The European Commission has prepared a draft Proposal for a Regulation on Money Market Funds, a copy of which was recently leaked and made available by the Irish Funds Industry Association (“IFIA”) to the members of its Money Market Funds Taskforce. The draft Proposal is not yet publicly available, but it is expected that the Commission will publish it in early May.
The draft Regulation can be regarded as the culmination of reform packages recommended for money market funds by bodies such as IOSCO, the ESRB and the FSB. Significantly, three of the reforms that were most aggressively pursued by these bodies, i.e. the conversion of CNAV funds to VNAV funds, a ban on sponsor support and the limited use for valuation of the amortised cost method, have not been adopted by the Commission in the leaked draft Regulation.
The provisions of the draft Regulation are summarised below.
A MMF would be permitted to invest in one or more of the following categories of financial assets and only under the conditions specified in the draft Regulation:
- Money market instruments
- Deposits with credit institutions
- Financial derivative instruments
- Reverse repurchase agreements
Accordingly, a MMF would not be permitted to utilise repurchase agreements; engage in short selling of money market instruments; gain exposure to equities or commodities; enter into securities lending or securities borrowing agreements; engage in securitisation; or borrow or lend cash.
Additional eligibility requirements for each of the asset types referred to above are also set out in the draft Regulation.
A MMF would not be permitted to invest more than 5% of its assets in money market instruments issued by the same body (currently 10%); or 5% of its assets in deposits made with the same credit institution (currently 20%).
In addition, the aggregate amount of cash provided to the same counterparty pursuant to reverse repurchase agreements entered into by a MMF would not be permitted to exceed 20% of the MMF.
A MMF would be required to ensure both that:
- At least 10% of its portfolio shall be comprised of daily maturing assets
- At least 20% of its portfolio shall be comprised of weekly maturing assets
Operational Policies and Procedures
Credit Quality of Money Market Instruments
Prudent and rigorous internal procedures should be put in place by the manager of a MMF for assessing the credit quality of money market instruments.
Know Your Customer
The manager of a MMF must exercise all due diligence to identify the number of investors in a MMF, their needs and behaviour and the amount of their holdings, with a view to correctly anticipating the effect of concurrent redemptions by several investors.
The manager of a MMF should put in place sound stress testing processes that allow for the identification of possible events or future changes in the economic conditions that could have unfavourable effects on the MMF.
CNAV MMFs would have to establish and maintain a NAV buffer amounting at all times to at least 3% of the total value of the MMF’s assets. The NAV buffer could only be used to cover differences between the MMF’s constant NAV per share and the MMF’s NAV per share. The amounts in the NAV buffer could not be included in the calculation of the NAV or constant NAV of the CNAV MMF. Furthermore, the NAV buffer can be composed only of cash and be held in a protected reserve account opened with a credit institution in the name and on behalf of the MMF.
It appears that IMMFA has already informally indicated to the Commission that the cost of capital renders the maintenance of a buffer of 3% uneconomical. IMMFA has recommended that the NAV buffer be dispensed with or limited to 1% of the total value of a MMF’s assets.
Significantly, the draft Regulation provides that when the NAV buffer has not been replenished within one month and the amount of the NAV buffer has decreased below the 3% by 10 basis points, the MMF shall automatically cease to be a CNAV MMF and be prohibited from using the amortised cost and/or rounding methods.
The Fund would not be permitted to receive external support other than in the form of a NAV buffer under the conditions laid down in the draft Regulation. It is not clear whether the seeding of a sub-fund, during its initial offer period, would constitute external support. However, this lack of clarity will be raised in the IFIA’s response to the Commission on the draft Regulation.
Anticipated Implementation Date
It is currently anticipated that the draft Regulation will be discussed in depth at Council and EU parliamentary level during the Lithuanian Presidency in Q3/Q4 of 2013. Due to a number of factors, such as the EU parliamentary elections in May 2014, it will likely be the case that the Regulation is rushed through and finalised and implemented in Q4 of 2013 or in early 2014.