11 Financial services: money market
funds
Committee's assessment
| Politically important |
Committee's decision | Not cleared from scrutiny; further information requested
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Document details | (a) Draft Regulation concerning money market funds; (b) European Central Bank Opinion on the draft Regulation
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Legal base | (a) Article 114 TFEU; co-decision; QMV; (b)
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Department
Document numbers
| HM Treasury
(a) (35298), 13449/13 + ADDs 1-2, COM(13) 615
(b) (36321), 12713/14,
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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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