The new European Regulation on money-market funds (MMFs) highlights existing good practices
The key players had already implemented the main aspects of the new prudential rules. The role of ESMA in supervising this market has been reinforced.
After a first set of rules harmonizing the management of UCITS money-market funds in Europe in 2011, the further reinforcement of the prudential framework desired by the European regulatory authorities is excellent news. The new European Regulation, which has just been published in the next few weeks is, first, a compendium of the good prudential practices that are already implemented by many of the players on this market (in particular on the question of rigorous analysis of the assets eligible for this form of liquidity management). It also gives a new monitoring role to ESMA, the European supervisory body.
As a result, the stress tests carried out by asset management companies will now have to be based on market scenarios imposed by ESMA. Similarly, the transparency obligations concerning mandatory disclosures to the supervisory authority will be reinforced, and regular reports on the portfolio composition of MMFs will have to be submitted to the authority. This information will improve the authority’s ability to evaluate the systemic risk of these products. Additionally, the investment rules will be made slightly stricter, in terms of the liquidity ratio (15 % in weekly maturing assets and 7.5 % in daily maturing assets) and the maturity of the underlying assets. The new Regulation will also generalize the obligation to keep the fund’s liabilities under control: detailed knowledge of the investment policy of clients will enable fund managers to anticipate their redemption requests, accurately assess the gap between liabilities and assets and consequently construct a portfolio with minimum transformation risk
The Regulation also ratifies the move away from the over-reliance of MMFs on the ratings of credit rating agencies: the emphasis must of course be on internal credit quality assessment. Although the ratings that agencies provide on the credit quality of the underlying securities will continue to play an indicative role, any downgrading must not automatically lead to exclusion of the issuer from all European money-market funds. This principle is further reinforced by the obligation imposed on asset management companies to establish an internal assessment procedure to analyse the eligible assets independently of management.
Risk of contagion
The European authorities are also very alert to the risk of contagion in the event of a major incident affecting an MMF. In response to certain practices common during the years 2007-2008, the authorities have decided to prohibit support, in other words-any refinancing of a fund that is in difficulty by the fund management company (or its parent company). Similarly, the master – feeder structure is now prohibited (except in the case of employee savings schemes).
Since the international institutions (such as G20, FSB and IOSCO) were worried at the prospect of investor runs on MMFs, they have attempted to prevent any possible incentives for investors to be the first to pull out of a fund (“first mover advantage”). This measure was particularly aimed at funds having constant net asset value (CNAV MMFs). Here too, the new Regulation brings progress. To improve transparency, these funds, which by definition do not report any change in value in response to fluctuations in the value of their underlying assets, without offering any guarantee, will in future have to calculate and publish the difference between the constant value and the market value. of the asset. The European authorities also envisaged imposing a capital buffer, but this measure was judged to be impossible to implement, and so the project was abandoned. Their investment rules have also been made more restrictive, in that only State bonds will now be eligible. Additionally, asset management companies will be better equipped to deal with redemptions, since they must now impose redemption “gates” and fees: the spirit of this rule is that the liquidity price should now be paid by the investors wishing to leave the fund and not by those who stay, as sometimes happens today.
Finally, an intermediate class has been created. Low volatility net asset value (LVNAV) funds will be required to obey the same rules as CNAVS, with the exception that they will only be allowed to apply cost amortization to the proportion of the assets maturing in less than 75 days, and they will not be limited to public debt. However, we do not anticipate that the main players on the market will be greatly interested by this hybrid category.
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