Money market funds: Presidency and EP reach agreement - EU monitor

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Wednesday, January 22, 2020
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Source: Slovak presidency of the EU (Slovak presidency)†i, published on Wednesday, November 16 2016.

Brussels (14 November) - On 14 November 2016, the presidency reached provisional agreement with representatives of the European Parliament†i on a draft regulation on money market funds (MMFs), aimed at making such products more robust.

The draft regulation is intended to ensure the smooth operation of the short-term funding market. It sets out to maintain the essential role that money market funds play in the financing of the real economy. It follows efforts by the G20†i and the Financial Stability Board to strengthen the oversight and regulation of the 'shadow banking' system.

With assets under management of around Ä1 trillion, MMFs are mainly used to invest excess cash within short timeframes. They represent an important tool for investors because they offer the possibility to diversify their excess cash holdings, whilst maintaining a high level of liquidity.

While an overall agreement was reached at political level, a number of technical issues relating to the draft regulation are to be finalised in the coming days. The agreement will then be submitted to the Permanent Representatives Committee for endorsement on behalf of the Council. The Parliament and the Council will then be called on to adopt the regulation at first reading.

Role and features of MMFs

There are currently two kinds of MMFs that are used for short-term financing for companies and government entities:

  • those that offer a variable net asset value (VNAV) that mainly depends on market fluctuations;
  • those that offer a constant net asset value (CNAV) and aim to offer share purchases and redemptions for a fixed price.

When markets are stressed

The financial crisis of 2007-08 showed that MMFs can be vulnerable to shocks and may even spread or amplify risks throughout the financial system. Investors are likely to redeem investments as soon as they perceive a risk, which can force funds to sell assets rapidly in order to meet redemption requests. This can fuel an investor 'run' and liquidity crisis for an MMF, potentially triggering further negative effects on other parts of the financial system.

Common standards

The draft regulation lays down rules for MMFs, in particular the composition of their portfolios and the valuation of their assets, to ensure the stability of their structure and to guarantee that they invest in well-diversified assets of the highest credit quality.

It also introduces common standards to increase the liquidity of MMFs, to ensure that they can face sudden redemption requests when market conditions are stressed. In addition, the text provides for common rules to ensure that the fund manager has a good understanding of investors' behaviour, thus preparing for any future redemption requests. It provides investors and supervisors with adequate and transparent information.

Issues resolved

The agreement reached at the final meeting of 'political' negotiators covers, in particular, the core issues concerning regulation of MMFs, such as liquidity and diversification requirements, assets on which MMFs can invest including the role of government debt, transparency. It also provides fora report by the Commission on the functioning of the regulation, accompanied by a review clause.