European Commission DG MARKT Unit 02 Rue de Spa, Brussels Belgium

Transcription

1 AGA - n 3045_06/Div. European Commission DG MARKT Unit 02 Rue de Spa, Brussels Belgium markt-consultation-shadow-banking@ec.europa.eu Paris, 15 June 2012 AFG s response to the Commission s Green Paper on Shadow Banking The Association Française de la Gestion financière (AFG) 1 welcomes the Commission s Green Paper on Shadow Banking and thanks for the opportunity thus given to express our opinion on points that are key to the fund industry. 2 General comments We strongly believe that the Asset Management industry in Europe should not come under the scope of «shadow banking» (SB). As a general rule, the greatest majority of collective 1 The Association Française de la Gestion financière (AFG) 1 represents the France-based investment management industry, both for collective and discretionary individual portfolio managements. Our members include 411 management companies. They are entrepreneurial or belong to French or foreign banking or insurance groups. AFG members are managing 2600 billion euros in the field of investment management, making in particular the French industry the leader in Europe in terms of financial management location for collective investments (with nearly 1600 billion euros managed from France, i.e. 23% of all EU investment funds assets under management), wherever the funds are domiciled in the EU, and second at worldwide level after the US. In the field of collective investment, our industry includes beside UCITS the employee savings schemes and products such as regulated hedge funds/funds of hedge funds as well as a significant part of private equity funds and real estate funds. AFG is of course an active member of the European Fund and Asset Management Association (EFAMA) and of the European Federation for Retirement Provision (EFRP). AFG is also an active member of the International Investment Funds Association (IIFA). 2 AFG supports the views expressed on the same topic by Efama in its response to the Commission s Green Paper on Shadow Banking.

2 investment funds in Europe are strictly regulated by the UCITS Directive or national laws (that will gather under the European umbrella with the AIFM Directive that comes into force in June 2013). The leverage effect, maturity and liquidity transformation as well as the credit risk exposure are tightly limited. In this respect, it should be stressed that risks come from the excessive use of techniques which is neither limited nor monitored and it is not the case for general purpose funds whether packaged as UCITS funds or nationally regulated (and monitored soon under the AIFM Directive). The proposed definition of SB relies on a list of adapted, but not conclusive, indications; it should be completed by additional criteria such as accumulation of two or several indications or excessive weight of one of the mentioned indications (for example leverage is a question of degree); Authorities should not consider regulating what is not risky or under a threshold of significance and may not impact the balance of the financial system; therefore an additional work on the mapping of SB should be undertaken by the Commission. We believe that shadow banking should be linked to non regulated entities or structures embedding systemic risk or to express regulatory arbitrage. We believe that the collective investment industry does not correspond to any of these categories. Shadow banking should imply opaque activities bearing systemic risk, with no definition or specific rules attached. We strongly believe that the collective European asset management industry is tightly regulated both at the activity and actor levels with materially reduced nonfinancial risks. The European fund industry is a highly transparent industry that plays a stabilizing role for the economy, and as such cannot be captured in the shadow banking scope. The industry of fund management is tightly regulated and Money Market Funds (MMF) and Exchange Traded Funds (ETF) should not be mentioned as shadow banking (SB) entities. We would like also to stress that regulators keep reinforcing/toughen already tightly regulated products such as UCITS funds and recent tendency would even be to ban rather than regulate. The effect is that it orientates the market towards less protective structures and hinders low risk trusted practices financing the economy. We also believe that the word shadow banking should be rather changed into shadow finance. This is because shadow banking could wrongly imply that non-bank regulations are lighter regulations that the banking one. Actually, non-bank regulations are as highly protective as non-bank ones, are subject to ongoing regulatory scrutiny and have consistently succeeded to address risks. For instance, the occurrence of accidents could be a very good metric of success of the European non-bank regulation (and especially the asset management regulation we are subject to). In our view, it is necessary to avoid confusing the concept of finance which is generally the provision of monetary resources and banks which represent a specific branch equipped to collect deposits and specifically regulated for the special purpose of maturity and risk transformation. This last characteristic amply justifies a certain number of privileges such as the access to central bank liquidity. In any case, any regulation of these activities must be preceded and followed by the appropriate measuring means making it possible to identify the activities, to measure positions and flows and to indicate the sensitive spots where to carry scrutiny and potentially regulation. 2

