Key features of LVNAV accumulating share classes

Transcription

1 Information for investors in the HSBC Euro Liquidity Fund on the conversion to accumulating share classes on 18 March 2019 For professional clients only Introduction On the 4 February 2019, the HSBC Global Liquidity Funds plc implemented a number of changes under new European Money Market Fund rules including the conversion of Prime USD, GBP, EUR, CAD and AUD funds from Constant Net Asset Value (CNAV) funds into Low Volatility Net Asset Value (LVNAV) funds. In addition, on 18 March 2019 the distributing share classes of the HSBC Euro Liquidity Fund only will be converted to accumulating share classes as explained in this document. Accumulating share classes are not new and have been available to investors in Money Market Funds for many years. HSBC believes that Euro investors will consider the LVNAV accumulating share class as the most suitable alternative to replace an LVNAV distributing share class as the fund will continue to offer same daily liquidity, unchanged dealing cut-off times and with no change in investment risk. In November, the Central Bank of Ireland (the regulator of the HSBC Global Liquidity Funds plc) clarified to all Money Market Fund providers that the Reverse Distribution Mechanism (RDM), used to deal with negative yields in Europe, would not be permitted post reform. Subsequently the regulator has approved the use of accumulating share classes which can operationally deal with negative yields. Therefore, in order to continue to provide investors with a EUR Money Market Fund that can support the current negative yield environment, on the 18 March 2019, HSBC will be converting all distributing share classes in the HSBC Euro Liquidity Fund into accumulating shares classes. Following the conversion much will remain the same; the fund will continue to have same day liquidity and settlement, the dealing cut-off times are unchanged, ISINs will remain the same and investment risk will all remain unchanged. The key change will be the way that the accumulating shares are priced in comparison to the distributing shares they replace. In this paper you will find a more detailed assessment of the differences between the share classes and considerations for investors with focus on; pricing and volatility, investment risk, accounting treatment and operational risk.

2 Key features of LVNAV accumulating share classes Since the new Money Market Fund regulations were published in June 2017 there has been a wealth of information comparing the existing CNAV funds to the new LVNAV funds. The following information is to assist investors in understanding the difference between distributing and accumulating share classes within a new LVNAV fund. The table below highlights key areas of difference between a distributing and accumulating share class: Low Volatility NAV Fund Distributing Accumulating Unit pricing Stable price Daily change in price Price volatility No price volatility (assuming mark-tomarket price +/- 0.20% from 1.00) Low price volatility in certain circumstances Accounting method Investment risk Amortised cost accounting up to 75 days mark-to-market >75 days Short-term MMF Accounting treatment Cash or cash equivalent 1 Dealing times (EUR) Settlement NAV method Priced to two decimal places 13:00 (Dublin time) Same day Priced to at least seven significant figures Effect in a positive yielding fund Effect in a negative yielding fund Income distributed on a monthly basis Not possible without RDM Accrual of income typically reflected in daily increase in price (assuming no mark-to-market movement) 2 Accrual of income typically reflected in daily decrease in price (assuming no mark-to-market movement) 3 Unit pricing and volatility The most significant difference between an LVNAV distributing (dist) share class and an LVNAV accumulating (acc) share class is the price. The new regulation allows for LVNAV dist shares to continue to be priced at a stable unit value of 1.00 (unless the markto-market price is +/- 0.20% from the stable price of 1.00). However, in the case of LVNAV acc shares the price will change on a daily basis to reflect any interest that has accrued. In a positive yield environment, this means that an LVNAV acc share will typically see an upwards trend in price. However, in the case of negative yields this mean that an LVNAV acc share will typically see a downward trend in price, reflecting the negative accrued interest. Under the new regulation, an LVNAV dist share can be priced with two decimal places. (This would change to four decimal places in the event of a breach of the 20bps fund collar). In contrast, an LVNAV acc share would typically be priced with at least seven significant figures. This allows the price of the share to accurately reflect small daily accruals in interest 4. It is also important to understand the difference between price changes due to accruing interest and price volatility due to a change in price of underlying assets. As already described, an LVNAV dist share will have a stable value of 1.00 and will therefore see no price change (unless the markto-market price is +/- 0.20% from the stable price of 1.00). An LVNAV acc share will see a price change due to accruing interest and potentially a small element of price volatility due to mark to market pricing of the underlying assets in the fund. PRICE CHANGE = ACCRUED INTEREST + ANY MARK-TO-MARKET ASSET PRICE CHANGE The new regulation states the all assets with <75 days to maturity can be priced on an amortised cost basis, whilst any assets with maturities >75 days have to be priced on a mark-to-market basis. It is the latter assets that can potentially contribute to a small amount of volatility in the share price. 1 See Accounting Treatment section for more details. 2, 3 Price movements will be driven by both the accrual of income and any mark-to-market pricing please see additional information in next section. 4 See Operational section for more information.

