ESMA Proposes Money Market Fund Regulation Reforms

Decouple regulatory thresholds from suspensions/gates

Two options considered by ESMA include:

• Removal of tie between liquidity and liquidity fees on redemptions/redemption gates – ESMA has proposed that completely removing the tie between the thresholds and the imposition of fees and gates is one possible reform. Fund boards could be required to impose fees or gates when doing so is in the best interest of the fund, without reference to any specific level of liquidity.
• Reform of conditions for imposing redemption gates – ESMA suggests that funds could be required to obtain permission from regulatory authorities or notify regulatory authorities prior to imposing gates.

Require MMFs to use swing pricing and/or anti-dilution levies (ADL) / redemption fees

ESMA has suggested it could be appropriate to require MMFs to use mechanisms such as swing pricing, and/or anti-dilution levies (ADL) / liquidity fees. ESMA believes that using such mechanisms would allow the transfer of the liquidity costs of assets sale to redeeming investors; the cost would otherwise be borne by investors who remain invested in the fund.

It is hoped that the above proposal if implemented, would help reduce redemption requests under stressed market conditions

Increase liquidity buffers, review their calibration and/or make them usable/countercyclical.

Under the MMF Regulation, MMFs are currently required to maintain a certain level of liquidity in their portfolio, commonly defined as a percentage of daily and weekly liquid assets out of the total net assets (e.g. 7.5% daily and 15% weekly liquid assets).

ESMA has proposed two option of reform:

Option 1 would be that that the current minimum daily and/or weekly WLA requirements could automatically decline in certain circumstances, such as when net redemptions are large or when the regulatory authority provides temporary relief from WLA requirements. Any thresholds linked to a fund’s minimum WLA requirements (e.g., fee or gate thresholds) would also move with the minimum.

Alternatively, the WLA could be defined as the greater of the current WLA and a buffer calibrated by the regulator based on stress tests performed by MMF managers in accordance with shocks defined by the regulators.

Option 2 provides that the buffers could be relaxed, at the initiative of a supervisor in times of stress or by the managers in the interest of investors and for financial stability purposes (assessment of the supervisor/ EU macro-prudential authority). To avoid any non-intended consequences, the buffer would be non-public.

In terms of reforms targeting both the liability and asset side of MMFs, ESMA has proposed

• Eliminating stable NAV MMFs
• Converting Public debt CNAV and LVNAV funds to Public Debt VNAV and VNAV;
• Converting only LVNAV funds to VNAV;

This proposal suggests that all MMFs should always deal on the basis of a floating NAV, irrespectively of the investor base or the assets they hold. The rationale behind this proposal is that CNAV and LVNAV mechanisms imply nonlinearities by definition, and are therefore intrinsically prone to first-mover advantages and other amplification effects.

ESMA is assessing whether the role of sponsor support should be modified.

According to Article 35 of the MMF Regulation, MMFs are unable to receive external support, defined as “direct or indirect support offered to an MMF by a third party, including a sponsor of the MMF, that is intended for or in effect would result in guaranteeing the liquidity of the MMF or stabilising the NAV per unit or share of the MMF.

ESMA has proposed amending the current requirement of article 35 of the MMF Regulation under which sponsor support is prohibited.

Strengthen the role of MMF stress-testing (including from a system-wide perspective)

The current requirements of article 28 and 37 of the MMF Regulation, complemented by the ESMA Guidelines on MMF stress tests, which are updated every year as per article 28(7), specify:

1. The types of stress tests that managers need to have in place, the risk parameters they should take into account (including shocks to credit risk, interest rates or redemptions) (article 28(1)),
2. The frequency of the stress tests exercise (article 28(2)),
3. The type of reporting of the results of these stress tests to National Competent Authorities and ESMA (article 37 and ESMA Guidelines on MMF stress tests), and
4. The corrective measures that managers of MMFs need to take, in case the stress tests reveal vulnerabilities of the MMFs (article 28(3) to 28(6)).

In order to strengthen this coordination mechanism, and the corresponding abovementioned corrective measures, several options could be envisaged, such as:

1. Specifying that ESMA would, together with the National Competent Authority, receive directly from the manager of the MMF the report mentioned in Article 28(5) of the MMF Regulation, so that ESMA can play its coordination role with National Competent Authorities in the more effective way, and in real-time;
2. Specifying further the corrective measures that managers of MMFs need to take when stress tests reveal vulnerabilities of a specific MMFs or specify the process of adoption of such measures and the role of supervisors in that process.

Further harmonise and enhance international MMFs reporting framework

The MMF Regulation includes a detailed reporting framework from managers of MMFs to NCAs and ESMA. ESMA believes that the current reporting provided to NCAs and ESMA on a quarterly basis for MMFs with AuMs above EUR 100 million, and on a yearly basis for funds below that threshold, is not enough during a crisis such as the one seen during March 2020.

ESMA has proposed that reporting on at least a monthly basis for larger funds/managers in terms of AuM and quarterly for smaller funds/managers would be more appropriate.

Alternatively, ESMA has proposed that more frequent reporting could be activated in stressed market conditions (e.g. daily) with a subset of key indicators of the MMF Regulation reporting (e.g. Total Net asset value (TNA), WLA) to monitor the crisis, rather than systematically collecting the full MMF Regulation reporting on a monthly basis.

Disclose money market instruments main categories of investors to regulatory authorities

ESMA believes that disclosing information on the main investors in money markets would help to understand the dynamics of the market based on the behaviour of the main categories of investors.

Under this proposal, Authorities would require a periodical disclosure of the investor base in normal market conditions.

Set-up a liquidity exchange facility (“LEF”) funded by MMF or asset managers

Finally, ESMA has put forward proposals regarding the creation of a liquidity exchange facility (LEF) funded by MMF or asset managers.

Subject to EU supervision, this LEF could serve as a centralised source of liquidity and/or credit during periods of stress. This could mitigate liquidity pressures on MMFs and reduce the benefit of ‘first mover advantage’ for investors resulting in an accelerating spiral of investor redemptions and asset fire-sales.