UK Money Market Reform Change Coming for UK Money Market Funds

European money market funds (MMFs), and especially those investing largely in non-government assets such as Low Volatility NAV (LVNAV) and Variable NAV (VNAV), have been at the centre of policy discussions in recent years. Notably, their levels of outflows and performance during recent market stress events have led regulators to question the strength of the existing regulatory framework applicable to the sector.

Discussions are more advanced in the UK, in response to the market events around March 2020 “Dash for Cash” and the 2022 liquidity event, which exposed a rapid rise in UK gilt yields, impacting some money market funds and their LDI client base. The FCA and HM Treasury published new draft rules in December 2023 addressed to UK-domiciled MMFs.

From the UK regulators’ perspective, the new rules seek to address the vulnerabilities shown in particular by some Sterling-denominated MMFs, which saw significant outflows during March 2020. Beyond strengthening the resilience of MMFs, UK authorities are also mindful of reducing the need for future extraordinary central bank interventions of the kind that occurred in March 2020 and Autumn of 2022.

The proposed rules, which have not been finalized yet, do not alter the current MMF operating model based on the three MMF structures of Public Debt Constant NAV (CNAV), LVNAV and VNAV. The option previously considered by regulators – of changing or removing constant NAV operation has not been taken forward – mean that LVNAVs will be able to continue dealing at their constant NAV price, provided the ‘underlying real NAV’ per unit stays within a ‘collar’ of 20 bp up or down of the constant NAV per unit.

The Financial Conduct Authority recognised that a removal of the constant NAV operation from LVNAVs would have severely reduced user utility, leaving large parts of MMF investors struggling to meet their cash management needs. To address potential risks of ‘breaking the collar’, the draft rules introduce instead enhanced operational requirements on managers to notify the FCA when the constant NAV per unit differ by more than 15 bps (approaching the collar) and to have in place stricter governance and stress-testing requirements. Some funds will already have internal reporting threshold limits at 10 bps – ahead of any FCA notification requirements.

Where the proposed rules depart most significantly from the current regime is on liquidity requirements. The proposal introduces significant increases in the minimum thresholds for weekly liquid assets (WLAs) and daily liquid assets (DLAs). These are currently set at different levels according to the type of MMF (for example: LVNAV funds currently set WLA at 30% and DLA at 10%) and under the new proposal will be raised to 50% and 15%, respectively.

UK authorities consider these increases adequate, with the market capacity in the assets that comprise WLA a point that has been contested by the industry. It remains unclear at this stage if the levels of liquidity will be confirmed in the final rules and what the transition period will be to adjust portfolios in light of the new requirements.

In parallel, the draft rules propose increasing KYC requirements and requiring MMF managers to take “appropriate actions” in case of excessive investor concentration. This could result in a manager deciding that it must hold liquidity above the new minimums or result in a manager requiring one or more investors to reduce the size of their holding in the MMF. It is worth noting that many managers already have investor concentration thresholds and actively engage with investor to understand flow patterns.

Moreover, UK authorities are also proposing to support the “usability” of liquidity resources by removing the requirement for a manager to consider activating ‘Fees & Gates’ when the MMF breaches the regulatory minimum thresholds.

Finally, contrary to recent SEC rules on MMFs, the UK reform is not proposing to introduce mandatory tools such as swing pricing or redemption fees (Liquidity Management Tool – LMT) to impose the costs of liquidity on redeeming investors. Instead, UK MMFs will be required to have the ability to suspend dealing and to select at least one LMT to be used while the fund remains open. In any case, managers remain able to decide on which LMTs to use, when and how to deploy them in the best interest of their investors.

Key Takeaway

After public consultation, the final UK MMFs rules were expected to be finalized in late 2024, but a delay to Q1 2025 is possible.

The proposed rules mark a departure from the existing rules relevant to EU MMFs. Considering that the UK-domiciled MMFs represent only about 10% of the sterling MMF sector, with the rest being EU-domiciled MMFs, a substantial divergence between the UK and EU frameworks might call into question the ability of MMF managers to continue offering their MMFs across the two jurisdictions. The EU has so far not proposed a revision of its framework, even though policy discussions are likely to re-emerge with the new European Commission over the course of 2025.