Today, we excerpt from the second half of the "ICI Global & EFAMA Talk Regulatory Issues" session from last week's European Money Fund Symposium in Paris, France. (See Monday's News, "ICI Global's Pedroni at European MFS: No EU Reforms in Near-Term; US?") EFAMA's Deputy Director for Regulatory Policy Federico Cupelli comments, "In terms of who we represent in the money market fund space, it's important to know that our members are very much managing all types of MMFs. We have certainly two camps, the LVNAV and the VNAV, well-represented within our money market fund task force. I am very happy to say that really on all of these proposals that we will be discussing here today, there is a very good consensus on the way forward. In the past, this has not always been the case, as some in the room remember. However, I think that this time around we are far more aligned, at least on these broad policy topics that have been kicked up since March 2020."
He outlines, "Here's a quick overview of my presentation to you here today. I will just briefly look at what came out of the March 2020 market correction. I'll present a quick reform timeline of the key reform proposals, those we like and those we like less. And then what are we to expect in Europe from the European Commission going forward? Coming to the March 2020 selloff, as we've experienced it, I think that we all agree on the fact that the industry has been resilient, the product itself, first and foremost, but also the regulatory framework."
Cupelli continues, "So, I think kudos here to the European co-legislators and to the Commission initially for having really put out a solid piece of legislation. I think its success has been demonstrated by the fact that all redemptions were met under dire liquidity circumstances. There were no breaches to the regulatory liquidity requirements and consequently for LVNAV and public debt CNAV funds, there was no LMT activation by the managers nor the boards. The LVNAVs specifically were not forced to convert to variable pricing upon reaching their 20-basis point collars because they did not breach them. Some individual funds got close to it, but they were not beyond."
He tells us, "Important also is the fact that outflows stabilized almost immediately, returning positive in April 2020. This really goes to show two things: that the correction was short lived and secondly, that investors trust the product, here, especially investors in LVNAV. Hence, I think [the] bulk of evidence demonstrates that any knee-jerk reaction to overhaul existing legislation is misplaced, misguided and not well-informed, quite frankly."
Cupelli asks, "Why fix something that isn't broken? Right. And [reforms] should also be proportionate [focusing on] addressing the key concerns and the key problems, which are really dealer incentives due to banking requirements, limitations on balance sheet usage, specifically when markets get rough. If necessary, they will also need more transparency [in] creating and developing a euro denominated CP market in Europe, offering players as well as the central banks more transparency around volumes, pricing, issuance, collateral eligibility. I understand there are a number of initiatives there already that need to be capitalized."
He then says, "Coming to the reform timeline, Michael has already mentioned a number of key stages. It started with IOSCO's thematic note that came out in November 2020, where they simply took stock of what happened in March and April and suggested areas for further analysis. Further analysis was done by the FSB through a consultation and then final report, which came out in October of last year. The ESMA consultation came out in March 2021 with many of the FSB options in it. This was followed by the ESRB's own recommendations. For those who don't know, the ESRB is the European Systemic Risk Board. It is basically the FSB in Europe, a macroprudential supervisor that comes out of the industry with a very bank centric view of the world."
Cupelli comments, "To the ESRB there still are quite a lot of alleged systemic vulnerabilities in the industry. And I'll be elaborating on some of the recommendations that were issued in in December 2021. ESMA naturally had to take some of these recommendations into its stride, and so finalized its report, taking the inputs received from the industry in the first part of 2021, combining it with the ESRB's own recommendations, putting out a report with an annex. The annex has the opinion as to what has been believes are sensible policy options for the Commission to consider putting forward."
He states, "The Commission by the 21st of July of this year had to deliver a report on the review of the whole MMFR to the European co-legislators and so consulted with this purpose in mind in April this year. We are expecting to see the release of this report. Its publication should be imminent. We know it's finalized [but] it's stuck inside the Commission for the time being.... Notice that I put end of 2022 should be imminent. It can come out next month, no later than November. And then obviously we'll see as to the timing of the proposal, how things will develop."
