Select Committee on Treasury Written Evidence


Memorandum from the Institutional Money Market Funds Association (IMMFA)

EXECUTIVE SUMMARY

  1.  The Institutional Money Market Funds Association (IMMFA) is the trade association representing the promoters of triple-A rated money market funds and covers nearly all major promoters of this type of fund outside the USA. Members' funds under management exceed US$500 billion.

  2.  Confidence is a critical component of the financial system. The events of the summer saw confidence rapidly disappear, due partially to poor information flows and a lack of understanding of some of the complex instruments in circulation.

  3.  IMMFA recognises that there is no current European definition of a money market fund, unlike in the USA. Such a definition would have prevented sweeping generalisations being made by financial commentators, which ultimately further exacerbated the turbulence in global financial markets. IMMFA represents only Treasury-style money market funds, which have distinct product profiles and objectives, and should not be confused with any other fund in operation in financial markets.

  4.  Treasury-style money market funds are the only fund type permitted under to use amortised accounting for valuation purposes, in accordance with the Eligible Assets Directive (due for implementation in July 2008). This, and the underlying Committee of European Securities Regulators (CESR) guidance, should provide the definition which would differentiate between money market fund types. However, IMMFA recognises that the onus remains with IMMFA to educate market participants and commentators on the distinctions, definitions and risks inherent in the different types of money market fund available and prevent further occurrences of misunderstanding in the market.

  5.  The nature of Treasury-style money market funds—which invest exclusively in short-term, high quality money market instruments, have a weighted average maturity of no more than 60 days, and hold assets to maturity, continues to enable these funds to provide same-day liquidity to investors. This has been true throughout the most turbulent and volatile market conditions experienced over the summer months.

  6.  Recognition of this liquidity has already been achieved through the amendments made to the UK liquidity mismatch regime. However, the events of the summer have heightened the need for liquidity by all financial institutions. Whilst the pan-European review of liquidity commissioned by the European Commission will address those instruments eligible as collateral, we urge consideration of amendments to the UK regime to include Treasury-style money market funds in advance of this timetable, in order to provide further liquidity facilities to all financial institutions in the UK.

INTRODUCTION

  7.  The Institutional Money Market Funds Association (IMMFA) are grateful for this opportunity to provide evidence to the Treasury Select Committee concerning financial stability and transparency.

  8.  IMMFA is the trade association representing the promoters of triple-A rated "treasury-style" money market funds (Treasury-Style MMFs) and covers nearly all of the major promoters of this type of fund outside of the USA. Treasury-Style MMFs are bought primarily by institutions to manage their liquidity positions and not for "total return" investment purposes. They are used as an alternative to wholesale money market deposits by a wide range of investor types as they offer a practical means of consolidating and outsourcing short-term investment of cash.

  9.  Comments are provided on two important areas; (i) a need for standard recognised financial product definitions and (ii) the provision of robust liquidity facilities.

FINANCIAL STABILITY

  10.  One of the key components of a stable financial system is the confidence of all those participating within that system. The events of the summer saw confidence quickly evaporate, both in wholesale markets, and more latterly—and visibly—in retail markets.

  11.  Confidence is inherently built once there is understanding of the fundamentals of the system. This understanding may only be achieved through the provision of sufficient information in a decipherable format that the end user can interrogate. Principal in this is the production and dissemination of widely accepted terminology which is recognised by users within that system.

  12.  The nature of today's global financial markets has seen innovative developments of an increasingly complex nature, masked by an increasingly inaccessible language. However, the pro-longed benign market conditions prevalent prior to this summer's turbulence bred complacency which limited the desire for information from end users. Put simply, the prolonged bull market was too good an opportunity to make money for product providers and investors alike without the bother of asking detailed questions on what was being purchased.

  13.  The absence of a recognised definition for money market funds within Europe has seen sweeping generalisations and assumptions made in relation to any fund which bears this name. As the trade association representing the providers of Treasury-Style MMFs, IMMFA has been working tirelessly for a number of years to educate wider market participants and commentators on the different types of money market fund on offer in Europe, in an attempt to provide clarity and latterly to help try to restore some semblance of confidence in aspects of the wholesale markets.

  14.  Money market funds first appeared in the USA in the early 1970s. Their success resulted in amendments to the Investment Company Act 1940, which instigated direct regulation of this fund type through Rule 2A-7 of the Securities and Exchange Commission (SEC). Following the implementation of this Rule in 1983, no fund within the USA is permitted to call itself a "money market fund" unless it complies with the requirements of SEC 2A-7.

