Money Market Funds Regulation (MMFR)
It has been recognised by the G20 and the Financial Stability Board that money market funds pose a potential systemic risk to the global economy. The Money Market Funds Regulation (MMFR) is the EU response to this risk assessment. It is a broad set of new regulatory measures that apply to money market funds established, managed or marketed in the EU. This is a €1 trillion market and is largely currently unregulated.
The MMFR aims to make Money Market Funds (or MMFs) more resilient and resistant to contagion risks. The new regulation Imposes rules on eligible assets, portfolio diversification, portfolio maturity and the valuation of assets. It also introduces new categories of MMFs that can offer a constant net asset value (“NAV”) per share if they meet certain requirements.
The MMFR was published in the EU Official Journal on 30th June 2017 and will generally apply from 21st July 2018. Existing MMFs can use a further six month transition period to submit an application to their competent authority demonstrating compliance with the MMFR.
Without doubt, the MMFR will shake up this sector of the investment market. It is highly prescriptive and it may stifle inward investment from non-EU investors. It should be noted that not all Member States have welcomed its introduction (eg Luxembourg).
The Money Market Funds Regulation (MMFR) is a broad set of new regulatory measures that apply to money market funds established, managed or marketed in the EU. This is a €1 trillion market. Globally, it has been recognised that money market funds pose a potential systemic risk and the MMFR aims to make these investment products more resilient and resistant to contagion risks. The sector is currently largely unregulated. The MMFR lays down rules and common standards to:
- ensure stability in the structure of money market funds
- guarantee that they invest in well-diversified assets of a good credit quality
- increase the liquidity of money market funds, to ensure that they can face sudden redemption requests
- it also introduces new categories of money market funds that can offer a constant net asset value (NAV) per share if they meet certain requirements.
It should be noted that the MMFR was adopted at a meeting of the EU General Affairs Council without discussion. The decision was taken by qualified majority with Luxembourg voting against.
The MMFR was published in the EU Official Journal on 30th June 2017 and came into force on 20th July 2017. Article 11(4), Article 15(7), Article 22 and Article 37(4) will apply immediately although the remainder of the regulation will apply from 21st July 2018.
KEY ASPECTS OF THE MMFR
SCOPE: All UCITS and AIFs that invest in short term assets (assets with a maturity not exceeding two years) and have an objective of offering returns in line with money market rates and/or preserving the value of the investment are in scope of the MMFR.
The MMFR will also impact non-EU MMFs as they will not be permitted to be marketed in the EU as a MMF.
TYPES OF MONEY MARKET FUNDS (MMFs): Only UCITS and AIFs authorised under the MMFR will be permitted to use the designation ‘money market fund’ or ‘MMF’ in any documents, prospectus, advertisements or communications. A MMF must clearly indicate whether it is a short term MMF or standard MMF in any written communication, external documents or in advertisements distributed to investors.
A MMF may be established as a:
|MMF Type:||Standard MMF||Short Term MMF|
|Variable NAV MMF (VNAV MMF)||√||√|
|Low volatility NAV MMF (LVNAV MMF)||X||√|
|Public debt constant NAV MMF (Public Debt CNAV MMF)||X||√|
WHAT ARE THE KEY DIFFERENCES BETWEEN THE THREE TYPES OF MMF?
VNAV MMF: This is the most flexible type of MMF and it can be established as a short term MMF or as a standard MMF. It will issue and repurchase shares at a variable NAV using the Market Valuation.
LVNAV MMF: Is also a flexible type of MMF but unlike the VNAV MMF it can only be set up as a short term MMF. LVNAV MMFs have the ability to issue and repurchase shares at a constant NAV per share and to use the Amortised Valuation. They will not be subject to further restrictions on eligible investments but their ability to offer a constant NAV and use the Amortised Valuation will be subject to certain conditions. The Amortised Valuation will only be permitted if the assets of the LVNAV MMF have a residual maturity of up to 75 days. Also, if the Amortised Valuation of the assets deviates from the Market Valuation by more than ten basis points, the Amortised Valuation cannot be used. In addition, shares will be capable of being issued and redeemed at a constant NAV per share only as long as the constant NAV per share does not deviate from the Market Valuation by more than 20 basis points.
PUBLIC DEBT CNAV MMF: This is the most restrictive type of MMF. Similar to the LVNAV MMF, it can only be established as a short term MMF. This type of MMF is permitted to issue and repurchase shares at a constant NAV per share and use the Amortised Valuation. Unlike LVNAV MMFs, it is subject to further rules in respect of eligible investments being required to invest at least 99.5% of its assets in certain public debt securities, reverse repos secured by eligible public debt securities and cash. Due to these major restrictions Public Debt CNAV MMFs are not subject to further conditions relating to offering a constant NAV per share and use of the Amortised Valuation.
Please note LVNAV MMFs and Public Debt CNAV MMFs must follow specific procedures if the proportion of daily and/or weekly maturing assets fall below certain thresholds. These include escalation procedures, application of gates and suspension of redemptions. When, within a period of 90 days, the total duration of suspensions exceeds 15 days these two types of MMFs will automatically cease to be a Public Debt CNAV MMF or a LVNAV MMF.
MMF investments: MMFs will be permitted to invest in the following:
(a) Money market instruments
(b) Deposits (on demand or less than 12 month maturity) with eligible credit institutions
(c) Eligible securitisations and asset backed commercial paper (ABCPs)
(d) Reverse repos (Reverse repurchase agreements) if with the ability to close out the agreement on no more than two working days’ notice
(e) Repurchase agreements (for liquidity management purposes if with the ability to close out the agreement on no more than two working days’ notice)
(f) Financial derivative instruments but to hedge interest rate or exchange rate risks only
(g) Units of other MMFs (subject to short term MMFs only investing in units of other short term MMFs)
However, Public Debt CNAV MMFs are subject to further restrictions.
