The European Parliament's ECON Committee put forth a new version of a proposal for money market fund reform in Europe in November. The new rapporteur of the ECON Committee drafted the amendments, which updates the EU's original proposal from September 2013. Partner Dan Morrissey and attorneys at Irish law firm William Fry, published a report entitled, "ECON publishes new report on proposed EU Money Market Fund Regulation" that summarizes the revised proposal. It explains, "The draft regulation, which was first proposed by the European Commission on 4 September 2013, contains new measures that would apply to all Money Market Funds, whether UCITS or AIFS, that are established, managed or marketed in the EU. While the European Commission has proposed the draft regulation, both the European Parliament and the Council of the EU have a role, in accordance with the EU's ordinary legislative procedure, in negotiating and deciding the final text to be adopted."
The Fry report says, "The draft regulation provides that all CNAV MMFs would be required to establish and maintain at all times a "capital buffer" amounting to at least 3% of the total value of their assets (NAV Buffer). This NAV Buffer should be composed of cash and held in a protected reserve account in the name of the CNAV MMF. Importantly, the draft regulation allows a transitional period for existing CNAV MMFs to establish the NAV Buffer." But no formal vote ever took place on it and in March 2014, any action on MMF reform was postponed. Wrote Fry, "In October 2014 the newly re-constituted ECON Committee appointed Neena Gill, a British MEP, as the new rapporteur for the draft regulation. In November 2014, Ms. Gill published a new draft ECON report on the draft regulation."
An important difference in the new draft proposal by Gill concerns the capital buffer. In the Explanatory Statement, the new proposal is summarized. "MMFs are an important short term investment instrument. They have the potential to play a crucial role in the setting up of a European CMU [Capital Markets Union] and in revitalising a European industrial policy. Within this context, it's the rapporteur's opinion that a competitive MMF market will contribute to a well-functioning CMU."
It goes on to explain the development of the new proposal. "During the last months, the rapporteur has had an intensive dialogue with a cross section of stakeholders and organised a roundtable on the 4th of November which was well attended by MEPS, regulators, investors and the fund industry. The rapporteur fully recognises the role MMFs play as a short term cash management instrument for investors as well as for borrowers and she also appreciates that a significant proportion of industries, local authorities, charities and foundations make use of MMFs to manage their excess of cash. Therefore her objective is to have a well regulated, supervised and transparent European MMF market in line with the political aim to boost economic growth and forge a capital markets union, to maximise the benefits of capital markets and non-bank financial institutions for the real economy. However, it is important to understand that MMFs remain investment funds, susceptible to different risks. It is the rapporteur's opinion that this regulation should tackle the vulnerability of MMFs to investor runs and the risk to tax payers' money on the one hand and ensure an important source of short term funding for banks and European industry remains alive on the other hand.... Due to the experiences during the financial crisis, both CNAV as well as VNAV MMFs proved to be risky and needed different kinds of support. It is the rapporteur's opinion that the intrinsic vulnerabilities of both types of MMF should be tackled and that the rules should be applied to both where appropriate."
It then discusses a new plan for CNAV funds. "The rapporteur recognises the benefits of CNAV MMFs, both for investors using these funds as well as for the Member States in which the largest part of this type of MMF are domiciled.... However, the rapporteur is concerned about the long term future of the CNAV industry to deliver a constant net asset value in a perpetual low interest rate environment. To address the risks that pose this structural stability issue, the rapporteur distinguishes different options. 1. The European Commission proposal addresses this through the introduction of a capital buffer. However the rapporteur believes this proposal should be amended. 2. It is the rapporteur's opinion that a new category of CNAVS should be established in the coming years: EU government CNAV MMF funds. EU government CNAV MMFs offer the option of a CNAV fund which invests a majority of its assets into EU government debt. This would have several benefits relative to a VNAV fund. The majority of the funds would be invested in government debt -- high quality and liquid; EU governments would benefit from a healthy demand for their short-term debt; the balance of the funds would still be available to invest in high quality banks/corporates or via ABCP, in the SME sector. Furthermore, the rapporteur proposes to introduce stringent diversification and concentration requirements to ensure that these funds are deployed across the EU."
