Just under US$5 trillion of assets were held in money market mutual funds (MMF) by the end of 2Q11, according to a report by the European Fund and Asset Management Association (EFAMA) and US-based Investment Company Institute (ICI). These assets were held in a range of product types and currencies, and domiciled in 42 countries around the world.
The report shows that assets held in MMFs are concentrated in three main markets: first, the US, with US$2.7 trillion (55%); second, in countries adhering to the Code of Practice of the Institutional Money Market Funds Association (IMMFA), with US$648bn (13%); and third, France, with US$532bn (11%). French and IMMFA funds are registered as UCITS under EU regulation, with the latter principally domiciled in Ireland (US$456 bn1) and Luxembourg (US$192bn2).
Although the markets described above hold the lion’s share of global MMF assets, smaller but thriving MMF industries exist in many countries around the world. As securities industry and banking regulation has evolved in developing countries such as China, India and Brazil, so have new domestic industries for MMFs.
The Major Markets
The MMFs industry in the US is mature and well-established, with products following a blueprint mandated by the Securities & Exchange Commission (SEC) and enshrined in Rule 2a-7 of the 1940 Investment Company Act. US-based MMFs seek to maintain a stable US$1.00 constant net asset value (CNAV) per share at all times. IMMFA funds are typically offered as CNAV products closely resembling Rule 2a-7 MMFs, but often with two types of share classes: the majority, known as ‘distributing’ classes, declare daily income as dividends, which is then paid out as cash or reinvested in new shares on a monthly basis; the rest, termed ‘accumulating’ classes, add daily income to principal, thereby resulting in a steadily increasing share price.
Figure 1: Global Money Market Fund (MMF) Assets Under Management 2Q11
By contrast, MMFs offered outside the US and IMMFA industries can be relatively diverse in structure. For example, the largest single domestic market for MMF products outside the US is France, where all funds regulated by the Autorité des Marchés Financiers (AMF) have a variable net asset value (VNAV) per share. In the French market, MMFs follow rules introduced by EU regulation in 2011, which now define two types of MMFs that can be classified as UCITS – ‘short-term MMFs’ and ‘regular MMFs’. The former follow more conservative guidelines than the latter, including shorter instrument and portfolio maturities.
To understand the differences between the products offered in today’s major markets, it is useful to understand how they evolved. In the US, CNAV funds were first offered in the 1970s and steadily grew in popularity for both institutional and retail investors over the following decades, culminating in their peak in early 2009 at a little over US$4 trillion in assets under management. Initially, US money market funds became popular with retail investors as an alternative to bank deposit products providing portfolio diversification, stability of principal, liquidity and money market rates of return.
Over time, MMFs became widely adopted by institutional investors as vehicles that could hold significant cash balances while providing diversified alternatives to single credit exposure via banking products. Today, institutional MMFs comprise some 65% of US MMFs industry assets under management.
In France, the industry grew rapidly in the 1980s following the introduction of regulation that prevented banks from paying investors interest on deposits. Although this changed in 2004, the industry had by then become well-established and, at its peak at the end of 2009, had just under US$700bn in euro-denominated assets under management.
In other European countries, including Italy, Switzerland, Germany and Spain, domestic funds have invariably been offered as VNAV products. While it could be said that US MMFs are relatively homogeneous, in Europe the sector is much more diverse, with European asset managers following more complex and ‘sophisticated’ strategies to achieve competitive returns. These strategies include using derivatives to hedge duration and currency, investing in fixed income securities with a wider range of credit quality and maturities than permitted in Rule 2a-7 or IMMFA funds, and seeking to achieve performance returns relative to a variety of European market benchmarks such as EONIA or EURIBOR.
International or IMMFA funds have, for the most part, been offered by asset managers familiar with managing portfolios within the constraints of Rule 2a-7. A high proportion of cash invested in IMMFA funds is sourced from subsidiaries of multinational corporations or ‘global’ corporations headquartered in many locations, including North America, Asia, Europe and Latin America. In recent years, largely due to concerted efforts by asset managers to raise investor awareness, CNAV funds have steadily grown in popularity among domestic institutional investors in many countries around the world.
