On 7 December 2016, the Permanent Representatives Committee approved, on behalf of the Council, an agreement with the European Parliament on money market funds (MMFs).
The draft regulation is aimed at making these funds more robust, ensuring the smooth operation of the short-term funding market. It sets out to maintain the essential role that money market funds play in financing the real economy.
It follows efforts by the G20 and the Financial Stability Board to strengthen the oversight and regulation of the 'shadow banking' system.
“This is a milestone in the regulation of the shadow banking sector as it should reinforce financial stability”,
Peter Kažimír, Slovak minister for finance and president of the Council
With assets under management of around €1 trillion, MMFs are mainly used to invest excess cash within short timeframes. They represent an important tool for investors because they offer the possibility to diversify their excess cash holdings, whilst maintaining a high level of liquidity.
Role and features of MMFs
There are currently two kinds of MMFs in the EU that are used for short-term financing for companies and government entities:
those that offer a variable net asset value (VNAV) that mainly depends on market fluctuations;
those that offer a constant net asset value (CNAV) and aim to offer share purchases and redemptions at a fixed price.
When markets are stressed
The financial crisis of 2007-08 showed that MMFs can be vulnerable to shocks and may even spread or amplify risks. Investors are likely to redeem investments as soon as they perceive a risk, which can force funds to sell assets rapidly in order to meet redemption requests. This can fuel an investor 'run' and liquidity crisis for an MMF, potentially triggering negative effects on other parts of the financial system.
The draft regulation lays down rules for MMFs, in particular the composition of their portfolios and the valuation of their assets, to ensure the stability of their structure and to guarantee that they invest in well-diversified assets of a goodcredit quality.
It also introduces common standards to increase the liquidity of MMFs, to ensure that they can face sudden redemption requests.
It establishes common rules to ensure that the fund manager has a good understanding of investor behaviour, and to provide investors and supervisors with adequate information.
The regulation prohibits sponsor support from third parties, including banks.
A new category of funds
An important new element of the regulation is the introduction of a permanent category of "low volatility net asset value" (LVNAV) MMFs. This new category has been made available as a viable alternative to existing CNAV MMFs.
Under the new regulation, money market funds will be subject to new and strengthened liquidity requirements as well as other safeguards. In the case of CNAV and LVNAV MMFs, there are also additional safeguards such as 'liquidity fees and redemption gates'. These will be designed to prevent and limit the effects of sudden investor runs.
The agreement reached with the Parliament covers, in particular:
liquidity and diversification requirements;
assets in which MMFs can invest, including the role of government debt;
a review clause for government CNAVs.
As concerns liquidity, the agreement includes the following requirements:
for LVNAVs and CNAVs, a minimum 10% portfolio investment in daily maturing assets and minimum 30% portfolio investment in weekly maturing assets. Of the minimum liquidity required in weekly maturing assets, up to 17.5% may be held in public debt instruments;
for VNAVs, a minimum 7.5% portfolio investment in daily maturing assets and minimum 15% portfolio investment in weekly maturing assets. Of the minimum liquidity required in weekly maturing assets, up to 7.5% may be held in money market instruments or units/shares of other MMFs.
As concerns diversification, the agreement provides for:
a 17.5% limit on investments in other MMFs, with a safeguard to prevent 'circular' investments;
a 15% limit on reverse repurchase agreements;
specified limits for covered bonds and for deposits in the same credit institution;
a targeted exemption from diversification rules for employee saving schemes.
The agreement also includes a review clause requiring the Commission to report after five years on the functioning of the regulation.
For public debt CNAVs, the Commission will report after five years on the feasibility of establishing an 80% EU public debt quota. The report will have regard to the availability of short term EU public debt instruments and assess whether the LVNAV MMF might be an appropriate alternative for the non EU government debt CNAV MMF.
Provisional agreement with the European Parliament was reached on 14 November 2016. The regulation is expected to be approved by the Parliament at first reading. It will then be submitted to the Council for adoption.
November 2016 draft directive on money market funds
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