  15.  In Europe, Treasury-Style MMFs—equivalent to their SEC 2A-7 USA counterparts have been a later development, but the similar objectives of these funds and subsequent appetite for them has quickly seen them established as a staple component of a corporate entity's treasury management. Unfortunately, continental Europe has over the last 20 years developed a different style of "money market fund" which has more the characteristics and investment aims of a total-return, short-dated bond fund (Investment-Style MMFs). This has undoubtedly added to the confusion for investors.

  16.  However, there is no regulation within Europe similar to that in the USA to define a money market fund and to restrict the use of the name. Consequently, a plethora of cash funds operate under the general money market fund banner. The absence of a recognised definition has seen contamination of the reputation of all money market funds following the action taken by AXA Investment Management to support its LIBOR-plus funds and BNP Paribas in relation to is asset-backed security funds, which were widely quoted as money market funds in the global press when in fact they lacked the stable pricing and strong liquidity characteristics inherent in a Treasury-Style MMF.

  17.  A Treasury-Style MMF is a collective investment scheme (CIS) that invests in quality money market instruments as defined by the Eligible Assets Directive (EAD) such as: fixed deposits; certificates of deposit, repurchase agreements, commercial paper (including asset backed); and floating rate notes, and is used mainly for corporate liquidity cash management purposes. All Treasury-Style MMFs must be awarded a triple-A rating from one of the three recognised independent credit rating agencies, and must also have the lowest susceptibility to market interest rate volatility. IMMFA only represents the interests of providers of Treasury-Style MMFs.

  18.  Treasury-Style MMFs should not be confused with their Investment-Style MMF counterparts which seek to achieve enhanced total-returns (ie combined capital and interest returns) by taking greater risks. These `enhanced' or "dynamic" funds have more the characteristic of short-dated bond funds. The enhanced yield opportunity results from the usual risk-reward conundrum of higher credit and/or market risk combined with lower liquidity. Whilst markets were stable, the susceptibility to market volatility of these funds was not evident, and the greater risk was accepted by investors seeking more competitive returns. When markets became volatile and investors sought to redeem their investments, the liquidity risk inherent within many of these funds became immediately apparent, with significant reductions in fund values caused by the "forced-selling" of quality credit assets into illiquid markets, triggered by difficulties in valuing assets, resulting in many cases for capital support to be provided by willing sponsors or parents.

  19.  The important distinction between the two types of money market funds was not made on numerous occasions throughout the market turbulence; for example, Kate Burgess in the Financial Times described the distinction as being "blurred".[13] However, as explained the risk profile and objectives of each type are fundamentally different and are intended to meet the requirements of different types of investors.

  20.  Whilst Treasury-Style MMFs have the characteristics to maintain capital security and increase liquidity in the most volatile and illiquid of market conditions, Investment-Style MMFs are simply not as robust and cannot provide an investor with the same level of comfort.

  21.  Treasury-Style MMFs are the only investment fund type permitted to value their assets portfolio on an amortised accounting basis—similar to most banks. This has been recently confirmed in the Eligible Assets Directive 2007/16/EC, and is recognition of the lower levels of risk presented by such funds.

  22.  IMMFA believes that the fact that Treasury-Style MMFs are the only mutual funds permitted to value assets using this methodology provides an opportunity to create a unique regulatory definition that would help resolve the historic definitional confusion that exists between liquidity and `total-return' money market funds as recently evidenced during the market turmoil. However, at present the onus remains on IMMFA to educate market participants and commentators on the distinction, definitions and risks inherent in the different types of money market funds available in the absence of a regulatory taxonomy.

  23.  IMMFA is also taking steps to enhance the information which is made available to investors in a Treasury-Style MMF. This need had been identified—in advance of the events of the summer—in recognition that the implementation of the Capital Requirements Directive would attract greater investment from financial institutions which in turn would necessitate greater provision of management information, especially for credit risk and large exposure calculation purposes.

  24.  However, IMMFA recognises that we also have lessons to learn from recent events, especially the need for meaningful data provision in market turmoil situations in order to retain investor confidence in Members' funds. We are therefore planning to work closely with investors to determine their information requirements and if possible to produce this in a standardised format.

TREASURY-STYLE MMFS AS A LIQUID INVESTMENT

  25.  Treasury-style MMFs have capital preservation and liquidity as their main two investment objectives with the achievement of competitive returns of secondary importance. As such, they provide an ideal opportunity to enhance European prudential liquidity provision.

  26.  There are two basic types of Treasury-Style MMFs available; constant net asset value (CNAV) and accumulating net asset value (ANAV). Both types use amortised accounting to value their underlying asset portfolios. Shares in CNAV funds are issued with an unchanging face value (eg £1 per share). Income in the fund is accrued daily and can either be paid out monthly to the investor or used to purchase more shares in the fund. ANAV funds operate under the same investment guidelines as CNAV funds and income is accrued daily. However, unlike CNAV funds, income is not distributed; instead income is reflected by an increase in the value of the shares.

