Documents considered by the Committee on 4 February 2015 - European Scrutiny Contents


11 Financial services: money market funds

Committee's assessment Politically important
Committee's decisionNot cleared from scrutiny; further information requested
Document details(a) Draft Regulation concerning money market funds; (b) European Central Bank Opinion on the draft Regulation
Legal base(a) Article 114 TFEU; co-decision; QMV; (b) —
Department

Document numbers

HM Treasury

(a) (35298), 13449/13 + ADDs 1-2, COM(13) 615

(b) (36321), 12713/14, —

Summary and Committee's conclusions

11.1 Money market funds (MMFs) are open-ended funds that invest in short-term debt securities such as treasury bills and commercial paper. They take one of two forms — constant net asset value (CNAV) MMFs, which seek to maintain a fixed value of units in the fund so that the redemption values of investors' holdings do not change, and variable net asset value (VNAV) MMFs, which have a floating unit value that fluctuates with changes in the value of the underlying assets.

11.2 This draft Regulation would introduce rules specific to MMFs. It would deal with investment policies, risk management, valuation rules, CNAV MMFs and external support. We considered the draft Regulation in October 2013 when we said that, given the Government's reservations about aspects of the proposal, we would not consider this proposal further until we heard about progress in Council working group discussion (which we recognised would not be for some time) on these issues. We asked also to hear about the Government's estimate of the costs of the proposal, once established.

11.3 In August 2014 the European Central Bank published this Opinion on the Draft Regulation, seeking to influence negotiation of the text. We asked how the Opinion was playing into the negotiation.

11.4 The Government now tells us that:

·  on 17 December 2014, the Italian Presidency circulated a revised Presidency compromise text of the draft Regulation, which amends the Commission's proposals in an attempt to reach a compromise between the different views expressed by Member States in Council discussions;

·  the proposed text has not been approved by Council and the Latvian Presidency has not indicated whether it wishes to use this text as a basis for further discussions; but

·  it may wish to make progress in the second half of its term.

11.5 The Government outlines, and comments on, several aspects of the proposal as now modified by the Presidency. It also tells us about some of the possible financial implications of the revised proposal. However, the Government does not mention the European Central Bank Opinion.

11.6 We are grateful to the Government for this account of where matters now stand on this draft Regulation. We look forward to hearing about further consideration of the proposal, whether under the Latvian Presidency or subsequently, and for the Government's assessment of any text that might be nearing agreement by the Council. However we remind the Government that we wish to hear also how the European Central Bank Opinion is playing into the negotiation. Meanwhile the documents remain under scrutiny.

Full details of the documents: (a) Draft Regulation on Money Market Funds: (35298), 13449/13 + ADDs 1-2, COM(13) 615; (b) European Central Bank Opinion on a draft Regulation on money market funds: (36321), 12713/14, —.

Background

11.7 Money market funds (MMFs) are open-ended funds that invest in short-term debt securities such as treasury bills and commercial paper. Through these investments MMFs provide short term finance to financial institutions, corporations and governments. For investors they represent highly liquid, stable, short term cash management tools. They provide a safe place to invest in easily accessible cash-equivalent assets characterised as low-risk, low-return investments.

11.8 MMFs take one of two forms:

·  constant net asset value (CNAV) MMFs seek to maintain a fixed value of units in the fund so that the redemption values of investors' holdings do not change — they achieve this in part by rounding the net asset value per unit to the nearest percentage point; and

·  variable net asset value (VNAV) MMFs have a floating unit value that fluctuates with changes in the value of the underlying assets.

11.9 MMFs are currently regulated either under the Undertakings for Collective Investment in Transferable Securities Directive (UCITS) or, for some MMFs, indirectly under the Alternative Investment Fund Manager Directive. The Committee of European Securities Regulators (CESR) also issued guidelines on MMFs in 2010, which were fully implemented by the Financial Services Authority.

11.10 This draft Regulation, document (a), would introduce rules specific to MMFs. It would deal with investment policies, risk management, valuation rules, CNAV MMFs and external support. We considered the draft Regulation in October 2013 when we said that, given the Government's reservations about aspects of the proposal, related to capital buffers, repurchase agreements and eligible securitisations and credit rating agencies, we would not consider this proposal further until we heard about progress in Council working group discussion (which we recognised would not be for some time) on these issues. We asked also to hear about the Government's estimate of the costs of the proposal, once established. Meanwhile the document remained under scrutiny.

11.11 In August 2014 the European Central Bank (ECB) seeks, with this Opinion, document (b), to influence and inform negotiation of the draft Regulation. The Bank supports the proposals. It outlines alternative drafting in some technical areas and makes additional points from a policy perspective. We asked that when the Government reported back to us with the information we have asked for in relation to the draft Regulation, to tell us how the Opinion was playing into negotiation of that proposal. Meanwhile this document also remained under scrutiny.

