The European Securities and Markets Authority issued an amendment last Friday, August 22, that would tweak the Committee of European Securities Regulators' guidelines on the Common Definition of European Money Market Funds. The key change by ESMA says all references to credit ratings in guidelines and recommendations must be removed. Specifically, "Article 5(b)(1) of the CRA Regulation -- as amended by the CRA3 Regulation -- states: [ESMA, EBA and EIOPA], shall not refer to credit ratings in their guidelines, recommendations and draft technical standards where such references have the potential to trigger sole or mechanistic reliance on credit ratings by the competent authorities, the sectorial competent authorities, the entities referred to in the first subparagraph of Article 4(1) of the CRA Regulation or other financial market participants. Accordingly, EBA, EIOPA and ESMA shall review and remove, where appropriate, all such references to credit ratings in existing guidelines and recommendations by 31 December 2013." (Note: For those interested in more on European money market fund regulations, our European Money Fund Symposium, which is Sept. 22-23 in London, is still accepting registrations.)
The definitions for money market funds in Europe were adopted by CESR in 2010. "The CESR guidelines distinguish between Short-Term Money Market Funds (ST MMFs) and Money Market Funds (MMFs) on the basis of certain key characteristics, such as the weighted average maturity and weighted average life. ESMA is the legal successor of CESR. The CESR guidelines also set out criteria that money market instruments should respect in order to be considered as eligible investments for ST MMFs and MMFs. In particular, ST MMFs and MMFs should only invest in high quality money market instruments. According to the CESR guidelines, a money market instrument should not be considered to be of high quality by managers of ST MMFs and MMFs unless it has been awarded one of the two highest available short-term credit ratings by each recognised credit rating agency that has rated the instrument."
However, after reviewing the CESR guidelines against the provisions of the CRA3 Regulation, "ESMA concluded that they had the potential to trigger sole or mechanistic reliance on credit ratings. As a consequence, the Authority decided to review the CESR guidelines as required by Article 5(b)(1) of the CRA Regulation; this led to the publication on 6 February 2014 by ESMA, EIOPA and EBA of the joint final report on Mechanistic Reference to Credit Ratings in the ESA's Guidelines and Recommendations (JC 2014 004). This report sets out the manner in which the CESR guidelines were to be amended, in particular with respect to the assessment of credit quality of money market instruments by managers of ST MMFs and MMFs. The purpose of this opinion is to explain how national competent authorities should apply the modifications set out in the aforementioned report when monitoring the application of the CESR guidelines by the relevant financial market participants." ESMA says national competent authorities should take into account the new amendments (highlighted below) when they monitor the application of the CESR guidelines on a Common Definition of European Money Market Funds.
Specifically, Paragraph 4 of Box 2 of the original ESMA guidelines should be replaced with the following: "For the purposes of point 3a), ensure that the management company performs its own documented assessment of the credit quality of money market instruments that allows it to consider a money market instrument as high quality. Where one or more credit rating agencies registered and supervised by ESMA have provided a rating of the instrument, the management company's internal assessment should have regard to, inter alia, those credit ratings. While there should be no mechanistic reliance on such external ratings, a downgrade below the two highest short-term credit ratings by any agency registered and supervised by ESMA that has rated the instrument should lead the manager to undertake a new assessment of the credit quality of the money market instrument to ensure it continues to be of high quality."
The replaced language said a money market instrument should not be considered "high quality unless it has been awarded one of the two highest available short-term credit ratings by each recognised credit rating agency that has rated the instrument or, if the instrument is not rated, it is of an equivalent quality as determined by the management company's internal rating process." The amendment also crosses out two other references to credit ratings: paragraph 10 of the explanatory text under Box 2 of the original CESR guidelines and paragraph 25 of the explanatory text under Box 3 of the original CESR guidelines "since this paragraph deals with the minimum credit rating of money market instruments."
Also, ESMA recommends that paragraph 2 of box 3 of the original guidelines should be amended as such: "May, as an exception to the requirement of point 4 of Box 2, hold sovereign issuance of a lower internally-assigned credit quality based on the MMF manager's own documented assessment of credit quality. Where one or more credit rating agencies registered and supervised by ESMA have provided a rating of the instrument, the management company's internal assessment should have regard to, inter alia, those credit ratings. While there should not be mechanistic reliance on such external ratings, a downgrade below investment grade or any other equivalent rating grade by any agency registered and supervised by ESMA that has rated the instrument should lead the manager to undertake a new assessment of the credit quality of the money market instrument to ensure it continues to be of appropriate quality. 'Sovereign issuance' should be understood as money market instruments issued or guaranteed by a central, regional or local authority or central bank of a Member State, the European Central Bank, the European Union or the European Investment Bank." ESMA will not reissue the CESR guidelines on a Common Definition of European Money Market Funds as ESMA guidelines under Article 16 of the Regulation. "This means that national competent authorities will not have to notify ESMA whether or not they comply or intend to comply with the amended version of the CESR guidelines. However, ESMA will monitor the application of this opinion by national competent authorities."
Here's some background on the CESR guidelines. "The key purpose behind a harmonised definition of 'money market fund' is improved investor protection. This reflects the fact that investors in money market funds expect the capital value of their investment to be maintained while retaining the ability to withdraw their capital on a daily basis. A common definition will also help provide a more detailed understanding of the distinction between funds which operate in a very restricted fashion and those which follow a more 'enhanced' approach."
CESR's guidelines define European money market funds in two ways: Short-term money market funds and money market funds. The former is similar to U.S.-style money funds. "This approach recognises the distinction between short-term money market funds, which operate a very short weighted average maturity and weighted average life, and money market funds which operate with a longer weighted average maturity and weighted average life." In the amendment, ESMA lays out the complete guidelines, including the new changes, as stated above, within the context of the guidelines.
The U.S. Securities and Exchange Commission, along with its July 23 Money Fund Reform proposal, also recommended removing references to credit ratings. Says the SEC, from our July 23 article: "The re-proposed amendments would implement section 939A of the Dodd-Frank Act, which requires the SEC to remove any reference to or requirement of reliance on credit ratings in its regulations and to establish appropriate standards of creditworthiness in place of certain references to credit ratings in SEC rules. Currently, to ensure that these funds are invested in high quality short-term securities, rule 2a-7 requires that money market funds invest only in securities that have received one of the two highest short-term ratings (that is, are rated either "first tier" or "second tier") or if they are not rated, are of comparable quality. It also currently requires that a money market fund invest at least 97 percent of its assets in first tier securities. In addition, rule 2a-7 requires that a fund's board of directors (or its delegate) determine that the security presents minimal credit risks. This determination must be based on factors pertaining to credit quality in addition to any rating assigned to the security.... The re-proposed amendments to rule 2a-7 would eliminate the credit ratings requirements for money market funds. Instead, a money market fund could invest in a security only if the fund's board of directors (or its delegate) determines that it presents minimal credit risks, and that determination would require the board of directors to find that the security's issuer has an exceptionally strong capacity to meet its short-term obligations."
