Explanatory Memorandum to COM(2013)615 - Money Market Funds - Main contents
Please note
This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2013)615 - Money Market Funds. |
|---|---|
| source | COM(2013)615  |
| date | 04-09-2013 |
Money Market Funds (MMFs) are an important source of short-term financing for financial institutions, corporates and governments. In Europe, around 22% of short-term debt securities issued either by governments or by the corporate sector are held by MMFs. MMFs hold 38% of short-term debt issued by the banking sector.
On the demand side, MMFs offer a short-term cash management tool that provides a high degree of liquidity, diversification, stability of value combined with a market-based yield. MMFs are mainly used by corporations seeking to invest their excess cash for a short time frame, for example until a major expenditure, such as the payroll, is due.
MMFs, therefore, represent a crucial link bringing together demand and offer for short-term money. With assets under management of around 1000 billion Euros, MMFs represent a category of funds that is distinct from all other mutual funds. The majority of MMFs, around 80% of the assets and 60% of the funds, operate under the rules of the Directive 2009/65/EC on Undertakings for Collective Investment in Transferable Securities (UCITS). The rest of MMFs should been operating, since July 2013, under the rules of the Alternative Investment Fund Manager (AIFM) Directive 2011/61/EU. The average size of a MMF by far exceeds the average size of a UCITS fund. For example, an individual MMF can reach the size of €50 billion. MMFs are domiciled in a few Member states with FR, IE and LU representing more than 95% of the market. The market is nevertheless highly interconnected with other countries due to the high proportion of cross border investments and investors, and the cross border contagion links between the MMF and their sponsor, in the preponderance of cases domiciled in a country different from the domicile of the MMF.
Because of the systemic interconnectedness of MMFs with the banking sector on the one hand and with corporate and government finance, on the other hand, the operation of MMFs has been at the core of the international work on shadow banking. The Financial Stability Board (FSB) and other institutions, such as the International Organisation of Securities Commissions (IOSCO) and the European Systemic Risk Board (ESRB) have analysed the financial sector and concluded that certain activities and entities were of systemic importance but had not been addressed by regulators to a sufficient degree. In the asset management sector, MMFs were singled as systemically relevant. The European Parliament adopted a resolution on shadow banking in November 2012 where it invites the Commission to submit a proposal with particular focus on the MMF issue[1].
The ESRB provided a sound analysis of the systemic risks inherent in the operation of MMFs. In particular, its recommendations pertained to the stability and the liquidity of MMFs and also contain additional transparency and reporting rules. Those recommendations have been largely reflected in the Commission's proposal while taking into account also their possible negative impacts on the financing of the European economy.
MMFs represent a convenient tool for investors because they offer features analogous to bank deposits: instantaneous access to liquidity and relative stability of value. In light of these characteristics, investors view MMFs as a safe and more diversified alternative to bank deposits. But in reality the MMFs are classic investment funds with the inherent market risks attached to any fund investment. Therefore when the prices of the assets in which the MMFs are invested in start to decrease, especially during stressed market conditions, a MMF cannot always maintain the promise to redeem immediately and to preserve the value of the unit or share issued by the MMF to investors. Some fund sponsors (mostly banks) may be able to ‘prop up’ share values by granting sponsor support, while others (mostly asset managers) may not have the capital to do so. Due to the maturity mismatch between the daily liquidity that an MMF offers to investors and the liquidity of assets held in the MMF portfolio, immediate redemption might not always be possible. The promise of stable redemption prices is often underlined by an AAA rating. The downside is that investors, as soon as they perceive a risk that the MMFs may fail to live up the promise of liquidity and stable redemptions at any time, will redeem, possibly leading to a so-called investor 'run'.
Investor runs are characterized by massive and sudden redemption requests by a large group of investors aiming to avoid losses and be able to redeem at the highest possible price. Investor runs are systemically relevant as they force MMFs to sell their assets rapidly in order to meet outstanding redemption requests. The spiral of redemptions itself accelerates the decline in the fund's net asset value (NAV), thus exacerbating declines in the NAV and the fear that the money market as a whole is unstable. Because MMFs play a central role in the short term funding of entities like banks, corporations or governments, investor runs on MMFs may cause broader macroeconomic consequences. While banks account for the largest part (85%) of the 1000 billion EUR of financial instruments issued to MMFs, governments represent a share of around 10% whereas corporates account for roughly 5%. Governments and very large corporates use the money market as a means to obtain short term financing, alongside bank credit lines.
