Money Market Funds: A Regulatory Update
by Nathan Douglas, Secretary General, IMMFA
Regulatory change in the broader financial services industry continues apace, in order to further strengthen the financial system. Money market funds have so far been captured within these regulatory changes, in terms both of restricting the exposure to risks and providing investors with further clarity over the nature of their investment.
The changes made to date
In Europe, the key regulatory change impacting money market funds will be the introduction of a definition of the product. In May 2010, CESR, the Committee of European Securities Regulators, issued guidance which creates the first pan-European definition of a money market fund. The guidance uses a two-tier approach, differentiating between ‘short-term money market funds’ and ‘money market funds’. Both categories include specific criteria which must be met in order for the fund to be classified as a money market fund. These criteria include restrictions on exposure to interest rate and credit risks, with general obligations imposed regarding the risk management of the fund.
There is a notable risk differential between the two categories. The investment parameters within which the short-term money market funds can operate will be tighter than those for the broader money market funds category. The risks within these short-term funds should on average be less than in the broader money market funds category. This is illustrated in Figure 1.
Once the definition is implemented be national regulators, only those funds which have capital security as their principal objective will be able to define themselves as a money market fund. This will provide clarity to investors. Any fund which does not fall within one of the two categories will not be able to refer to itself as a money market fund after this time.
Money market funds have a key role to play in the financial system, providing benefits to investors and acting as a key source of funding for many institutions.
Also in Europe, IMMFA revised its Code of Practice in December 2009. This Code, which is voluntarily complied with as a pre-condition for IMMFA membership, establishes best practice standards for the management and operation of triple-A rated money market funds. The recent amendments, which introduced additional risk limiting provisions, were intended to improve the resilience of the product and further enhance the ability of these funds to provide security and liquidity. Additional disclosure requirements have also been imposed on the funds, making it easier for investors to understand the funds’ exposure to risk and compare competing products.
In the US, the Securities and Exchange Commission (SEC) has amended its rules which govern the management and operation of money market funds. Again, these changes implement additional quantitative and qualitative restrictions that are designed to improve the robustness of the product.