On 9 October 2012, the International Organisation of Securities Commissions (IOSCO) published its final report on policy recommendations for MMFs which proposes 15 recommendations as the basis for common standards for the regulation and management of MMFs across jurisdictions.
The report which follows a consultation in April 2012 (IOSCO – Money Market Fund Systemic Risk Analysis and Reform Options), acknowledges the systemic importance of MMFs and the fact that they provide a significant source of credit and liquidity. IOSCO also acknowledges that the regulatory reforms in 2010 (in the US and Europe) in response to the 2007 – 2008 financial crisis addressed important areas of risk, but that market trends since the 2010 reforms suggest that these reforms did not fully mitigate the systemic risks that MMFs represent for the broader global economy and the possibility of runs.
IOSCO’s recommendations, which are grouped under seven different categories, are as follows:
General:
1. MMFs should be explicitly defined in collective investment scheme (CIS) regulation – MMFs have several features that make them unique among the CIS arena and therefore would benefit from a specific definition (albeit taking into account various jurisdictional nuances) that would refer to the preservation of capital and provision of daily liquidity, while offering returns in line with money market rates.
2. Specific limitations should apply to the types of assets in which MMFs may invest and the risks they may take – MMFs should be permitted to invest mainly in high-quality money market instruments and other low-duration fixed income instruments and not be permitted to take direct or indirect exposures to equities or commodities. Currency risk should also be appropriately managed.
3. Regulators should closely monitor the development and use of other vehicles similar to MMFs.
Valuation:
4. MMFs should comply with the general principle of fair value when valuing securities held in their portfolios (the amortised cost method should only be used in limited circumstances) – MMFs should be valued according to current market practices, provided that those prices are available, reliable and up-to-date and where market prices are not available or reliable, funds may value the securities held in their portfolios using the fair value principle. Further the use of amortised cost accounting should be subject to strict conditions, including the requirement that materiality thresholds and escalation procedures should be in place to ensure that corrective actions are promptly taken when amortised cost no longer provides a reliable approximation of the price of the instruments.
5. MMF valuation practices should be reviewed by a third party as part of their periodic reviews of the funds’ accounts – there should be oversight on the sourcing of prices for valuing assets, and where weaknesses are identified, remedial actions should be taken.
Liquidity Management:
6. MMFs should establish policies and procedures to know their investors – MMFs should be in a position to anticipate redemption so as to avoid large redemptions having a material effect on a fund’s ability to satisfy redemptions.
7. MMFs should hold a minimum amount of liquid assets to strengthen their ability to face redemptions and prevent fire sales – The amount of liquid assets to be held should be adjusted depending on market conditions and the investor base.
8. MMFs should periodically conduct appropriate stress testing.
9. MMFs should have tools in place to deal with exceptional market conditions and substantial redemption pressures – IOSCO identify such tools as temporary suspensions, gates and / or redemptions-in-kind, in order to manage a run on the fund.
Stable NAV MMFs:
10. MMFs that offer a stable NAV should be subject to measures designed to reduce specific (run) risks associated with their stable NAV feature and to internalise the costs arising from these risks; Regulators should require, where workable, a conversion to floating / variable NAV or introduce safeguards to reinforce stable NAV MMFs’ resilience and ability to face significant redemptions – IOSCO’s view is that a conversion to floating NAV MMFs will reduce the specific risks associated with constant NAV funds and limit the effects of a credit event impacting a money market fund. It will also allow fluctuations in share prices which, it is hoped, will improve investors’ understanding of the risks inherent to these funds and the difference between MMFs and bank deposits. IOSCO acknowledges that such a move from constant NAV to floating NAV would be challenging, and recognises that a transition period may be appropriate, during which time sponsors, distributors, clients and other market participants can adapt and prepare.
Use of Ratings:
11. MMF regulation should strengthen the obligations of the responsible entities regarding internal credit risk assessment practices and avoid any mechanistic reliance on external ratings.
12. Credit rating agency supervisors should seek to ensure credit rating agencies make more explicit their current rating methodology for MMFs.
Disclosure to Investors:
13. MMFs documentation should include a specific disclosure drawing investors’ attention to the absence of a capital guarantee and the possibility of principal loss.
14. MMFs disclosure to investors should include all necessary information regarding valuation practices and applicable procedures in times of stress.
Use of Repos:
15. Where necessary, regulators should develop guidelines strengthening the framework applicable to the use of repos by MMFs, taking into account the outcome of current work on repo markets
As the size, features and systemic relevance of MMFs differ significantly between countries, IOSCO acknowledges that the implementation of the recommendations may vary between countries.
IOSCO proposes to review the application of the recommendations within two years to assess whether the recommendations should be revised, complimented or strengthened.
Reaction of Irish Funds Industry Association
William Fry participates in the Irish Funds Industry Association (“IFIA”) Money Market Funds Taskforce. The IFIA has indicated that it will oppose any compulsory move to variable NAV MMFs, on the grounds that MMFs domiciled in Ireland have sufficiently robust safeguards in place to: (a) protect MMFs from the risk of a run; and (b) preserve liquidity. These safeguards include the possibility of imposing redemption gates.
It is worth noting that the deputy governor of the Central Bank of Ireland recently outlined the Central Bank’s position on the on-going debate on MMF reform. He stated that requiring MMFs to switch from constant NAV to variable NAV would not adequately address the likelihood of an investor run on an MMF. Instead, the Central Bank is of the opinion that substantial reform can be achieved through a range of measures such as capital buffers, dilution levies for exiting investors and tighter liquidity requirements.
Next Steps
It is clear, however, that the European Commission is intent on pushing through MMF reforms. Any measures introduced by the Commission will be based on IOSCO’s policy recommendations. It is thought that the full extent of the Commission’s proposals will be set out in a Consultation Paper that will likely issue later this year.
For further information, please contact one of the key contacts listed above or your usual contact in our Asset Management and Investment Funds Team.