The problems linked to investor runs are of a systemic nature due to: (1) MMFs close links to the real economy (the role that MMFs play in satisfying the short-term financing needs of entities using the money market as a funding tool), (2) their link to sponsors. In addition, runs on MMFs also have an investor protection angle, since those that redeem late (usually private investors) are at an inherent disadvantage when compared to early redeemers.
The proposed Regulation addresses these problems. It introduces common standards to increase the liquidity of MMFs as well as to ensure the stability of their structure. Uniform rules will be introduced to ensure a minimum level of daily and weekly liquid assets. A standardized policy will be established to permit the fund manager to gain a better understanding of its investor base. Common rules are also introduced to guarantee that MMFs invest in high quality and well diversified assets of good credit quality. These measures shall ensure that the liquidity of the fund is adequate to face investors’ redemption requests.
The stability of the MMF will be ensured through the creation of clear and harmonized valuation rules for the assets in which the MMFs invest in. These valuation rules will restore the evident truth that MMFs are normal mutual funds whose investment assets are subject to price fluctuations.
Certain MMFs will have the possibility to maintain the accounting methodology permitting a stable subscription and redemption price on condition that they build up appropriate cash reserves. This so-called “NAV buffer” shall serve to absorb the market movements inherent in the capital markets. This should also prevent that sponsors be unprepared should their MMFs require external support. The buffer will amount to 3% of the assets under management of the MMF. According to the observed events of sponsor support during the crisis (123 instances on US MMFs), only 3 times the support was higher than 3%. When the Reserve Primary Fund defaulted in 2008, it lost 3% on 1.5% exposure to Lehman assets. The buffer will not provide a full guarantee to the holders of CNAV shares but the level strikes the balance between the need to have a robust and safe CNAV model and the financing capacities of the managers. The costs for the MMF will depend on the financing costs of each manager. These costs may vary between 3% and 10% annually. Applied to a buffer of 3%, this would result in an increase of the management fees of 0.09% to 0.30% annually. It is expected that a portion of this cost increase will be paid by the manager while the rest will be passed on to the investors. The fee increase will have an impact on the yield that investors can achieve in investing in MMFs but on the other hand they will benefit from a product with an additional layer of insulation against market movements in the underlying assets.
In addition to these provisions, a common rule on rating will ensure that fund managers and investors stop relying on external credit ratings that could be detrimental to the functioning of the money market when downgrades occur. These measures will be accompanied by increased transparency requirements to ensure that the investor correctly understands the risk and reward profile of its investment.
The proposed regulation will rely on the existing authorisation procedures for UCITS which are harmonised by the UCITS Directive. It will introduce a harmonised authorisation procedure for AIF MMFs, as the AIFM Directive leaves authorisation of AIFs at the discretion of Member States. The harmonised procedure for AIF MMFs will mirror the harmonised authorisation procedure foreseen for UCITS. Managers will continue to be regulated by either the UCITS or AIFM Directive but managers and funds falling under the scope of this Regulation will have to comply with this additional layer of specific MMF product rules.
These uniform rules intend to safeguard the integrity of the internal market and increase its robustness to minimise the effects of a new crisis. Investors will gain awareness over the risks attached to these regulated products and certainty about the homogenous investment proposition associated with money market funds in the Union. Managers will benefit from harmonized product rules all over Europe. Issuers of money market instruments will profit from a more stable environment that will preserve the role of MMFs as a financing tool.
Contents
- RESULTS OF CONSULTATIONS WITH THE INTERESTED PARTIES AND IMPACT ASSESSMENTS
- LEGAL ELEMENTS OF THE PROPOSAL
- BUDGETARY IMPLICATION
- 2.1. Consultation with interested parties
- 2.1.1. Green paper on shadow banking
- 2.1.2. Consultation on asset management
- 2.2. Impact assessment
- 3.1. Legal basis and choice of the legal form
- 3.2. Subsidiarity and proportionality
- 3.3. Impact on fundamental rights issues
- 3.4. Detailed explanations of the proposal
As of the beginning of 2012 the Commission has engaged in extensive consultation with representatives from a wide range of organizations. The interaction has taken the form of bilateral and multilateral meetings, one public consultation on shadow banking, one public consultation on asset management issues including MMFs and a public conference on shadow banking. Through this process the Commission has obtained a wealth of information about the functioning of the MMF market and its various segments, as well as views on the issues to be solved and how to solve them.