The Government's Supplementary Explanatory Memorandum

11.12 In her Supplementary Explanatory Memorandum of 23 January 2015 the Economic Secretary to the Treasury (Andrea Leadsom) first tells us that:

·  on 17 December 2014, the Italian Presidency circulated a revised Presidency compromise text of the draft Regulation;

·  the Presidency's text amends the Commission's proposals in an attempt to reach a compromise between the different views expressed by Member States in Council discussions;

·  the proposed text has not been approved by Council; and

·  the Latvian Presidency has not indicated whether it wishes to use this text as a basis for further discussions, but it may wish to make progress in the second half of its term.

THE REVISED TEXT

11.13 The Minister says on investment policies of MMFs that:

·  Articles 7-20 set out what would be the permissible investment policies of MMFs;

·  these include stipulations as to the types of assets that they could hold, requirements for diversification of investments, and rules on the portion of an MMF that could be held by a single client;

·  these rules are designed to ensure that MMFs would be suitably diversified and invested only in assets of high credit quality;

·  they would also limit the amount of exposure MMFs could have to a single issuer of money market instruments or to a single counter-party;

·  these rules would require MMFs to develop internal assessments of the credit quality of investments held, so as to reduce reliance on external ratings agencies; and

·  the Presidency compromise text proposes several changes to the Commission's original draft, including requirements for allowing MMFs to invest in repurchase agreements, broadening the scope of eligible securitisations, requirements for allowing MMFs to invest in units or shares of other MMFs and specific provisions to allow proportionate credit assessments to be carried out by small MMF asset management firms.

11.14 The Minister says on risk management of MMFs that:

·  Articles 21-25 set out requirements to ensure that MMFs would have sufficient liquidity and would be able to plan for and accommodate investor redemption requests;

·  rules include enhanced liquidity requirements, stress testing and "know your customer" requirements;

·  MMFs would be precluded from soliciting or paying an external ratings agency to rate their products;

·  different rules would be introduced for short-term and standard MMFs;

·  the former would be required to hold more liquid assets with shorter maturity limits and greater diversification;

·  standard MMFs would face somewhat looser requirements, but would only be able to operate under the VNAV model; and

·  the Presidency compromise text proposes changes to the way the weighted average life of a short-term MMF would be calculated when a financial instrument embeds a put option.

11.15 The Minister says on valuation rules that Articles 26-28 would set out how MMFs net asset value per share should be calculated and how their investment assets should be valued.

11.16 The Minister says on CNAV MMFs that:

·  the Presidency compromise text makes a number of changes to the Commission's proposals;

·  the Commission's Articles 29-34 set out detailed requirements for MMFs that operate under the CNAV model;

·  CNAV MMFs were to be required to hold a cash capital buffer equal to 3% of the total value of their assets;

·  this buffer was intended to be used solely to compensate for deviations between the fixed unit value offered to investors and the value of the underlying assets held by the fund;

·  additional rules on the authorisation of CNAV MMFs and how the buffer was to be used and operated were included in this section;

·  the Presidency compromise removes the CNAV buffer from the draft Regulation; and

·  in its place, the Presidency has proposed introduction of a 'small professional CNAV MMF' along with liquidity fees and redemption gates.

11.17 The Minister says on external support that:

·  historically, sponsors of MMFs have provided discretionary support to MMFs that have faced difficulty;

·  Articles 35-26 would prohibit such support, save for the mandatory 3% buffer for CNAVs, in most scenarios; and

·  the Presidency compromise text further limits the circumstance in which sponsors of MMFs could provide support.

THE GOVERNMENT'S VIEW OF THE PRESENT POSITION

11.18 The Minister says that the draft Regulation would provide additional protections that would benefit investors and would help improve competitiveness by providing a level playing field across the EU; and that as such the Government welcomes many of the proposals including enhanced liquidity requirements, new "know your customer" rules and improved transparency. She then explains in greater detail a number of issues as follows.

11.19 On capital buffers the Minister says that:

·  the Government recognises that MMFs provide an important function to businesses, investors and the wider economy — they are important providers of short term finance to financial institutions, corporations and governments;

·  for investors MMFs represent highly liquid, stable, short term cash management tools — they provide a safe place to invest in easily accessible cash-equivalent assets characterized as low-risk, low-return investments;

·  this important role gives rise to prudential concerns that under stressed market conditions MMFs could pose a source of systemic risk;

·  the Government acknowledges that further safeguards need to be put in place with regard to MMFs to address prudential concerns;

·  the Commission's proposed capital buffer and the mandatory conversion of CNAV MMFs to VNAV MMFs may, however, be unduly burdensome on business, especially considering new EU measures that already exist (that is CESR Guidelines on MMFs) and existing market dynamics;