3 Using the most basic example, an LVNAV fund that had all assets invested with <75 days to maturity would have acc shares that, under normal market conditions, reflect only the accruing interest. However, in reality an LVNAV fund is highly likely to have a proportion of investments in assets with maturities >75 days. Summary: An LVNAV acc share price could contain a small element of volatility derived from the underlying assets in the funds that have maturities >75 days and are therefore priced on a mark to-market basis or from assets with maturities <75 days that have to be priced on a mark-to-market basis as a regulatory requirement 5. Most markets consider CNAV funds as cash or cash equivalent and since there are clear similarities of the features between CNAV and LVNAV, we are confident that major global accountancy firms will continue to classify LVNAV as such going forward. As discussed there could be a small element of the LNVAV acc share price change that can be attributed to the volatility of the underlying mark-to-market assets. However, this is likely to represent an insignificant risk of change in value as defined in IAS7. In November 2018 the French Accounting Norms Authority published advice to the French regulator (AMF) stating that all Money Market Fund including LVNAV and VNAV should be deemed cash and cash equivalents; this advice was accepted by the AMF. Investment risk An LVNAV acc share will have exactly the same investment risk profile as an LVNAV dist share. They represent different share classes of the same underlying fund and will therefore carry the same underlying investment risk. Accounting treatment International Accounting Standards 7 ( IAS7 ) defines cash equivalents as: Short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value International Accounting Standards 7.7 ( IAS7.7 ) then notes that cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes IAS7.7 also notes that: an investment normally qualifies as a cash equivalent only when it has a short maturity of say 3-months or less from the date of acquisition The table below summarises the key characteristics of the HSBC Global Liquidity Funds in light of the International Accounting Standards: Summary: Although the available information strongly suggest that LVNAV funds, including both dist and acc shares, should be considered cash or cash equivalents, we would encourage clients to engage with their internal and external auditors in relation to this topic. Operational Rebasing The conversion of the dist share class into an acc share class will take place on 18 March The process should be seamless and should not require any action from investors. At the point of conversion the shares will also be rebased. Currently the dist shares are price at 1.00, but the acc shares will be priced at 10, The main reason for the rebasing is to make sure there are enough significant figures to accurately reflect small daily interest accruals, an example of which is shown below. At the same time that the dist share classes are converted to acc share class and being rebased, the existing acc share classes will also will also be rebased to 10, IAS7 terms Short term 3-months or less Highly liquid Low Volatility Net Asset Value Fund Maximum weighted average life 90-days Same-day liquidity with no bid / offer spread Readily convertible to cash Insignificant risk of change in value Same day liquidity with no bid / offer spread with sale proceeds paid in cash Historic actual MMF price data and the back test conducted demonstrate that there is an insignificant risk of a change in value (the risk is not zero) 5 It should be noted that the new regulations state the any individual asset that is priced on an amortised cost basis (i.e. those with maturities <75 days) must be priced on a mark-tomarket basis when the individual price deviates by more than If this occurs then an element of volatility could be introduced to the NAV that is not purely due to interest accrual.

4 Example of price impact The example below shows an initial investment of 10m into three differently price LVNAV acc share classes. The first is price at 10,000 with four decimal places, whilst the other two are price at 1 with four and two decimal places respectively. Using an example yield of negative 0.45%, then the daily negative accrual on the initial 10m investment would be approximately or a % change in price. This percentage change in price cannot be reflected accurately in either of the share classes that are priced at 1 and as a result the value of the investment stated is overvalued. Initial investment Share price Number of shares Daily price change New unit price Investment value 10m 10, , , ,999, m ,000, ,000, m ,000, ,000, On the 18 March 2019, the current dist shares in the GLF LVNAV Euro fund will convert into acc shares at a price of 10, The key difference that investors need to consider is that the LVNAV acc share will not maintain a constant value and will be price to nine significant figures rather than the two decimal places seen with an LVNAV dist share. We would encourage clients to engage with their support functions to ensure that the price change from the rebasing can be correctly reflected internally. ISIN The conversion process means the original ISIN for a particular dist share class will carry over to the respective acc share class. As mentioned above, existing acc shares will be rebased but this will also have no impact on ISIN s. Following the conversion, on 18 March, the Euro Liquidity fund will have two sets of acc shares. Returning to positive yields When interest rates and market yields return to positive territory, the option for investors to consider distributing share classes would also return. At that time, HSBC will share information to help investors prepare for such an event, including our planned approach for accumulating share classes in the HSBC Euro Liquidity Fund. Settlement and dealing times The approval of accumulating shares classes by the regulator has allowed us to meet two of the most important client requirements when managing cash: Settlement will continue on a same day basis providing investors timely access to their cash Dealing cut-times will remain at 13:00 (Dublin time) to enable investors to manage their cash requirements as late in the day as possible Summary: Operationally there should be very little difference for clients. Rebasing aside, the accumulating share classes with continue with same day settlement, the same dealing cut-off times and unchanged ISINs. Conclusion The information provided should give investors comfort that the move from distributing to accumulating share classes does not represent a significant change. The change has been necessary in order to provide investors with the option of an LVNAV fund in Euro, post the removal of RDM. HSBC firmly believe that investors will find an LVNAV acc share class a viable alternative to a distributing share class and a much more suitable alternative than a Variable NAV fund. Although there a considerations around the daily change in price, the LVNAV share continues to provide same day settlement, identical cut-off times and the same investment risk profile as the distributing share class it replaces.

