European Commission Releases Proposal for Regulation of Money Market Funds 4 September 2013

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1 European Commission Releases Proposal for Regulation of Money Market Funds 4 September 2013 Today the European Commission (EC) released a proposal for a regulation on money market funds (MMFs) established, managed and / or marketed in the European Union (EU). This proposal follows several recommendations by global and European organisations, including the International Organisation of Securities Commissions and the European Systemic Risk Board, to implement changes to money market fund regulation. The proposal does not constitute a final rule; rather it is proposed reform that must go through the European Union s ordinary legislative procedure before approval and implementation. In summary, the proposed regulation establishes new or expanded investment requirements for money market funds, some of which have already been voluntarily adopted by many managers or already implemented at the European level through ESMA* guidelines, including: setting maximum weighted average maturity (WAM) and weighted average life (WAL) limits; establishing minimum daily and weekly liquidity allocations; limiting the maximum allocation to issuers, counterparties, and asset types to ensure diversification and concentration; know your customer policies and procedures; and requiring stress testing. *European Securities and Markets Authority Most importantly the proposed regulation includes some very notable changes that have not previously been voluntarily adopted and which are not being contemplated by U.S. MMFs regulator, the Securities and Exchange Commission (SEC): a 3% net asset value (NAV) buffer with a three-year phase in for money market funds using a constant NAV (CNAV); a current inclusion of government money market funds, with a note that the EU Commission will review buffer requirement for government CNAV MMFs three years after entry into force; a prohibition on rating MMFs as it occurs today, through specifically requiring no solicitation or financing of a credit rating agency by a fund manager for rating an MMF; establishing requirements for internal processes for credit quality determination; limiting eligibility of securitised investments which includes Asset Backed Commercial Paper (ABCP); use of financial derivatives only for the purpose of hedging duration and exchange rate risks; and maintaining two types of MMFs: short-term and standard. Below is GSAM s summary of the EU legislative process and additional details of the proposed regulation. 1

2 Overview of European Union Legislative Process The EU legislative process follows certain steps involving the EU legislative bodies, the European Parliament and EU Council. As of 4 September 2013 This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advise. 2

3 Details of Proposed Regulation The proposed regulation is divided into nine chapters, each specifying different types of requirements for MMFs. Overall the regulation aims to establish minimum requirements that any money market fund (UCITS or AIFM)* would have to follow in order to become authorised in a Member State. *UCITS: Undertakings for Collective Investment in Transferrable Securities; AIFM: Alternative Investment Fund Manager I. General provisions: This section contains general rules, including scope, definitions and rules on authorisation of MMFs. II. Provisions on Investment Policies of MMFs Permitted Investments Money market funds would be limited to investing in only certain permitted investments: Money market instruments; Deposits with credit institutions; Financial derivatives instruments; and Reverse repurchase agreements. Additionally, money market funds would be prohibited from specific investment activity including: Short-selling money market instruments; Gaining exposure to equity or commodities; Securities lending or securities borrowing agreements; Engaging in repurchase agreements; Borrowing and lending cash. Diversification - The proposal establishes minimum requirements for diversification of certain investments, including: Maximum 5% of assets in instruments of a single issuer; Maximum 5% of assets in deposits with the same credit institution; Maximum 20% of assets in reverse repurchase agreements with the same counterparty Concentration The proposal requires that a fund may not hold more than 10% of the money market instruments issued by a single body, excluding those issued by a central, regional or local authority or central bank of the EU. 3