3 FSB identified potential sources of risks Leverage risk The asset management industry in Europe is strictly structured through a set of regulations and directives and is subject to regulatory agreement. The major part of investment funds are regulated general purpose funds such as funds issued under the UCITS Directive, a rigorous European standard that became a worldwide recognized label. In general, UCITS funds do not use or use very little leverage. In any case, leverage is limited to two and a precise, detailed and adequate calculation methodology has been set by the regulator (and recently revised as July ). In addition, is should be taken into account the new AIFM Directive that will regulate managers of non-ucits funds and organise the monitoring of AIFs. European regulated general purpose funds have very strict limitations to borrowing. Liquidity risk UCITS funds invest in liquid markets and respect strong diversification requirements, thus making it possible to offer the stated valuation and liquidity for the fund in normal markets. In the specific case of money market funds, French funds (as well as the traditional Europeantype funds) are all structured with a floating/variable NAV. This accounting policy allows daily marked to market valuation of the fund s portfolio, thus ensuring investors equality as well as making the redeemers pay the price for liquidity. Therefore, there is no first mover advantage (prone to lead to a run risk). Currently, the SEC and the FSB/IOSCO investigate the relevance of applying this model to the US-type constant money market funds which do not exhibit the fall of the NAV until a certain threshold. It should be stressed that despite of their short term orientation, MMFs continuously and crucially finance the real economy through their ongoing subscriptions and correlative rolling investments in short dated securities issued by banks, corporates, municipalities and sovereigns. Indeed, French MMFs investments represent about 30% of certificates of deposits issued by banks in France, more than a third of commercial papers and medium term negotiable notes issued by corporates. Credit risk Regarding the credit risk exposure, the fund industry does not represent a systemic risk because of the relative modesty of its size compared to bond markets. At the European level, according to the ECB, the market share of bonds in euros held by the bond funds represents 5.3%, half of which representing sovereign securities. European bond ETFs hold 0.3% of the bond market in euros. Asset managers act on behalf of clients. They do not collect any deposits but invest liquidities received from investors seeking an exposure and aware of the corresponding potential profits and losses. There is no credit risk transfer, as the credit risk is entirely passed on to the end investor. 3 CESR s Guidelines on Risk Measurement and the Calculation of Global Exposure and Counterparty Risk for UCITS (CESR/10-788) 3

4 Detailed comments What is shadow banking? a) Do you agree with the proposed definition of shadow banking? SB should focus on unregulated activities which create systemic risk. It is important to identify and address risks outside of the regulated sector. Financial services activities outside of the regulated banking sector should not be considered by nature as shadow banks. It is totally relevant to define SB as certain types of activities conducted by certain types of entities. However AFG disagrees when the Commission mentions that being engaged in one of the listed activities is sufficient to belong to shadow banking. We believe that the accumulation of several indications is necessary to be considered as a SB activity; alternatively being engaged with a very high degree in one single activity might also be conclusive. For example using leverage 4 in high proportions is in itself a sufficient indication, but performing maturity and /or liquidity transformation is not conclusive of being part of SB if it is done to a limited extent in a regulated framework, as it is the case for general purpose funds (UCITS or nationally regulated in Europe). b) Do you agree with the preliminary list of shadow banking entities and activities? Should more entities and/or activities be analysed? If so, which ones? Many of the entities and activities listed by the Commission do not operate in the shadow of the regulation. Most of the key players and investment funds are already regulated: for example investment funds (UCITS or not) and the European investment firms which manage these products are regulated locally and at the European level and have to comply with robust risk regulation. Investments in securitisation are also strongly regulated in Europe. Securities lending and repo We believe that not all securities lending and repo activities must be considered as SB. A supplementary criterion should be added such as the use of repo to gain leverage in excess of 1 or reuse of collateral more than once. The fact that players that carry securities lending or repo activities (a bank, an insurance company or an investment firm) are regulated should be a factor to be taken into account. Leveraged funds If the definition of a leveraged fund is understandable, the definition of a fund that provides credit is rather unclear for an asset manager that complies with either UCITS or AIFM 4 With the precondition of the use of a precise and adequate measure of leverage, understood as the capacity of amplification of risks, net of risk compensations. For instance, depending on the fund strategy, using the sum of notionals as a leverage measure will clearly (1) not reflect all risks embedded, (2) fail to carve out those risks that in reality are compensated and (3) do not permit to single out those entities / funds that are materially making use of a higher capacity of amplification of risks. 4

