Throughout August you will have seen a number of regulators publishing updated circulars, opinions and notices in relation to the application of the ESMA Guidelines on stress test scenarios under the Money Market Fund Regulation (EU) 2017/1131 (MMFR).
Including regulators such as the:
The reason for this heightened influx of MMFR related updates is due to the European Securities and Markets Authority (ESMA) publishing, on the 29th June 2021, the translations to the Guidelines that apply in relation to Article 28 of the Money Market Funds Regulation and establish common reference parameters for the stress test scenarios to be included in the stress tests conducted by money market funds (MMFs) or managers of MMFs in accordance with that Article.
The updated guidelines follow the Report published by ESMA on 16th December 2020. The update takes into account MMFs experiences during March 2020, particularly in relation to redemption scenarios.
The guidelines apply from two months after their publication on ESMA’s website in all EU official languages. In turn, all managers of MMFs were therefore expected to as of the 29th August, be in compliance with the updated Guidelines.
Background
On 21 March 2018, ESMA issued guidelines which include practical examples and detailed guidance for the establishment of a stress test scenario framework for MMFs. These guidelines are updated at least every year taking into account the latest market developments.
MMFs and managers of MMFs are expected to measure the impact of the common reference stress test scenarios specified in the guidelines. On the basis of these measurements, they are expected to fill in the reporting template referred to in Article 37 of the MMF Regulation and set out in Commission Implementing Regulation (EU) 2018/7083 and send the results to NCAs with their quarterly reports required by Article 37.
What’s changed?
ESMA’s ’Final Report’ on Guidelines on stress test scenarios under the MMF Regulation published on 16 December 2020, takes into account the extreme market movements observed during the COVID-19 crisis.
The report included:
- Unchanged principle-based guidelines on stress testing the MMF or the manager of an MMF shall regularly conduct (sections 4.1 to 4.7 of the guidelines).
- Unchanged guidelines under section 4.8 of the guidelines (guidelines on the establishment of common reference stress test scenarios the results of which should be included in the reporting template mentioned in Article 37(4) of the MMF Regulation).
- Updated guidelines on specifications on the type of stress tests and their calibration, so that managers of MMFs have the information needed to fill in the corresponding fields in the reporting template mentioned in Article 37 of the MMF Regulation (section 5 of the guidelines).
Section 5 Update
Section 5 of the Guidelines has been updated with the shocks calibrated to be severe, plausible and consistent with the ECB and the ESRB projections, taking into account the impact of the COVID-19 pandemic.
The scenario calibration reflects important systemic risks identified by the ESRB General Board, including
- Widespread defaults in the private sector due to any deep global recession,
- Any re-emergence of sovereign financing risk and debt sustainability concerns, and
- Instability and pockets of illiquidity in financial markets.
Therefore, liquidity discount factors and credit spreads reflecting shocks to government and corporate bonds and asset-backed securitizations have been significantly increased.
MMF managers are required to carry on a reverse liquidity stress test, a weekly liquidity stress test and a concentration stress test. Since some MMFs exceeded the 25% redemption rate for professional investors during the COVID-19 crisis, the severity of the redemption shock calibrated for the weekly liquidity stress test has been increased in light of the vulnerabilities identified for some of the Low Volatility Net Asset Value MMFs denominated in USD and some Variable Net Asset Value MMFs denominated in EUR.
In the updated scenario, managers of MMFs should apply a stressed redemption scenario where the fund receives net weekly redemption requests from 40% of the professional investors and 30% of the retail investors. This is a large increase from the previous scenarios of 25% and 15%.
Stay compliant with Liquidity Stress Testing
The issue of illiquid assets and open-ended funds has gained heightened prominence and regulator focus, most recently since 2019 after the suspension of the high profile LF Woodford Equity Income Fund and the COVID-19 pandemic. Issues such as this are likely to grow in prominence as mutual funds increasingly seek out and/or rely upon illiquid assets to generate greater returns in the prevailing and foreseeable low interest rate environment. For this reason, it is paramount that managers have in place tools in place to monitor their liquidity.
The Funds-Axis Liquidity Risk Management Solution can reduce this burden and increased workload, and assist firms with meeting these liquidity requirements in both times of market normality and stress.
Our solution has been designed to meet international requirements in respect of Liquidity Risk Management and Liquidity Stress Testing. It is a holistic module which embeds Liquidity Risk Management Monitoring into product governance, throughout the product lifecycle.
We also offer a full package of supporting documentation, including:
- Liquidity RMP Template
- Liquidity calculation methodologies
- Checklists assessing compliance with ESMA, IOSCO
- Stress test calibrations
- Liquidity stress testing simulation forms and templates
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