treasury policy allow, and is the board comfortable with, their cash investment being reported on a mark-to-market basis? Will the auditors allow a VNAV investment to be accounted for as a cash and cash equivalent on the balance sheet?
It is anticipated that fund managers will offer other products in place of the euro LVNAV distribution share class, once the ban on RDM becomes effective.
Michelle Price is an associate director in the ACT’s policy & technical team