Money Market Funds Are You EU Reform Ready?

Money Market Funds Are You EU Reform Ready?

EU MMF Reforms The European Union (EU) money market fund (MMF) reforms will become effective from 21 January 2019. The reforms are set to change the landscape of Europe s 1.2 trillion cash investing market. 1 In preparation for the changes, investors are reviewing the new parameters to better understand their fund allocation options, while fund providers ascertain which fund types will garner demand and what to make available for investment. All existing MMFs will experience some change with a range of potential benefits identifiable for all strategies and fund types. 1 Source: IMMFA as at 31 December 2016. 2 State Street Global Advisors

A Natural Home for Cash We believe there is no alternative to money funds for a better balance of safety, diversification and liquidity while delivering a market rate of return for cash investors. Indeed, in our view, EU MMF reform will serve to bolster the stability of money market funds without compromising investment potential. Preparing for Change The change to the new regime will be relatively straightforward for many USD and GBP investors who have indicated they will remain in their current vehicle as the rules take effect. Many are well prepared, having already lived with redemption gates and variable net asset values (NAV) built into existing MMFs and are comfortable with them. As a result, we do not anticipate a replication of the extreme asset migration witnessed in US regulated money market funds in response to reforms there; in the US, more than $1 trillion in assets were transferred from prime to government strategies. It should be noted that institutional prime funds in the US were required to convert to variable NAV and also become subject to liquidity fees and redemption gates. Meanwhile, government strategies could continue to offer a constant NAV and were not subject to fees and gates. The preparations of some investors were disrupted by an announcement from the European Securities and Markets Authority (ESMA) that effectively ruled out Constant NAV (CNAV) and Low Volatility NAV (LVNAV) fund types for EUR investors as long as yields are negative. Although EUR investors can still choose an LVNAV strategy, the current guidance and existing fund structures would expose them to variable NAV and fees and gates. At present, the ESMA statement has no impact on GBP and USD investors as these currencies are not in a negative yield environment at this time. Implications of ESMA View ESMA stated in February that the use of Reverse Distribution Mechanism (RDM) for money market funds that are negative yielding is incompatible with the principle of reform. RDM is a technique used by fund managers that offer CNAV funds to allow them maintain a share price of 1 in a negative interest rate environment. ESMA view would effectively rule out CNAV or LVNAV funds in EUR in the near term. This would effectively eliminate the possibility of CNAV or LVNAV funds in EUR in the near term. If interest rates rise to a level that allow funds to produce a yield that is above zero, CNAV and LVNAV funds can then be reintroduced to the market. This situation is a function of the negative yields on offer and would equally apply if USD or GBP yields were negative providers would have to review their CNAV or LVNAV funds. Discussions between ESMA and industry groups are ongoing. We will monitor developments closely and ensure our clients are quickly updated if there is any change to the current situation. Money Market Funds Are You EU Reform Ready? 3

Are You Prepared? ESMA s interpretation was unexpected, but the countdown continues regardless. While there is still time to decide on final fund allocations, investors should be checking off their to-do lists. Investors now know what the reforms are and what funds will be offered in certain markets. Full engagement with their risk management, operations, and senior leadership teams is essential to ensure clarity in the fund type they will utilise in each market. Systems and operational testing should be scheduled to ensure a smooth transition. Investment policy statements should be updated and prepared for sign-off. Checklist Initial Planning Optimising for Yield Investment Policy Changes Systems Review Implementation At this point, investors should understand the EU MMF reforms, have considered the pros and cons of the fund segments and determined which fund types best meet their needs. Investors have modelled their needs by separating cash into operating, core and strategic segments. In the context of negative EUR yields, investors should be considering allocating core and strategic cash to higher-yielding, marginally less liquid funds, such as Standard VNAV funds. Check that your Investment Policy Statement (IPS) allows investment in your fund segments of choice: CNAV, LVNAV, VNAV. Are internal systems compatible with segment-choice features? Can accounting systems handle NAV changes? Prior to allocation, compare available funds, assessing such differentiators as track record, risk metrics, expertise, relationship management, thought leadership and operational convenience. Review fund performance according to post-reform parameters such as: daily and weekly liquidity, investor flows and mark-to-market NAV calculations. Draft for Management Approval Schedule Testing Determine Transition Date Support at State Street Global Advisors State Street Global Advisors is prepared for reform implementation and ready to provide support for investors. While some technical and operational questions remain and must still be addressed, we recognise the importance of clarity and transparency with regard to our future product line-up. To that end, we have worked diligently to ensure that our funds align with investor needs and that we remain able to satisfy current and future cash management requirements. The following section details the investor options, the variables that will drive the decision process and what choices we believe will prove popular and why. 4 State Street Global Advisors

