On 11 June 2018, HM Treasury published the Money Market Funds Regulations 2018 (the “UK Regulations“), which will come into force on 21 July 2018. The UK Regulations are published in the context of the EU Regulation 2017/1131 on money market funds (the “EU MMF Regulation“) which will become applicable in the UK on the same date.
While the EU MMF Regulation is directly applicable in the UK, the UK Regulations amend the Financial Services and Markets Act 2000 and relevant secondary legislation in order to designate the FCA as the authority responsible for authorising and regulating money market funds (“MMFs“) in the UK. The FCA will have the power to investigate and bring enforcement actions against funds directly for breach of the EU MMF Regulation.
Overview of the EU MMF Regulation
The EU MMF Regulation introduces a framework of requirements towards enhancing the liquidity and stability of MMFs. In particular, the EU MMF Regulation aims to address concerns relating to MMFs spreading or amplifying risks throughout the financial system.
MMFs are investment funds that invest in highly liquid, short-term debt instruments such as government bonds or corporate debt. They are primarily used to provide short-term finance to financial institutions, corporations and local governments, allowing those entities to spread their credit risk and exposure and avoid relying solely on bank deposits. MMFs are operated by asset management companies which may either run the MMF independently or be sponsored by a bank to do so. MMFs can be denominated in any currency, however those based in Europe are generally denominated in Euro, pound sterling or US dollar.
Article 1 of the EU MMF Regulation sets out that the Regulation applies to a collective investment undertaking that meets the following conditions:
- it requires authorisation as an Undertaking for the Collective Investment of Transferable Securities (“UCITS“) or is authorised as a UCITS under the UCITS Directive 2009/65/EC (“UCITS Directive“), or it is authorised as an alternative investment fund (“AIF”) under the Alternative Investment Fund Managers Directive (“AIFMD“);
- it invests in short-term assets, i.e. financial assets with a residual maturity not exceeding two years; and
- it has distinct or cumulative objectives offering returns in line with money market rates or preserving the value of the investment.
The EU MMF Regulation provides for three types of MMF: variable new asset value MMFs, public debt constant net asset value MMFs, and low viability net asset value MMFs. New transparency requirements under the EU MMF Regulation mean that investors should be clearly informed of the type of MMF and whether the MMF is of a short-term or a standard nature. The manager of an MMF is further required to make certain information available to investors on a weekly basis, including the maturity breakdown of its portfolio, its credit profile, the total value of its assets, its net yield, and details of the ten largest holdings in the MMF.
The EU MMF Regulation prescribes the assets that MMFs are permitted to invest in. Broadly, these are money market instruments, eligible securitisations and asset-backed commercial papers (“ABCPs“), deposits with credit institutions, financial derivative instruments, repurchase agreements, reverse repurchase agreements, and units or shares of other MMFs. Diversification requirements in the EU MMF Regulation mean that an MMF is not permitted to invest more than 5% of its assets in money market instruments, securitisations and ABCPs issued by the same body, or 10% of its assets in deposits made with the same credit institution. The aggregate of all MMF’s exposures to securitisations and ABCPs may not exceed 20% of the assets of the MMF.
Also introduced by the EU MMF Regulation is the requirement for an MMF to have a prudent internal credit quality assessment procedure for determining the credit quality of the money market instruments, securitisations and ABCPs in which it intends to invest.
Next steps for MMF managers and sponsor banks
Where a fund is already authorised as a UCITS or an AIF, it will need to submit prescribed documentation to its competent authority in order to be authorised as an MMF. The UK Regulations provide that the competent authority in the UK will be the FCA. The EU MMF Regulation contains a transitional provision for existing UCITS and AIFs, allowing an 18 month window from the date the EU MMF Regulation comes into force for the fund to submit an authorisation application. Therefore, the deadline for existing funds to apply for authorisation is 21 January 2019.
For new funds, a UCITS can apply for authorisation as an MMF as part of the UCITS authorisation process. An AIF can only be authorised as an MMF if its manager is already authorised under AIFMD.
Authorisation will be valid across all EU member states. Before applying for authorisation, managers and sponsors of existing MMFs will need to consider which of the new model MMFs is most suitable for the fund to operate as, as well as how the fund will need to be adapted in order to comply with the new requirements.