Published: August 18, 2014
The implementation of any change to money market funds in Europe is still comfortably in the distance, but the debate over the eventual style and shape of this important cash management tool has moved forward. Here we’ve tried to explain how the process works, and how the future of MMF Regulation is decided in Europe.
The European Commission (EC) proposed a new Regulation for money market funds (MMF) in September 2013. This was already considerably later than had been expected and as anticipated, the proposal contained many measures which would be problematic for MMFs and their investors.
The key issues from an investor’s point of view are:
Following the EC’s proposal of a Regulation, the European Parliament and Council of Ministers then each separately considers and amends the EC’s document, formally adopting their own positions which can be significantly different from the original proposal.
The Members of the European Parliament (MEPs) started to consider this piece of work at the end of last year. However progress was slow and at times difficult. In the Parliament the MMF work is done initially by the Committee for Economic and Monetary Affairs (ECON). The ‘rapporteur’ is the MEP responsible for leading the ECON’s work. Each major party grouping appoints its own ‘shadow rapporteur’ to lead its efforts. As the topic is debated, the MEPs are guided by the position of their party, but also by the make-up of their own constituencies. The MEPs work towards finding a version of the Regulation which a majority can support; the final European Parliament report is adopted in a full plenary session, when all the MEPs are able to vote.
The original rapporteur, Said El Khadraoui of the Socialists and Democrats grouping, supported much of what the EC proposed. However, after various debates, a majority of the ECON Committee either disagreed with the proposal or believed that more time was needed to better understand its ramifications. Therefore the ECON Committee decided not to vote on the draft report proposed by the rapporteur before the end of the closing parliamentary session and the May 2014 elections.[[[PAGE]]]
One of the key inputs to this early stage of the debate was that of MMF investors, including corporates, pension funds and local authorities of various different nationalities, who had the opportunity to meet many of the key MEPs and explain first-hand the problems presented by the proposed changes. This type of engagement proved to be extremely effective.
At the European elections in May, many members of the ECON Committee either stood down or were not re-elected. Consequently the composition of the ECON Committee and of the European Parliament as a whole has changed significantly. Work on the MMF topic is not likely to restart in earnest until September or October at the earliest. Many of the incoming group of MEPs will not be particularly familiar with money market funds and the issues which need to be addressed; some will be starting from scratch on this subject.
However from a positive perspective the longer the debate goes on, the better seems to be the understanding of some of the fundamental issues and the more stakeholders have the opportunity to counter some of the inaccurate perceptions which have been carried forward from the earlier debate.
The third arm of the European process, the review of the proposal by the Council of the European Union, also known as the Council of Ministers, started earlier this summer. Representatives from the various Ministries of Finance of all the different Member States of Europe come together to decide their approach to the Regulation which has been proposed by the European Commission. Progress on this facet of the debate depends to some extent of the agenda of the country which is holding the presidency of the Council at the time. From July to December 2014, Italy holds the presidency. This will be followed by Latvia (Jan-Jun 2015) and Luxembourg (Jul-Dec 2015).
The concerns of the Council may differ from those of the MEPs. Also, the representation from any one country might represent the input of the government ministry, the central bank and the securities regulator of that country. Again it is important that MMF investors are given the opportunity to explain the significance of MMF to their cash management and operation and how they might be impacted by any regulatory change. IMMFA, either directly or through its members, has already had extensive interaction with many of those who will be involved in this part of the debate and this will continue through the autumn.
Once both the Parliament and Council have agreed their own independent positions, all three entities (the EC, the EP and the Council) come together in the ‘Trilogue’ process. This involves looking at the three different versions of the proposed Regulation and agreeing a compromise text which will be the final form of the new Regulation. As this is a Regulation (rather than a Directive) the rules apply directly in each of the EU nations – there is no need for the rules to be transcribed to the national level.
The European consideration of MMFs is not happening in isolation, so another aspect of the delay in Europe is the interplay between the US and Europe. The SEC has carried out extensive research into the behaviour of MMFs during the turbulence of 07/08 and beyond. Their more recent work involved a public consultation which attracted more than 1,200 responses.
In the US, the options considered are either
i) a conversion to VNAV (possibly only for Prime funds, possibly only for institutional investors), or
ii) the use of redemption gates and liquidity fees.
iii) A combination of both of these measures
The result of this consultation and the final decision on the new rules for US MMF are expected over the summer of 2014.
Although there is an overriding ambition from global regulators to avoid regulatory arbitrage, the regulators in each region are keen to find a solution which they believe to be most appropriate for their situation. So although we don’t expect that European regulation will follow what is enacted in the US, the fact that the US regulation is expected to come out before the EU debate regains momentum may influence the nature of the debate in Europe and probably increases the chance that future regulation in the two areas will be more closely aligned.
If European CNAV MMF are changed so much that they become ineffective for end-investors, the money that is currently invested in them (circa €475bn) will need to be placed elsewhere. Research carried out by IMMFA members suggests that investors expect to place much of this cash back into ‘national champion’ banks. However other, unrelated regulation, such as Basel III or the Bank Recovery and Resolution Directive (BRRD) is already making it both more difficult for banks, and unattractive for investors, to have more cash in very short-term bank deposits.[[[PAGE]]]
The risk profile of a short-term money market fund is the same whether it is operated as a CNAV MMF or a VNAV MMF (assuming it is comprised of the same set of underlying assets). Even if all the CNAV investment were to move into VNAV MMF, then the degree of systemic risk would not have been changed. However, we know this will not be the case and as appears more likely, a large part of the cash will move into ‘national champion’ banks. The businesses, charities and local authorities looking to responsibly invest the liquidity needed to keep themselves solvent will be obliged to expose themselves to more concentrated risk.
The aim of the changes to MMF regulation is to reduce systemic risk. Yet if the EC’s proposal goes ahead as proposed, this seems to be an unlikely outcome.
Whatever rules are finally agreed, fund managers want to provide products which meet investors’ needs. The direct involvement of investors – businesses who use these cash management tools – has proved to be the most effective way of conveying to regulators and politicians the fact that real world concerns need to be taken into consideration.
We encourage all of you to be involved in the debate.
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