Q&a With Fitch Ratings’ Fund and Asset Manager Rating Analysts Charlotte Quiniou and Alastair Sewell

There has been a lot of talk about potentially negative yields on European money market funds. What would this mean?
Euro money market funds’ (MMFs) nominal yields have stabilised at marginally positive levels two months after the ECB-POLICY-3fdc7763-f2c0-4c30-b494-8614852eaf43>ECB cut its deposit facility rate to zero. They could nevertheless post negative yields if short-term euro market rates move further into negative territory. This would lead fund managers to review their investment objectives and the structural features of their funds.

How would this affect MMF ratings?
Negative MMF yields stemming from the short-term market rate environment would not be a negative rating factor per se for Fitch-rated MMFs. This remains true even for those rated at ‘AAAmmf’. Fitch recognises that MMFs yields will be consistent with prevailing safety and liquidity costs, commensurate with alternative high-quality short-term instruments, such as ‘AAA’-rated euro treasury bills. We would also highlight that Fitch MMF ratings are and should remain a ranking of funds on the basis of their liquidity, market and credit risk profile, as opposed to an opinion on the prevailing interest rate environment in which a fund operates.

What sort of yields are European MMFs currently seeing?
At end-August 2012 constant net asset value (CNAV) MMFs denominated in euros were generating net nominal yields of 8bp on average, down by 11bp from their early July level, before the ECB-POLICY-3fdc7763-f2c0-4c30-b494-8614852eaf43>ECB rate cut. While fund managers are still able to find short-dated euro assets delivering small positive yields, further potential actions by the ECB-POLICY-3fdc7763-f2c0-4c30-b494-8614852eaf43>ECB to reduce its reference rates would likely push market rates well into negative territory, and euro MMF yields ultimately as well.

What can fund managers do about this?
There is a limit to the extent that fund managers can prevent their funds’ yield from turning negative amid a negative short-term market rate environment, while still maintaining prudent investment strategies.. So far, other MMF managers have taken a series of measures to maintain their funds’ yields above zero. These include partial fee waivers, which have already been implemented on about half of the euro CNAV funds, and/or selective investment strategy adjustments (for example, marginally extending average portfolio maturities), after an initial wave of closing funds to new investments.
Fund managers have now started to prepare for the possibility of negative yields on euro MMFs, reviewing fund structural features accordingly. This notably entails an adjustment of funds’ investment objectives to introduce explicitly the notion of relativity to prevailing short-term market rates. For CNAV funds, the stable NAV and related yield distribution mechanism is being reviewed with a view to limiting operational challenges as well as minimising accounting and tax implications for investors.

How big is the European money market fund market?
Assets in the European MMF industry totalled EUR1.1trn at end-June 201, of which about 50% were CNAV funds. CNAV funds are typically denominated in euro, sterling or US dollar. At end-August, euro-denominated CNAV MMFs represented total assets of EUR106bn.

Is money flowing out of funds because of the issue of negative yields?
Overall, investors in euro CNAV funds have remained relatively stable throughout the summer. However, government-only euro MMFs, which are a small segment of the euro CNAV with EUR8bn of assets, have experienced large investor asset outflows since early July (-26%).