The responses to the Green Paper offered a broad picture of the European shadow banking sector. This allowed for the development of more targeted questions specific to the operation of MMFs in a public consultation on asset management that was launched in July 2012. A public conference in April 2012, attended by stakeholders from the EU and the US, also contained a section devoted to MMFs. Representatives from the regulatory and industry sides, forming the panel on MMFs, presented their views on the need to reform the EU MMF market.
A MMF chapter has been introduced in a broader public consultation on various asset management issues published on 26 July 2012 (this consultation closed on 18 October 2012). The Commission services received 56 responses related to the MMF section.
In line with its policy on 'better regulation', the Commission conducted an impact assessment examining various policy alternatives. In order to ensure the liquidity and the stability of MMFs, a total of 16 options were analysed. All these options were analysed against the general objectives, namely to enhance the financial stability in the single market and to increase the protection of MMF investors, but also against the more specific objectives of this initiative: (i) to prevent the risk of contagion to the real economy, (ii) to prevent the risk of contagion to the sponsor and, (iii) to reduce the disadvantages for late redeemers, especially with respect to redemptions in stressed market conditions.
The impacts including the costs and benefits on the various stakeholders, investors, asset managers, issuers of short term debt, sponsors were analysed. Such analysis concluded in favour of the creation of a more robust framework for MMFs: increased liquidity levels and more stable structure. The impact of the preferred options is expected to benefit the MMFs and the money market in general by improving their resilience against stressed market conditions. This shall result in a more stable money market environment in Europe that will profit to investors, issuers of short term debt and banks sponsoring MMFs.
DG MARKT services met the Impact Assessment Board on 16 January 2013. The Board analysed this Impact Assessment and delivered its positive opinion on 18 January 2013. During the meeting the members of the Board provided DG MARKT services with comments to improve the content of the Impact Assessment that led to some changes to the final draft. The problem definition has been improved to provide greater detail on the MMF markets and its description was enriched with further examples in the Union illustrating, in particular, the cross-border dimension of the problems. The objectives and the options with the identified problems have been better linked and more quantifiable operational objectives have been used. The impacts on investors as well as the compliance costs that the envisaged measures would entail have been explained in more detail. The impacts on Member States and on international regulatory coherence have also been better described. Finally the stakeholder’s views, in particular in the sections analysing and comparing the options, have been systematically introduced.
Article 114(1) TFEU provides the legal basis for a Regulation creating uniform provisions aimed at the functioning of the internal market. Prudential product rules establish the limits of the risks linked to MMFs. As such, they do not regulate access to asset management activities but govern the way such activities are carried out in order to ensure investor protection and financial stability. They underpin the correct and safe functioning of the internal market.
In pursuit of the objective of the internal market integrity the proposed legislative measure will create a regulatory framework for MMFs in view of ensuring an increased protection of investors in MMFs, as well as enhancing financial stability by preventing contagion risk. The proposed provisions will specifically target to ensure that the liquidity of the fund is adequate to face investor redemption requests and to render the structure of MMFs safe enough to withstand adverse market conditions. A Regulation is considered to be the most appropriate legal instrument to introduce uniform requirements that will deal, amongst others with the scope of eligible assets, with diversification rules, rules related to exposures to credit, interest rate and liquidity risks, as well as rules regarding the authorisation of the funds intending to engage in money market investment. These are essentially prudential product rules that aim to render the European MMFs more secure and efficient, mitigating hereto related systemic risk concerns.
The taking up of activities as fund manager is regulated either by the UCITS Directive or by the AIFM Directive. The activities of the managers will continue to be subject to AIFMD and UCITS Directive but the product rules contained under UCITS framework will be supplemented by the product rules contained in this new Regulation.
