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. [[[PAGE]]]
There has been broad consistency in the additional measures that have been introduced by IMMFA, the SEC and CESR. This reflects the closeness of thought between market participants and regulatory bodies. Both constituencies agree that action was needed in order to further limit the risks to which a money market fund may become exposed, and both also agree on the most appropriate mechanisms for implementing these additional risk mitigants.
The credit rating agencies have also taken action. In late 2009, Fitch Ratings issued revised criteria for money market fund ratings. This included the introduction of a specific AAAmmf rating which is only attributable to money market funds and is intended to allow investors to identify the product more easily. Standard & Poor’s has also recently conducted a consultation process on amending its rating criteria. The final revisions should be announced later this year. Both the amendments by Fitch and the proposals from Standard & Poor’s are intended to account for risks better, and to ensure the characteristics of the funds remain consistent with the high rating awarded.
And what of the future?
The changes which have been made to date are not however the end of the reform of the money market fund industry.
Recent months have seen comments made about money market funds by central bankers, notably Paul Tucker of the Bank of England, and Paul Volcker, previously the Chairman of the Federal Reserve. The objective of both individuals has been to address the potential systemic risk which can result from the behaviour of money market funds or the investors in the product.
Within a constant net asset value money market fund, a single share is intended to remain at a stable price. If, for whatever reason, the value of a share falls, many investors may seek to withdraw their investment at the same time for fear of losing capital. The industry on both sides of the Atlantic is considering how best this risk may be mitigated. In the US, the President’s Working Group on Financial Markets is also considering the issues associated with how money market funds are structured. Although the debate has yet to conclude, it is again clear that both the industry and the regulatory community are working together to address this issue.
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. Any changes made by regulators must ensure that the industry is not altered in such a way as to prevent money market funds from effectively performing these two roles. It is reassuring that the industry has proactively engaged with regulators on this issue. All should seek to identify a practicable solution which will alleviate regulatory concerns whilst maintaining the product in a format that continues to provide benefits to investors.