5 directives. We think that mentioning specifically ETFs is pointless as the vast majority of European ETFs are just plain UCITS. MMFs We also believe that European money market funds (MMFs) as a whole should not be captured by SB. The definition of the type of fund subject to scrutiny under SB should be focused on the risks which stem from the discrepancy between marked to market and published NAV in the specific case of constant NAV MMFs. We strongly think that Variable NAV MMFs are not part of SB activities. French MMFs are investment products like other funds. They have been classified by the French AMF regulator as money market funds since They comply with the UCITS Directive and are subject to the restrictions set forth in the Eligible Assets directive and the July 2011ESMA Guidelines on a common definition on European Money Market Funds. French MMFs cannot be created with a constant NAV, but only with a floating NAV, as any other funds. This means that French MMF s NAV is subject to the fund s underlyings valuation and as such their share price can fall. French MMFs may be seen as an alternative to bank deposits but have no characteristics that could confuse them with bank deposits: they are held in securities accounts; their NAVs fluctuate ; they cannot be used as a means of payment; they are constantly monitored by AMF and Banque de France; there is no implicit guarantee; no confusion in the fund naming or accounting recordings; their prospectus clearly states that the invested capital is not guaranteed; French MMFs are held by a majority of professional investors, aware of the way their assets are managed, including the embedded risks. MMFs do not use leverage in their investment strategy. The maturity / liquidity transformation performed by MMFs is very limited and subject to tight guidelines defined by the regulator (ESMA). This liquidity mismatch is far smaller and much simpler to assess than the one performed by banks. Moreover, asset quality of the MMFs is high, and liquidity risk is actively monitored: at the asset level : liquidity profile of the portfolio taking into account instruments maturities ; assessment of the liquidity level of each instrument / issuer; (industry) minimum liquidity bucket, marked to market valuation (with potential shift to bid price in case of worsening market conditions). at the liability level : tracking clients behaviour to anticipate in/out flows; The prospectuses of MMF provide a clear description of the risks and rewards attributable to investors, and create no expectations of explicit or implicit underwriting of those risks by the 5

6 fund manager. The mark to market valuation reflects the value of the underlying assets. This price transparency removes the first mover advantage existing in constant NAV funds associated with the risk of run due to this type of cliff-effect valuation. What are the risks and benefits related to shadow banking? c) Do you agree that shadow banking can contribute positively to the financial system? Are there other beneficial aspects from these activities that should be retained and promoted in the future? We believe that SB developed also because it contributes to the financial system. The real question should be to enquire whether these contributions should not better be brought in the scope of regulated entities (we designate by regulated entities not only banks, but also insurance or asset management companies for example). We generally agree with the benefits identified by the Commission, i.e. they provide alternatives for investors to bank deposits; channel resources towards specific needs more efficiently due to increased specialization; constitute alternative funding for the real economy, which is particularly useful when traditional banking or market channels become temporarily impaired; and constitute a possible source of risk diversification away from the banking system. We would like to highlight that asset management funds and securitisation play an important role in the financing of the real economy. Fund industry The fund industry plays a key role in the management of long-term savings and pension schemes for the benefit of millions of European citizens. Regarding MMFs, they have also a strategic role as they contribute to the efficiency of money markets and to the short-term financing of the economy (ie: banks, corporates and sovereigns). They provide an intermediation service between lenders and borrowers in the short-term debt markets. French MMF industry represents 347,6 Bn as of end of December 2011, that is about one third of overall French funds. In Europe, the French industry represents a third of MMFs. French MMFs are owned for more than 75% by institutional investors and non financial companies. Retail investors account for about 9% and banks for 5%. French MMFs invest about 30% of certificates of deposits issued by banks in France, more than a third of commercial papers and medium term negotiable notes issued by corporates. 6

7 They are investment products offering access to credit expertise, risk diversification, liquidity management and secure and efficient operational processes that would be prohibitively expensive to most cash investors outside of the pooled-fund environment. The absence of MMFs would certainly increase the risk of disorderly runs on banks as investors would be forced to invest in deposits, but with much less diversification (only a few counterparties) than the one performed in MMFs. Securitisation Since the mid 90 s, European securitisation has become one of the most important term funding instrument for European financial institutions (banks, insurance companies and finance companies owned by auto-manufacturers) which enable them to grant mortgage loans, consumer loans, credit cards, auto loans and loans to small and medium size companies. In 2011, non central bank investors held approximately Euro equivalent of 975 bn of European securitisation. From 2006 to 2011, annual new issuance dropped from Euro equivalent of 480 billions to euro equivalent 75 billions. The funding shortfall from placed securitisation came at a time when European financial institutions were confronted with similar shortfall from bank debt market. This was counterbalanced by the ECB emergency intervention which is financing banks against collateral, European securitisation being one of the assets (through Euro 1 trios LTRO end of 2011 and beginning of 2012). d) Do you agree with the description of channels through which shadow banking activities are creating new risks or transferring them to other parts of the financial system? Yes, the description of the main risks (run, leverage, regulatory arbitrage and pollution of the banking system) is correct. However it is implicit and should be formally expressed that these risks are significant and might constitute a threat only when there is an excess either (i) in the unbalance between liabilities and assets or (ii) in the level of leverage and re-use of collateral or (iii) an important regulatory arbitrage or (iv) an incorrect appreciation of risk by banks when granting credit lines or assessing market volatility. e) Should other channels be considered through which shadow banking activities are creating new risks or transferring them to other parts of the financial system? We have no comment on the description of the channels through which shadow banking activities can transfer risks to other parts of the financial system. We would like to highlight that entities to which those risks can be channelled are regulated entities and comply with risk management rules. 7

