A new reform of money market funds in Europe?

Money Market Funds (i.e., MMF’s) have a major role to play in the economy, even in times of recession and even when interest rates are very low or even negative. By constantly trying to reform an asset to make it more resilient, for example, there is sometimes a risk of distorting it and making it a less attractive product for investors and managers. When a product is a means of short-term financing, it can impact the entire chain. By trying to do better, we can sometimes do less well than better.

ESMA consultation on MMF’s

The European Securities and Markets Authority (ESMA) has launched a consultation aimed at possibly reforming money market funds. Yet, these are useful investment vehicles for investors and for the financing of the entire economy. The COVID crisis, although sanitary, had profound economic repercussions that required ESMA to review whether there was a need to revise the regulation of money market funds in the short term. It is obvious that a market like Paris, given the importance of money market funds within the French investment fund industry (i.e., 40+%) and given the historical French specialty in MMF's, is at the forefront and concerned by any substantial change, even if justified. It is an essential means of financing for companies, banks and governments and an interesting asset for excess liquidity and cash. The idea has always been to diversify risks while preserving a short-term return like a bank investment/deposit. The fact that Paris is the leader in EUR-denominated MMF's adds to this interest for any regulatory change envisaged. The "classic VNAV" exists alongside the new "LVNAV" (i.e., Low Volatility) and constant value funds (limited and subject to strict conditions). This consultation covers several aspects: e.g., fund ratings, systemic stress tests, MMF reporting, guarantee funds and fund perimeter. This consultation is concomitant with that of IOSCO or the FSB, which intend to present recommendations to the G20. Europe, in this framework, must analyze the possible reforms and whether they are necessary, but also analyze them in a more global framework, to remain relevant. The associations of this type of funds are of the opinion that they should be preserved in the interest of investors and short-term financing needs, without any explicit or implicit guarantee promised to the investor. In such a reforming context, the role of treasury associations and EACT is crucial to defend treasurers’ interest.

Gauging options means knowing what motivates investors

During the COVID-19 crisis in March 2020, the large outflows were explained by uncertainty, unfounded fears of a credit crunch, and immediate cash needs when the economy was at a virtual standstill. Most of what went out went back into the MMFs. Investor confidence is therefore intact. The exogenous crisis did not reveal any structural or asset quality fragility. In a way, every crisis is a life-size test to be considered to ensure the solidity of the whole. With gates and caps on redemptions, the restrictive and protective measures have pushed investors to anticipate the exit when the one-week liquidity pocket was in danger of falling below 30%, to avoid the restrictive measures. These pockets of liquidity must be able to play their role in case of need, a countercyclical role. What would be the point of giving a water bottle to a cyclist during a race who could not unseal it??Liquidity cushions are useful (admittedly discussed and debatable as to their level) but useful. ESMA is also considering an anti-dilutive mechanism in the form of a "swing price" or adjustment of the fund's net asset value upwards if the change in the fund's value is positive and downwards if the change in the fund's value is negative, to reduce the costs of portfolio rearrangement for investors, when liabilities are moved. Fund entry and exit fees can be adjusted and therefore vary according to the situation. The idea is to make the "exiting" investors bear the exceptional liquidity cost, allowing them to recover their liquidity in case of immediate need, while respecting and preserving the investment value of the "remaining" investors. These thresholds could be calculated automatically, with a triggering threshold, a flat rate, etc. The objective is to make this market more fluid while preserving it and protecting the investors who remain invested in these money market funds. However, the difficulty lies in the calibration and precise determination of the action levels. If the trust between investors and fund management intermediaries is broken, the system would be affected. Acting on pockets of liquidity by setting minimum overnight (i.e., 7.5%) and weekly (i.e., 15%) thresholds was an objective of the reform of variable-value funds. The rules must consider the European specificities and the absence of governmental assets qualifying for the very short term. We must go back to the fundamentals and reasons for such instruments if we want to avoid killing them with too many heavy and costly rules for the manager and the investor. As often, the “better is the enemy of the good”. As mentioned above, a strong crisis is a wonderful "live" test. However, one should not draw too hasty conclusions from a very exceptional situation (of the "black swan" type) and when these same funds have resisted. If we sterilize part of the funds (with good intentions), we may risk making them inefficient, unprofitable, and uncompetitive. Reducing risk is recommended, but not at the expense of return if the latter is strongly penalized. Finally, there is the question of external support for the net asset value or liquidity of funds. In Europe, any support is prohibited. We believe that such a possibility would be counterproductive and would risk the disappearance of players in an industry that has already been affected for over 10 years. Denaturing an industry and an asset can be dangerous. The managers or "sponsors" could disappear or refocus, to the detriment of the entire economy.

Do not try to do too well

ESMA is also considering a “Liquidity Exchange Facility” (LEF) to centrally guarantee funds, in the form of an insurance-type guarantee fund. Unfortunately, every measure has a cost and eventually someone will have to pay for it. Yet every crisis is different, and no one knows where the next one will come from. We can always try to make the funds more solid and resistant, if the reforms do not kill the product. By dint of doing and re-doing, we make things complicated, cumbersome, expensive, and possibly uninteresting. Even if the objective is laudable, each crisis reveals another fragility and by wanting to foresee and prevent everything, we can end up destroying an industry that is necessary to the economy. The best is the enemy of the good and moderation (even in financial regulation) is always advisable.

Fran?ois Masquelier, Chair of ATEL??- September 2021