4 Credit Quality The proposal establishes a requirement that a manager of a money market fund must implement and apply prudent and rigorous internal assessment procedure for determining the credit quality of money market instruments, taking into account the issuer of the instrument and the characteristics of the instrument itself. Additionally, ESMA will develop technical standards to specify guidelines for managers credit process methodologies. Governance of Credit Quality Assessment The proposal establishes a requirement for senior management oversight of a manager s internal credit quality assessment process. III. Risk Management Requirements Portfolio Rules The proposal establishes minimum portfolio composition requirements for short term money market funds and standard money market funds. Portfolio Characteristic Maximum weighted average maturity (WAM) Maximum weighted average life (WAL) Minimum in daily maturing assets Minimum in weekly maturing assets CNAV or VNAV Pricing Proposed Short-Term MMF Proposed Standard MMF Requirement Requirement 60 days 6 months 120 days 12 months 10% 20% 20% 20% CNAV only with 3% NAV buffer or VNAV VNAV only Prohibition on Ratings Under the proposed regulation, money market funds and managers of money market funds would be prohibited from soliciting or financing a credit agency rating for a money market fund. Know Your Customer Each money market fund manager must establish procedures and exercise due diligence to understand the investors in the fund in order to correctly anticipate the effect of concurrent redemptions on several investors. This also extends to omnibus and nominee accounts. Stress Testing Each money market fund manager must regularly conduct stress testing and develop action plans for different possible scenarios. The stress tests must be conducted at a frequency determined by the board of directors of the manager (at least yearly), with results being submitted to the board of directors and regulators who shall send the report to ESMA. 4

5 The stress tests must take into account at least the following factors: a. Hypothetical changes in the level of liquidity of the assets held in the portfolio; b. Hypothetical changes in the level of credit risk of the assets held in the portfolio c. Hypothetical movements of interest rates d. Hypothetical levels of redemption; Additionally, CNAV MMFs stress tests must estimate for differences between the CNAV per unit share and the market value NAV per unit share which includes any impact of the difference on the NAV buffer. IV. Valuation Rules Valuation of MMFs assets MMFs asset must be valued at least daily using mark to market whenever possible, following the specific methods recommended in the regulation. Additionally, CNAV MMFs may be valued using the amortised cost method. Calculation of NAV The proposed regulation establishes uniform requirements for calculating the NAV, including that the NAV shall be rounded to the nearest basis point (0.01%) and calculated at least daily, with a CNAV permitted to round to the nearest percentage point. Issue and Redemption Price The proposed regulation establishes the NAV as the issue and redemption price, with the CNAV as the issue and redemption price for CNAV MMFs. V. Specific Requirements for CNAV MMFs NAV Buffer - The proposed regulation stipulates that MMFs using a CNAV must follow specific additional requirements, most notably the establishment and maintaining of an NAV buffer to at least 3% of the total value of the CNAV MMFs assets within three years from the final rule (phased in over three-years). MMF managers must follow specific rules about the use and implementation of the buffer, and regulators have the authority to review and approve plans. The NAV buffer would be used exclusively to cover differences between the MMF s CNAV and market value NAV. The buffer would be composed only of cash and held in a protected reserve account segregated from the MMF. If the buffer falls below 3%, the competent authority of the CNAV MMF and ESMA would be immediately notified, and the buffer would need to be replenished. Short term money market funds that do not opt for a capital buffer would be required to convert to VNAV pricing. 5

6 VI. External Support The proposed regulation prohibits external support for MMFs that would result in guaranteeing the liquidity of the MMF or stablising the NAV. External support includes cash injections or explicit or implicit guarantees by a third party. External support would be permitted only in exceptional circumstances justified by systemic implications or adverse market conditions, provided several other requirements are fulfilled, including that the external support is limited in terms of amount and period of time when it is made available. VII. Transparency Requirements The proposed regulation includes disclosure requirements for, such as indicating whether it is a short-term or a standard MMF and that it is not a guaranteed investment. Reporting Requirements Each MMF must report to the competent authority at least quarterly with, among other requirements, the portfolio characteristics (e.g., NAV, WAM, WAL), the size of the NAV buffer, and the results of the stress tests. ESMA will develop technical standards and a reporting template for submitting this information. VIII. Supervision The proposed regulation establishes requirements for competent authorities (i.e., organisations with oversight responsibility of MMFs as appropriate by fund type and / or jurisdiction) to oversee compliance with the regulation, grants ESMA the powers necessary to carry out its duties under the regulation, and calls for cooperation among authorities in different jurisdictions. IX. Final Provisions The proposed regulation requires existing MMFs (UCITS or AIF) to submit an application demonstrating compliance with the regulation within six months after it enters into force. 6

