The 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.
Types of MMFs
there are three types of MMFs:
-Variable NAV MMF (VNAV),
-Public Debt Constant NAV MMF (Public Debt CNAV or CNAV), and
-Low Volatility NAV MMF (LVNAV).
MMFs are allowed to invest in the financial asset classes in Article 9(1) of the Regulation:
-eligible money market instruments
-eligible securitisations and asset backed commercial paper (ABCPs)
-eligible deposits with credit institutions
-eligible financial derivatives;
-eligible reverse repurchase agreements; and
-units or shares of other MMFs
Article 9(2) then specifies the activities which MMFs are prohibited from undertaking including:
-engaging in short selling of money market instruments
-gaining exposure to equities or commodities
-entering into securities lending or securities borrowing agreements; or
-borrowing or lending cash
Articles 10 to 16 contain further provisions on the categories of eligible assets that MMFs may invest in.
Internal credit risk assessment
Each MMF must internally assess each money market instrument and assign it an internal credit rating (except for MMIs issued by or guaranteed by the EU, an EU Member State, the ECB, the ESM or the EIB) within the manager’s internal six grade rating system for non-defaulted issuers. The MMF will then only be permitted to invest in money market instruments assigned the first or second grade on its internal rating scale. These rules on an internal assessment of the credit quality of MMF investment instruments are intended to avoid any mechanistic reliance on ratings issued by rating agencies.
Diversification and concentration requirements
The Proposed Regulation aims to limit risk-taking by MMFs and subjects the portfolio of MMFs to clear diversification requirements. The Regulation contain detailed rules on the diversification of eligible investments that each MMF has to respect and also the concentration limits that an MMF (as investor) can hold in a single issuer.
An MMF may invest no more than:
-5% issuer limit for money market instruments issued by the same body; or
-10% limit on deposits with the same credit institution (or up to 15% in certain cases).
A VNAV MMF may invest up to 10% of its assets in money market instruments issued by the same body under the condition that the total value of the money market instruments held by the VNAV MMF in the issuing bodies in each of which it invests more than 5% of its assets shall not exceed 40 % of the value of its assets.
Obligations in relation to risk management
The new rules on maturity limitiations - weighted average maturity (WAM) and weighted average life (WAL), together with the requirements on holdings of daily and weekly maturing assets aim to reduce MMF portfolio risk, increase the liquidity profile of an MMF, and thus its ability to satisfy investor redemptions.
For short-term MMFs the portfolio must have (Article 24):
-a WAM of no more than 60 days;
-a WAL of no more than 120 days.
For standard MMFs which invest in longer term instruments, the portfolio must have at all times (Article 25):
-a WAM of no more than 6 months;
-a WAL of no more than 12 months.
Minimum liquidity requirements
-Minimum daily/weekly liquidity requirements of 10/30% and 7.5/15% for CNAV, LNAV and VNAV Funds respectively
-Government securities and certain money market instruments that are eligible for the funds may be counted in weekly liquidity calculations to different degrees between CNAV and VNAV funds
Redemption monitoring and stress Testing
As part of a prudent risk management, the Regulation requires that the manager of a MMF should put in place sound stress testing processes that allow for the identification of possible events or future changes in the economic conditions that could have unfavourable effects on the MMF. Although the board of directors of the manager of the MMF may decide the frequency, stress testing must be carried out in any event at least yearly and, on detecting a vulnerability risk, the manager is expected to act in order to strengthen the robustness of the MMF. The Regulation also introduces a requirement to submit an extensive report with the results of the stress testing (Article 28).
ESMA shall issue guidelines with a view to establishing common reference parameters of the stress test scenarios to be included in the stress tests.
Know Your Customer (KYC) policy
Article 27 requires the manager of the MMF to exercise due diligence to identify the number of investors in the MMF, their needs and behaviour and amount of their holdings, so as to anticipate concurrent redemptions by several investors. This "know your customer policy" together with the requirement to invest in high quality and well diversified assets of good credit quality, are designed to ensure that the liquidity of the MMF is adequate to meet investors’ redemption requests.
These rules set out how an MMF has to value its individual investment assets, calculate the NAV per unit or share of the MMF, as well as the frequency of both sets of valuations. While there is a general rule favouring mark-to-market valuation, MMFs may also use marking to model, where marking to market is not possible or market data are not of sufficient quality. The method chosen for calculating the NAV is particularly important when issuing and redeeming shares or units in a MMF.
Liquidity fees and redemption gates
Article 29 sets out specific requirements for CNAV and LVNAV funds. Liquidity fees and redemption gates would be applied to CNAV and LVNAV funds only. If weekly liquidity falls below 30% of total assets or weekly liquidity falls below 10% of total assets or the net daily redemptions on a single business day exceed 10% of total assets, the Board of the MMF would decide which measures regarding liquidity fees and redemption gates would apply.
MMFs may not receive external support.
The Regulation includes increased transparency requirements. The proposals establish reporting requirements on all MMFs that apply in addition to the requirements under Directives 2009/65 and 2011/61. The taking up of activities as fund manager is regulated either by the UCITS Directive or by the AIFM Directive. The activities of the managers will continue to be subject to both Directives but the product rules contained under UCITS framework will be supplemented by the product rules contained in this new Regulation. Existing UCITS or AIF that invest in short term assets and have as distinct or cumulative objectives offering returns in line with money market rates or preserving the value of the investment will be required to submit an application to the competent authority together with all documents and evidence necessary to demonstrate the compliance with the MMF Regulation (within 18 months following the date of application of the MMF Regulation).
The manager of the MMF is required to report information to the competent authority of the MMF, for each MMF managed, at least on a quarterly basis. For MMFs whose assets under management in total do not exceed EUR 100 million, the manager of the MMF is required to report at least annually to the competent authority of the MMF.