National regulatory approaches are inherently limited to the Member State in question. Regulating the product and liquidity profile of a MMF at national level only entails a risk of different products all being sold as MMFs. This would create investor confusion and would impede the emergence of a Union wide level playing field for those who offer MMFs to either professional or retail investors. Equally, different national approaches concerning the essential characteristics of a MMF would increase the risk of cross-border contagion, especially when issuers and the MMF are located in different Member States. As MMFs invest in a broad range of financial instruments across the EU, the failure of one MMF (due to insufficient regulation at national level) would have repercussions on Government and corporate financing across the EU.
In addition, as many operators that offer MMFs in Europe are domiciled in Member States other than those where the funds are marketed, the creation of a robust framework is essential to avoid cross-border contagion. Cross-border contagion should also be avoided between a MMF and its sponsor that is often located in a different Member State. This is especially acute when the sponsor is located in a Member State that may not have the budgetary resources to bail out a defaulting sponsor.
As regards proportionality, the proposal strikes the appropriate balance between the public interest at stake and the cost-efficiency of the measure. The requirements imposed on the different parties have been carefully calibrated. Whenever possible, requirements have been crafted as minimum standards (e.g., daily or weekly liquidity, issuer concentration limits) and regulatory requirements have been tailored so as not to unnecessarily disrupt existing business models (e.g., providing for appropriate transitional periods before the NAV of a MMF has to be floated or leaving operators the choice between stringent capital requirements and floating the NAV of their MMF). In particular, the need to balance investor protection, avoidance of cross-border contagion, efficiency of the markets, the financing of the European industry and costs for the industry have all been balanced in laying out these requirements.
The proposal has relevance for the impact on two fundamental rights of the European Charter of Fundamental Rights, namely the freedom to conduct business (Article 16 and 22) and consumer protection (Article 38).
The general interest objective of the proposal, which justifies certain limitations of the above-mentioned fundamental rights, is the objective of ensuring market integrity and stability. The freedom to conduct business may be impacted by the necessity to follow the specific objectives of ensuring sufficient liquidity, preventing the risk of contagion and enhancing safeguarding of investors’ interests. However, the proposal fully respects the essence of this fundamental freedom. The proposed new rules will overall reinforce the right to consumer protection (Art. 38), whilst respecting the fundamental rights and observing the principles recognised in the Charter of Fundamental Rights of the European Union as enshrined in the Treaty on the Functioning of the European Union.
The proposal for a Regulation on Money Market Funds (MMF) is structured in nine chapters.
3.4.1. Chapter I –General provisions (Articles 1-6)
Chapter I deals with general rules, such as the subject matter and scope of the proposed rules, definitions, the authorisation of MMFs and the interplay of the proposed Regulation with existing rules contained in Directives 2009/65/EC (UCITS) and 2011/61/EU (AIFMD).
Article 1 specifies the subject matter and specifies the scope of the proposed Regulation as applying to all MMFs established, managed and/or marketed in the Union and specifies that the requirements contained in the Regulation are intended to be exhaustive, that is that they are conceived as leaving no scope for additional gold-plating at national level. MMFs are either UCITS or AIFs that invest in short-term financial instruments and have specific objectives. Article 2 contains essential definitions necessary for the uniform application of the proposed Regulation. Article 3 requires that collective investment undertakings be authorised explicitly as MMF either as part of the harmonised authorisation procedure of UCITS or following the new harmonised procedure laid down in Article 4 for AIFs. Article 5 reserves the designation MMF only to funds that comply with the Regulation. Article 6 describes the interaction between the existing UCITS and AIFMD rules and the new MMF Regulation, essentially specifying that compliance with the Regulation shall be incumbent on the manager of the MMF.
3.4.2. Chapter II – Obligations concerning the investment policies of MMFs (Articles 7-20)
Chapter II contains the rules on permissible investment policies to be pursued by an MMF, such as eligible assets, diversification, concentration and credit quality of investment assets.