7 Goldman Sachs Asset Management s Position on Money Market Fund Reforms GSAM remains supportive of reform that is in the best interest of money market fund shareholders and that strengthens the money market industry. Our primary goal is to maintain money market funds as a viable liquidity option for our clients. As such, we plan to share any concerns we and more importantly, our clients have with the proposals and continue to work closely with the regulators and industry peers. Finally, we recognize that regulatory change of some sort looks increasingly likely. In the face of potential change, we remain committed to providing solutions that can help meet our clients liquidity needs. Additional Information European Commission The website links provided are for your convenience only and are not an endorsement or recommendation by GSAM of any of these websites or the products or services offered. GSAM is not responsible for the accuracy and validity of the content of these websites. All information in this release is as of the date listed unless otherwise noted and are subject to change. This material is not financial research and was not prepared by the Goldman Sachs Global Investment Research. It was not prepared in compliance with applicable provisions of law designed to promote the independence of financial analysis and is not subject to a prohibition on trading following the distribution of financial research. The views and opinions expressed herein are valid as of the date of this publication only and may differ from the views and opinions expressed by the Global Investment Research or other departments or divisions of Goldman Sachs and its affiliates. Goldman Sachs International has no obligation to provide any updates. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice. This material has been prepared by GSAM and is not a product of Goldman Sachs Global Investment Research. The views and opinions expressed may differ from those of Goldman Sachs Global Investment Research or other departments or divisions of Goldman Sachs and its affiliates. Investors are urged to consult with their financial advisors before buying or selling any securities. This information may not be current and GSAM has no obligation to provide any updates or changes. This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. Please note that neither Goldman Sachs Asset Management International nor any other entities involved in the Goldman Sachs Asset Management (GSAM) business maintain any licenses, authorizations or registrations in Asia (other than Japan), except that it conducts businesses (subject to applicable local regulations) in and from the following jurisdictions: Hong Kong, Singapore, Malaysia, Korea, and India. This material has been communicated in Canada by Goldman Sachs Asset Management, L.P. (GSAM LP). GSAM LP is registered as a portfolio manager under securities legislation in certain provinces of Canada, as a non-resident commodity trading manager under the commodity futures legislation of Ontario and as a portfolio manager under the derivatives legislation of Quebec. In other provinces, GSAM LP conducts its activities under exemptions from the adviser registration requirements. In certain provinces, GSAM LP is not registered to provide investment advisory or portfolio management services in respect of exchange-traded futures or options contracts and is not offering to provide such investment advisory or portfolio management services in such provinces by delivery of this material. This material has been issued for use in or from Hong Kong by Goldman Sachs (Asia) L.L.C, in or from Singapore by Goldman Sachs (Singapore) Pte. (Company Number: W), and in or from Korea by Goldman Sachs Asset Management Korea Co. Ltd., in or from Malaysia by Goldman Sachs(Malaysia) Sdn Berhad and in or from India by Goldman Sachs Asset Management (India) Private Limited (GSAM India). This material has been issued or approved in Japan for the use of professional investors defined in Article 2 paragraph (31) of the Financial Instruments and Exchange Law by Goldman Sachs Asset Management Co., Ltd. This material has been approved by Goldman Sachs Asset Management International, which is authorized and regulated in the United Kingdom by the Financial Conduct Authority. This material is approved for distribution to permitted countries in the Asia Ex-Japan region. Opinions expressed are current opinions as of the date appearing in this material only. 7

8 Confidentiality: No part of this material may, without GSAM s prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient. Although certain information has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness. We have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. Please see additional disclosures Goldman Sachs. All Rights Reserved OTHER.MED.TMPL/9/2013 Date of first use: 4 September