In a report last month from Moody’s Investors Service, the credit rating agency warned that the proposed regulations, if introduced, could cause assets under management in the $4.5 trillion MMF industry to plunge by at least 30%.
This would have repercussions for the industry and the large, medium and small companies and financial institutions that use the funds as a crucial source of short-term financing.
Corporate treasurers have long viewed MMFs as one of the most effective means of managing short-term intra-day liquidity and diversifying counterparty risk, but they are now being forced to adjust this strategy and seek alternatives.
“Money-market funds have traditionally been attractive to corporates because they are liquid, have a credit rating, give diversity of investment – we are effectively outsourcing our credit research – and most importantly they were attractive for capital preservation,” says Andy Nash, senior vice-president and group treasurer of Netherlands-based retail group Ahold.
Nash says Ahold has changed the way in which it uses MMFs, due to the low-rate environment as well as questions relating to capital preservation.
“We have already made key changes in managing our investments: our counterparty policy has been updated and the total amount of counterparty risk for financial institutions increased to cope with the possibility that we come out of MMFs,” says Nash.
“We are using alternatives from the treasurer’s investment instrument toolbox, such as repos/sticky deposits and other funds offering security; with more use of good old-fashioned term deposits again.”
A similar shift in strategy could be expected among other companies, but changing investment policy can be a laborious process, and one often requiring board-level approval.
“If the regulations go through as they stand now, treasurers will have to do something,” says Jennifer Gillespie, head of money markets at Legal & General Investment Management in London.
“But reviewing this issue may not be a quick process for companies which have to change their mandates and their treasury, and obtain board-level approval for any changes. The process might take six months to a year – and companies will not want to wait until any changes go through before they begin switching over.”
Under US and European regulators’ proposals, MMFs are set to change their approach to pricing, potentially moving from a constant net asset value (CNAV) model to a variable net asset value (VNAV) model, where the price will fluctuate according to the market value of the underlying assets.
Other changes under consideration by regulators include restricting investor redemptions during periods of market stress, as well as the introduction of a capital buffer.
However, it is looking likely that regulators in the US will adopt a different approach to regulators in Europe.
In September, the European Commission published changes to its proposed framework, including the introduction of a 3% capital buffer to “support stable redemptions in times of decreasing value of the MMFs investment assets” – an outcome which some believe will make CNAV funds no longer viable.
In the US, the SEC is considering requiring CNAV funds to convert to a VNAV mode, and/or limiting redemptions during periods of stress.
These different approaches to regulatory change could make funds fundamentally different on either side of the Atlantic.
“If a multinational corporation is using money market funds in both Europe and the US, these funds may operate in significantly different ways in the future,” says Gillespie.
According to a JPMorgan survey in November, almost 71% of respondents said they would continue to use MMFs if a VNAV model was imposed, but many would reduce their allocations. For respondents with a cash balance of more than $5 billion, for example, only 22% would continue to invest in MMFs without reducing their allocations.
Another concern relating to the proposed regulatory changes is that MMFs will no longer receive external credit ratings.
“One potential outcome in Europe is that VNAV funds won’t be rated,” says Gillespie. “So if a company’s treasury policy dictates that the company can only invest in rated entities, that company may not be able to invest in VNAV funds at all.”
If, as Moody’s research predicts, MMFs are set to lose substantial assets next year, the question is where corporate treasurers will invest their cash instead.
Gillespie says in the past some corporate treasurers have opted to wait and see rather than taking pre-emptive action – but with a big regulatory push under way, awareness is growing of the proposed changes and the possible consequences.
“Until now, we hadn’t seen much awareness of the issues unless the fund manager has actively gone to clients and explained that this could happen,” she says. “But the issue is in the news a lot more now, and we are seeing more awareness of this topic.”
Respondents to the JPMorgan survey who were planning to reduce or eliminate their use of MMFs in the case of a move to VNAV were predominantly planning to reallocate their cash into bank deposits or earnings credit rate products, with 58% of respondents with a cash balance of more than $5 billion indicating this would be the preferred course of action.
A quarter of the $5 billion-plus respondents said they would shift funds into repos, certificates of deposit, commercial paper or corporate bonds. Some 8% planned to outsource the cash portfolio.