  27.  The underlying assets of Treasury-Style MMFs must have a fixed maturity date, or maximum interest reset period, of no more than 397 days, and the weighted average maturity (WAM) which measures the market interest rate risk in a fund's asset portfolio must not exceed 60 days. This is crucial in reducing market risk from significant interest rate volatility and to ensure that a fund can provide same-day liquidity to investors. In effect, a Treasury-Style MMF operates as a "hold-to-maturity" fund in that it seeks to ensure that it has sufficient assets maturing each day to meet any potential investor redemptions.

  28.  Quality assurance is to a large extent provided by the fund's rating. The rating criteria stipulate the fund's asset range and restrictions (such as quality, type and currency), acceptable counterparty risk and acceptable choice of custodian. Treasury-style MMFs are all registered under the UCITS Directive 85/611/EEC and are subject to the associated legislative requirements and regulations imposed within the fund's domicile. In addition, IMMFA operates a Code of Practice, designed to maintain highest standards of market practice by members.

  29.  During the market turbulence of recent months, Treasury-Style MMFs have maintained strong credit quality and liquidity throughout. There have been no downgrades of a triple-A rated Treasury-Style MMF on either side of the Atlantic, and no assets held within an IMMFA members' Treasury-Style MMF have been placed on market-watch by any credit rating agency.

  30.  The short-term nature of the funds is specifically designed to provide liquidity for investors as and when required. The constant maturity stream of underlying holdings ensured that same-day liquidity was available throughout the most illiquid conditions experienced in August and September.

  31.  The ability to value assets on an amortised basis enables Treasury-style money market funds to hold assets to maturity. There has been no "fire-selling" of assets, with redemption being made at par at maturity. This strategy ensures that susceptibility to market volatility is reduced to a minimum.

  32.  The market turbulence saw investors flee for security and quality. Members' funds have grown significantly over the summer to record highs, with over US$504 billion in funds under management as at October 2007. This growth is a clear indication that the underlying principles of Treasury-Style MMFs—of capital security and liquidity—make them a valuable component of a treasurer's liquidity cash management policy.

UK LIQUIDITY REGULATIONS

  33.  The liquidity of credit institutions within the UK is subject to one of two regulatory regimes; (i) the liquidity mismatch regime; or (ii) the Sterling Stock liquidity regime. Amendments to the liquidity mismatch regime to permit holdings in a qualifying money market fund[14] to be eligible for liquidity purposes were only formally introduced to the FSA Handbook on 6 October 2007. This was too late to provide additional liquidity facilities to UK banking institutions when they were needed most during the summer.

  34.  Whereas amendments have been made to the liquidity mismatch regime, no corresponding changes were made to the Sterling Stock liquidity regime. The outcome of the pan-European liquidity review, initiated by the European Commission before any of the events of the summer had begun to unfold, will include determination of the list of eligible collateral for liquidity purposes, which may influence the UK Sterling Stock liquidity regime.

  35.  However, we strongly advocate that Treasury-style money market funds are included as eligible collateral within all liquidity regimes in operation throughout Europe—including the Sterling Stock liquidity regime. The performance of these Treasury-style money market funds in stressed conditions is indicative of their robustness and low levels of volatility. The ability to have access to liquidity in all circumstances is a fundamental necessity for all financial institutions, the importance of which cannot be underestimated following the events of the summer. Further, whilst the pan-European review of liquidity will present an ideal opportunity to widen the list of eligible collateral (where appropriate), the events over the summer highlight a pressing need for liquidity provision in advance of the timescale of any European Commission review. We therefore recommend that appropriate amendments to the UK Sterling Stock liquidity regime be considered in advance, and independent of, the work of the European Commission.

  36.  Treasury-style MMFs are able to provide a solution to liquidity needs; however, IMMFA recognise that we have a responsibility to further enhance our liquidity provision for the benefit of Treasury-Style MMF investors. To that end, we are currently working on an initiative to improve our liquidity provision still further, through the introduction of the ability to repo Treasury-Style MMF shares. This would not only allow investors to monetise their holdings by entering into a repo with a counterparty who was willing to take the shares as collateral but also support lender of last resort activities during a general market turmoil situation as currently experienced. Such a facility would provide further liquidity to the investor, whilst the counterparty to the repo would receive collateral which would not redeem at anything below par.

November 2007






13   Financial Times, 29 August 2007 "Casualties still emerging from credit crisis" by Kate Burgess. Back

14   As defined in Article 18 of the MiFID Implementing Directive 2006/73/EC. Back


 
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