Money Market Reform Switches to Europe

Terry Flanagan

Recent changes in US regulations will make it harder for Europe to maintain a floating net asset value for money market mutual funds according to Sean Tuffy, senior vice president and head of regulatory intelligence at Brown Brothers Harriman.

Tuffy said in a report: “The general feeling is that, while not ideal, the new rules were the best result that they could have hoped for. With the rules finalized in the US, attention shifts across the Atlantic to Europe.”

In July the US Securities and Exchange Commission adopted new rules that require a floating net asset value (NAV) for institutional prime money market funds and allow the imposition liquidity fees and redemption gates to stop runs during periods of market stress.

In the US institutional prime money market funds maintained a constant share price of $1. Under the new rules they are required to value their portfolio using market-based factors and sell and redeem shares based on a floating NAV.

The rule changes were a result of the 2008 financial crisis when the Reserve Primary Fund, a $62.5bn money market fund “broke the buck” as its net asset value fell below $1.

Money market funds are meant to be safe investments but the Reserve Primary Fund had invested in Lehman Brothers bonds and the fund broke the buck after Lehman filed for bankruptcy. The US government was forced to offer a guarantee for all money market funds in order to avoid a run on the sector.

Norm Champ, director of the SEC’s division of investment management, said in July: “Today’s adoption of final money market fund reforms represents a significant additional step to address a key area of systemic risk identified during the financial crisis.”

Tuffy said that European policymakers have taken a much stronger stance against constant NAV money market funds than the US. The more stringent European proposals require a constant NAV money market fund to establish and maintain a minimum 3% cash capital buffer, based on the total value of the fund’s gross assets.

Opponents of the capital buffer argued that the cost would make many constant NAV funds uneconomical in an era of historically low interest rates.

“While this argument is accurate, it misses the bigger point: for many EU policymakers, the goal is to eliminate CNAV funds. Indeed, during debates earlier this year, a vocal contingent of policymakers called for an outright abolition of CNAV funds,” added Tuffy.

The capital buffer was the reason that EU policy¬makers failed to reach agreement on the final proposals earlier this year. Ireland, the United Kingdom and Luxembourg, supporters of CNAV funds, could not reach a compromise with opponents led by France and Germany.

Tuffy noted that more than $400bn is invested in constant NAV funds in the EU and last year ratings agency Moody’s estimated that a move to a variable NAV structure would lead to a 50% outflow.

“EU money market fund debate has a long way to go and the fate of the CNAV fund will continue to be fiercely debated. However, it seems that developments in the US just made the task much harder for European proponents of CNAV funds,” he added.

Tuffy said in an email to Markets Media that there is unlikely to be any movement on the EU proposals before November or December as there are some appointments that need to be made for the regulation to proceed.

Said El Khadraoui, the regulation’s original rapporteur, responsible for a certain topic on behalf of a committee in the European Parliament, lost his re-election bid in May and a new rapporteur needs to be named.

The new portfolios also to be allocated in the European Commission by Jean-Claude Juncker, the new president.

“Things are complicated a bit by the fact that money market reform originated from the Internal Market and Services Directorate General, which, if reports are to be believed, has been abolished by Juncker,” added Tufty. “Presumably, it will fall under the prevue of the new ‘Economic and Monetary Affairs Commissioner’.”

Featured image via Dollar Photo Club

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