What is the Difference Between CNAV and VNAV Funds?
In essence, all MMFs aim to achieve the same end result to greater or lesser degrees: portfolio diversification, high levels of credit quality, low-to-zero price volatility and same (T+0) or next day (T+1) liquidity for the end investor. Differences in product form have evolved in the various markets due to a variety of factors, including local market perceptions and tolerances around risk, investor preferences for income or capital gains due to differing rates of taxation, operational simplicity and accounting regulation. The key difference between funds offered as CNAV or VNAV products is in their income distribution accounting policies.
Typically, CNAV funds account for capital and income separately and treat income as a daily declared dividend accruing to the shareholders of a fund. These are distributed or paid out to investors in the form of a cash dividend or reinvestment in new shares at the end of each month. By contrast, VNAV funds roll up daily income into the share price, which changes in value on a day-to-day basis as a result.
For some investors, such as multinational corporations, the accounting and operational simplicity provided by CNAV funds makes their use more attractive than VNAV products. In particular, the lack of price volatility in CNAV shares means that it is not necessary to track and reflect a daily gain or loss in a firm’s accounting records.
Another difference, closely linked to their income policies, is the extent to which CNAV and VNAV funds use amortised cost or mark-to-market accounting. CNAV funds will generally use amortised cost for all securities within their portfolios. Amortised cost allows a security to be valued on a straight line basis from its initial purchase price to par value at maturity, thereby ensuring that there is an even and predictable change in its daily valuation, and provided the price remains within certain tolerances.
By contrast, VNAV funds will, for the most part, follow mark-to-market accounting whereby securities are valued at the market price at which they could be sold. In practice many VNAV funds follow hybrid models through which securities maturing within a certain time period – for example three months – might be valued at amortised cost, whereas those maturing later than three months would need to be priced at their market value.
The Role of Regulation
Today, Rule 2a-7 is arguably the most comprehensive body of regulation governing any component of the global MMFs industry. Although it has become more substantive in recent years, pan-European regulation has historically allowed for greater scope for MMF product descriptions and diversity in investment guidelines.
Following the credit crisis of 2007-2009, regulators in both the US and European markets have focused on money market funds for a number of reasons. In the US, for example, MMFs have been perceived by regulators as representing a source of systemic risk. This has led to changes in the SEC Rule 2a-7 in areas such as liquidity and transparency, and also tightened existing parameters in areas such as maturity, credit quality and reporting.
European-based MMFs are generally UCITS funds, which means they have to follow both EU regulation and any additional rules set by the local market regulator. As a result of the credit crisis, the European Securities and Markets Authority (ESMA) introduced new guidelines for money market funds domiciled within the EU, which will come into effect by the end of 2011.
ESMA also introduced two categories of MMFs – ‘short-term MMFs’, which are required to follow more restrictive investment guidelines, and ‘MMFs’, which have greater investment flexibility. IMMFA CNAV funds fall into the short- term category and, as mentioned earlier in this article, French VNAV MMFs are offered as both ‘short-term MMFs’ and ‘MMFs’.
Since IMMFA is not a regulatory body, its Code of Practice is voluntary. However, changes in the Code of Practice made post the credit crisis of 2007 to 2009 are largely consistent with those made by the SEC to Rule 2a-7 and the new classifications introduced by ESMA.
In France and other jurisdictions around the world, regulators have continued to review how MMF products are classified and what investment parameters need to be followed to hold the designation.
A Changing World
The credit crisis of 2007-2009 changed both regulators’ and investors’ perceptions of the risks associated with many sectors of the investing markets. The MMF sector in particular has been subject to scrutiny by regulators around the world as the extent to which its role as a lender to financial and non-financial institutions in the short-term credit markets have become more widely understood.
Many commentators believe that the changes introduced in 2010 in the US and EU markets have succeeded in strengthening the risk framework for both CNAV and VNAV MMFs. However, while these changes have been welcomed by the industry and investors, regulators have continued to seek ways to minimise the systemic risk that they believe MMFs present to the markets. At the time of writing, several regulatory bodies, including the SEC, ESMA, FSB and IOSCO, continue to assess the need for additional changes to regulatory frameworks, in particular for CNAV funds.
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