Seeds of reform
While the CSRC drew up a list of guidelines relating to money market funds as early as 2004 using international guidelines and regulations as a blueprint, they have not kept up with ongoing international regulatory reforms. As a result, there is a clear divergence between international and Chinese money market funds.
The CSRC stepped in again in 2016 given fears that the market could overheat, resulting in potential liquidity problems for some MMFs. In an attempt to protect retail investors from a run on MMFs, the CSRC instituted new regulations for higher liquidity requirements for domestic public funds.
In August 2017, the CRSC announced additional regulatory reforms including, new reserve capital limits, constant-NAV client (single investor) limits and new restrictions on investment instruments. However, one of the unintended consequences was that the requirements caused the yields to drop, leading to slower growth and signs that retail investors could begin to move out of public MMFs and look for other, higher-yielding alternatives.
With the level of cash pouring into MMFs from both retail and institutional investors, the number of MMFs has more than doubled since 2014. While there are now over 400 money market funds, most of the assets are concentrated among a small number of asset managers, including Yu’e Bao’s manager, Tianhong Asset Management.
Still, competition has increased, and with Chinese retail investors primarily focused on yield, some fund managers adopted aggressive investment strategies, such as buying less liquid or lower-quality bonds.
With retail investors beginning to move out of public funds, institutional investors became forced sellers to remain in compliance with their internal guidelines, such as limiting holdings to a certain percentage of a fund’s total assets under management.
MMF assets under management contracted further, leading to a higher need for liquidity, thus starting the vicious circle of lower yields and slower growth in assets under management.
Considering a private alternative
China’s attempt to bring more stability and safety into the domestic and public MMF space also simultaneously presents the funds with additional challenges. Under the new regulatory reforms for domestic public MMFs, it will become more difficult to mix institutional and retail clients in the same fund.
Going forward, some fund managers likely won’t even accept institutional clients. With diminishing investment opportunities, institutional investors could consider a private fund structure that could provide a stable investment framework and could better align with global MMF standards.
A private fund structure could involve a pool of assets managed by a fully licensed, offshore asset manager and could offer several advantages including:
- Attractive yield and greater diversification in asset allocation.
- Flexible structure designed to take advantage of liquidity within a pooled fund to meet clients’ liquidity needs.
- Ability to apply the fund manager’s own risk framework for risk control at both fund and investment instrument level.
- No redemption constraints on settlement.
Furthermore, many multi-national corporations have internal investment guidelines that require their MMF investments to have a AAA MMF rating from an international rating agency such as Fitch. However, ratings agencies have tightened restrictions required to garner an international AAA MMF rating.
For example, in order to receive a AAA rating from Fitch, the rating agency requires Chinese MMFs to invest only in a narrow list of securities rated by Fitch, which could increase liquidity risk. As a result, one could argue that a non-rated fund that can invest in a broader investment universe provides wider diversification and better access to liquidity, less issuer concentration and possible yield pick-up. These attributes come without increasing the fund’s intrinsic risk by maintaining a AAA rating.
In the relatively short period of time since the first MMFs were launched in China, they have become a crucial asset class.
Given the increase in the number of MMFs and the rapid growth of assets in them, China’s new guidelines sought to provide better protection for retail investors. However, institutional investors are left with far fewer options.
As the guidelines evolve and become clearer, it will be important for cash managers with significant holdings in China to become familiar with options for investing their cash.