Article 7 describes the relationship with the UCITS rules on investment policies and the proposed rules on investment policies of MMF, considering that the MMF constitutes a lex specialis in relation to the UCITS rules specifically enumerated in Article 7. Article 8 describes four categories of financial assets that an MMF can invest in: money market instruments, deposits with credit institutions, financial derivatives and reverse repurchase agreements. On the other hand, a MMF may not invest in any other assets, engage in short selling of money market instruments, gain exposure to equities or commodities, enter into securities lending or securities borrowing agreements, enter into repurchase agreements or borrow or lend cash, as these asset classes and practices would undermine the liquidity profile of an MMF. Articles 9 to 13 further describe the eligibility conditions for the four categories of assets that a MMF can invest in. In particular Article 13 contains rules aimed at ensuring that the collateral received in exchange of a reverse repurchase agreement is sufficiently liquid to permit its rapid sale when needed.
Article 14 contains detailed rules on the diversification of eligible investment assets that each MMF has to respect, such as upper limits on how much a single issuer can represent (as a percentage of the MMFs assets under management) and rules on maximum risk exposure that an MMF can have vis-à-vis a single counterparty. Article 15, on the other hand, addresses the maximum limits that an MMF (as investor) can hold in a single issuer (concentration limits). In order to reduce mechanistic reliance on external ratings, Articles 16 to 19 contain detailed rules on an internal assessment of the credit quality of MMF investment instruments. Article 20 describes the governance requirements governing the internal credit rating process, in particular the role of senior management.
3.4.3. Chapter III – Obligations concerning the risk management of MMFs (Articles 21-25)
Chapter III deals with risk management aspects, such as the maturity and the liquidity profile of MMFs’ assets, soliciting of ratings, and so-called know-your-customer policies and stress testing that an MMF is obliged to introduce.
The new rules on weighted average maturity (WAM) and weighted average life (WAL), combined with the requirements on holdings of daily and weekly maturing assets are essential planks in increasing the liquidity profile of an MMF and thus its ability to satisfy investor redemptions. Article 21 contains the important provision on the maturity profile that short-term MMF have to comply with. Article 22 contains corresponding rules for standard MMFs which invest in longer term instruments than a short-term MMF. Standard MMFs have different maturity limits, such as WAL and WAM, and can use a lower diversification limit for the investments in money market instruments issued by the same entity. These features are coherent with the objectives of standard MMFs to offer slightly higher returns than money market rates. The characteristics of this MMF category are also coherent with the fact that standard MMFs cannot be managed as a constant NAV MMF (Article 22(5)) and are therefore less prone to massive outflows.
Article 23 prevents an MMF from soliciting or financing an external credit rating and thus complements the rules on internal ratings contained in Articles 16 to 19. Article 24 introduces requirements on knowing-your-customer. The aim of these rules is to allow MMFs to better anticipate redemption cycles. Article 25 contains rules on stress testing.
3.4.4. Chapter IV – Valuation rules (Articles 26-28)
Chapter IV deals with the valuation of an MMF's investment assets and the calculation of the MMF's net asset value per unit or share.
Articles 26 to 28 contain rules on how an MMF has to value its individual investment assets, calculate the net asset value (NAV) per unit or share of the MMF, as well as the frequency of both sets of valuations. While there is a general rule favouring mark-to-market valuation, MMFs may also use marking to model, where marking to market is not possible or market data are not of sufficient quality. Only CNAV MMFs may also value assets at amortised cost. The method chosen for calculating the NAV is particularly important when issuing and redeeming shares or units in a MMF (Article 26).
3.4.5. Chapter V – Specific requirements for CNAV MMFs (Articles 29-34)
Chapter V contains specific requirements for MMFs that value their assets at amortised cost or advertise a constant NAV per unit or share or round the constant NAV per unit or share to the nearest percentage point– so-called constant NAV or CNAV MMF.
Article 29 contains specific authorisation requirements that apply only to MMFs that use amortised cost to value their assets or advertise a constant NAV per unit or share or round the constant NAV per unit or share to the nearest percentage point. These CNAV MMFs must establish and maintain at all times a buffer amounting to at least 3% of the total value of their assets. Article 30 describes the constitution of the buffer (the 'NAV buffer'), while Article 31 describes its operation. Most importantly, Article 31 contains the rule that the NAV buffer can only be used to compensate the difference between the constant NAV per unit or share and the real value of a unit or share. In addition, Article 31 contains rules on when the NAV buffer must be debited and when it can be credited. Finally, Articles 32 to 34 contain the obligation to replenish the buffer and the consequences of a failure to replenish the NAV buffer.
