Euro Money Market Funds Are Likely

To Remain Resilient, Despite The

ECB's Subzero Deposit Rate
Primary Credit Analysts:
Francoise Nichols, Paris (33) 1-4420-7345; francoise.nichols@standardandpoors.com
Andrew Paranthoiene, London (44) 20-7176-8416; andrew.paranthoiene@standardandpoors.com
Secondary Credit Analysts:
Emelyne Uchiyama, London (44) 20-7176-8414; emelyne.uchiyama@standardandpoors.com
Joel C Friedman, New York (1) 212-438-5043; joel.friedman@standardandpoors.com
Table Of Contents
Under Our Rating Approach, Declines In NAVs Could Trigger Downgrades
The Sector May Suffer Some Outflows, But Should Remain Resilient
Related Criteria And Research
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Euro Money Market Funds Are Likely To Remain
Resilient, Despite The ECB's Subzero Deposit Rate
In an unprecedented move, the European Central Bank (ECB) lowered its key interest rates by 10 basis points,
effective June 11, 2014. Notably, the refinancing rate and the deposit rate in Europe are now 0.15% and minus 0.10%,
respectively. The purpose of the ECB's recent actions was to keep ultralow inflation from gaining traction and derailing
the fragile recovery in the eurozone (European Economic and Monetary Union or EMU). However, the move has set
the eurozone's money markets on an uncertain course.
After the rate cut, EONIA fell to 6 basis points (bps) on June 11, 2014, and since then is close to zero, a long way from
its end of May level of 44.8 bps. (EONIA is a key money market benchmark for overnight euro deposits in the
interbank market.) In our view, it is only a matter of time before euro-denominated money market funds feel the
impact. That could be especially the case for short-term money market funds that currently exhibit the lowest yields,
such as government liquidity funds, or for funds subject to high management fees. Standard & Poor's Ratings Services
considers that the prevailing ECB negative deposit rate is flowing through the financial system and will result in
negative yields in some parts of the money markets. Will the new norm for investors in euro-denominated money
market funds become paying for the privilege of investing their cash?
Overview
As a result of the European Central Bank's recent cut in its key interest rates, we believe that more investors
may pull out of euro money market funds as yields decline.
Standard & Poor's nevertheless believes that the funds will remain a valuable tool for corporate cash
management.
Furthermore, we would not expect that, in and of itself, the ECB's recent rate cut will lead to rating actions in
the next 12 months on the euro money market funds that we rate 'AAAm', representing 80 billion in assets at
the end of May 2014.
Euro-denominated money market funds are no strangers to low interest rates. They have endured them well before,
when the ECB dropped its deposit rate to 0.00% in July 2012, and have been able to deliver a modest positive return
to investors. For the euro-denominated money market funds we rate, we calculate an average net seven-day yield
(after fees), which was 18 bps on May 31, 2014, according to the latest available data (see chart 1). Some market
participants expect to see the ECB deposit rate below zero for the foreseeable future. However, Standard & Poor's
economists believe that the deposit rate has reached its lowest point. Our forecast for 2015 and 2016 is for a slight rise
in the ECB's refinancing rate. Because yields do not directly affect our ratings on money market funds, we see a low
likelihood that the ECB rate cuts would lead to negative rating actions in the next 12 months, as long as the funds'
metrics remain in line with our criteria.
The ECB's negative deposit rate will do little to promote the attractiveness of money market funds compared to
higher-yielding asset classes. However, we believe that compared to similar investment offerings, such as bank
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deposits, a diversified pool of high credit quality and highly liquid instruments providing daily access to investors is still
a valuable tool for cash management, despite a low return.
Chart 1
Under Our Rating Approach, Declines In NAVs Could Trigger Downgrades
A small negative yield, in and of itself, does not have a direct, immediate effect on the principal stability fund rating
(PSFR) that we assign to a money market fund. That's because our ratings analysis focuses on principal stability. A
small fluctuation of the net asset value (NAV) per share--the fund's share price--is consistent with our PSFR criteria
(see table 2 and "Fixed-Income Funds: Methodology: Principal Stability Fund Ratings," published on June 8, 2011).
However, if the negative yield causes a decline in the mark-to-market NAV per share of a fund below the range that we
specify in our ratings methodology, which is 0.25% for a fund that we rate 'AAAm', then we would consider a
downgrade. For example, a money market fund rated 'AAAm' that strikes a NAV per share of 0.9964 would most likely
result in a lowering of the PSFR to 'Am'.
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Euro Money Market Funds Are Likely To Remain Resilient, Despite The ECB's Subzero Deposit Rate
Table 2
NAV Ranges
AAAm AAm Am BBBm BBm Dm
NAV ranges* +/- 0.25% (0.9975
to 1.0025)
+/- 0.30% (0.9970
to 1.0030)
+/- 0.35% (0.9965
to 1.0035)
+/- 0.40% (0.9960
to 1.0040)
+/- 0.50% (0.9950
to 1.0050)
> 0.50% (Less
than 0.9950)
*For all funds (regardless of rating), daily portfolio pricing, marked-to-market NAV calculations, and stress testing are monitored when the NAV
goes beyond +/- 0.15% deviation, or 0.9985 or 1.0015. Source: Fixed-Income Funds: Methodology: Principal Stability Fund Ratings, published
June 8, 2011.
