The months leading up to US money market fund reform resembled a fire sale when it came to flows out of institutional prime funds. But in Europe, on the eve of major reform very much like the US, investors are reacting much more calmly about the coming rules. One reason is the offering of low volatility net asset value (LVNAV) funds, according to Fitch Ratings.
Prior to the US rules being implemented, more than $1 trillion left prime institutional funds which were losing their constant net asset value (CNAV) guarantee and flooded into government money market funds, which was keeping CNAV. This left institutional prime “a shadow of its former self,” Roger Merrit, a managing director at Fitch Ratings said during Treasury Strategies’ Quarterly Corporate Cash Briefing. A year later, there are flows coming back to US prime funds, “but you’re still looking at a trillion dollars that left the real economy and moved into funding government paper.”
The good news in Europe is that there won’t be the massive dislocation seen in the US, Mr. Merritt said. That’s mainly because of the LVNAV, which Mr. Merritt said investors see as a “viable and credible alternative” to CNAV funds, which are also disappearing in Europe. “The introduction of the LVNAV fund category can be viewed as embodying characteristics seen within the equivalent US government and prime fund types,” Fitch said in a recent report. “[S]pecifically, the flexibility to invest in non-government securities, but permitted to maintain a stable asset value. Early indications suggest investors view this fund type as their preferred option in Europe post-reform.”
Fitch’s report cited a few other factors that would stem prime fund outflows, the most important being the “low probability of gates and fees being triggered based on historic data” unless there is a market shock. Factoring in a likely change in fund behavior post-reform to increase liquidity reduces that probability further,” Fitch said in its report.
Also, European investors are more familiar with the coming rules, as some have already been in place for a while. “Liquidity fees, redemption gates and a host of other liquidity control measures already exist in European mutual fund regulations and fund prospectuses, including in MMFs,” noted Fitch. “Therefore European investors are likely more accustomed to their presence than US investors who had only encountered them previously as exceptional measures.”