Government Funds We expect that EU-domiciled government MMFs in USD and GBP will convert into Public Debt CNAV funds. The money fund reform imposes fewer changes to public debt funds than to any other fund strategy. Amortised cost accounting will enable these funds to reliably seek to maintain a constant NAV, and the threat of a liquidity-based fee or redemption gate being implemented seems extreme in even the direst situation. In the US, regulators exempted government strategies from fees and gates because those holdings had proved liquid during even the darkest days of the 2008 global financial crisis. Public Debt CNAV funds could see increased interest from USD investors. Growth has been evident in those strategies and we anticipate some investors will move to this more conservative option during the transition to new regulations. GBP investors have shown little to no interest in this strategy before now, and we don t expect reform to change that. In EUR, the decline in public debt assets under management (AUM) reflects the interest rate environment; the ESMA determination could result in the AUM of this asset class declining to zero. Prime Funds Prime funds account for by far the greatest share of AUM in the EU institutional market, and providers of USD and GBP strategies will likely favour either LVNAV or VNAV funds to comply with the reforms. EUR strategies will most likely be converted to VNAV funds unless the ESMA interpretation on the use of RDM is overturned. We see no fundamental reason for fund providers to favour any one of these options over another. Instead, they will likely be happy to offer the strategies that meet their clients' preferences. An LVNAV fund will continue to trade at a constant NAV as long at its mark-to-market valuation does not deviate from its amortised cost valuation by more than 20 bps. Low Volatility NAV vs Variable NAV LVNAV funds are the prime fund choice for USD and GBP investors seeking an option that will maintain a constant NAV, assuming they are willing and able to accept the possibility of liquidity fees and redemption gates. Under normal market conditions, we expect investors to see little difference between LVNAV funds and pre-reform Constant NAV funds. This, we believe, will be a significant allure of this segment. Short-Term VNAV funds are the likely choice of EUR investors. These avoid liquidity fees and redemption gates. We expect the NAV fluctuation on post-reform Short-Term VNAV funds to be low under normal operating conditions generally less than five basis points per year. VNAV funds could potentially offer marginally higher returns than LVNAV funds, given that their liquidity requirements are lower (see appendix). This enables managers to hold a greater concentration of higher-yielding assets. NAV Fluctuations An LVNAV fund will continue to trade at a constant NAV as long as its mark-to-market valuation does not deviate from its amortised cost valuation by more than 20 bps. We believe that this threshold would likely only be breached in the event of a major market issue an issuer impairment, massive outflows, and/or a dramatic interest rate shock. Still, the possibility of a NAV change is explicitly built into these funds and cannot be ignored. Money Market Funds Are You EU Reform Ready? 5

Investor Contradictions We have actively sought the views of investors to ascertain priorities and likely segment preferences. Our early-2017 survey* offered good insights, although it was also clear that investors were still considering options at that time. For example, our survey revealed the feature of money fund reforms that most concerned respondents was liquidity fees and redemption gates. And yet the top choice of investors was the LVNAV segment, which is subject to those very fees and gates. This may simply reflect respondents concern precisely because they are a feature of the LVNAV funds to which they planned to allocate. Alternatively, this contradiction could be viewed as investors lacking a thorough understanding of the new regulations. If this is the case, despite the expressed preference for LVNAV, some investors may be more comfortable with VNAV funds and may make allocations to this segment as the deadline draws closer. Current prime investors who find that they lack the mechanisms to invest in post-reform prime strategies may choose to allocate to CNAV strategies. Some prime investors may compare post-reform prime funds with the next segment in our discussion Standard VNAV and see an attractive option for at least part of their cash holdings. Standard VNAV Standard VNAV funds offer potentially greater yield, with marginally lower liquidity and principal preservation assurance. Positioned between traditional MMFs and short-term bond funds, Standard VNAV funds have long existed in the EU and are the strategy of choice for investors in certain countries notably France. Standard VNAV funds, though still ultra-conservative, have longer maturity and asset life constraints, and have less stringent diversification requirements. The potential to earn additional yield for GBP and USD clients on core and/or strategic cash not needed for immediate operations is likely to be a key reason investors will consider allocating to the segment. The desire to mitigate negative returns for EUR investors will also continue to drive interest. The bottom line is that this strategy carries marginally lower standards of liquidity and principal preservation, but by reaching further out the curve there is the potential for higher yields. With reform eliminating true constant NAV prime strategies for EUR, we believe that a portion of EU prime investors will be tempted by the potential yield of Standard VNAV funds. Partnering with State Street Global Advisors After assessing investors needs and expectations, our intention is to offer a full suite of funds under MMF reform, subject to regulatory approval and investor demand. EUR investor choice may be limited if ESMA's interpretation does not change, but we expect the VNAV option will likely meet most investor requirements. We believe that by providing a complete product range, we remain best placed to provide a full service solution, offering a one stop shop for all cash management requirements. Visit our website to view our intended post reform product range. * EU Money Market Fund Reform Survey Methodology. The survey was presented online to SSGA cash clients in Europe during Q2 of 2017, and completed by 99 senior cash decision makers, primarily headquartered in Great Britain. 6 State Street Global Advisors

