Following the adoption by the US Securities and Exchange Commission (SEC) of amendments to the rules governing US money market funds (MMFs), the focus is shifting to Europe. In fact, the prospects for sensible MMF reforms in Europe may be brighter as a result of the US MMF reforms and recent changes to the European political landscape. This article provides a brief overview of the US MMF rule amendments and then discusses the outlook for MMF reforms in Europe.
The US amendments in brief
The US MMF reforms adopted by the SEC: (i) permit (and under circumstances, require) certain MMFs to impose a “liquidity fee” (up to 2%) and/or “redemption gate” if weekly liquidity levels fall below the required regulatory threshold; and (ii) require “institutional” MMFs to operate with a floating net asset value (NAV), rounded to the fourth decimal place (e.g., $1.0000). The reforms also include other notable changes, such as tightening diversification, disclosure, reporting and stress testing requirements, as well as clarifying other provisions of Rule 2a-7.
Liquidity fees and redemption gates
When a MMF’s “weekly liquid assets” fall below 30% of total assets, a board, at its discretion, is permitted to temporarily impose a liquidity fee and/or a redemption gate (for up to no more than 10 business days within any 90-day period). When the weekly liquid assets of an MMF fall below 10% of total assets, the liquidity fee becomes mandatory and the MMF would be required to impose a 1% liquidity fee on all redemptions, unless the board determines that imposing such a fee would not be in the MMF’s best interests or determines that a lower or higher fee (up to 2%) would be appropriate. Liquidity fees and redemption gates are required to be suspended once an MMF’s weekly liquid assets rise up to or above 30% of its total assets, or sooner, if determined by the board.
“Institutional” MMFs (i.e., MMFs that do not meet the definition of a “government” or “retail” MMF) must operate with a floating NAV by calculating their market-based NAV per share to the nearest basis point or equivalent level of precision (e.g., $1.0000 or $10.000). The US reforms exempt “government” and “retail” MMFs from the floating NAV requirement. “Government” MMFs are defined as MMFs that maintain at least 99.5% of their total assets in cash, US government securities and/or repurchase agreements that are collateralized fully by cash or US government securities. “Retail” MMFs are defined as MMFs that have “policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons.” MMFs that meet the requirements to be a government or retail MMF may continue to use penny-rounding pricing and the amortized cost method of valuation to price their shares and maintain a stable NAV.
Other changes and the industry’s reaction
The 869-page SEC release contains many other significant changes to disclosure, diversification and stress testing requirements. The SEC also incorporated a number of clarifying amendments to the rules governing MMFs. In the words of SEC chair, Mary Jo White, “the reforms will fundamentally change the way that most money market funds operate.” However, the US MMF industry’s reaction generally has been one of acceptance with a sense that the reforms could have been worse.
While US MMF managers and boards continue to digest the fine print of the SEC release, attention now turns to Europe.
Will Europe follow the US?
As the MMF industry is a global industry, the finalization of the US MMF reforms will, undoubtedly, be expected to have a significant influence on the final regulatory outcome in Europe. However, the following comments from SEC commissioner, Daniel Gallagher, on the impact of the reforms are worth noting:
Given the level of chatter about this rulemaking in the EU, IOSCO, and the FSB, there will be international reactions to today’s rule amendments. It will be up to local authorities to determine whether reforms are needed in their markets, and I caution policymakers abroad to recognize that our reforms reflect the unique features of the US money fund marketplace. In this era of increasingly brazen attempts at reckless, unprecedented “one world” financial regulation, it is crucial to acknowledge that one size does not fit all for money fund reform.
While the US reforms provide for the continuation of a stable or – as referred to in Europe – a constant NAV (CNAV) for retail MMFs, most European MMFs would not qualify under that definition. In fact, the market for MMFs in Europe is almost entirely institutional. Accordingly, not much comfort can be taken from the preservation of CNAV MMFs for retail MMFs in the US.
The European Commission proposals
The European Commission published a “Proposal for a Regulation of the European Parliament and of the Council on Money Market Funds” (Commission Proposal) in September 2013. The Commission Proposal stated that only MMFs that establish and at all times maintain a capital buffer of 3% of NAV may be constituted as CNAV MMFs. If this requirement cannot be met, the MMF would be required to be constituted as a variable NAV MMF. The Commission Proposal was to have been brought to the Economic and Monetary Affairs Committee of the European Parliament (ECON) in March of this year, but there was not sufficient consensus at the ECON table to bring the matter to a vote of the Parliament as a whole. In the words of Gay Mitchell, an Irish Member of the European Parliament (MEP) for Dublin, “There has been very little effort to meet the genuine concerns about CNAVs. The majority feel we should leave it to the new Parliament to give it timely consideration. Rushed legislation will be bad legislation.” The delay also gave legislators the opportunity to consider the US MMF amendments.
New European Parliament and Commission
With the can having been kicked down the road by the previous Parliament, the baton of European MMF reform has now been taken up by the new Parliament and Commission along with the rotating presidency of the EU Council. While the Commission Proposal is still the only proposal formally on the European table, there are indications that some of the key players within the regulatory firmament of European politics may be more disposed to accept genuine industry concerns.
At the European Commission, new Commission President, Jean-Claude Juncker, is a former Luxembourg Prime Minister. Coming from a prime European funds domicile gives him a unique perspective on funds industry concerns. Also, while UK nominee LordJonathan Hill still has a few hurdles to jump in the approval process, it is likely that he will be appointed as Financial Services Commissioner. It is expected that a commissioner from the UK would be more sympathetic to European funds industry concerns.
At the level of the ECON, the rapporteur for money market fund reform is Neena Gill, a UK Labour/Socialist MEP who has stated that she will seek “to ensure there is a format there that enables these funds [MMFs] to continue to exist.” She further noted that she does “not think that it is a job of the Parliament to define what sort of investments you have or not.” She is proposing a roundtable in November to discuss potential solutions, with a vote likely in January. The shadow rapporteur is a new MEP for Dublin, Brian Hayes. While the Irish government supports the regulatory imperative to better regulate shadow banking, it does not support the capital buffer proposal, which Irish Financial Services Minister Simon Harris believes will “damage the industry [in Ireland], but also throughout the EU, and could lead to an outflow of investment from Europe.”
What are the options?
It is incumbent upon the opponents of the capital buffer to bring something new to the table. The view of the industry – as set out in a Position Paper published by the Institutional Money Market Funds Association (IMMFA) in response to the Commission Proposal – is that the use of redemption gates and liquidity fees (a fundamental aspect of the US reforms) is the “simplest and most effective mechanism by which to achieve” the objective “of better regulation of MMFs [which] is to prevent large-scale runs from funds, which would likely amplify the risks to the banking system at a time of systematic disruption.”
In addition to the “fees and gates” proposal, other proposals being considered include a proposal for a MMF structure that is a compromise between a CNAV MMF (with penny rounding to two decimal places) and a variable NAV MMF – a lower volatility NAV, which would allow for rounding to three decimal places. The MMF industry is facing into severe headwinds with the current ultra-low interest environment. It may be that while the forecast for ultra-low interest rates remains stable, the outlook with regard to MMF reform may appear a little brighter.
Declan O’Sullivan is a partner based in Dechert’s Dublin office. Jack W. Murphy is a partner based in Dechert’s Washington DC office. Stephen T. Cohen is an associate based in Dechert's Washington, DC office.