3.4.6. Chapter VI – External support (Articles 35-36)
Chapter VI contains rules on external support. It lays down the rule that CNAV MMFs may receive external support only through the NAV buffer, whereas other MMFs are as a rule prohibited from receiving external support
Article 35 describes what needs to be understood by external support and contains a non-exhaustive enumeration of instances of external support. The aim of this Article is twofold: to ensure that all sponsor support is granted to CNAV MMFs via the transparent mechanism provided for in Article 31 by having recourse to a pre-established NAV buffer or, if sponsor support is granted to other MMFs, that the competent authorities allow such support only if exceptional circumstances linked to the maintenance of financial stability justify the ad hoc grant of sponsor support (Article 36).
3.4.7. Chapter VII – Transparency requirements (Articles 37-38)
Chapter VII contains transparency rules when MMFs are advertised to investors and reporting requirements to competent authorities.
Article 37 contains special transparency requirements. Article 38 establishes reporting requirements on all MMFs that apply in addition to the requirements under Directives 2009/65 and 2011/61.
3.4.8. Chapter VIII – Supervision (Articles 39-42)
Chapter VIII contains the applicable rules on supervision of MMFs: Article 39 explains the respective roles of the competent authorities of the MMF and of the manager of the MMF. Article 40 states that the powers of competent authorities under the UCITS and AIFM Directives should be exercised also by reference to the proposed Regulation. Article 41 refers to ESMA’s powers, whereas Article 42 provides for the cooperation between authorities.
3.4.9. Chapter IX – Final provisions (Articles 43-46)
Chapter IX contains rules on the treatment of existing UCITS and AIFs acting as MMFs to ensure their compliance with the new rules on MMFs and a review clause for the application of NAV buffers to certain CNAV MMFs In particular, Article 43 states how existing UCITS and AIFs that meet the criteria of the definition of a CNAV MMF should build progressively the NAV buffer. Article 45 states that the application of NAV buffers to CNAV MMF that concentrate their portfolios on debt issued or guaranteed by Member States should be reviewed by three years after the entry into force of this regulation.
Work on the reform of MMFs has been closely coordinated with the European Securities Market Authority (ESMA). Commission experts in the area of fund management have been in regular contact with their counterparts at ESMA; both in the context on the operational working group on MMFs and in the Standing Committee on Investment Management Services established at ESMA.
Indeed, ESMA suspended on-going work on MMFs because the Commission announced its intention to propose legislation in the area, amongst other issues, enshrining certain principles contained in pre-existing CESR and ESMA guidelines on MMFs into the corpus of primary law. This suspension came against the background of ESMA having already started a work-stream on alternative rating methodologies. This work-stream was instituted in order to substitute credit ratings issued on money market instruments by credit rating agencies. ESMA has suspended this work-stream in order to await the formal mandate that this work would receive by virtue of proposed legislation. In addition, as part of its efforts on establishing convergence in the field of MMFs, ESMA is already engaged in creating a database on supervisory practices and adherence to its existing guidelines.
Hence, ESMA is already well equipped to fulfil the mandate in the proposed Regulation; indeed all of this work had already commenced prior to the Commission's proposal on MMF.
In these circumstances, the Commission has not identified implications for the EU budget. In light of the above, no additional funding and no additional posts will be required for ESMA to perform the tasks that the proposed legislation will entrust to it: developing an alternative rating methodology and setting up a database of approved MMF. As explained above, these tasks are already part of well-established work-streams within ESMA.
Work on defining operational rules in the area of MMF furthermore already fall within the scope of existing responsibilities of ESMA: As part of its overall task of supervising and creating regulatory convergence in the field of UCITS funds, ESMA has already dedicated staff resources to developing policy and supervisory tools with respect to MMFs, a special category of funds that are regulated either as UCITS or as AIFs.
In pursuance of these efforts CESR, the predecessor of ESMA has, in May 2010, issued extensive guidelines on MMF (CESR 10/049).
In 2012 ESMA conducted a resource-intensive peer review to assess how Member States applied the guidelines in practice (12 Member States applied the guidelines while eight had not transposed them into their regulatory practice).
In 2013, the MMF Guidelines were supplemented by detailed Q&A.