What are the main impacts for asset managers?
The text came into force on July 20, 2017. Its provisions will apply respectively on July 21, 2018 for new money market funds and January 21, 2019 for existing ones.
Three categories of money market funds concerned
- Money Market Funds (MMF) with variable net asset value (VNAV), the current French model. In this category, the funds can be either short-term money market funds (current French “short-term money market” MMFs) or standard money market funds (current French “money markets” MMFs).
- MMFs with constant net asset value (CNAV). They will have to be invested in the public debt up to 99.5%, without any special conditions relating to the credit quality of the securities or the domiciliation of their issuers.
- MMFs with low volatility net asset value (LVNAV). This is a hybrid model. As long as the assets are not too volatile, they function as constant LV funds. Otherwise, these funds must automatically convert to variable net asset value funds.
Funds with constant net asset value (CNAV) and those with low volatility net asset value (LVNAV) can only be short-term money market funds. Managers are strictly supervised: they must calculate a “shadow NAV”, and implement specific stress tests or even procedures for NAV suspension under certain conditions.
Read more: European regulation update: shadow banking (June 2017)
When are MMF rules more restrictive than UCITS and AIFM regulations?
The UCITS and AIFM regulations apply respectively to mutual and alternatives money market funds, except where specific or more restrictive rules are laid down by the Regulation. Thus, there are distinctive features regarding the ratios and asset eligibility rules:
- Restrictive list of securities and securities financing transactions eligible for inclusion as an MMF: Money market instrument complying with residual maturity criteria, deposits with credit institutions, use of derivative contracts solely to hedge against market/interest rate/currency risks, MMF shares, ancillary liquid assets, stakes and repurchase agreements, securitisation products (subject to liquidity and minimum credit quality)
- Ineligible assets/prohibited transactions: all other assets (shares, commodities, etc.), securities lending/borrowing transactions, cash borrowing, short selling
- New liquidity ratios: a minimum of 7.5% of the fund’s net assets must be invested in financial instruments with a residual maturity of one day and a minimum of 15% of the net assets (7.5% of which may be derived from MMF units) must be invested in financial instruments with residual maturity of one week
- New diversification ratios:
- Repurchase transactions (repo) are allowed for the management of cash and not for investment purposes, up to a limit of 10% of the assets of the fund;
- Repurchase transaction vehicles must be eligible money market instruments (no securitisation products);
- MMF units held are not limited for employee savings funds but are limited to 17.5% of the fund’s net assets in other cases (with a maximum limit of 5% per MMF held). Except for ESF, master-feeder MMF set-ups are therefore prohibited;
- Deposits are limited to 10% of assets. This limit can be increased to 15% of the assets when the banking sector is too concentrated or when there is an insufficient number of credit institutions;
- The counterparty risk via OTC derivatives is limited to 5% of the assets;
- The counterparty risk via repo is limited to 15% of the assets of the MMF.
The characteristics in terms of maximum residual maturity of portfolio securities, weighted average maturity and weighted average life (respectively WAM and WAL) remain almost identical to those set out in CESR guideline 10-049 (formerly ESMA) published on May 19, 2010 and included in the AMF 2011-19 (UCITS) instructions, 2011-20 (general purpose alternative fund), 2011-21 (ESF) and 2012-06 (declared MMFs).
As a reminder, the maximum residual maturity of each security in the portfolio for a short-term money market fund is 397 days, the WAM must be less than 60 days and the WAL less than 120 days; The maximum residual maturity of each security is 2 years for a standard money market fund, WAM must be less than 6 months and WAL less than 12 months.
Structuring impacts for MMF managers
In addition to the liquidity matrices to follow on a day/week, the asset manager should:
- Have a strengthened and “proprietary” analysis of the credit quality of the securities, i.e. an internal analysis at the asset management company, without support from the parent company in the context of a group relationship
- Put in place regular stress tests based on credit events, macro-systemic shocks and interest rate assumptions or major redemptions
- Reinforce their knowledge of the liabilities of the MMF (type of investors, number of shares held, etc.). The asset manager must be able to verify that the value of a holder’s units does not affect the fund’s liquidity profile
- Set up new quarterly reports to the competent authorities
- Set up, within the framework of a reinforced requirement of transparency, regular reporting to the holders: weekly communication on the WAM/WAL, ten largest lines of the portfolio, value of the assets, net performance of the fund
The asset management companies managing MMFs will therefore need to update their business plans, obtain approval for new money market funds and apply for MMF compliance for existing money market funds. The regulatory documentation for the MMFs concerned (prospectus, KIID, regulations/statutes) will have to be updated.
The regulation also modifies the valuation rules for money market funds:
- For MMFs with variable net asset value, the valuation of financial instruments must be carried out at market value or mark to model and it will therefore be prohibited to perform, as is currently possible, a linearisation of the valuation of securities
- The assets of money market funds will have to be valued at least once a day, the NAV of these funds will therefore have to be daily
Delegated acts dealing with the credit quality method as well as draft technical implementation standards concerning reporting to the competent authorities or guidelines drawn up by the ESMA on stress tests are still awaited to complete the provisions of the regulation. A consultation was launched this summer by ESMA on draft technical standards.
The Commission will review this regulation no later than five years after the date of entry into force of the regulation i.e. no later than July 21, 2022.