8 What are the challenges for supervisory and regulatory authorities? f) Do you agree with the need for stricter monitoring and regulation of shadow banking entities and activities? We may agree if and only if the definition of shadow banking includes a criterion of accumulation of indications and a notion of significance threshold. No, if it implies regulating and monitoring the proposed list of activities and entities as presented in 3. More specifically, general purpose funds (such as UCITS) are subject to a strict regulation that cannot lead to any suspicion of SB on their part. There are already robust liquidity risk management processes and leverage monitoring and/or transparency in place by European investment fund managers which certainly explains for a large part that the vast majority of European investment funds went through the global financial crisis in 2008 without major problems. g) Do you agree with the suggestions regarding identification and monitoring of the relevant entities and their activities? Do you think that the EU needs permanent processes for the collection and exchange of information on identification and supervisory practices between all EU supervisors, the Commission, the ECB and other central banks? Yes, provided that relevant entities may be exempted from any further reporting and specific monitoring as long as their relevant activities do not exceed a threshold or are not of a nature (even if listed above) that constitutes any SB. In any case, it should be efficient and not result in a burdensome and expensive obligation relative to the expected results. We believe that an effective, calibrated and focused monitoring should permit a consistent basis for potential regulatory action. h) Do you agree with the general principles for the supervision of shadow banking set out above? We are of the opinion that an extensive mapping of SB with an indication of the corresponding level of risk for each activity/entity should be undertaken. Before applying the proposed principles to the on-going supervision, a definition of priorities and exemptions should be realised. To this end, the filter of significance thresholds as well as accumulation of several indications should be included. SB appears to be the typical field where a smart regulation should be the way forward. 8

9 i) Do you agree with the general principles for regulatory responses set out above? Our members see in the FSB s principles of targeted and proportionate action a suggestion to start with a mapping of risks and a definition of priorities. j) What measures could be envisaged to ensure international consistency in the treatment of shadow banking and avoid global regulatory arbitrage? Fund management is regulated and subject to strong supervision, and therefore, investment funds (including securitisation funds) could not be used to circumvent banking regulations. We would like to note that the regulation of investment funds differs significantly between the different regions. Furthermore, when the rules are consistent, the implementation dates are different from a region to another and do not maintain a level playing field or avoid regulatory arbitrage. It is the case for example for the retention rule related to securitisation assets which is already applied in Europe and is not yet applicable in the US. Regarding MMFs, more international consistency / coherence between regulations could bring some clarity and set a level playing field for funds sold with the same MMF designation. Generally, we are of the opinion that FSB and IOSCO are the bodies from which an international coordination is expected. What regulatory measures apply to shadow banking activities in the EU? k) What are your views on the current measures already taken at the EU level to deal with shadow banking issues? We strongly believe that the existing (and regularly evolving) regulation is appropriate to prevent UCITS and other general purpose funds from being under the scrutiny of SB. The existing EU regulatory framework already addresses the concerns raised by the Commission in its Green Paper in relation to investment funds in general. Focus on MMFs While we understand the European Commission s position about maturity / liquidity transformation and leverage within the shadow banking system and the associated concerns about systemic risks, we do not consider that French variable NAV MMFs have any reason to be captured as shadow banks. 9

10 We believe a distinction should be made between two different concepts that are "systemic risk" on one side and "run risk" on the other side. Systemic risk is very difficult to fight as by definition "tail risks" cannot structurally be covered. Conversely run risk can be better addressed. For instance, the first mover advantage that can accentuate the likelihood of a run does not exist on VNAVs thanks to the fact that the NAV reflects the marked to market value of the underlings in the portfolio. There is no such thing compared to "breaking the buck" effect in our industry. The cliff effect and collective type of threshold induced by breaking the buck constitutes a material difference of CNAV funds with other types of funds, where every investor may have his individual threshold that may trigger a redemption linked to his individual loss aversion and time horizon. This is possible as the fund continues operations despite a drop in the NAV and potential redeemers that incurred their cost of liquidity. Also, the concept of "first mover advantage" is not coherent with our major principle and regulation of shareholders equality. Their value fluctuates in line with money markets evolution and it may decline, as it was the case recently (some examples are shown in the chart reproduced hereafter). 5 Chart: Annualised weekly performances compared of 7 European MMFs since june 2009 to November 2011 Subscriptions and redemptions are done at the NAV level and there is no intervention to maintain a stable level. Indeed, the prospectus of the fund clearly states that there is no 5 We would like to clarify that we are presenting data, figures and arguments relative to the VNAVs variability because of recent arguments that may be presented by some against VNAVs with the only objective to draw regulator s attention away from issues pertaining specifically to CNAV structures. 10

