In the past two years, we have seen a surge in the number of publicly offered money market funds (or MMFs) in Hong Kong. This trend is perhaps not surprising, given the continuous rate hike which makes it sensible for investors to put money in these relatively low risk products.
On 17 December 2024, the Securities and Futures Commission (SFC) published a Circular to management companies of SFC-authorised money market funds (Circular). The Circular reiterates the Code on Unit Trusts and Mutual Funds (UT Code) requirement for MMF managers to maintain and implement effective liquidity risk management policies and procedures and highlights a number of good practices.
Managing liquidity risks has always been a key concern of the SFC, and is more important especially when these products may be subject to massive redemptions. For example, money market funds may be offered on stock trading platforms, where investors may withdraw their entire holdings frequently for the purpose of participating in initial public offerings. Also, as the SFC observed, a reverse in interest rate policies may lead to more substantial outflow, or as investors decide to reallocate their portfolios in response to changing market sentiment.
We summarise below the good practices highlighted by the SFC:
A. Minimum levels of liquid assets
The UT Code requires an MMF to hold at least 7.5% of its total net asset value (NAV) in daily liquid assets (DLA) and at least 15% of its total NAV in weekly liquid assets (WLA). While this is the minimum requirement, it is good practice for MMF managers to monitor prevailing market conditions in assessing the liquidity profile of the fund, to adjust DLA and WLA levels as and when appropriate. For example, where the manager anticipates an increase in potential redemption requests, adjustments may be made to allow additional liquidity.
B. Portfolio construction
The liquidity profile of MMFs’ liabilities and assets should be monitored regularly using both quantitative metrics (such as days to trade, cost to trade or time to maturity), and qualitative factors (such as asset class and credit quality). “Laddering” arrangements or the negotiation for early termination of fixed-term deposits under favorable terms are noted as good practices of managing liquidity for money market funds.
C. Investors’ profile
A MMF’s investor profile and investors’ historical and expected redemption patterns should also be regularly assessed. In Hong Kong, most funds are distributed through intermediaries. Accordingly, MMF managers should seek to understand underlying investors’ profile by active engagement and communication with distributors to gauge and manage investor demand, particularly where holding is concentrated. Historical redemption patterns may also be a useful indicator as to the times when massive fund outflows may likely occur.
D. Anti-dilution liquidity management tools (LMTs)
Anti-dilution LMTs should be used appropriately to protect investor interests and to ensure fair treatment. Transparency is essential where LMTs are used – the fund’s offering documents must describe relevant LMTs and explain when they may be used, their impact on the fund and investors, and any attendant risks involved.
It is important for MMF managers to review the available tools for the funds under their management, and ensure that appropriate disclosure has been made. Nowadays, it is typical for fund documents to describe detailed mechanisms of anti-dilution LMTs. For MMFs, if costs will be incurred in the liquidation of assets (for example, the penalty for breaking a deposit), the manager can have the discretion to adjust the redemption price, for example, by a swing pricing mechanism, to attribute such costs to the exiting investors.
On a related note, in conjunction with its holistic review over the market turmoil that happened in March 2020, the Financial Stability Board stated in a report (available here) that the International Organisation of Securities Commission (IOSCO) plans to revisit its last policy recommendations for MMFs. We expect the SFC, being a member of IOSCO, would follow IOSCO’s policy recommendations. Therefore, when these new policy recommendations are available, new rules for MMFs might come shortly afterwards, to help to address the vulnerabilities identified in the FSB report. MMF managers are advised to stay tuned for relevant developments.
For further information, please contact:
Ming Chiu Li, Partner, Deacons
mingchiu.li@deacons.com
