EUROPEAN COMMISSION MEMO Brussels, 4 September 2013 New rules for Money Market Funds proposed Frequently Asked Questions 1. What is a Money Market Fund? A Money Market Fund (MMF) is a mutual fund that invests in short-term debt such as money market instruments issued by banks, governments or corporations. Money market instruments traditionally include treasury bills, commercial paper or certificates of deposit (see notes to editors at the end). The above-mentioned financial instruments are eligible for an MMF as long as their residual maturity does not exceed 397 days (short-term MMF) or two years (standard MMF). MMFs can be denominated in any particular currency; those domiciled in Europe mostly invest in debt denominated in euro, pound sterling or US dollar. 2. What is a constant value MMF? A constant net asset value (CNAV) MMF is a fund that, unlike other mutual funds, seeks to maintain a stable 1 per share when investors redeem or purchase shares. The net value of the assets held by an MMF can, however, fluctuate, and the market value of a share may therefore not always be exactly 1. To avoid a fluctuating share value, a CNAV MMF uses amortised costs to value its assets. Not all MMFs promise redemptions or purchases at a stable price. In line with the practice employed by all other regulated mutual funds, variable net asset value (VNAV) MMFs offer redemptions and subscriptions at a price equal to the fund's NAV per share. 3. How is the net asset value (NAV) of an MMF calculated? The net asset value (NAV) of any mutual fund is the market value of the fund's assets minus its liabilities. The NAV is stated on a per share basis. As mentioned above, VNAV MMFs redeem and allow investors to purchase shares on the basis of the fund's NAV per share, while CNAV funds assume that a share purchased or redeemed is always worth 1. 4. Who operates MMFs? Asset management companies, which are either sponsored by banks or who run an MMF independently may operate MMFs. To offer an MMF, any authorised asset management company (be it under Undertakings for Collective Investment in Transferable Securities (UCITS) or the Alternative Investment Fund Managers Directive (AIFMD)) needs to obtain a separate permit granted once the competent regulator has established compliance with the MMF Regulation. The great majority of MMFs are bank sponsored. Nine out of the 10 MEMO/13/764
biggest EU MMF managers are sponsored by commercial banks. This illustrates the high degree of interconnectedness between the banking and the MMF sectors. Moreover, MMF assets are extremely concentrated. The 200 biggest MMFs account for more than 86% of the entire MMF assets under management. 22 MMFs manage assets exceeding 10 billion, and the biggest single MMF has more than 50 billion of assets under management. Most MMF managers do not, however, manage one single fund. They manage a portfolio of several MMFs. So a single manager can manage a portfolio ranging up to 120 billion. 5. Who invests in MMFs? Mostly corporate treasurers who need to hold large amounts of cash on a short-term basis and who do not want to put all of their cash in one single bank deposit account. Corporate treasurers can instead invest in MMFs that provide a high degree of liquidity, diversification and stability of value which is combined with a market-based yield. In Europe, corporate treasurers can choose to invest either in CNAV or VNAV MMFs. The split between both MMF models in Europe is roughly 50/50. 6. Why do corporates not want to put their cash in a bank account? Huge sums are at risk if a bank defaults. As a result corporate customers prefer to invest their cash holdings in a highly diversified portfolio of MMF instruments. Under the proposed new rules, an MMF would be required to invest in short-term debt issued by a range of financial, government or corporate issuers. For short-term MMFs a single issuer may not exceed 5% of an MMF's assets, while a standard MMF can only invest up to 10% of its assets with a single issuer. MMFs are currently the only regulated investment fund where cash can be invested with such a high level of issuer diversification. Exceptions to the above diversification limits only apply when the money market instruments are issued or guaranteed by a public authority such as a government, a central bank or a public bank. 7. Why are MMFs so important? MMFs are an important source of short-term financing for financial institutions, corporate bodies and governments. For example almost 40% of short-term debt issued by the banking sector is held by MMFs. MMFs represent a crucial link bringing together demand and offer for short-term money. With total assets under management of roughly 1 trillion, MMFs represent around 15% of the European fund industry. 8. What is the problem with MMFs? Due to their size (see above), MMFs can be systemically relevant. If an MMF collapses, a source of refinancing for banks and corporates disappears. MMFs are investment funds, with all the inherent market risks attached to any fund investment. During stressed market conditions, as in 2007 and 2008, they could not always maintain the promise of immediate redemptions (liquidity) and preservation of value (stability). This led in some cases to massive and sudden redemption requests by large groups of investors (the so-called run on the fund ). 2
MMFs are deeply interconnected with the money market as a whole and with the banking sector through the sponsors of the MMFs. In consequence, their disorderly failure can cause broader consequences, such as contagion to the real economy and bail-out risks for their sponsor and, ultimately, public authorities. These problems can have repercussions across the European Union, since both investments in MMFs and investments by MMFs are largely performed across borders. 9. What is the problem with sponsor support? MMFs, especially those that promise redemption at a stable share price (CNAV MMFs), have historically relied on discretionary capital from their sponsors to maintain their NAV per share in times of falling asset values. Sponsors are often forced to support their sponsored MMFs out of fear that their MMF's decreasing NAV may trigger a panic that could spread into the sponsor's other businesses. The support that the sponsor provides to the MMF may drain its liquidity, putting the sponsor itself at risk. For bank sponsors, the risk is even more acute because the panic could spread to the bank's depositors, which could lead the bank into default. In order to avoid this negative chain of events, public authorities have had to step in to stabilise the MMF sector. 10. Do banks currently set aside funds allowing them to stabilise the NAV of their MMF? No, sponsor support is entirely discretionary and even big MMF sponsors have not set aside funds explicitly to stabilise their MMFs if needed. Depending on the size of the fund and the extent of redemption pressure, sponsor support may reach proportions that exceed their readily available reserves. This is why the proposed rules require the constant NAV funds to build up a cash reserve, the so called 'NAV buffer'. After careful consideration of the sponsor support events during the crisis, the buffer will amount to 3% of the assets under management of the MMF. This amount represents some of the empirically observed 'worst case' loss scenarios. 