MMF investment restrictions: MMFs will be prohibited from:
(a) Shortselling money market instruments, securitisations, ABCPs and units of other MMFs;
(b) Entering into securities lending agreements or securities borrowing agreements;
(c) Taking direct or indirect exposure to equities or commodities;
(d) Borrowing or lending cash.
Diversification and concentration: MMFs will be subject to detailed rules on the diversification of eligible investments. These rules include issuer concentration limits, limits on exposure to credit institutions and counterparties and investment in other MMFs.
Portfolio maturity: MMFs will be subject to portfolio maturity limitations. This is in order to reduce portfolio risk, strengthen MMFs ability to face redemptions, and prevent MMFs assets from being liquidated at heavily discounted prices.
|MMF type||Weighted average maturity (“WAM”)||Weighted average life (“WAL”)|
|Short-term MMFs (Public Debt CNAV, LVNAV and VNAV MMFs)||≤ 60 days||≤ 120 days|
|Standard MMFs (VNAV MMFs)||≤ 6 months||≤ 12 months|
MMFs will also be required to hold a minimum amount of liquid assets that mature daily and weekly.
|MMF type||Daily maturing assets||Weekly dealing assets|
|Public Debt CNAV and LVNAV MMFs||≥ 10% of NAV||≥ 30% of NAV|
|VNAV MMFs||≥ 7.5% of NAV||≥ 15% of NAV|
Please note: Daily maturing assets include reverse repos (capable of being terminated within one working day) or cash (capable of being withdrawn within one working day). Weekly maturing assets include reverse repos (capable of being terminated within five working days) or cash (capable of being withdrawn within five working days).
Credit assessment: The manager of a MMF will be required to use an internal credit quality assessment procedure on an ongoing basis.
Valuations: MMFs will be required to value assets on a daily basis using mark to market whenever possible and otherwise mark to model (the ‘Market Valuation’). In addition to valuing assets on a Market Valuation basis, Public Debt CNAV MMFs and LVNAV MMFs will also be permitted to value assets on an amortised basis (ie the ‘Amortised Valuation’).
Reporting to regulators: The manager of a MMF is required to submit detailed information on the MMF to his or her competent authority. This includes the type and characteristics of the MMF, portfolio indicators and information on the specific portfolio assets. The competent authorities should be able to spot potential risk in the MMF market by monitoring such information. This reporting is in addition to that already required for UCITS and AIFs.
External support: MMFs are prohibited from receiving external support from any third party, including the sponsor of the MMF. This is In order to mitigate the risk of contagion.
HOW DOES THE MMFR INTERACT WITH THE EXISTING UCITS DIRECTIVE AND AIFMD?
The MMFR builds on the current regulatory regime operating under the umbrella of the UCITS Directive, AIFMD (Alternative Investment Fund Managers Directive) and the 2010 ESMA “Guidelines on a common definition of European money market funds” [CESR/10-049]. Funds in scope of the MMFR will have to comply with obligations under the UCITS Directive/AIFMD (where applicable) and the new MMFR rules.
The MMFR will be factored into the authorisation process/existing regulatory regime for new UCITS/AIF MMFs as soon as the new rules apply.
THE MMFR TIMELINE
The MMFR will apply from 21st July 2018 (ie 12 months after coming into effect). However, existing MMFs can use a further six month transition period to submit an application to the competent authority demonstrating compliance with the MMFR.
The MMFR provides that where a MMF comprises more than one investment compartment, each compartment can be regarded as a separate MMF for the purposes of certain provisions of MMFR. It will, therefore, be possible to designate sub-funds within an umbrella as different types of MMFs.
SPONSORS OF AN EXISTING MMF: WHAT DO YOU NEED TO DO?
(a) Consider which of the new model MMFs is most suitable for your fund
(b) Identify the key characteristics of your fund that will need to be adapted
(c) Consider all the operational, legal and regulatory implications of any changes
(d) Initiate a project to convert your MMF including shareholder approval
(e) Ensure project completion before Q1 2019
New EU rules to govern money market funds are a direct response to the initiatives launched by the G20 and the Financial Stability Board. It is after all a €1 trillion market in the EU that is currently largely unregulated and its collapse could pose a systemic risk to the global economy should we experience another banking crisis. That being said, the regulation is far from simple in interpretation and it is likely to stifle innovation.
Limehouse Consulting does, of course, support the overall objective of the MMFR to make all categories of MMFs safer and more robust as we recognise the key role played by MMFs in the financing of the real economy. We do, however, have much sympathy with the Luxembourg viewpoint that the situation of MMFs that are exclusively distributed to investors outside of the EU and of MMFs that are structured as master-feeders is not properly addressed by the MMFR. A quota of EU-debt for public debt CNAV MMFs is legally disputable and it sets a questionable precedent which will ultimately hinder the development of this new category of MMFs. We agree that the MMFR could jeopardise the viability of some categories of MMFs in the longer term with the risk that this source of financing might ultimately disappear.
The MMFR has all the hallmarks of recent EU regulations. It has been launched in haste and against a background of compromise. This is not a great recipe for good and cost-effective regulation. We can but hope that our concerns are unwarranted but the proof of the pudding will be in the eating.
Roger Davies is Principal Consultant at Limehouse Consulting.
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