While the regulatory developments seem to have slowed in the summer months, managers should be prepared to address three key regulatory issues come fall.
Welcome to the regulatory doldrums! The time of year when regulatory developments slow to a crawl as policymakers take leave for their summer holidays. Of course, this respite from regulatory change is only temporary. Policymakers will be back refreshed and things will pick up again in September. However, this calm gives us the opportunity to reflect on where we stand with three key regulatory issues.
MONEY MARKET REFORM
In the US, money market reform is in the home stretch and comes into effect on 14 October. The new rules hope to avoid a repeat of 2008, when the US Government, fearing a liquidity crisis, stepped in to backstop several so-called “prime” money market funds whose NAVs famously “broke the buck.” The new rules essentially require non-retail or non-government money market funds to move to a floating NAV, instead of the traditional constant NAV of $1. Additionally, the new rules allow for money market funds to use liquidity fees and redemption gates in the event of substantial redemptions. The new rules have completely reshaped the US money market funds landscape. According to the ICI, in March the assets in government money market funds eclipsed the assets in prime money market funds. This is due to the fact that many investors prefer the stability of the constant NAV. It remains to be seen what the long-term implications of the new rules will be. However, with the implementation of the new rules imminent, the picture around the institutional liquidity market has become clear.
In Europe, the pace of money market fund reform is much slower. After a period of inactivity, the process lurched forward in April. The Dutch, who held the rotating EU Presidency, attempted to move the discussion forward with a new proposal. The proposal attempted to bridge the gap between the supporters of the Constant NAV fund and those who favor floating NAV funds. The proposals are due to be discussed by the EU Parliament’s ECON committee in September. However, at the moment, it seems that final agreement remains somewhere on the distant horizon.
US SEC LIQUIDITY PROPOSALS
Last year, the SEC created a bit of a stir by publishing a proposal for new mutual fund liquidity rules. The rules were drawn up in reaction to the concerns from the US FSOC (Financial Stability Council) and the FSB (Financial Stability Board) around liquidity mismatches in funds. The key parts of the proposals were:
- Maintain a classification of portfolio securities into six liquidity categories, based upon how quickly the securities could be converted to cash.
- Calculate and maintain a capital-requirement-like buffer known as the fund’s “three day liquid asset minimum.”
- Have the board of mutual funds directly approve, oversee, and periodically review their fund’s liquidity risk management practices.
- Allow funds to employ “swing pricing,” which is designed to reduce or eliminate the dilution of remaining shareholder interests following redemption activity.
Since the proposal there have been two major fund liquidity events. In the US, on 10 December 2015, Third Avenue Asset Management suspended trading of its Focused Credit Fund due to unsustainable redemption requests. Then in the UK following the Brexit vote, eight UK open-ended property funds suspended trading in the wake of redemption requests. Both cases underscored the concerns regulators have about mutual fund liquidity.
Despite regulators’ concerns, it seems unlikely that the SEC liquidity proposals will be finalized this year. First, some aspects of the rules proved to be highly controversial. Second, it is an election year in the US, which historically has slowed the regulatory process. Nonetheless, this delay should not be interpreted as a retreat by the SEC. The issue remains front of mind with global regulators and will certainly remain on the agenda.
On 31 December 2016, the new PRIIPs (Packaged Retail and Insurance-Based Investment Products) rules come into effect. PRIIPs requires a KID (Key Information Document) to be created for all retail financial products. The trouble for the industry is that the rules are not officially finalized just yet. The EU Commission signed off on the new rules in June but the EU Parliament has not yet approved the rules. In fact, recent reports indicate that the EU Parliament may reject the rules over concerns with future performance requirements. Their main concern with this approach is that using a set formula to predict future performance may be misleading. These concerns have also been widely echoed by the industry.
The challenge of course, is that the implementation date is about four months away, leaving the industry in limbo. Many are certainly hoping for a delay in implementation, though it is not guaranteed. Hopefully there will be resolution shorty, but that may mean a bit of a scramble for managers this autumn as they rush to get their KIDs produced.
Or course, aside from these three issues there are other regulatory items on the horizon. MiFID 2 will remain a key concern even though implementation isn’t until 2018. With any luck the industry should receive final guidance on all the rules by the end of the year. The EU Coalition is set to meet in September (presumable to kick the can on the FTT again). Finally, lest we forget there’s always Brexit to content with. Beyond all of this, there is always the unknown. The coming months will almost certainly bring new regulatory proposals and challenges. However, this is all a problem for the future. For now, enjoy these lazy days of summer because it’s going to be a busy fall.