More on the potential EU Government CNAV funds: "The mechanics of an EU government CNAV MMF would be to increasingly invest into a greater percentage of European public debt until the percentage reaches at least 80% by 2020. As a consequence, EU government CNAV MMFs would be exempt from any form of capital buffer requirement. The capital buffer will be based on the risk profile of the assets and have a sliding scale in terms of the percentage. The capital buffer would be applied proportionally until the fund reaches the 80% of EU public debt investment. The EU public debt needs to be defined in a broad way: it should be defined as cash, government assets or reverse repos secured with government debt."
It goes on, "a package of extra measures is required to be implemented to ensure stability of the market. One of these will be on sponsorship. MMFs need to demonstrate that they are able to stand alone, independently from its parent or sponsor bank and that every type of explicit and implicit sponsoring will be prohibited (except for the building up of the capital buffer). It is understood that more than $12 billion [sic] was invested by sponsors to maintain the constant value of CNAV funds during the crisis. Therefore any exception to this principle should be interpreted restrictively and be subject to a transparent procedure, in order to avoid contagion. The concept of sponsoring should be interpreted as widely as possible: every type of supporting measure by a parent or linked bank should therefore be notified, in advance, to the EC and ESMA for approval. Breaking this rule should be sanctioned by withdrawal of the MMF authorisation."
On transparency it says, "Secondly, increased transparency is a top priority for the rapporteur. Firstly the actual net asset value of CNAVs should be subject to daily disclosure requirements, including publication on the fund's websites; stress tests should take place on a quarterly basis; additionally, all documents targeted at investors of the fund should clearly state that the fund is an investment product which is not guaranteed by any kind of sponsor support and that there are risks to the investor's capital. The investor should sign a statement confirming that they have clearly understood this."
There's also discussion of a new "retail" category, as well as fees and gates. "The rapporteur is mindful of the necessity for some investors, like foundations, municipalities, charities, housing companies and individual investors who are unable to invest in VNAVs. In particular, the fact that the statutes of these organisations make it difficult or prohibit investment in floating funds. For this reason, it is the rapporteur's opinion that a 'retail' category of investors should be recognized. That should be allowed to continue using CNAV MMFs provided a comprehensive package is put into place including a very stringent system of liquidity fees and redemption gates that will be applied in times of serious stress. The European Commission will be asked to review the macro-economic impact of this exception after 3 years."
On fees and gates it says, "After lengthy discussions with the representatives from the CNAV industry on their proposal to establish a system of liquidity fees and redemption gates, as an alternative to the capital buffer, the rapporteur still has reservations if this was the only instrument. On its own, it is not the most effective way to prevent the risk of investor flight. In practice the onus is completely on the fund manager to decide when to impose such a measure, if at all. During the earlier crisis such measures were not used by CNAV MMFs despite their availability under the UCITS directives. A liquidity fee is akin to a decrease in the redemption price, so can therefore be deployed as and when necessary. The rapporteur is concerned that these instruments could cause strong pro-cyclical effects. However they could be form part of the total package, provided that the discretionary element for using liquidity fees and redemption gates is taken away and that the moment of triggering is clearly defined and disclosed."
It concludes, "MMFs should continue to play a crucial role in financing the economy and in particular in establishing the capital markets union. Both CNAV and VNAV funds should have the same regulatory treatment, with the exception of the capital buffer for VNAV funds. Excessive risks in CNAV and VNAV MMFs should be tackled properly to avoid investor runs; the real economy should be protected from regulatory gaps and loopholes and excessive systemic risks, resulting in a strong European economy."
Finally, the William Fry report outlined the next steps. "The ECON Committee has indicated that any proposed amendments to the latest draft report will be submitted by 11 December 2014. The draft report, and any proposed amendments, are due to be considered by the ECON Committee at its January meeting and a provisional vote by the ECON Committee has been scheduled for February 2015. A vote on the draft regulation by all Members of the European Parliament has been tentatively set for March 2015. The Council published its first compromise text to the draft regulation dated 10 November 2014 and importantly proposed the removal of the requirement for CNAV MMFs to establish the NAV Buffer. In addition, the Council introduced the concept of a retail and small professional money market fund to which certain protections may be imposed such as imposing liquidity fees of up to 2% on redemptions, redemption gates that limit the amount of shares or units that can be redeemed on any day, or suspension of redemptions for up to 15 days. The Council compromise text will be considered further by the Council in due course."
