Money fund reforms in Europe took a giant step towards becoming a reality this week as the European Council of the EU agreed to a compromise proposal. The Council is expected to vote on the reform proposal Friday, then it goes to the EU Parliament for "trilogue" approval before becoming law. (See our May 10 Link of the Day, "Reuters on EU Reform Compromise.) The statement, "Money market funds: Council agrees its negotiating stance," was issued yesterday, as well as the release, "Commission welcomes EU Council's backing for a new regulatory framework of Money Market Funds." Reuters first reported the news in its story, "European Union states agree rules on money market funds."
The European Council's release says, "On 15 June 2016, the Permanent Representatives Committee (Coreper) agreed, on behalf of the Council, a negotiating stance on a draft regulation on money market funds, aimed at making such products more robust. The draft regulation is intended to ensure the smooth operation of the short-term funding market, maintaining the essential role that money market funds play in the financing of the economy. The Council will confirm Coreper's agreement at a meeting on 17 June 2016, and will ask the presidency to start talks with the European Parliament. The Parliament's ECON committee approved its negotiating stance in March 2015."
It continues, "Jeroen Dijsselbloem, Netherlands minister for finance and president of the Council, said: "For the Dutch presidency it is important to have an agreement on this essential file, to ensure the future stability and viability of the MMF sector, which is an important source of short-term finance to the real economy. We expect endorsement of the preliminary agreement during the Ecofin Council this Friday."
The statement adds, "Money market funds (MMFs) are an important source of short-term financing for companies and government entities. There are currently two kinds of MMFs: those that offer a variable net asset value (VNAV) that mainly depends on market fluctuations; those that offer a constant net asset value (CNAV) and aim to offer share purchases and redemptions for a fixed price. With assets under management of around E1 trillion, MMFs are mainly used to invest excess cash within short timeframes. They represent an important tool for investors because they offer the possibility to diversify their excess cash holdings, whilst maintaining a high level of liquidity."
It explains, "However, the financial crisis of 2007-08 showed that MMFs can be vulnerable to shocks and may even spread or amplify risks throughout the financial system. Investors are likely to redeem investments as soon as they perceive a risk, which can force funds to sell assets rapidly in order to meet redemption requests. This can fuel an investor 'run' and liquidity crisis for an MMF, potentially triggering further negative effects on other parts of the financial system."
The Council's release adds, "The draft regulation lays down rules for MMFs, in particular the composition of their portfolios and the valuation of their assets, to ensure the stability of their structure and to guarantee that they invest in well-diversified assets of good credit quality. It also introduces common standards to increase the liquidity of MMFs, to ensure that they can face sudden redemption requests when market conditions are stressed. In addition, the text provides for common rules to ensure that the fund manager has a good understanding of his/her investors, and provides investors and supervisors with adequate and transparent information. In order to further mitigate 'contagion risk', an MMF would not be allowed to receive external support from a third party, including from its sponsor, as the discretionary nature of external support might contribute to uncertainty in times of instability."
It explains, "An important new element of the draft regulation is the introduction of a permanent category of "low volatility net asset value" (LVNAV) MMFs. These LVNAV MMFs will gradually replace most of the existing CNAV MMFs, which would be required to convert into LVNAV MMFs within 24 months of entry into force of the regulation. LNAV MMFs would be allowed -- to a limited extent and under strict conditions -- to offer a constant net asset value. Only two types of CNAV MMFs would be allowed to continue to operate under the draft regulation, namely: those that invest 99.5% of their assets in public debt instruments; those with a specific investor base solely outside the EU. Both categories of CNAV and LVNAV MMFs would be subject to reinforced liquidity requirements as well as safeguards such as "liquidity fees and redemption gates." These would be designed to prevent and/or limit the effects of sudden investor runs."
The EU Commission's statement, "Commission welcomes EU Council's backing for a new regulatory framework of Money Market Funds," says, "The European Commission welcomes the agreement on the reform of Money Market Funds (MMFs) that was reached today at the Permanent Representatives Committee (COREPER) of the Council. The agreement marks a further step in the completion of the post-crisis reform agenda and paves the way for trilogues with the European Parliament."
It tells us, "The Commission adopted its proposal for a regulatory framework of MMFs in September 2013 in order to address their potential impact on the financial system. MMFs are a key part of the international work on shadow banking and sustainable, market-based finance. These funds serve as an important source of short-term financing for financial institutions, businesses and governments. However, they have also been vulnerable to investor 'runs' on redemptions and have given rise to misperceptions that their returns are guaranteed. Today's Council agreement marks a major step in our efforts to ensure that MMFs can better withstand redemption pressures in stressed market conditions, while at the same time ensuring that they continue to provide a secure tool for European companies to manage their finances."
Jonathan Hill, EU Commissioner responsible for Financial Stability, Financial Services and Capital Markets Union, comments, "Today's agreement is a step in the right direction. Strengthening the regulation and oversight of MMFs will ensure that the potential systemic risks are addressed, in line with the recommendations issued by the Financial Stability Board. It will also ensure MMFs can continue to provide their key role in supporting financing in the wider economy." The release adds, "Now that the Council has a negotiating mandate, the Commission expects trilogues with the European Parliament to commence shortly."
The Commission's release provided some background on the MMF reform process. It says, "Money market funds are an important source of short-term financing for financial institutions, corporates and governments. In Europe, around 22% of short-term debt securities issued by governments or by the corporate sector are held by MMFs. They hold 38% of short-term debt issued by the banking sector. Because of this systemic interconnectedness of MMFs with the banking sector and with corporate and government finance, their operation has been at the core of international work on shadow banking."
Furthermore, they write, "The Commission published its proposal for a regulation on Money Market Funds in September 2013. The proposal reflected the recommendations issued by the Financial Stability Board (FSB) in October 2012, the main one being that all stable redemption MMFs (CNAV MMFs) should float their NAV (VNAV MMFs), where workable. Where conversion is not workable, the FSB proposed measures that are "functionally equivalent in effect to capital, liquidity, and other prudential requirements on banks that protect against runs on their deposits." European-domiciled MMFs hold short-term assets accounting for approximately EUR 1 trillion, half of these assets are held by CNAV MMFs, the other half by VNAV MMFs. Given the significance of MMFs to the European short-term debt funding market, the Commission set out proposals to ensure risks were appropriately managed, whilst ensuring that money market funds can continue to support the financing of the wider economy."
Reuters "European Union states agree rules on money market funds" story," summarizes, "European Union member states have agreed rules on money market funds, the bloc's financial services commissioner said on Tuesday, ending three years of deadlock with a compromise that will force half the industry to lay off various risks.... The deal would give CNAV funds the option of investing in lower-risk products or becoming safer variable net asset value (VNAV) funds within two years of the new rules being adopted, a draft of the proposed regulation, seen by Reuters, said."
Finally, it adds, "An official said that the draft law, prepared by the Netherlands which holds the rotating EU presidency, will be formally adopted by EU envoys on Wednesday and endorsed by finance ministers on June 17 at a regular meeting in Luxembourg. Germany wanted CNAV to be phased out but countries with a strong fund industry presence -- such as Ireland, Luxembourg and Britain -- opposed that. The deal needs European Parliament approval to become law."
