(Aug. 31, 2018) On July 21, 2018, new rules to make money market funds (MMFs) more resilient against financial market difficulties, reduce the risk of runs, and limit cross-border contagion began applying to newly issued MMFs in the European Union (EU). Existing MMFs must show compliance by January 21, 2019. MMFs are mutual funds that invest in short-term debt, such as treasury bills, commercial paper, or certificates of deposit, and are used by investors as an alternative to bank deposits. The recent global financial crisis revealed that some features of MMFs spread or amplify risk throughout the financial system. The EU passed the MMF Regulation to reduce such risk in money market funds. (Regulation (EU) 2017/1131 of the European Parliament and of the Council of 14 June 2017 on Money Market Funds (MMF Regulation), 2017 O.J. (L 169) 8, EUR-Lex website; Press Release, European Commission, Memo: New Rules for Money Market Funds Proposed – Frequently Asked Questions (Sept. 4, 2013), European Commission website.)
The MMF Regulation introduces stricter liquidity requirements for MMFs to meet any sudden withdrawal of investment, establishes rules on portfolio diversification and valuation of assets, increases the requirements for credit quality, prevents MMFs from receiving any external financial support, and imposes direct obligations on MMF fund managers.
Scope of the Regulation
The MMF Regulation applies to all MMFs that are established, managed, or marketed in the EU. (MMF Regulation art. 1, para. 1.) There are three different types of MMFs, with different compliance requirements for each. (Id. art. 3, para. 1.)
- Variable Net Asset Value (VNAV) MMFs: their value depends on the assets they hold and therefore on market fluctuations.
- Public Debt Constant Net Asset Value (CNAV) MMFs: Their value is calculated according to a formula based on the purchase price of the assets (amortized cost method) and remains relatively constant, typically €1.00 (about US$1.17) per share. They must invest 99.5% of their assets in public and government debt and in cash.
- Low Volatility Net Asset Value (LVNAV) MMFs: These funds are newly introduced by the MMF Regulation as an alternative to CNAVs. Their value is constant up to a certain limit. They may use the amortized cost method of valuation for assets with a residual maturity of less than 75 days.
The Regulation introduces new liquidity requirements to ensure there is sufficient liquidity to meet investors’ redemption requirements. 10% of LVNAV MMF assets and 10% of CNAV MMF assets must be able to be repaid by the issuer within a day, and 30% within a week. (Id. art. 24, para. 1(c) & (e).) VNAV MMFs are required to hold at least 7.5% of assets that mature within a day, and 15% that mature within a week. (Id. art. 24, para. 1(d) & (f).)
The MMF Regulation sets portfolio diversification requirements in order to limit risk-taking by the MMFs. (Id. recital 28.) MMFs may therefore not invest more than 5% of their assets in money market instruments, securitizations, and asset-backed commercial papers issued by the same body, and not more than 10% of their assets in deposits made with the same credit institution. (Id. art. 17, para. 1.) In addition, there is a 15% limit on the cash amount in reverse repurchase agreements. (Id. art. 17, para. 5.) Furthermore, MMFs may generally not invest more than 17.5 % of their assets in units or shares of other MMFs. (Id. art. 16, para. 3.) However, there is an exception from the portfolio diversification rules for employee savings schemes, because employees cannot redeem their investment on demand, even in stressed market situations. (Id. recital 30; art. 16, para. 5.)
Article 35 prohibits all MMFs from receiving external support. The MMF Regulation states that the reason for the prohibition is that the contagion risk between the MMF sector and the rest of the financial sector increases through external support. (Id. recital 49.) “External support” is defined as any “direct or indirect support offered to an MMF by a third party, including a sponsor of the MMF, that is intended for or in effect would result in guaranteeing the liquidity of the MMF or stabilising the NAV [net asset value] per unit or share of the MMF.” (Id. art. 35, para. 2.) The Regulation provides a nonexhaustive list of items that constitute external support:
- cash injections from a third party
- purchase by a third party of assets of the MMF at an inflated price
- purchase by a third party of units or shares of the MMF in order to provide liquidity to the fund
- issuance by a third party of any kind of explicit or implicit guarantee, warranty, or letter of support for the benefit of the MMF
- any action by a third party the direct or indirect objective of which is to maintain the liquidity profile and the NAV per unit or share of the MMF (Id.)
The managers of MMFs are responsible for ensuring compliance with the MMF Regulation and may be held liable. (Id. art. 7, para. 4.) They are obligated to establish, implement, and apply internal credit quality assessment procedures to determine the credit quality of the assets they invest in. (Id. art. 19.) This rule is meant to reduce the overreliance on external ratings, which turned out to be a problem during the last financial crisis. (Id. art. 19, para. 4(d); art. 20, para. 1.)
In order to further transparency, MMF managers are obligated to inform investors weekly about
- the maturity breakdown of the portfolio of the MMF;
- the credit profile of the MMF;
- the weighted average maturity (WAM) and weighted average life (WAL) of the MMF;
- details of the 10 largest holdings in the MMF;
- the total value of the assets of the MMF; and
- the net yield of the MMF. (Id. art. 36.)
Furthermore, the managers must provide information on the MMF to the competent authorities on a quarterly basis. (Id. art. 37, para. 1.) As an exception, managers of MMFs with assets worth less than €100 million (about US$117 million) must report on an annual basis. (Id.) The reports must include
- the type and characteristics of the MMF;
- portfolio indicators such as the total value of assets, NAV, WAM, WAL, maturity breakdown, liquidity and yield;
- the results of stress tests and, where applicable, the proposed action plan;
- information on the assets held in the portfolio of the MMF; and
- information on the liabilities of the MMF. (Id. art. 37, para. 2.)
The MMF Regulation is supplemented by a report from the European Securities and Markets Authority (ESMA), which contains technical advice on liquidity and credit quality requirements, draft implementing technical standards to establish a reporting template for managers of MMFs, and guidelines on stress tests. (ESMA, Final Report: Technical Advice, Draft Implementing Technical Standards and Guidelines Under the MMF Regulation (Nov.13, 2017), ESMA website.)
The issue of whether share destruction/share cancellation, a common practice used by CNAV MMFs to reduce the amount of an investor’s shares corresponding to the amount of negative yield, should no longer be allowed for CNAV MMFs, was referred to the European Commission’s legal service. (Id. at 7.)