ESMA Consultation on the Draft Guidelines on Stress Testing Scenarios
On the 28 September 2018, ESMA published a Consultation Paper setting out draft guidelines on stress test scenarios under the MMF Regulation, which applies to all new and existing money market funds (“MMFs”).
In accordance with Article 28 of the MMF Regulation, each MMF is required to establish sound stress testing processes that allow for the identification of possible events or future changes in economic conditions which could negatively impact on a MMF. In order to assess the potential impact that such events or changes could have on a MMF, the manager of a MMF must regularly conduct stress testing based on objective criteria and consider the effects of severe plausible scenarios. Where the stress testing reveals any vulnerability of a MMF, the manager of the MMF is obliged draw up an extensive report with the results of the stress testing and a proposed action plan.
Article 28 of the MMF Regulation obliges ESMA to develop guidelines with a view to establishing common reference parameters of the stress test scenarios to be included in the stress tests which managers of MMFs are required to conduct. ESMA is obliged to update these guidelines at least every year taking into account the latest market developments. ESMA published the first set of these guidelines on 21 March 2018 (the "Guidelines"), however, it indicated at the time that section 4.8 of those Guidelines would be updated so that managers of MMFs have the stress testing information needed to fill in the corresponding fields in the reporting template mentioned in Article 37 of the MMF Regulation (i.e. the reporting template that must be used by managers of MMFs to report certain prescribed information to the competent authority of each MMF that they manage on a periodic basis). This information will include specifications on the type of stress tests and their calibration as well as the way to report the results in the reporting template.
This consultation paper proposes common parameters and stress testing scenarios that consider the following hypothetical risk factors:
- changes in the level of liquidity of the assets held in the portfolio of the MMF;
- changes in the level of credit risk of the assets held in the portfolio of the MMF,
- including credit events and rating events;
- movements of the interest rates and exchange rates;
- levels of redemption;
- widening or narrowing of spreads among indexes to which interest rates of portfolio
- securities are tied; and
- macro systemic shocks affecting the economy as a whole.
The consultation paper provides a detailed explanation on the content of ESMA’s proposals and assesses the different methodology options in relation to the above risk factors. EMSA has issued questions throughout the consultation paper in order to seek stakeholders’ input on specific issues. Stakeholders’ views are especially sought on the methodology, including the methodology itself, risk factors, data and the calculation of the impact.
While ESMA has pointed out that the calibration of the stress test scenarios is not part of the consultation, ESMA states that any input from stakeholders on the way to calibrate the scenarios is welcome. ESMA invites comments on all matters of the consultation paper and in particular on the specific questions outlined in Annex I.
ESMA will consider all responses received by 1 December 2018, which can be sent using the response form, via the ESMA website, under the heading ‘Your input/Consultations’.
The publication of the consultation paper is to be welcomed as it will provide MMF managers and investors with an opportunity to provide feedback to ESMA on the proposed guidelines on stress testing scenarios under the MMF Regulation. It is clear from the consultation paper that ESMA will use comments it receives from stakeholders to assist with finalising the guidelines.
We would strongly recommend MMF managers, investors and other stakeholders in MMFs to read the consultation paper and provide feedback to ESMA, on either the specific questions raised or any other matter which they deem relevant.