How EU legislation damages financial services
Generally speaking I only blog about things I understand. But just occasionally I get to hear about issues outside my day-to-day experience. I think I understand the money market issue that follows, but I’ll be honest – I got someone who knows more about it than I do to draft it (and checked it with a couple of colleagues before letting it loose). So far as I can tell, it’s a new piece of EU legislation which is entirely unnecessary, and seems to have resulted from French lobbying to impose a continental model on money market funds which will not only damage the City, but is likely also to disadvantage public authorities in the UK which invest in these funds. Here goes.
There are essentially two flavours of Money Market Funds (MMFs): Constant Net Asset Value (CNAV) and Variable (VNAV) Funds. The European Parliament is considering a regulation that would require constant net asset value MMFs to either convert to variable net asset value MMFs, or maintain a capital “buffer” of 3% of their total assets. A 3% buffer will kill most CNAV MMFs. Investors won’t pay for it. Managers, unless backed by the largest banks, cannot afford it.
CNAV MMFs are an effective cash management tool for local authorities, charities, universities and businesses. They provide diversification and credit risk management that investors cannot achieve on their own. They meet investors’ need for stable value and liquidity by allowing redemptions at a constant NAV per share (usually £1). CNAV MMF are an important source of short-term funding to governments and business. They maintain CNAV by holding a diverse portfolio of very short-term, high-quality debt instruments. They value these assets at amortised cost so they can process same-day redemptions.
A compromise draft is being developed in the ECON Committee. It would incorporate amendments of a MEP from France, where a form of VNAV MMFs is popular, while dismissing most amendments of MEPs from Britain and other EU countries where CNAV MMFs operate. The current “compromise” would not save CNAV MMFs and would not hold VNAV MMFs to the same high standards that CNAV MMFs have voluntarily adopted.
Many local authorities, charities, and universities cannot invest in VNAV MMFs because of investment restrictions and operational challenges. If the proposal is adopted, they would probably move their cash into bank deposits. But they would lose the diversification that MMFs provide, as the credit risk of their cash investments would be concentrated in a few banks; they would also lose the market rate of return that MMFs pay. Directing more deposits to the largest banks, of course, also increases systemic risk. Few among us want to move in that direction.