5 Key risks The value of investments and any income from them can go down as well as up and investors may not get back the amount originally invested. Asset backed securities (ABS) risk. ABS and MBS typically carry prepayment risk, as well as having potential for default. The securities can carry an above-average risk of being hard to value or to sell at a desired time and price. Counterparty risk. The possibility that the counterparty to a transaction may be unwilling or unable to meet its obligations. Credit risk. A bond or money market security could lose value if the issuer s financial health deteriorates. Derivatives risk. Derivatives can behave unexpectedly. The pricing and volatility of many derivatives may diverge from strictly reflecting the pricing or volatility of their underlying reference(s), instrument or asset. Exchange rate risk. Changes in currency exchange rates could reduce or increase investment gains or investment losses, in some cases significantly. Investment leverage risk. Investment Leverage occurs when the economic exposure is greater than the amount invested, such as when derivatives are used. A Fund that employs leverage may experience greater gains and/or losses due to the amplification effect from a movement in the price of the reference source. Liquidity risk. Liquidity Risk is the risk that a Fund may encounter difficulties meeting its obligations in respect of financial liabilities that are settled by delivering cash or other financial assets, thereby compromising existing or remaining investors. Money Market Fund risk. The Fund s objective may not be achieved in adverse market conditions. During times of very low interest rates, the interest received by the Fund could be less than the costs of operating the Fund. Operational risk. Operational risks may subject the Fund to errors affecting transactions, valuation, accounting, and financial reporting, among other things. Important information For professional clients only, and should not be distributed to or relied upon by retail clients. The material contained herein is for information only and does not constitute legal, tax or investment advice or a recommendation to any reader of this material to buy or sell investments. You must not, therefore, rely on the content of this document when making any investment decisions. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe to any investment. Any views expressed were held at the time of preparation, reflected our understanding of the regulatory environment; and are subject to change without notice. The funds mentioned in this document are sub-funds of HSBC Global Liquidity Funds plc, is an openended Investment company with variable capital and segregated liability between sub-funds, which is incorporated under the laws of Ireland and authorised by the Central Bank of Ireland. The company is constituted as an umbrella fund, with segregated liability between sub-funds. UK based investors in HSBC Global Liquidity Funds plc are advised that they may not be afforded some of the protections conveyed by the provisions of the Financial Services and Markets Act The Company is recognised in the United Kingdom by the Financial Conduct Authority under section 264 of the Act. The shares in HSBC Global Liquidity Funds plc have not been and will not be publicly offered for sale in the United States of America, its territories or possessions and all areas subject to its jurisdiction, or to United States Persons. All applications are made on the basis of the current HSBC Global Liquidity Funds plc Prospectus, Key Investor Information Document, Supplementary Information Document (SID) and most recent annual and semi-annual reports, which can be obtained upon request free of charge from HSBC Global Asset Management (UK) Limited, 8 Canada Square, Canary Wharf, London, E14 5HQ. UK, or the local distributors. Investors and potential investors should read and note the risk warnings in the prospectus and relevant KIID and additionally, in the case of retail clients, the information contained in the supporting SID. It is important to remember that there is no guarantee that a stable net asset value will be maintained. HSBC Global Liquidity Funds are Money Market Funds (MMF) and therefore: a) are not a guaranteed investment b) are different from an investment in deposits and there is a risk that the principal invested in an MMF may fluctuate; c) do not rely on external support for guaranteeing the liquidity of the MMF or stabilising the NAV per unit or share; d) the risk of loss of the principal is borne by the investor The MMF have availed of the derogation provided for under Article 17(7) of the Money Market Fund Regulation and accordingly a Fund may, in accordance with the principle of risk-spreading, invest up to 100% of its assets in different money market instruments issued or guaranteed separately or jointly by the European Union, the national, regional and local administrations or their central banks, the European Central Bank, the European Investment Bank, the European Investment Fund, the European Stability Mechanism, the European Financial Stability Facility, a central authority or central bank of a third country, the International Monetary Fund, the International Bank for Reconstruction and Development, the Council of Europe Development Bank, the European Bank for Reconstruction and Development, the Bank for International Settlements, or any other relevant international financial institution or organisation to which one or more member states of the European Union belong. HSBC Global Asset Management (UK) Limited provides information to Institutions, Professional Advisers and their clients on the investment products and services of the HSBC Group. Approved for issue in the UK by HSBC Global Asset Management (UK) Limited, who are authorised and regulated by the Financial Conduct Authority. HSBC Global Asset Management (UK) Limited All rights reserved. I-0691