Ireland and Luxembourg signal the end of ‘share destruction’

The Irish and Luxembourg regulators have warned money market funds that they must axe a popular mechanism used to cancel shares, dashing the hopes of asset managers who had lobbied against the move. The Central Bank of Ireland has written to money market funds domiciled in the country asking them to submit plans to unwind “share destruction”, a process used to deal with negative interest rates while maintaining a constant net asset value.

The Commission de Surveillance du Secteur Financier (CSSF), the Luxembourg regulator, has also told money market funds that they will no longer be allowed to use a share cancellation mechanism. Ireland and Luxembourg are home to most of the EU’s money market funds, which are short-term investment vehicles that provide clients with a liquid alternative to cash.

Their action is expected to prompt other financial watchdogs to take a similar line. Last summer the European Commission said the share cancellation structure would not be permitted under money market rules expected to come into force in January.Those rules, though, did not explicitly mention share destruction, prompting the industry to hope that it could continue to use the system, also known as a reverse distribution mechanism.

The action by Dublin and Luxembourg follows a letter from Brussels to the European Securities and Markets Authority, the pan-European financial regulator, which said the mechanism would be incompatible with the new regulations.

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“The central bank is now asking fund management companies [with] existing money market funds to provide details of their arrangements to bring the fund into compliance with the requirements of the regulation,” the bank said.

The CSSF said it would no longer allow the share cancellation mechanism because of the European rules. “Existing funds have ... been asked to bring their operations into compliance with this decision.”

Fears for funds

Share destruction is used to deal with low yields and negative interest rates. Cancelling shares allows a fund to retain the same value per share even if the value of its assets slip.

The fear is that scrapping the mechanism could present a problem for euro-denominated funds whose assets of nearly €100 billion are linked to European interest rates.

According to the Dublin regulator, the total value of Irish-authorised money market funds is about €480 billion and euro-denominated money market funds account for €70 billion.

Marina Cremonese, senior analyst at rating agency Moody's, said she expected other regulators to follow the Irish example. "I would not expect any other EU regulator to accept it any longer," she said.

Ms Cremonese said that portfolio managers would need to convert the funds into new structures in order to comply.

“It will be disappointing for some investors – some of them were very keen to continue using the product,” she said.

Irish Funds, the trade body for asset managers in Ireland, said it had lobbied on the issue of money market fund regulation since 2013 and was “surprised and disappointed” by the commission’s decision.

“In the interests of investors and to avoid unnecessary market disruption we have requested and expect reasonable transition arrangements are facilitated during 2019,” the group said.

Money market funds were once thought to be as safe as bank deposits but became controversial after the collapse of the Reserve Primary Fund in the US in 2008. Since then, the €3 trillion global industry has been subject to reform in the US and Europe. The new European reforms introduce stress test and liquidity requirements.– Copyright The Financial Times Limited 2018.