Cupelli also asks, "What are the key reform proposals? If we take what has come from ESMA's opinion to combine it within ESRB's own policy recommendations, there are some that we fully support and here we were well joined up with ICI. I think there's really a global consensus around this point and what needs to be removed is this famous link between breaches to the regulatory liquidity requirements and potential activation of liquidity management tools in Europe, especially with regard to LVNAV."
He describes, "There are options there that we do not like, I think first and foremost, the phasing out of the LVNAV structure. Why remove something that at the end of 2021 accounted for roughly 46% of all AUM invested in European money market funds. Investors like the product, they like the stable NAV feature, and what we told the Commission is that for the purpose of writing the report to the co-legislators, yes, of course, to consider it also because it is in the review clause of the MMFR. But be very careful as they there are no comparable second-best alternatives there. Increase liquidity buffers, I mentioned that this is not only an issue that would elevate the existing liquidity buffers for VNAV and LVNAV funds as proposed by the ESRB. But it's also about adding on this public debt quota that, as I said before, will not work."
On the "Use of swing pricing," Cupelli comments, "I won't elaborate that we're fully behind the evidence there to show that swing pricing will not work. It has served non MMFs, open-ended funding so well. But if we are to avoid the first mover advantage, then definitely liquidity fees, anti-dilution levies are a far better place for obvious reasons. Swing pricing is incompatible with stable NAV pricing as well. So, by the way, we also filed a two-pager to the US SEC during the comment period rectifying that misread that we don't use swing pricing for money funds in Europe."
He also tells the EMFS, "Enhance reporting is another option that ESMA is toying with. Why not enhance the current reporting requirements? Depending on whether your fund is managing about 100 million or less, you may be required to enhance reporting from quarterly to monthly if you are above the 100 million threshold or otherwise go from annual to quarterly. This will not serve the purpose that NCA and ESMA are looking to achieve. They would like an early warning system that will allow them to detect the buildup of risk in well ahead of time. Given how quickly a money market portfolio changes in the matter of even a few weeks, even upgrading to monthly reporting will not yield a significant difference. We believe rather think that the good practice that has been shown to work very well during the crisis is to have firms respond to ad hoc requests coordinate closely with their NCA as the crisis develops so that they are better able to get a view of what is happening in the market at a certain point in time."
Cupelli also says, "The picture in Europe would not be complete without a quick look at the U.K. We know that a joint discussion paper was published in May this year. Essentially, it is a nod to the FSB led reform proposals with a more U.K. focus.... What is reassuring, however, is that the FCA has also published handbook guidance, clarifying again that managers do not need to automatically apply LMTs, even where the liquidity thresholds are breached. This, I think, goes to show how the FCA values giving managers that flexibility to manage their portfolio, rather than have these hard buffers and hard limits telling you what to do. Obviously, all of this seems to go in the best interests of investors. Looking at what may happen next, we believe that the FCA and the Bank of England will, will hold their fire. Their policy choices ultimately will depend on the direction of the EU and in part also due to the fact that the majority of MMFs that are marketed and sold in the UK are domiciled in Europe, Ireland and Luxembourg. So the U.K. FCA is really limited to a small portion of the of UK marketed funds."
He adds, "Finally, what to expect from the European Commission. I fully subscribe to what Michael was saying. It really seems that proceeding with the MMFR is a second order priority, if not third order. The Commission needs to finish what it has already started. And of course, there's the broader geopolitical context that makes matters all the more difficult. So, we wait to see this report. The Commission earlier this year in June told us that whatever comes in the report to the co-legislators will prejudge in no way what it will then propose at a certain stage to reform again the MMFR. I think that we certainly need to keep an eye out around the phasing out of the LVNAV, although I think that we've given them enough evidence and arguments to scrutinize this heavily. The same thing goes with this idea of a 80% European public debt quota.... So, yeah, definitely, I would say that the proposal will come later, if not under a new Commission. It seems that those that want this reform are the central banks, and I think the Commission is being pressured to do something also because of the parallel debate in in the U.S. around the new rule. So that is where we stand in Europe."
