Money market funds came to the attention of regulators with the collapse of Lehman Brothers in 2008. Funds with exposure to Lehman Brothers’ commercial paper suffered huge waves of redemptions when the bank folded, and the Reserve Primary Fund "broke the buck", and suspended its constant asset value.
The SEC leapt into action to reform the industry and, a swift eight years later on October 14, US prime money market funds were forced to allow their NAVs to fluctuate with the value of the underlying assets. They also imposed restrictions on liquidity — fees and gates — to reduce the possibility of catastrophic runs.
The EU has made slower progress with its version of the bill, but perhaps the enactment of the US reform spurred it on.
On November 16, it finally reconciled the three separate versions of the reform produced by the European Commission, the European Parliament and the European Council, discarding in the process the suggested 3% capital buffer requirement. Though technical details are yet to be settled, the bill's reduced ambitions are gradually becoming clearer.
Lobbying from constant net asset value (CNAV) fund managers has left the reform lacking the bite of its American counterpart.
The regulation was initially expected to force CNAV funds to convert to variable NAVs (VNAVs).
Then, the concept of a low volatility NAV (LVNAV) fund emerged. These are a halfway hybrid, that would allow funds to maintain a fixed net asset value, provided it remains within 20bp of the real net asset value — down from the 50bp presently allowed to CNAVs.
When LVNAVs were first floated, it was as a temporary measure to ease the transition to full VNAV status — a transition that was to be enforced by a five year sunset clause that would force LVNAVs to convert to full VNAVs. But the sunset clause has been abandoned — a casualty of lobbying — so the mutant LVNAV is here to stay.
Even if Europe were to introduce a hardline reform: mandatory immediate conversion to VNAVs, the consequences would be far less drastic than the turmoil in US funds.
The US reform triggered a $1tr shift from prime funds to government-only funds, but such a sharp move is unlikely in Europe. For one thing, government only funds in Europe yield minus 70bp, while there simply isn’t the capacity in short term European public debt to allow a mass influx of prime fund money.
But most importantly, VNAVs are a far more familiar and less frightening concept to European investors than they were to US investors because, unlike America, Europe already has a flourishing community of VNAV funds.
In any case, the US funds are already adjusting to the new environemnt, designing alternative products to entice investors (who are realising that a floating NAV is no bad thing) to return from the low yielding government only funds.
It is regrettable that the EU has caved in to pressure, and is planning to add an unnecessary layer of complexity to a reform that should simplify the market and make the risks inherent in investment clearer to investors.