- The EC released its long awaited proposal for MMF reform to increase the resiliency of MMFs.
- The proposal includes provisions for a 3% capital buffer for CNAV funds, reduced reliance on external credit ratings and minimum liquidity requirements.
- If the proposal is adopted in its present form, the EU MMF industry could face significant change, including the elimination of some of the key features of MMFs.
After extensive consultation with relevant industry participants, fund investors and interested parties, the European Commission (EC) proposed new legislation for money market funds (MMF) on 4 September 2013. It is important to mention that this remains a legislative proposal. The Regulation must pass through the European law-making procedure involving the European Parliament and European Council before it can become a new European law. The parliamentary elections to be held next year are expected to delay the process, and it is unlikely that the Regulation will be considered before mid-2014.
The proposal, entitled Regulation of the European Parliament and of the Council on Money Market Funds (“the Regulation”) provides uniform rules for applicable MMFs established, managed and/or marketed in the EU. The regulatory measures would apply to European MMFs, both in the context of UCITS and also funds within the scope of the Alternative Investment Fund Management Directive 2011/61/EU.
Here we describe some of the most significant measures of the proposal1:
Constant Net Asset Value (CNAV) Buffer: Each MMF that utilises amortised cost valuation or maintains a stable NAV must establish and maintain a capital reserve. The cash buffer, held in a protected reserve account in the name of the CNAV fund, must amount to at least 3% of the total value of the fund’s assets and should only be used to absorb the day-to-day fluctuations in the value of the fund’s assets. Funds will have a three-year ramp-up period to comply with the buffer requirement.
Eligible Assets: The Regulation specifies that MMFs shall only invest in the following four categories of eligible assets: money market instruments; deposits with credit institutions (on demand or less than 12 months); financial derivatives instruments (only to hedge duration and exchange rate risk); and reverse repurchase agreements (with a maximum close-out facility of two business days). Additionally, the collateral received by the fund as part of a reverse repurchase agreement transaction must fall within one of the categories of money market instruments, must have a legal maturity of 397 days or less and have one of the two highest internal rating grades. The narrow definition of securitisation will hamper a fund’s ability to invest in asset-backed commercial paper.
Ratings: To avoid overreliance on external ratings, MMF managers must establish an internal assessment procedure for determining credit quality based on an internal rating system provided for by the Regulation. There will be six grades for non-defaulted issuers and one for defaulted issuers on the rating scale. MMFs will be permitted only to invest in instruments assigned the first or second grade on its internal rating scale. Fund managers would also be prohibited from soliciting credit rating agencies to obtain an external rating for the fund.
Liquidity Requirements: Uniform rules would be implemented to increase the liquidity profile of MMFs. The funds would be required to maintain a minimum level of daily and weekly liquid assets. MMF managers must establish “know your customer” policies to ensure a better understanding of the behavior of the shareholder base. Together, these tools are designed to allow MMFs to better anticipate and meet investor redemptions.
If the draft is adopted in its present form, the changes to the EU MMF industry could be significant and damaging in our view. Assuming that fund providers consider the 3% capital buffer economically unviable, under the draft many European CNAV funds may no longer be available to investors. If this occurs, investors will potentially need to seek other investment solutions. The prohibition of the use of amortised cost accounting may also make it impractical to operate MMFs on a same-day basis. This in turn will ultimately remove one of the key features of MMFs. Western Asset continues to assess the possible impact on its MMFs and will continue to monitor the situation closely as it evolves.