11 guarantee to maintain the price of the share and that it may fall. Thus, there is no systemic risk linked to these funds. Risks linked to underlyings evolution (ex: credit risk) are supported by investors. During market turmoil, the NAV variability contributes to prevent any risk of run since there is no bonus for a potential first mover, instead there is equal treatment between investors. The application of the principle of equal treatment is closely supervised by the French regulator. A clear distinction should be made between runs on one side and large outflows that can occur on MMFs on the other side. The latter are generally seen as business as usual by asset managers (due for example to clients cyclical needs) and that can be perfectly managed as portfolios are designed to cope with these large potential in/outflows. Some of our members believe that market practices as stress tests may also provide a consistent framework in order to manage and construct a dynamic portfolio considering future potential risks. Stress tests provide an analysis on potential shocks (yields and credits) as well as on investor concentration by investment specificities. Future potential cost estimations lead to a reduction of global risk and a better consistency on liquidity management in order to satisfy client redemptions. Moreover, market practices as conservative approaches on short term liquidity (with instruments maturing within 1/7 days representing 10-15% of the portfolio) provide flexibility on potential outflows. Also, French funds are generally not rated, thus there is no potential cliff effect on this side. Investors do their own due diligence on firms and funds. In addition, French MMFs cannot be used as a payment means by the investor; there is no check writing on MMFs units. We thus firmly think that French MMFs do not bear by nature fragilities that would make them prone to the run risk. Outstanding Issues l) Do you agree with the analysis of the issues currently covered by the five key areas where the Commission is further investigating options? Our members are concerned on banking regulation when the Commission mentions the possibility to consolidate bank-sponsored entities for prudential purpose. Funds are independent entities, even when called after the name of the bank that sells them to its clients and that the only possible consolidation refers to funds in which the bank invests. Regarding asset management regulatory issues, MMFs and investment funds in general are already highly regulated. The asset managers are also already subject to strong regulations. Asset management funds (and especially general purpose funds such as UCITS) cannot be suspected of SB. With respect to ETFs, the Commission is right to point that issues are not specific to that type of funds but common to all investment schemes. It should be noticed that the quality of collateral is a question of risk and the suspected conflict of interest a question of compliance that are difficult to link to SB. The possible mismatch between liquidity offered to holders and liquidity of assets is limited and constitute a constant care for the fund manager: it 11

12 is one of the key risks he manages and monitors. Here again there is no direct relationship with SB. MMFs The analysis of MMF s reaches the point where it underlines that the discrepancy between published NAV and shadow NAV of a constant NAV MMF creates an incentive to exit first in case of a shock, thus making possible a run. The management of credit and liquidity risks on variable NAV funds is the job of the fund manager and is severely limited by regulation. Furthermore, transparent information and reporting to clients informs them of the actual risks taken, just as for any other fund. With reference to variable NAV MMFs, we support the ESMA s guidelines on MMFs which are of high quality and technically constitute an effective regulation. We also support the Commission s thinking regarding the possible creation of a pan-european MMF label by reaffirming the existing ESMA s guidelines on MMFs at a higher and transversal norm level. Indeed, the designation "Money Market Fund" for distribution in Europe shall be reserved to those funds that comply with the UCITS Directive provisions and related level 3 guidelines/technical standards issued by ESMA. In this respect, the Commission should ensure that a uniform concept of what constitutes a qualifying money market fund prevails across the Union. European MMFs are sold to institutional as well as to retail investors; thus it is natural to consider from the start that UCITS Directive rules as well as financial management rules established through the CESR s guidelines should apply. It seems therefore appropriate to take into account the existing CESR s guidelines with some rare exceptions (detailed hereafter at question n). Compliance with UCITS rules ensures effective and harmonised protection to investors in MMFs (eligibility rules, diversification, counterparty, collateral, etc). Indeed, there should be level playing field between products sold in the EU with the same designation MMFs, whether they are packaged as UCITS, AIFM or under local national law. We firmly believe that to prevent run risks, a fund should seek the equal treatment of investors. In this respect, liquidity buckets and marked to market valuation favour the equal treatment by ensuring there is no first mover advantage. When the NAV is a look-through of the market prices, there is confidence in the sincerity of the valuation. The equal treatment of investors is a fundamental concept to be observed for collective asset management vehicles and it should be clearly reaffirmed for all funds and in particular for MMFs. Indeed, operations on the fund (such as valuation, management of subscriptions/redemptions, etc) should not prejudice interests of investors (either new or existing investors). Marked to market valuation respects this principle. Any marked to model valuation has to earn investors common confidence that they are treated equally. Thus, the fund management s duty is to seek on an ongoing basis to create favourable conditions to apply equal treatment for the sake of the mutualised interest of investors in a collective scheme (and not privilege individual investors or past/new investors over each other). 12