Appendix EU Money Market Fund Reform at a Glance Public Debt CNAV Low Volatility NAV Short-Term VNAV Standard VNAV Share Price Constant NAV Constant NAV per share, but converts to VNAV when markto-market valuation gap >20bps Variable NAV Valuation Method Amortised Cost Amortised cost for assets <75 days to maturity and with gap to mark-to-market <10bps Mark-to-market All other assets mark-to-market Fund Valuation 2 decimal places / /$1.00 4 decimal places / /$1.0000 Liquidity Fees/Redemption Gates Restrictions Asset Maturity If weekly liquidity drops below 30% and the fund has net redemptions greater than 10%, the Board must decide which action to take, if any Liquidity fees or redemption gates are mandatory if weekly liquidity falls below 10% Fund share price floats if redemption constraints exceed 15 days in 90 day period Maximum 397 days No constraints specified by MMF reform, but redemption gates are allowed under UCITS directive Max 2 years, with max 397 days to next interest rate reset WAM Maximum 60 days 6 months WAL Maximum 120 days 12 months Minimum Overnight Liquidity 10% 7.5% Minimum Weekly Liquidity 30% 15% Weekly Liquidity Eligible Assets Minimum 12.5% cash, reverse repo, deposits. Maximum 17.5% gov securities to 190 days. Other MMFs not permitted. Minimum 7.5% cash, reverse repo, deposits. Maximum 7.5% in other MMFs. Eligible Investment Assets Diversification 99.5% government assets, cash or reverse repo backed by government assets Max 100% per sovereign, agency or European supranational, across at least 6 issues, max 30% per issue; Max 15% per reverse repo counterparty Money market instruments, certain securitisations or ABCP, instantly accessible deposits, short-dated reverse repo, other short-term MMFs (excluding circularity), currency and interest rate derivatives (only for hedging purpose) Max 5% per issuer Max 10% per deposit counterparty Max 15% per reverse repo counterparty Max 10% per issuer and max 40% aggregate in issuers >5% Max 100% per sovereign, agency or European supranational, across at least 6 issues, max 30% per issue Max 5% risk exposure per derivative counterparty Max 5% per MMF Max 15% overall exposure to securitisation and ABCPs Max 17.5% overall MMF exposure Money Market Funds Are You EU Reform Ready? 7

Glossary Money Market Fund (MMF) Typically a regulated commingled fund that must abide by specific regulatory rules that limit risk and set minimum liquidity requirements. Those rules can include maturity and duration limits, as well as asset quality requirements. Prime Fund This type of fund can be a money market fund that is permitted to invest in credit assets, such as bank and corporate obligations. Net Asset Value (NAV) The NAV is the price of a share determined by the total value of the securities in the underlying portfolio, less any liabilities. ssga.com Important Risk Information Australia: State Street Global Advisors, Australia, Limited (ABN 42 003 914 225) is the holder of an Australian Financial Services Licence (AFSL Number 238276). Registered office: Level 17, 420 George Street, Sydney, NSW 2000, Australia. T: +612 9240 7600. F: +612 9240 7611. Belgium: State Street Global Advisors Belgium, Chaussée de La Hulpe 120, 1000 Brussels, Belgium. T: 32 2 663 2036. 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