In June, EU finance ministers reached a long-awaited deal on a draft law regulating money market funds. The European Commission had initially proposed the bill in September 2013, as part of a comprehensive effort to tackle “shadow banking” (lending by investment funds), but it took more than three years for EU governments to reach an agreement.

Why did it take so long? Because EU countries were split on how to regulate constant net asset value funds, or CNAVs, a specific type of money market fund that seeks to maintain a constant price of €1 per share when investors redeem or buy shares into them.

Because of this stable price, this product is widely used by non-financial companies as an alternative to bank accounts. But the €1 guarantee can also make CNAVs dangerous, if the fund can’t always live up to its promise. That creates massive panic among investors, who all want to redeem as fast as possible, known as “breaking the buck”.

€152bn in Luxembourg

Luxembourg is home to one of Europe’s biggest CNAV markets. As of April there were 47 of them here, with total assets of €151.8 billion, according to the national supervisor, the Commission de surveillance du secteur financer. The total asset value of all CNAV funds in the EU amounts approximately to €500 billion, according to the Institutional Money Market Funds Association.

Under the June European Council compromise, most of Europe’s CNAVs will be phased out and transformed into low volatility net asset value funds, or LVNAVs, which move in value with market conditions and do not create the problematic illusion of a constant price. CNAVs will only be allowed to operate in the EU if they invest more than 99.5% of their assets in public debt, or if they are offered to retail clients located outside of the EU. This second exemption was specifically asked by Luxembourg, which sells a number of such products to clients all over the world.

Pierre Gramegna speaks during the annual Spring Conference organised by Alfi, Luxembourg’s funds trade group, in March 2014. Photo: Luc Deflorenne

For several EU governments, the compromise can seem disappointing. Luxembourg, the UK and Ireland didn’t get what they wanted, i.e., no regulation of CNAVs. France and Germany had to accept to let some CNAV-like products survive; both countries were in favour of a total ban on this type of fund.

“We’ve tried to be constructive”, Luxembourg’s finance minister, Pierre Gramegna, told reporters after the June EU talks. “The goal should be to regulate [CNAVs], but in such a way that they can still be used, and to keep this important source of liquidity from leaving the European market”.

Benoît Sauvage in a portrait provided by the ABBL, Luxembourg’s banking trade group

The financial sector did not welcome the new set up very warmly. “The proposed LVNAV structure is not an adequate substitute for the CNAV product”, the Institutional Money Market Funds Association, which represent the CNAV industry, said prior to the finance ministers meeting. Industry representatives point to the added compliance costs linked with the new product, and are concerned about market reactions.

“We are creating a new and complex product”, Benoît Sauvage, from the Luxembourg Bankers’ Association, told Delano. “We can not predict whether there will be investors’ demand or not.”

Neena Gill, the British Labour MEP, addresses a European Parliament plenary session in December 2015. Photo: European Parliament

“A LVNAV is almost a CNAV, but with a marginal VNAV variability”, said Antoine Kremer of the Association of the Luxembourg Fund Industry. “But after the financial crisis, it became politically necessary to change the CNAV legislative framework.”

“This compromise makes nobody happy, so it’s probably a good deal”, a financial sector source ironically told Delano.

Negotiations with parliament

The law-making process is far from being over. The European Council and the European Parliament must now reach a compromise on a common text, and there are a couple of issues that still need to be addressed during these so called three-way talks.

A finance ministry spokesperson told Delano that the council’s text has a number of shortcomings, “notably, but not only, in the area of liquidity requirements of MMFs”. The ministry aims to achieve “a workable solution and to avoid unintended consequences on MMFs”.

There is another significant difference over the LVNAVs: the parliament created this product as “temporary”, by inserting a so-called “sunset clause” that will phase them out after five years. The council LVNAV structure “goes to a certain extent into the direction of the EP text”, Neena Gill, lead lawmaker in the EU assembly on this bill, told Delano.

She sees the sunset close as one of the key issues for the upcoming negotiations. “What is crucial to me is to tackle the systemic risk involved in some types of MMF. We need to build up sufficient guarantees in this respect and at the same time ensuring that the MMF sector can continue to play its important role”, Gill said.

Petr Jezek, the Czech ALDE MEP, speaks during a European Parliament plenary session in Strasbourg on 12 April 2016. Photo: European Parliament

But each type of MMF must be both economically sustainable and attractive for investors, said Petr Jezek, the Czech MEP who conceived the LVNAV idea during the negotiations in the EP. “For LVNAV to be, it’s essential to remove the sunset clause”, he told Delano. He didn’t manage to gain enough support in the EU assembly last year to remove it.

Gill also pointed out the liquidity and diversification requirements, as main issues “to be thrashed out in the upcoming [negotiations]”.

The issue of liquidity requirements

During the technical talks among EU nations, member states clashed over the question of liquidity requirements. Luxembourg, the UK and Ireland argued that the requirement for LVNAVs and CNAVs to hold 30% of assets with a maximum maturity of one week (compared to 20% in the European Commission’s original proposal) was too restrictive. They called for public security to “count towards the calculation of the threshold”. Germany and France opposed the idea.

To please everyone, the Dutch presidency of the European Council came up with a compromise somewhere in the middle. Liquidity requirements for all types of funds remained unchanged, but some flexibility was allowed to include a certain percentage of government paper in the calculation of the threshold.

Gill expects the three way talks to begin before the summer, with the aim to get a deal in the autumn.