Currently all of our 29 rated euro-denominated money market funds exhibit NAVs per share within the ranges for their
rating category. Other key elements of our ratings assessment include credit quality (minimum 50% in assets rated
'A-1+'), weighted average maturity (below 60 days), and management. The euro-denominated funds that we rate have
an average 65% of their assets invested in 'A-1+' rated securities (as of May 2014), versus an average of 67% over the
past two years, and their average weighted average maturity (WAM) was 40 days, versus 36 days over the past two
years. These metrics are commensurate with our rating criteria for 'AAAm' rated funds, irrespective of their
type--whether they are variable net asset value (VNAV) funds or constant net asset value (CNAV) funds.
A key distinguishing characteristic of European money market funds is their valuation methodologies, commonly
referred to as CNAV (constant net asset value) or VNAV (variable net asset value). A CNAV money market fund seeks
to maintain an unchanging NAV (for example, $1, 1, or 1 per share) at all times. It uses amortized cost accounting to
value all of its assets. A VNAV money market fund generally uses mark-to-market accounting to value its underlying
assets. This means that actual market prices are used to value the fund's assets. Under our PSFR methodology, money
market funds have to conduct mark-to-market portfolio valuation at least weekly, irrespective of their type.
In our view, the ECB's interest rate cut will affect the performance of both types of funds, but in different ways. VNAV
funds could see a decline in their NAV per share. In contrast, we expect that CNAV funds will seek to offset the market
value decline by other means to retain a stable share price. Starting at the end of 2012, most CNAV money market
funds adopted mechanisms that they will use, if needed, to maintain the constant NAV per share of their funds. The
most common approach is share cancellation, which reduces the number of shares held by investors, in order to
maintain a 1.00 stable NAV.
When Standard & Poor's discusses the issue of share cancellation with CNAV money market fund managers, they
emphasize the mechanism's ability--though as yet untested--to maintain a stable NAV of 1.00, which is desirable to
investors seeking to preserve the same accounting treatment for their cash investments. Yet they concede that share
cancellation also means that shareholders may not get back the amount they originally invested in the money market
fund. We understand such share cancellation clauses have met the approval of investors at extraordinary general
meetings and authorization of fund regulators. In case of a share cancellation, the overall erosion of a shareholder's
principal value (through a reduction in the number of shares they own in the money market fund) reflects the yield of
the fund, net of all costs and expenses. At present, the difference between gross and net yield for 'AAAm' rated money
market funds is 17 basis points. Nevertheless, we believe that this approach may quickly lose its gloss in a stress
scenario, such as in 2008 when NAVs became volatile as the financial crisis erupted. At that time, liquidity dried up,
leading to fluctuations in the market price of the funds' underlying investments. In our view, share cancellation
amounts to an erosion of investor's invested principal and therefore does not prevent actual asset value decline.
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Euro Money Market Funds Are Likely To Remain Resilient, Despite The ECB's Subzero Deposit Rate
With a current average WAM of 40 days for the 29 rated euro-denominated funds, it won't take much time for the
impact of the ECB's deposit rate cut to flow through to MMF yields, that is, in the third quarter of 2014. However, we
believe that the funds have still some room to absorb the impact, given the gross average yield of 35 basis points (bps)
and the net average yield of 18 bps on May 30, 2014, for our rated euro-denominated funds. To compensate for the
reduced money market yield induced by the ECB rate cut, the funds may elect to lower or waive management fees. Or,
they could choose to "soft close" the funds. The possibility of soft-closing a fund to new investors can aid in protecting
existing shareholders from dilution. Dilution occurs because money market funds are permitted to issue and redeem
shares at 1.00, provided that their market value is between 0.995 and 1.005. Because funds can pay out 1.00 on
shares that may actually be worth as little as 0.995, the remaining shareholders in the fund absorb the difference,
resulting in the redemption of shares at a price above their actual market value, which thus dilutes the value of the
fund's holdings.
The Sector May Suffer Some Outflows, But Should Remain Resilient
Under current monetary and credit conditions, in the next 12 months we don't expect that VNAV money market funds
will see a significant decline in NAV per share or that CNAV money market funds will have to resort to share
cancellations for now. Furthermore, the recent ECB rate cut is unlikely to result in rating actions in the next 12 months
for Standard & Poor's rated euro-denominated money market funds, as long as their metrics remain in line with our
criteria. The most vulnerable money market funds, in our view, are those that currently exhibit the lowest yields, such
as government liquidity funds or funds subject to high management fees. We continue to monitor the portfolios of
more than 420 MMFs globally, denominated in seven major currencies, on a weekly basis as part of our surveillance
practices.
The ECB's latest move, however, may result in additional outflows from this sector, already under pressure from
regulatory uncertainty and lean management fees, and leave it open to further consolidation. The 29
euro-denominated money market funds that we rate 'AAAm' had approximately 80 billion in assets under
management on May 31, 2014, compared to a peak of 162 billion in September 2011 in the middle of the eurozone
crisis (see chart 2). We believe, however, that the industry will remain resilient to this latest setback. Money market
funds have long served companies and investors who need short-term, liquid investments that provide diversification
and safety of invested principal, and we believe that they will continue to do so despite low or even negative yields.
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Euro Money Market Funds Are Likely To Remain Resilient, Despite The ECB's Subzero Deposit Rate
Chart 2
Related Criteria And Research
Related criteria
Fixed-Income Funds: Methodology: Principal Stability Fund Ratings, June 8, 2011
Related research
Economic Research: European Weekly Monetary And Financial Roundup: The ECB Pulls Out The Big Guns, June 6,
2014
Interest Rate Uncertainty Clouds Future Performance Of 'AAAm' Euro Money Market Funds, Sept. 21, 2012
CreditFAQ: What Are The Implications Of Negative Yields For European Money Market Funds? July 16, 2012
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Euro Money Market Funds Are Likely To Remain Resilient, Despite The ECB's Subzero Deposit Rate
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