·  imposition of a capital buffer is more suited to the banking sector and should not be imposed upon investment funds, given the fundamental differences between the banking sector and collective investment schemes — MMFs are highly regulated and unleveraged by nature, making them safer, more liquid and transparent than banks;

·  the Presidency compromise text proposes that small professional investors should continue to be able to invest in CNAV MMFs — this represents around 15-20% of the existing CNAV MMF market;

·  the Presidency argued that, because small professional investors are less prone to reacting instantly to price changes, a capital buffer is unnecessary;

·  to strengthen the resilience of small professional CNAV MMFs against significant redemptions, the Presidency proposed introducing liquidity fees and redemption gates — liquidity fees require funds to impose a fee on redemptions once liquidity within the fund has reduced below a certain threshold;

·  in effect, this fee would ensure that those redeeming during a period of stress were unable to benefit from redeeming at a higher unit price than the underlying asset value, thus removing first mover advantage; and

·  in its progress report of 17 December 2014, the Italian Presidency noted that further work is needed to establish a suitable regime for the remaining CNAV market — any proposal should seek to maintain some of the utility of CNAV MMFs while dealing appropriately with systemic risk concerns.

11.20 In relation to repurchase agreements and eligible securitisations the Minister says that:

·  it is appropriate that MMFs' exposure to inappropriate asset classes and excessive risk be controlled;

·  the Government therefore welcomes the Commission's general aim of restricting the types of investments that MMFs may make;

·  however, the proposals go further than is necessary to meet this aim and underestimate the wider economic impact of preventing MMFs from making certain investments;

·  in particular, the draft Regulation provides strict rules as to what assets could be provided as collateral under a reverse repurchase agreement — under such agreements MMFs will purchase securities with an agreement that they will be repurchased by the seller at an agreed time and price, and as part of this agreement the seller may put up collateral to reduce risk in the event of a counter-party default;

·  the draft Regulation seeks to limit the types of collateral that may be provided by the seller under such agreements to Government debt and assets which could otherwise be ordinarily held by an MMF (so called money market instruments or MMIs) — MMIs are subject to strict maturity requirements designed to ensure they are sufficiently liquid;

·  the Government believes that since collateral provided under a reverse repurchase agreement is only realised in the event of a default, in which case it would be sold, the liquidity requirements are unnecessary;

·  the Commission's proposals also sought to limit the types of securitised assets which MMFs could hold — in particular, Article 10a states that MMFs would only be able to hold securitisations where the underlying asset was corporate debt;

·  securitisation of assets is an important way by which companies can enhance their liquidity and as such securitisation plays a significant role in financing economic growth in the real economy;

·  however, the majority of securitisations include exposures to both corporate and consumer debt — MMFs are significant investors in this asset class and as written the Commission proposals would prevent them holding such assets;

·  given that the draft Regulation already required the debt underlying securitisations to be both high quality and liquid for an MMF to invest, the additional limitation to corporate debt appeared unnecessary and likely to remove an important source of funding to the economy; and

·  the Presidency compromise proposal broadens the scope of eligible securitisations and seeks to align the criteria with other EU legislation.

11.21 The Minister says on credit ratings agencies that the proposed rules would prevent MMFs from financing or soliciting a rating by a third party credit ratings agency and, given the important role such agencies play in the investment guidelines used by investors, this appears unwarranted and could prove damaging.

11.22 On sponsor support the Minister says that the Presidency compromise proposal would place further limits on when a fund sponsor (often a bank) could provide support to a MMF facing difficulties, so that it should be justified for financial stability. She comments that sponsor support could potentially be a source of contagion to the rest of the financial sector, so limiting the circumstances when support could be given would help limit the broader systemic risk posed by MMFs.

11.23 Turning to financial implications the Minister says that:

·  EU CNAV MMFs would be subject to significant additional costs as a result of having to hold the 3% capital buffer;

·  this could make many CNAV funds uneconomical and lead to significant consolidation within the industry, potentially driving up costs for investors;

·  few CNAV funds are located in the UK, though many are managed from here and UK corporations make up a significant portion of their investor base;

·  the Government is currently working with stakeholders to establish an estimate of the cost of switching from CNAV to VNAV funds for both fund managers and investors;

·  if a significant portion of CNAV funds ceased to continue operating and their investors chose to reallocate their money elsewhere this could reduce the amount of money available to support short term financing in the EU; and

·  the proposed rules on eligible securitisations would potentially remove an important source of financing for the real economy as MMFs would be restricted in their ability to hold such assets.

Previous Committee Reports

Nineteenth Report HC 83-xviii (2013-14), chapter 12 (23 October 2013) and Fifteenth Report HC 219-xv (2014-15), chapter 9 (22 October 2014).


 
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