Money market funds: Council agrees its negotiating stance
The draft regulation is intended to ensure the smooth operation of the short-term funding market, maintaining the essential role that money market funds play in the financing of the economy.
The Council will confirm Coreper’s agreement at a meeting on 17 June 2016, and will ask the presidency to start talks with the European Parliament. The Parliament’s ECON committee approved its negotiating stance in March 2015.
Jeroen Dijsselbloem, Netherlands minister for finance and president of the Council, said: “For the Dutch presidency it is important to have an agreement on this essential file, to ensure the future stability and viability of the MMF sector, which is an important source of short-term finance to the real economy. We expect endorsement of the preliminary agreement during the Ecofin Council this Friday.”
Role and features of MMFs
Money market funds (MMFs) are an important source of short-term financing for companies and government entities.
There are currently two kinds of MMFs:
those that offer a variable net asset value (VNAV) that mainly depends on market fluctuations;
those that offer a constant net asset value (CNAV) and aim to offer share purchases and redemptions for a fixed price.
With assets under management of around €1 trillion, MMFs are mainly used to invest excess cash within short timeframes. They represent an important tool for investors because they offer the possibility to diversify their excess cash holdings, whilst maintaining a high level of liquidity.
When markets are stressed
However, the financial crisis of 2007-08 showed that MMFs can be vulnerable to shocks and may even spread or amplify risks throughout the financial system. Investors are likely to redeem investments as soon as they perceive a risk, which can force funds to sell assets rapidly in order to meet redemption requests. This can fuel an investor ‘run’ and liquidity crisis for an MMF, potentially triggering further negative effects on other parts of the financial system.
The draft 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. In addition, the text provides for common rules to ensure that the fund manager has a good understanding of his/her investors, and provides investors and supervisors with adequate and transparent information.
In order to further mitigate ‘contagion risk’, an MMF would not be allowed to receive external support from a third party, including from its sponsor, as the discretionary nature of external support might contribute to uncertainty in times of instability.
Low volatility net asset value funds
An important new element of the draft regulation is the introduction of a permanent category of “low volatility net asset value” (LVNAV) MMFs. These LVNAV MMFs will gradually replace most of the existing CNAV MMFs, which would be required to convert into LVNAV MMFs within 24 months of entry into force of the regulation. LNAV MMFs would be allowed – to a limited extent and under strict conditions – to offer a constant net asset value.
Only two types of CNAV MMFs would be allowed to continue to operate under the draft regulation, namely:
those that invest 99,5% of their assets in public debt instruments;
those with a specific investor base solely outside the EU.
Both categories of CNAV and LVNAV MMFs would be subject to reinforced liquidity requirements as well as safeguards such as “liquidity fees and redemption gates”. These would be designed to prevent and/or limit the effects of sudden investor runs.