13 Efficient Portfolio Management techniques Relative to repos and lending of securities (Efficient Portfolio Management techniques), there should be reminded that they are useful techniques and their excessive use only is to bring risk and to be monitored and regulated. Measuring this excess by measuring the excessive leverage obtained or the chain of reuse (more than once) is appropriate. In addition, these transactions are in general entered into by entities which are subject to strong regulations (investment funds, banks, insurance companies ). EPM techniques are being used by asset managers for a long time and are considered as highly useful in managing portfolios, pension funds, etc. The coming European regulation relative to collateral of these operations should be carefully calibrated and take into account impact studies so as to (1) permit managers to continue the effective management of risks, whether financial or operational risks and (2) permit these products to continue to play their positive role economy (financing and liquidity effects). ESMA investigates also the subject in the UCITS context; we urge regulators to facilitate coordination between regulations that are superposing and make the necessary impact studies so as to limit side effects and ensure the viability & coherence of envisaged rules. The reuse and repledge should be limited to one time (so as to limit the chain risk), but should not be prohibited, otherwise it would be very detrimental to investors. Securitisation Regarding securitisation, it is very important to clarify what the securitisation means in the context of shadow banking. Traditional securitisations, for example, are a form of fund, where a pool of assets is credit-tranched and sold to investors who receive payment of principal when the securitised assets are producing cash. As such, they involve no maturity transformation and do not involve any leverage issues: ie the loss is limited to capital invested and therefore there is no creation of systemic risks. Most synthetic securitisations mimic traditional securitisations. Synthetic mechanisms are used only because assets are not transferable. Those transactions neither create systemic risks nor involve maturity transformation. In the case of ABCP Conduits, maturity transformation can be undertaken, where any maturity mismatch between conduit assets and liabilities is absorbed through the existence of liquidity lines provided by banks. Other types of structured vehicles, such as Structured Investment Vehicles (SIVs), are not securitisations since SIV liabilities were not directly backed by SIV assets. However, SIVs did engage in leverage and maturity transformation. To conclude our view is that most securitisations do not generate shadow banking risks. Therefore the Commission will have to focus its actions on shadow banking on activities that generate risk rather than entities or asset classes. In addition, we are in line with the initiatives and measures taken by the industry, the regulators and the central banks to enhance the transparency and the standardisation of securitisation. These measures will help enhancing the quality of this asset class. 13

14 m) Are there additional issues that should be covered? If so, which ones? Some techniques used on financial markets do not contribute to market transparency and create a feeling of unfairness among actors. They seem not to directly relate to SB but rely on regulatory discrepancies. Such issues as dark pools and HFT should be considered and monitored and/or regulated. n) What modifications to the current EU regulatory framework, if any, would be necessary properly to address the risks and issues outlined above? We believe that there is a lot of regulation already in place. Nevertheless, increased disclosure and transparency, and collection of appropriate data including monitoring are appropriate solutions to avoid systemic risks. Securitisation With regards to securitisation, we note that changes have already been implemented (or are in the process of being applied) in CRD IV, CRA I, CRA III and AIFM. Our view is that traditional securitisations including CLOs do not generate shadow banking. Nevertheless, we support any effort to monitor the sector in order to ensure that instruments which could create shadow banking risks are strongly monitored and understood. Investment funds vs notes/certificates We also believe that the risk of confusion for final investors between Investment Funds and notes or certificates is currently very high. Notes and certificates are products that may appear similar to Investment Fund from a financial standpoint, but their legal form is very different. These products are less protective than Investment Firm for investors as the risks borne by investors are substantially different (issuer risk, lack of independent valuation, no counterparty risk control, lack of diversification requirements, no control on Global Exposure, lack of best execution obligations, no auditor nor depositary, no fiduciary duty, etc). We would like to stress that regulators keep reinforcing/toughen already tightly regulated products such as UCITS funds. The side effect is that, in comparison, notes appear more and more attractive to clients (for instance in terms of structured funds, ETFs, etc). The gap/unlevel playing field between UCITS and notes/certificates keeps widening and that is contrary to the PRIPS initiative s spirit and orientates the market towards less protective structures. 14

