While revising the EU’s Money Market Funds Regulation has taken the better part of a decade, July’s implementation deadline is coming into sight. However, one critically important policy issue remains unresolved. Now, both policymakers and asset managers have key decisions to conclude.
Ten years in the making, the EU Money Market Funds Regulation (MMFR) finally goes live this summer. The rules, which govern money market funds established, managed, or marketed in the EU, will apply to all new MMF fund launches starting July 21, 2018 and to existing MMFs as of January 2019. Unfortunately, the industry is not moving seamlessly toward compliance, as there are still significant wrinkles to iron out.
In April, the European Commission published the remaining required technical guidance for MMFR, without a mention of reverse distribution mechanisms, also called share destruction. ESMA and the European Commission said share destruction would be incompatible with the new regulation. It’s important to note, share destruction is not the only outstanding item, however it is the one causing the most disruption for asset managers, who must decide on their future strategy for these fund types, while remaining hopeful that regulators address the disconnect. Other unresolved issues within MMF include new fund types, credit quality reviews, stress testing and new rules on valuation and gates.
The industry developed share destruction for Constant Net Asset Value MMFs as a mechanism to maintain constant NAV within a negative interest rate environment. It was a necessary innovation to maintain CNAVs in the unprecedented existence of negative interest rates. At the time, both EU regulators and investors approved the practice in recognition of the prevailing interest rate environment and investor protection.
Asset managers across the industry currently use the practice in relation to euro denominated MMFs. A CNAV MMF fully distributes its net income and allocates that income to each investor in the form of new shares. Share destruction is the equal and opposite, and investors’ shares are reduced by the amount of the daily negative net income ESMA and the European Commission have on more than one occasion stated that the is not compatible with the upcoming MMFR. Unless regulators resolve this disconnect, euro-denominated CNAV funds will have to convert to variable NAV funds. This would likely result in redemptions from underlying investors who generally demand a stable NAV fund for their short-term liquidity management needs.
An estimated €90 billion is currently held in euro-denominated CNAV funds and would be impacted by the share destruction issue. Due to the scale of assets involved, asset managers and other industry stakeholders are pushing back on regulators to find a resolution. Many believe the practice is an important and necessary tool to deal with negative interest rates on behalf of investors. After ESMA referred the issue of share destruction to the European Commission for legal review, the Commission retained their original view – much to the displeasure of the industry. But there is still a chance they will decide to address share destruction in relation to MMFR before the July implementation.
While there have been drafting changes to ESMA’s proposed text, the Commission notes that “no significant changes have been introduced” and so they did not consider further consultation necessary.
After ESMA and the European Commission reconfirmed that share destruction was incompatible with new regulation, the policy debate kicked into top gear. Industry bodies and members of the European Parliament each expressed their surprise at the assertions. Further, four EU parliamentarians who had negotiated the original terms of the MMFR released a public letter stating that they had not decided one way or another on the issue of share destruction, suggesting that ESMA may have overreached by dictating the policy. This calls into question whether the parliament and co-legislators agreed on the item.
It is important that all MMF asset managers stay abreast of developments so they are appropriately positioned for rule implementation, whether regulators issue clarification of this issue or not. BlackRock has already acted by launching a new low volatility NAV product ahead of the final implementation date. Others are pondering a similar move considering the ongoing uncertainty on share destruction. These funds aim to ensure seamless service continuity for their existing client base, hedging against the possibility that euro denominated constant NAV funds could become untenable under the new regime. It’s time for asset managers to make key business decisions about the future of their European MMFs.