The European Commission published "Report from the Commission to the European Parliament and the Council "on the adequacy of Regulation (EU) 2017/1131 of the European Parliament and of the Council on money market funds from a prudential and economic point of view." Its Intro says, "Regulation (EU) 2017/1131 on money market funds (the MMF Regulation) was proposed in the aftermath of the global financial crisis, which exposed certain weaknesses of financial markets and their regulatory regimes around the globe. Since entering into application in January 2019, this Regulation has significantly strengthened the regulatory regime for MMFs in the EU, following recommendations by the Financial Stability Board (FSB), the International Organization of Securities Commissions (IOSCO) and the European Systemic Risk Board (ESRB) The new regulatory framework was put to the test by the market stress related to the COVID-19 pandemic. The impact of this stress on MMFs differed across jurisdictions due to differences in the structures of MMF markets (e.g the predominant types of MMFs, investor profiles, and underlying investments) and residual differences in the regulatory framework for MMFs."
The report continues, "Major central banks such as the European Central Bank (ECB) and the US Federal Reserve took various measures to mitigate the effects, including outright purchases of commercial papers on the primary and secondary markets, providing lending for banks to buy assets from MMFs (Federal Reserve), and extending the eligible collateral for refinancing operations to unsecured banks bonds (ECB). These interventions improved liquidity and confidence in short-term debt markets, which also contributed to a reduction in the pace of redemptions from MMFs. Although there were substantial outflows from certain types of MMFs in March 2020 and other market stress periods, no EU MMFs were required to trigger redemption fees or gates or to suspend redemptions."
The Commission writes, "Following the COVID-19 market stress, global and European prudential authorities started to work on policy proposals to increase the resilience of MMFs. In particular, the FSB, the ESRB and the European Securities Markets Authority (ESMA) proposed various reforms to ensure MMFs do not amplify liquidity shocks in times of stress. One of these proposals is to remove the possibility for Low volatily net asset value MMFs (LVNAVs) to use amortised cost accounting. However, this could reduce the effectiveness of MMFs as liquidity management alternatives to bank deposits, and limit the cash-management options of corporates."
Discussing the "Legal basis for the report, they tell us, "This report is prepared in accordance with Article 46(1) of the MMF Regulation, which requires the Commission to assess the functioning of the MMF Regulation based on an analysis of the current rules from a prudential and economic point of view, and following consultations with ESMA and, where appropriate, the ESRB, and in accordance with Article 6(2) which specifies the conditions this report needs take into consideration. This article also requires the Commission to assess whether changes are to be made to the regime for public debt constant net asset value MMFs (CNAVs) and LVNAVs."
On the "Methodology and consultation process," the Commission states, "This report draws on a number of studies carried out by European and international bodies. Both the FSB report and ESMA opinion benefitted from stakeholder feedback. The latter reports as well as the ESRB recommendations contain extensive sets of data and evidence from supervisory authorities. The ECB has published an assessment of the effectiveness of the EU's regulatory framework from a financial stability perspective, based on the behaviour of MMFs during the COVID-19 crisis. Academic papers have further informed this report."
They comment, "From 12 April to 20 May 2022, the Commission conducted a stakeholder consultation to collect stakeholders' views about the functioning of the MMF Regulation. A total of 48 respondents submitted a contribution. More than two thirds of respondents indicated that the MMF Regulation has been effective in delivering on its key objectives in terms of ensuring liquidity, increasing investor protection, preventing the risk of contagion, and improving transparency, supervision, and the financial stability of the single market. These respondents consider that the MMF Regulation has contributed to the integration of capital markets and made MMFs more resilient, in particular through its rules on credit quality and asset composition."
The report adds, "Feedback received from stakeholders also indicates the importance of ensuring consistency of the rules at EU level and of strengthening supervision. In addition, cross-border investors also appreciate that the MMF Regulation gives them the possibility to conduct cash management globally through a standard process from both an accounting and a risk management point of view."
The EC explains, "Before the introduction of the MMF Regulation, the majority of MMFs in the EU operated under the rules of the UCITS Directive, its implementing acts and guidelines, as well as industry codes of conduct. France, Ireland and Luxembourg are the major domiciles of EU MMFs. Luxembourg and Ireland developed a MMF sector with CNAV in foreign currencies targeted at institutional investors from outside the EU."
They continue, "The MMF Regulation introduced a dedicated and significantly more developed regulatory regime for MMFs in the EU. In particular, it aimed to address credit and liquidity risk challenges experienced by MMFs during the 2008 crisis. By harmonising the essential product features that constituted a MMF, the framework also established a uniform level of investor protection through rules on liquidity and liquidity risk management, including liquidity buffers, assets in which MMFs can invest, diversification, valuation and internal credit quality assessment. It also enhanced transparency towards investors and supervision, including via comprehensive reporting to the National competent authorities (NCAs)."
The EC states, "In addition, the MMF Regulation explicitly bans 'external support' to avoid the risk of contagion between the MMF sector and the rest of the financial sector. The 'Know-Your-Customer' policy obliges managers of all types of MMFs to anticipate the effect of concurrent redemptions by several investors. All managers have to adjust the actual level of liquidity to the specific cash needs of their customers at any time of their accounting cycles."
It tells us, "The MMF Regulation created a new type of MMF, the LVNAV, to replace CNAVs invested in non-public debt. Similarly to public debt CNAVs, LVNAVs are allowed to use amortised cost accounting to offer a stable redemption price, but only as long as the value of the underlying assets does not deviate by more than 20 basis points from the market value of the fund's net assets. The two values are published daily. If the deviation exceeds 20 basis points, the LVNAV fund has to switch from a constant NAV to a variable NAV."
The EC paper concludes, "This report delivers on the legal mandate under Article 46(1) and 46(2) of the MMF Regulation for the Commission to submit a report to the European Parliament and to the Council, reviewing the adequacy of the MMF Regulation from a prudential and economic point of view. The report shows that the MMF Regulation successfully passed the test of liquidity stress experienced by MMFs during the COVID-19 related market turmoil of March 2020, the recent interest rate increases, and related financial asset re-pricing. No EU-based MMF had to introduce redemption fees or gates or to suspend redemptions during these stress events. Similarly, EU MMFs focused on GBP assets withstood the redemption pressure linked to the September 2022 gilt market stress."
It says, "These experiences indicate that the the safeguards in the MMF Regulation have been working as intended. This includes the safeguards that were conceived to allow stable NAV MMFs (CNAVs and LVNAVs) to continue using, under certain conditions, the amortized cost method without creating systemic risks and harming investors. By introducing a dedicated regime, the MMF Regulation has significantly strengthened the regulatory framework for MMFs in the EU, which had before been subject to different rules. However, after 5 years of application of the MMF Regulation, this report identifies shortcomings which should be further assessed. In particular, the results of the stakeholder consultation and the recent market developments show that there could be scope to further increase the resilience of EU MMFs, notably by decoupling the potential activation of liquidity management tools from regulatory liquidity thresholds."
The paper adds, "In addition, this report highlights structural problems that are external to MMFs, and therefore also to the MMF Regulation, including those linked to the underlying short-term markets. These structural problems would merit a further assessment, and are also currently the subject of a more in-depth analysis at the level of FSB. Finally, EU MMFs will benefit from the ongoing review of the AIFM and UCITS Directives, which aims to introduce new harmonised rules to increase the availability of LMTs for open-ended funds. This new LMT framework will further strengthen the resilience of EU MMF's liquidity management in cases of stress."