11. How would the new rules work? The proposed Regulation requires: certain levels of daily/weekly liquidity in order for the MMF to be able to satisfy investor redemptions (MMFs are obliged to hold at least 10% of their assets in instruments that mature on a daily basis and an additional 20% of assets that mature within a week); clear labelling on whether the fund is short-term MMF or a standard one (short term MMFs hold assets with a residual maturity not exceeding 397 days while the corresponding maturity limit for standard MMFs is 2 years); a capital cushion (the 3% buffer) for constant NAV funds that can be activated to support stable redemptions in times of decreasing value of the MMFs' investment assets; customer profiling policies to help anticipate large redemptions; some internal credit risk assessment by the MMF manager to avoid overreliance on external ratings. 12. To whom would the new rules apply and to what extent? The proposed rules would apply to all funds that invest in money market instruments - independently of whether the basic parameters of the fund are governed by the UCITS 3
rules or whether the MMF operates as an alternative investment fund according to the Alternative Investment Fund Managers Directive (AIFMD). In line with the general policy to curtail 'overreliance' on third party credit ratings, any MMF manager is obliged to conduct its own credit assessment according to a set of harmonized rules. Harmonizing the parameters in which credit assessments need to be conducted is necessary to avoid arbitrage between MMF managers. The envisaged rules will only set a general framework within which European MMFs have to operate. Investors will still have to bear the risks inherent in an investment in money market instruments, most notably the risk of changes in interest rates (duration), the risk that assets held in a MMF decline in value and the risk that individual securities in an MMF portfolio suffer credit downgrades or even default. Transparency requirements will aim to ensure that all MMF investors are aware of these risks. 13. What exactly is a buffer? Each MMF that chooses to have a stable value of its NAV will have to set aside a capital reserve amounting to 3% of its assets under management. This cash reserve should be used like a buffer, or a cushion, to compensate the differences between the stable NAV of 1 and the price movements of the assets contained in the underlying portfolio. 14. Why not just ban CNAV MMFs? CNAV MMFs represent half of the European MMF market and some investors prefer this particular form of MMF. Analysis indicates that some investors may stop investing in MMFs if CNAV MMFs disappear. This could therefore have some negative repercussions on the entities that rely on the MMFs to get their funding. For this reason, there was the need to find an intermediate solution that takes the form a buffer imposed on CNAV MMFs. 15. Are you following the international approach on regulating the MMFs? To the extent possible, we seek alignment with the international work on shadow banking, mainly with the recommendations formulated by the Financial Stability Board (FSB) and the European Systemic Risk Board (ESRB). On most issues, such as the liquidity rules, issuer diversification and customer profiling the EU proposals seek to mirror the rules already applicable in the US (Securities and Exchange Commission Rule 2a-7). Differences in approach might result from the fact that the current European market is structured differently from other jurisdictions. For example, the European market does not address the separation that the SEC envisages between Government MMF (MMF that invest at least 80% of their assets in US Government debt) and 'prime' MMF (MMF that invest in corporate debt). While the SEC proposals provide that MMFs that are invested primarily in government debt may maintain stable prices per share at redemption, so-called 'prime' MMF would have to adopt the VNAV pricing model. As the EU has only a very small amount of euro or sterling denominated government MMF (accounting for roughly 3% of assets managed in the CNAV model), the vast majority of CNAVs currently operating in Europe can only continue operations in a responsible manner by setting aside capital to back up the promise of stable redemption prices per share. 4
16. What previous steps were undertaken prior to the proposal? This measure is preceded by extensive consultation with the relevant industry, MMF investors and other interested parties launched by a general consultation on asset management in July 2012. The Commission has thoroughly considered all contributions to various rounds of consultation and the information supplied in the course of these consultations is reflected in the Commission's impact assessment of March 2013. This impact assessment considered different policy options to ensure the liquidity and the stability of MMFs. It concludes that a general corpus of rules should apply to all MMFs while constant NAV MMFs should build up an adequate buffer to back up their promise to redeem investors at a constant price. Note to the editors Money market instruments are short-term debt instruments issued by banks, governments or corporations. Money market instruments include treasury bills, commercial paper, certificates of deposit and repurchase agreements. Certain types of securitization (those that are backed by company debt or trade receivables) may, upon certain conditions pertaining to minimum credit and liquidity thresholds, also be accepted as money market instruments as long as the residual maturity of the instrument and the underlying assets does not exceed 397 days. Commercial paper is short-term, unsecured note issued by a corporation to meet shortterm cash needs. Maturities range from overnight to up to 270 days. Commercial paper is usually issued by corporations with a high credit rating and sold at a discount from face value. Commercial paper is one of the main 'money market instruments' and an asset eligible for MMF investments. Certificates of deposit are savings certificates entitling its bearer to receive interest. A certificate of deposit (CD) has a specified fixed interest rate and is usually issued by a commercial bank. CDs are eligible for MMF investments. Repurchase agreements are a form of funding for securities dealers. The dealer sells securities to investors (such as MMF), usually on an overnight basis, and buys them back at a higher price that reflects the cost of borrowing cash. With a repurchase agreement, MMFs act as short-term lenders of cash. More information: http://ec.europa.eu/internal_market/investment/money-market-funds/index_en.htm 5