Fitch: New Chinese Money Fund Rules Move Closer to International Standards

New rules on money market funds published by the China Securities Regulatory Commission (CSRC) show some convergence with international standards, notably the introduction of liquidity requirements. In Fitch's view, the new regulations strengthen industry practices, foster greater investor protection and lower risk. Nonetheless, the regulations still permit Chinese money funds more latitude in taking investment risk than European or US money funds.

The new money fund rules being implemented by the CSRC introduce liquidity requirements, broaden the investment scope, implement liquidity fees and gates, and specify the actions expected in the event the net asset value (NAV) deviates from predetermined limits. The new rules, announced in December 2015, will take effect in February 2016 with an implementation period of up to a year for certain rules.

Liquidity

Until now, the Chinese regulation had not set out specific liquidity requirements. The new rules require Chinese money market funds to hold a minimum of 5% of assets in cash, government bonds, central bank bills and policy bank bonds and a minimum of 10% in the above-mentioned assets plus assets maturing within five trading days. Furthermore, non-tradeable assets maturing in more than 10 business days should not exceed 30% of the portfolio. In comparison, money funds operating in the US are currently required to maintain 10% of their portfolios in assets that mature overnight and 25% in assets that mature weekly; similar practices are followed by constant NAV European money funds.

CSRC has also reduced the funds' leverage ratio to 20% from 40%. Leverage is rarely used by money funds in developed markets - it is not allowed in the US and limited to 10% under the European UCITS (Undertakings for Collective Investment in Transferable Securities) regulation. The regular use of leverage by money funds is inconsistent with Fitch's rating criteria for 'AAAmmf' on the international scale and similarly for 'AAAmmf(chn)' rated funds on the Chinese national money fund rating scale. As such, no money fund rated by Fitch in China currently employs leverage.

Investment Scope

Starting February 2016, Chinese money funds may invest in negotiable certificates of deposit (NCDs), which should provide the funds with greater issuer diversification and access to an instrument that is tradeable in the secondary market. The market is, however, relatively new, and the ability of funds to effectively trade these securities, notably during periods of market stress, remains untested. Nonetheless, unlike most instruments typically held by Chinese money funds, NCDs are marketable securities, which would support a portfolio's secondary-market liquidity. NCDs are eligible investments for Fitch-rated Chinese money funds if the certificates meet the agency's criteria set out in its "National Scale Money Market Fund Rating Criteria", dated 24 April 2015.

Chinese money funds' ability to invest in NCDs also grants them access to a broader universe of issuers. Money funds' use of NCDs is unlikely to have a material effect on credit quality, despite a broader issuer pool as the primary issuers of NCDs are banks with which money funds already transact. However, the new regulations do allow money funds to invest in lower-quality corporate bonds: the minimum rating level for eligible corporate bonds has been reduced to 'AA+' (local rating) from 'AAA' (local rating). Fitch takes into account issuer credit quality in its assessment of a money market fund's rating. Under Fitch's criteria for 'AAAmmf(chn)' funds, issuers must be rated at least 'A-' by Fitch or another international rating agency.

Liquidity Fees and Gates

New rules require the asset managers to set up an internal liquidity risk management system and charge a 1% fee in case a single shareholder redeems more than 1% of the fund's assets when the five-day liquid assets (cash, government bonds, central bank bills, policy bank bonds and assets maturing within five trading days) on that day are below 5% of the fund and the NAV deviation is negative.

Asset managers may partially meet or delay the redemption if a single shareholder redeems more than 10% of the fund on a single day. The liquidity fee and gates should be specified in the fund purchase contract.

US prime institutional money funds will also be required to adopt liquidity fees and gates in October 2016, based on portfolio liquidity triggers and subject to board approval. Liquidity fees and gates have been widely discussed in the ongoing money fund regulation debate in Europe.

NAV Deviation

Money fund portfolio managers using amortised cost valuation are required to mark-to-market (MtM) the fund's NAV. If the MtM NAV negative deviation expands beyond the predetermined limits, asset managers should take measures to bring the deviation back within the limit. If the MtM NAV negative deviation has been more than -0.5% for two consecutive trading days, the asset manager should use fair value to adjust the book value of the holdings or suspend the subscription and redemption and terminate the fund.

Maturity Limits

CSRC shortened the maximum weighted average maturity (WAM) to 120 days from 180 days, and for the first time set a maximum limit on the weighted average life (WAL) of 240 days. In comparison, European and US money funds operate with maximum WAM and WAL of 60 days and 120 days, respectively.

Concentration limits are updated as well. For example, aggregated time deposits should not exceed 30% of a fund.