15 MMFs Regarding European MMFs, the implementation of the new CESR/ESMA guidelines which have taken full effect in January 2012 represent a major step towards greater transparency, increased clarity and better risk control of MMFs. Taking into account the post crisis evolution of industry best practices, we believe that these guidelines can be further improved to reduce risks: set a minimum liquidity bucket Regarding liquidity management, we recall that MMFs are funds with daily NAVs. Regarding liquidity on asset side, there are several sources to get liquidity in an MMF: - first the cash available in the fund; - second, the liquidity available thanks to the instruments maturing naturally within the portfolio without other intervention; - third, the liquidity obtained by selling of instruments in the fund prior to maturity and in this case, the closer the valuation is to the market conditions the better the evaluation of the fund liquidity; - and fourth, the liquidity sourced by clients through their investments cycle. These liquidity sources, used in conjunction, lead to an appropriate mix fund by fund. Indeed, liquidity is not an easy and stable concept, the manager s flexibility to set up the most appropriate mix of measures is very valuable. The use of asset liability matching techniques help to address liquidity issues naturally, through the structure of the portfolio and through active adjustments of the portfolio (with for example active bond selection). The knowledge and monitoring of the clients base as well as their subscription/redemption cycles allows building the fund on the maturity scale and monitoring the needed level of liquidity cushion. Especially in presence of institutional investors, managers should monitor the client base concentration as well as type of behaviour (by the means of statistical study and/or ongoing dialogue with clients). The weight of the liquidity bucket depends on the mix of measures each fund has put in place depending on its asset liability pattern. Notwithstanding the aforementioned, MMFs could be required to hold a minimum level of liquidity measured as a one month moving average of 10%-15% with instruments maturing in less than 1/7 day. A temporary difference should be acceptable if the liquidity bucket is used to meet a redemption that causes the fund liquid assets to fall below the liquidity ratios. The liquidity bucket should take into account instruments that can be transformed in cash without uncertainty, therefore a common definition of liquidity has to be linked to the concept of maturity. Eligible instruments should mature / have callable features within 1 to 7 days: cash, overnight and less than 7 days maturity instruments and deposits, repos with a call at 7 days or less, money market funds. Daily monitoring by the risk department should be in place and monthly publication through the fund s reporting. 15

16 impose a marked to market valuation with an exception only for less than 3 months instruments It should be reminded that MMFs are funds like any other and that valuation rules should respect the same principle which is: marked to market valuation. When prices are difficult to find or are inaccurate, instruments may be valued using a model. The UCITS Directive enables both valuation methods. Cost accounting valuation is a type of marked to model valuation. Funds should be continued to be authorised instrument by instrument - to apply amortised cost accounting only for negotiable debt securities with less than three months residual maturity and that have no specific sensitivity to market parameters. It should be reminded that this faculty implies no material difference with the market price/more advanced marked to model price. This faculty exists because the current system would need costly implementations to deal with more complicated models when market prices are not available. This less than three months amortised cost accounting is a simplifying valuation model that can only be used when there is no particular sensitivity to markets. The application of this amortisation faculty is to be controlled very strictly by the risk manager of the asset manager, the auditor and the custodian. The risks of using amortised cost accounting for negotiable debt securities with less than three months maturity are very small: the interest rate risk over a three months period is much lesser than on 397 days and the credit risk is four times smaller. Also, the three months period corresponds to the cycle of publication of results by issuers, meaning that a paper under three months has a very high likelihood to be reimbursed at par at maturity. Thus, the framework authorising the use of cost accounting should specify clearly that only negotiable debt securities with a residual maturity of less than 3 months and that have no particular sensitivity to markets can use amortised cost accounting. This is to be understood as a simplifying method to be used only in cases where: there is operational difficulty to access updated and reliable market prices, and in the absence of any particular sensitivities (to credit risk, interest rate risk,..etc), cost accounting proves to be an appropriate approximation (that justifies not to have the need for a more advanced model that would take into account credit curves for instance), and the asset manager has procedures in place, escalation plans, as well as commensurate human & technical means in order to monitor the possible difference that may arise between amortised cost and marked to market (or marked to more advanced model) price consolidated at the portfolio level. The escalation plan could define a materiality threshold where the asset manager has to analyse the need to take corrective action so as to keep the pricing difference at or below the threshold level. Corrective action may take the form of switching to a marked to market (if possible) or to a more advanced marked to model price (that would take into account credit curves for instance) in order to value the instrument. The threshold could be for instance 10 16

