After more than a decade of review and debate, the money market fund (MMF) industry will reach a major milestone this year when the EU's long-awaited Money Market Fund Regulation (MMFR) comes into effect. The rules, which govern MMFs established, managed, or marketed in the EU, will apply to new funds starting July 21, 2018. Existing MMFs will have until January 21, 2019 to transition to the new regime.
The regulation aims to increase the stability and resilience of MMFs during times of market stress, when there is a higher potential for large numbers of investors to make substantial redemptions at the same time. The new rules also establish four types of MMFs, each distinguished by unique portfolio composition rules. Investors can now review the rules and categories to better evaluate each fund type against their risk profile.
The new rules to be adopted by EU MMF managers are described in a report by the European Securities and Markets Association (ESMA), which outlines the technical advice, draft implementing technical standards, and stress-testing guidelines. The report requires MMF managers to:
- Have an internal assessment procedure for determining the credit quality of instruments being purchased. They can no longer rely on evaluation from credit rating agencies.
- Use a new simplified template for reporting quarterly information to national regulators. Managers will have to submit their first quarterly reports Q4 2019.
- Apply the same credit-quality assessment criteria for money market instruments and assets received as collateral under reverse repurchase agreements. The assessments must be “prudent, systematic, continuous, and subject to validation." A minimum haircut will be applied to collateral with a lower-rated counterparty.
Issues Still Open to Debate
The final report provided much-needed clarity, but there are several issues that remain unresolved, notably guidelines for share destruction, stress testing and “know your customer” assessments.
Before MMFR, regulators accepted a widespread practice known as “reverse distribution,” where MMFs cancel investors' units to account for a negative yield. While ESMA initially indicated that this practice would not be allowed, they have agreed to review it again following industry feedback. While still unresolved, there is a possibility they will allow the practice to continue with new requirements for managers to provide additional information when canceling shares. There is currently no public timeline for resolution.
The industry also awaits further guidelines before the May 2018 implementation date on the parameters around common reference stress tests. ESMA’s guidance currently includes two distinct sections on stress testing. The first outlines principles that must be adhered to in order to identify economic events that could adversely affect the MMF. The second requires asset managers to perform common reference stress test scenarios and submit the results to regulators in quarterly reports.
Know Your Customer
In addition to stress testing for hypothetical changes in liquidity, interest rates, and redemption levels, MMFs must prove they know who their investors are. This "know your customer" policy aims to ensure managers can anticipate the effect of redemptions by investors. MMF asset managers must pay particular attention to large investors holding a substantial portion of the MMF's assets. A decade ago, large cash withdrawals by institutional investors caused MMFs to become unstable to the detriment of smaller investors left behind in the funds.
EU-US Rule Divergence
The final rules will provide a welcome conclusion to a multi-year debate and the final ruleset incorporates much of the industry’s feedback. But there is still more work to be done. The EU MMF rules are inconsistent with US rules, so managers operating in both domiciles will need to analyze gaps and possibly alter processes to ensure compliance.
The areas of divergence include stress-testing, liquidity fees, and redemption gate structures. The distinct classifications of MMFs in the US also vary considerably from those in EU – meaning managers may need to maintain separate vehicles for each jurisdiction.
In any case, the industry hopes that implementation of the new rules will spur the significant amounts of cash that have been sitting in bank deposits to flow back into EU MMFs in 2018 and beyond.
This article was originally published in the 2018 Regulatory Field Guide. The guide features insights from a number of our experts on key regulatory developments that will have the greatest impact for asset managers in the year ahead – and beyond. Visit bbh.com/regulatoryfieldguide to explore the guide.
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