The drive to regulate money market funds has gone transatlantic. So has the pushback from money fund managers.
On September 4 the European Commission published its long-awaited proposals aimed at stemming the systemic risk posed by money market funds. The centerpiece of the draft regulation would introduce capital requirements for many funds to act as a buffer in times of crisis. The commission, the executive agency of the 28-nation European Union, hopes a capital cushion can prevent the kind of destabilizing runs that hit U.S. money market funds in 2008 after the Reserve Primary Fund broke the buck — meaning it did not have enough money to redeem investors at $1 a share — because of its exposure to Lehman Brothers.
Industry executives contend that the new rules could cause virtually half the industry — the €450 billion ($608 billion) market for constant net asset value (CNAV) funds — to disappear altogether and would weigh down other funds with onerous and inefficient regulation. Given that similar complaints torpedoed an attempt by the Securities and Exchange Commission to impose capital requirements on U.S. money market funds last year, European regulators can’t ignore the criticisms.
When he unveiled the new policy proposal, Internal Market and Services commissioner Michel Barnier said that the executive agency wanted to require CNAV funds to hold a capital buffer equal to 3 percent of assets. Such a buffer would have enabled the Reserve Primary Fund, whose shares fell in value to 97 cents during the 2008 crisis, to redeem them at the customary $1 apiece.
The Institutional Money Market Funds Association (IMMFA), the London-based trade body for CNAV vehicles, has declared that the capital buffer amounts to “a de facto abolition of CNAV funds, leading to fewer choices for investors.”
Susan Hindle Barone, secretary-general of IMMFA, says the cost for money market funds of maintaining a 3 percent buffer would be “prohibitively expensive.” She estimates that cost at some 30 basis points, well in excess of the prevailing management fee for most money funds of 10 basis points.
“Thirty basis points is clearly not affordable, unless the cost is passed on to clients,” she says. And they “would not be prepared to pay it,” she contends. If the capital requirement is adopted, Hindle Barone predicts that virtually all CNAV funds would convert to variable net asset value (VNAV) funds, whose share prices change constantly.
A conversion to variable asset values would please some regulators, who believe that floating prices leave funds immune to the risk of an investor panic during a crisis. Indeed, the SEC in June issued revised proposals that would require U.S. institutional money market funds to convert to VNAV to reduce their systemic risk.
Meanwhile, managers of VNAV funds have their own complaints about other elements of the commission’s proposal, notably draft rules on the kinds of instruments that money funds can buy.
“We are surprised by the very detailed approach of the EC’s text, which sets out a list of eligible instruments, a valuation methodology for assets and prescribed processes for calculating the ratings of the instruments in which the funds intend to invest,” says Mikaël Pacot, head of money market funds at AXA Investment Managers in Paris, which manages €25 billion of VNAV vehicles.
The proposed EU rules would require money market funds to invest at least 10 percent of their portfolios in assets maturing within a day, and an additional 20 percent in instruments maturing within a week.
Pacot says compliance with the proposed rules would increase funds’ costs. He adds that it’s too early to say whether AXA and other asset managers would pass on these extra costs to clients, and argues that setting out a detailed list of eligible instruments would make it impossible for money funds to innovate and invest in new types of securities. “Regulators need to have a long-term view,” Pacot says. “The more detailed the regulations are, the greater the risk they will become out of date.”
Some industry participants warn that excessive European regulation could push business across the Atlantic. IMMFA says the proposed capital requirements for CNAV funds posed a “serious risk that cross-border arbitrage opportunities will be created.”
Other participants dismiss talk of a U.S. migration, noting that all funds marketed in the EU are likely to be covered by the new rules even if they are based outside of Europe. In addition, it’s not clear that U.S. funds will get a lighter touch. Besides proposing that institutional money funds adopt variable net asset values, the SEC has recommended that retail-oriented funds impose liquidity fees or erect gates on withdrawals at times of stress.
With regulatory pressures coming from Washington and Brussels, industry executives are urging their overseers to adopt as common an approach as possible. “We are keen to see alignment with the SEC’s proposals in key areas, such as capital buffers, as this would otherwise create the risk of arbitrage,” says Jonathan Curry, CIO of global liquidity at HSBC Global Asset Management in London, which manages $42 billion worth of European money market funds domiciled in Europe.
The commission’s proposals must be approved by the EU’s Council of Ministers and the European Parliament, making them far from set in stone. The deadline for approval by the European Parliament is tight, however. The next parliamentary elections are in May, and each new European Parliament has tended to throw out the previous parliament’s legislation and start policymaking again from scratch.
Five years after the catastrophic event that prompted money market reform, a new regulatory system for this key element of the shadow banking system is still far from complete.
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