Money market funds are once again in the cross hairs of regulators in the US and Europe following a brief liquidity crunch in March 2020. Sebastian Ramos, Executive Vice President, Global Trading and Products, ICD, discusses the risks that over-zealous reforms could pose to the popular short-term investment instruments.
During the global financial crisis of 2008, the original money market fund (MMF) – the Reserve Primary Fund – ‘broke the buck’. As a result of its net asset value (NAV) falling below $1 for the first time, after the crisis both US and European regulators moved to amend the rules for MMFs.
This process had two stages in the US. The first targeted the underlying cause of the crisis by focusing on quality of portfolio, duration and portfolio transparency. The second focused on firming up an approach to liquidity and implemented the floating net asset value (NAV) for MMFs in the US.
In Europe the approach was similar but not as strict as in the US. As Ramos explains: “Rather than imposing a floating or variable NAV, a low volatility NAV [LVNAV] was introduced.” This tightens the spread at which a fund will have to reprice itself and start floating. “Historically, the funds had used penny-rounding with the fund having to reprice itself if there were a 50 basis point deviation of market value compared with the amortised cost value.”
What the regulators did for LVNAV was to narrow that spread to 20 basis points. Ramos continues: “In the US, funds now have to float out to four decimal places based on its mark-to-market value. Whereas, in Europe, regulators essentially kept the NAV stable but instituted a tighter band at which mark-to-market had to reflect or be in line with the amortised cost valuation.”
Europe also took a slightly different approach to liquidity. In the US, the rules mandate that if the liquidity of a fund drops below 30%, the fund’s board must determine if it wants to impose fees or gates on any redemptions. In Europe, regulators took a similar line, but focused on the root cause of the redemptions they were trying to prevent. Here, when it hits the 30% liquidity level, the fund must also have a 10% reduction in the portfolio’s assets under management (AUM) on a given day to trigger the board meeting. This 10% AUM drop is more indicative of a mass withdrawal or ‘run’ on a fund, as opposed to simply dropping below the 30% liquidity level.
“These are the two main differentiators,” says Ramos. “There’s a similar thought process, but the withdrawals that we saw when Covid-19 was declared a pandemic were much more significant in the US, in part because of the way the regulations were structured in the US versus the way they were in Europe.”
Source: Treasury Management