CNAV calm after the capital-buffer storm
On 12 March 2015, the European Parliament's Committee on Economic and Monetary Affairs (ECON) published its report (Report) on the Money Market Funds Regulation (MMF Regulation) following their vote on 26 February 2015. The Report appended the latest version of the MMF Regulation, whose key terms concern Constant Net Asset Value (CNAV) MMFs, calculation of the net asset value (NAV), the use of amortised cost, authorisation, and additional investor protection measures. Each of these aspects are summarised below.
The Report provides for three types of CNAV MMFs:
- A Retail CNAV MMF, which will only be available for subscription by charities, non-profit organisations, public authorities and public foundations;
- a Public Debt CNAV MMF, which would be required to invest 99.5% of its assets in public debt instruments; and
- a Low Volatility Net Asset Value MMF (LVNAV MMF), which will, under strict conditions, be able to display a constant net asset value. However, the authorisation of these MMFs lapses 5 years after the MMF Regulation comes into force.
Each of the three CNAV MMFs must implement liquidity fee mechanisms and redemption gates to prevent significant redemptions in times of market stress and to prevent other investors being unfairly exposed to prevailing market conditions. The liquidity fee should be equivalent to the actual cost of liquidating assets to meet the client redemption during periods of market stress and not a penalty charge over and above what would offset losses imposed on other investors by the redemption.
The Public Debt and Retail CNAV MMFs will automatically convert to being Variable NAV (VNAV) MMFs or be liquidated where they cannot meet the minimum amount of weekly liquidity requirements within 30 days of using the liquidity fees or redemption gates.
In order to reflect the actual value of assets, the Regulation requires marking to market be used as the preferred method for valuing the assets of MMFs. A manager should not use the marking to model valuation method when marking to market provides a reliable value of the asset.
Amortised cost and rounding
The Regulation recognizes that to accommodate the workings of CNAV MMFs, it is necessary that they be allowed to continue to use amortised cost accounting to determine their constant net asset value per unit. However, to monitor the difference between the constant NAV per unit and the actual NAV per unit, these funds must also value their assets using the marking to market or marking to model methods. As MMFs should publish a NAV that reflects all movements in the value of its assets, the published NAV should be rounded at maximum to the nearest basis point or its equivalent, up to four decimal places.
Funds which trade in money market instruments and which have other characteristics inherent to money market funds are obliged to become authorised as MMFs; and this authorisation will be in addition to the fund’s authorisation as an AIF or a UCITS.
Investor protection measures
The proposed text of MMF regulation imposes several investor protection measures on the MMF and its manager, including:
- following portfolio diversity requirements;
- following strict liquidity and concentration requirements and
- conducting stress testing at least on a quarterly basis.
- reporting on a weekly basis to investors the MMF’s liquidity profile, the credit profile and portfolio composition, the weighted average life and weighted average maturity of the portfolio as well as the concentration of the top five investors in the MMF.
- Informing investors prior to investing whether the MMF is short term in nature, and of sources of access to information on the portfolio of investment and the MMF's levels of liquidity.
The draft report as adopted by ECON is scheduled for a vote in the plenary session of the European Parliament to be held from the 27 to the 30 April 2015. As part of the ordinary legislative procedure in the EU, the Council must also approve the MMF Regulation before it has the force of law.