EUROPE: EU VNAV Move Could Disrupt Money Market Fund Investors but Not Ratings

Thursday November 1 2012

It has been reported that a regulatory requirement for all constant net asset value European money market funds to switch to a partial variable net asset value model would have little impact on fund ratings. The main uncertainty would be the reaction of investors and whether the switch could lead to significant disruption or outflows from a EUR500bn market segment.

It is thought that a move to partial variable net asset value (VNAV) funds – where assets with a residual maturity of less than three months continue to be priced on an amortised cost basis – along with new rules to combat liquidity risk, are among the most likely outcomes of the reviews of MMF regulation taking place in Europe. To date there is no regulatory proposal apart from recommendations made by IOSCO in October 2012 and discussed by the European Systemic Risk Board.

A constant net asset value (CNAV) fund that switches to partial VNAV while maintaining the safety of principal and timely liquidity would be unlikely to face a change in rating. We already rate some partial VNAV funds at ‘AAAmmf’, which indicates an extremely strong capacity to preserve principal and provide shareholder liquidity.

The proportion of assets that are longer-dated, and therefore valued by partial VNAV MMFs on a mark-to-market basis, is only 10%-20% for most of the MMFs in the short-term regulatory segment. The rest are valued using amortised accounting in the same way as CNAV funds. This allows partial VNAV funds to be rated using the same scale as CNAV. This assumes that ‘AAAmmf’ rated funds continue to follow “self-regulation”, with stricter portfolio and risk guidelines than required by the European Securities and Markets Authority for “short term MMF”. Full VNAV funds do not exist and could require an alternative methodology and/or ratings scale.

It is believed that the more relevant issue is whether some corporate and institutional investors will refuse to accept VNAV funds if they conflict with their investment guidelines or raise significant tax or accounting hurdles. If so, this could drive significant outflows from the European MMF market, which is split about 50:50 between CNAV and VNAV funds.

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