Local authorities are set to tweak their treasury management strategies after the European Union agreed new regulations on money market funds earlier this month.
The local authority sector breathed a collective sigh of relief as the EU finally agreed new rules on May 16th regulating money market funds which significantly watered down original proposals, the cause of some consternation in the investment sector.
The original proposals published by the EU in 2013 suggested the imposition of a 3% liquidity buffer for Constant Net Asset Value (CNAV) funds, which many feared would make them unviable. However, after a concerted campaign by the investment industry, the new rules allow for the creation of a new public debt CNAV instrument, along with a low volatility net asset value (LVNAV) money market fund.
Mark Horsfield, founding director of treasury adviser Arlingclose said: “Within our 2017/18 treasury management strategy statement documents we incorporated the potential change to LVNAV with the scope for clients to approve the use of short-term MMFs that offer same-day liquidity and very low or no volatility since we still believe they retain prudent security, diversification and liquidity attributes relative to fixed-term, unsecured deposits with individual bank counterparties.
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“The new regulations are likely to be implemented in the second half of 2018 so we would expect most MMFs to have moved or signified their move to LVNAV or short-term VNAV by the first half of 2018 and we will ensure that this is reflected in TMSs for 2018/19 as well.”
The new regulation was adopted at a meeting of the EU’s General Affairs Council, with only Luxembourg voting against.
Edward Scicluna, minister for finance of Malta, which currently holds the council presidency, said: “These rules will go a long way in improving supervision and regulation of a largely unregulated sector.
“Whilst money market funds are vital to investors and issuers alike, the crisis showed us that they can also be vulnerable to shocks.”
Michael Quicke, chief executive, at investment manager CCLA, said that the new regulation should help provide greater consistency across the European market.
He said: “We are pleased that the suggestion of applying a capital buffer and the prohibition of using external credit ratings have been removed.”
The new LVNAV will have strict concentration requirements to reduce risk, plus strict daily and weekly liquidity requirements.
It will also have a strict portfolio fluctuation band, meaning that it cannot deviate by more than 20 basis points from the actual net asset value – far stricter than the 50 basis points used by CNAVs.
In addition, LVNAVs would have a new regime of “fees and gates” to help prevent runs in times of crisis.
Quicke said: “The new LVNAV will follow stricter policy rules than the traditional Constant Net Asset Value (CNAV) fund but public sector investors will not see any material changes to the way they access and use sterling money market funds.”
Quicke suggested that councils include LVNAV funds in their 2018/19 treasury management strategy documents as they begin to prepare them this autumn.
CCLA said it has already begun planning the changes to switch its Public Sector Deposit Fund to LVNAV style.
Jennifer Gillespie, head of money markets at Legal & General Investment Management voiced relief that the regulation has finally been agreed.
She said: “After around five years looking at this issue, it was definitely time that something was passed.
“Where we have moved from has been considerable. There were some deep divisions in the European parliament over what should have been put in, between those who did not like MMFs and those who acknowledged their importance.
“Getting a compromise between these two positions has been tricky but we now have something that will work.”
Horsfield said that LVNAVs are likely to be managed even more conservatively in order to avoid being reclassified as a variable net asset value fund.
He said: “As a consequence, weighted average maturities and yields could be further constrained in the lower-for-longer interest rate environment.”
The European Securities and Markets Authority has also launched a consultation paper on technical advice and guidelines on the new regulatory framework.
Firstly, it is looking at the liquidity and credit issues in relation to repo transactions, secondly the assessment around the credit quality of an asset, thirdly how managers will report to the competent authorities and finally finding a common way to stress test money market portfolios.
Quicke said: “We shall be viewing the ESMA paper and hopefully be able to provide the authority with some positive contributions particularly from our experiences around credit analysis and reporting.”
At the last count, local authorities collectively held around £6.3bn of council cash in money market funds.
