An agreement, which has finally been reached on European money fund regulation between the European Union (EU), Parliament and Council after three years of debate, is likely to limit their appeal says Fitch Ratings.
The crediot ratings agency (CRA) notes that the EU’s decision to impose liquidity fees and redemption gates on many money market funds (MMFs) in its new regulatory regime will create uncertainty about future patterns of investor demand.
But Fitch’s analysts do not expect market disruption of the same scale as in the US. The impact “will be mitigated by the introduction of a new class of MMF and European funds that invest in government debt will be less attractive to investors than their US equivalents,” they predict
The rules agreed by the European Commission (EC), Parliament and Council after three years of debate, mean constant net asset value (CNAV) funds will cease to exist in their current form and will be limited to holding government debt. Low-volatility NAV (LVNAV) funds are introduced as a new compromise form that will operate close to CNAVs while holding a wider range of assets. They will co-exist with variable NAV (VNAV) money funds.
The implementation of liquidity fees and redemption gates for public debt CNAV and LVNAV funds is a key feature of the regime. These are intended to limit customer redemptions in times of stress. But many investors, particularly corporate treasurers, may be unwilling to accept the risk they will not have immediate access to their funds on demand.
Fees and gates were also introduced in the US, but not for government-only CNAVs. Around US$1.1 trillion, 74% of assets, moved out of traditional prime US MMFs and a similar amount moved into government MMFs in the 12 months before the rules took effect. The sharp drop in demand for short-term bank and corporate debt pushed up the London Interbank Offered Rate (Libor) and steepened the yield curve.
Fitch expects the market impact of the European reforms to be smaller because the fees and gates on European CNAV government funds will make them less attractive than in the US. In addition, the US system only allows two options, CNAV government funds or VNAV. European investors accustomed to CNAVs, which account for half of EU MMF assets, may be comfortable with the LVNAV form.
LVNAVs can hold a broad range of assets, so money flowing into these funds would not affect the balance in demand for short-term government, corporate and bank debt. Fund managers are likely to launch LVNAVs and adapt their existing fund ranges into the new categories during the 18-month implementation period. Their efforts to educate and inform investors of the changes during this time are likely to be critical to the success of these funds.
The final version of the European regulation does not include a sunset clause on LVNAVs. This would have only allowed LVNAVs to operate for five years, which we believe would have put off many firms from launching LVNAVs. The final rules on minimum weekly liquidity also provide more flexibility on eligible assets, which should make liquidity requirements manageable given the scarcity of ultra-short-dated asset supply, notably from banks, owing to their own prudential regulatory requirements.
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