17 bp (alert level) measured on a consolidated level for the entire portfolio and 25 bp (corrective action level). It is understood that apart this faculty, instruments (including instruments maturing in more than three months) are marked to market (or, if needed, to an appropriate model that takes into account credit spreads for instance). In cases of market stress that can have consequences on the NAV, the UCITS has the possibility to switch to a bid valuation (the bid valuation option would be clearly stated in the prospectus). This is a comprehensive measure that reflects even more the current price of liquidity on the redeeming investors. We believe that it should be used another terminology for CNAVs because the word constant may imply that the fund is not marked to market and cannot lose value (and may even wrongly imply there is a guarantee of the principal). For instance daily distribution fund may be more appropriate. French MMFs are marked to market and can use the three months amortisation faculty. Even if French managers have their own internal rules on the use of the cost accounting method, our materiality threshold proposal will give a more formal and collective frame to it. French MMFs are UCITS Directive compliant funds, even if they are not authorised to use the 397 days cost accounting amortisation provision. Even if the rule has been transposed into the French law (Comofi), the Chart of Accounts (Plan Comptable) has not integrated the provision (and this is the necessary condition to its application). Also, the French MMFs are not authorised to distribute capital gains until 01/01/2013 (and starting with this date, only realised capital gains - and not unrealised - could be distributed). Thus, French domiciled MMFs cannot be created with a constant NAV, but only with a floating NAV, as any other asset management fund. We believe an impact study should be made from an accounting and fiscal standpoint. An MMF, as any UCITS, may have both distribution and accumulation shares. Accumulating NAV funds and distributing NAV funds generally operate under the same investment guidelines, however income is accrued daily for the first and distributed for the latter. In the case of accumulating NAV funds, income is reflected in an increase in the value of the fund shares and is realized upon redemption of those shares at a higher price. Depending on the laws of the investors country of residence, the tax treatment of distribution and accumulation shares may be different. Also, the fiscal definition of what may be distributed or not (interest, dividends, realised vs unrealised income) differs. It should be clarified 1) if a classical share has the same fiscal effect as a 1 dollar/euro accounting and 2) how to achieve fiscal coherence throughout Europe on the definition of what may be distributed. no mechanistic reliance on CRAs ratings Relative to the current ratings reference in the CESR s Guidelines on a common definition of European money market funds, we believe there should be no mandatory reference to CRAs ratings. Indeed, we believe MMF managers should internally assess the instrument s 17

18 quality and CRAs ratings should only be an optional input. We believe the eligibility criteria should not be mechanistically linked to all external ratings given to the instrument, rather the mandate of the fund should specify that best quality short term credit levels instruments are eligible (corresponding naturally to Investment Grade type of rating) and that the quality is assessed by the asset manager. The asset manager has to ensure by all means at his disposal that the credit risk taken is consistent with the fund s objective as a MMF. He has to indicate his policy on the taking into account of ratings, if any, of the instruments in the portfolio. We believe that credit quality in a MMF should not go below Investment Grade-type of instruments. However, restricting by regulation the eligibility of instruments to A2/P2/F2 level is seen as too strict, even if MMF managers may very well at certain times (such as currently) restrict themselves the credit quality in response to the markets situation. Indeed, there should be no such marble graved rules that restrict the financing of the economy (as there are times when the market state permits the eligibility by the risk departments of MMFs). Regulation should not be set for one year or two; regulation should be set for long periods thus accommodating situations where markets are more or less confident with more or less credit risk. The day to day fine-tunded adjustment is the risk department s job. In any case, nothing prevents investors (more and more alert in Europe) to ask portfolio reportings detailed by CRA ratings that permit to have an external view on the portfolio credit quality. We would like to reiterate AFG s general position that backs regulators efforts to reduce over-reliance on rating agencies related both to requirements on ratings of instruments in the fund and ratings for the fund itself. interest rate derivatives should be eligible, so as to avoid limiting the financing possibilities of corporates (without any added risk to the investor) Corporate issuers do very little commercial paper issuance and they issue more on the form fixed rate bond than floating rate bond. We believe that this type of market characteristic should not be ignored when drafting regulation, especially when proven techniques exist. Interest rate derivatives should be eligible for MMFs. European MMFs can invest in securities with a residual maturity until the legal redemption date of less than or equal to 2 years, provided that the time remaining until the next interest rate reset date is less than or equal to 397 days. This feature corresponds to a two-year floating rate security that resets to a money market rate (or index) or to a two-year fixed rate security provided the interest rate risk of the security is hedged against a money market rate (or index) with a reset date less or equal to 397 days. We would like to recall that restricting eligibility to floating rate instruments only means exposing the fund heavily more to a banking risk than to a corporate risk (there is already a banking sector predominance on the short term issuance market compared to corporates). This is counterproductive from a diversification point of view by limiting the financing possibilities of corporates. With rating eligibility limitations, Basel III liquidity constraints that favour long issuances, and the fact that corporate issuers do very little commercial paper issuance (and they issue more on the form fixed rate bond than floating rate bond), the financing of the economy will be favoured by the eligibility of interest rate derivative + fixed income instruments. 18