The upcoming money market fund regulation

I. The Regulation introduces two new categories of MMF, with each MMF required to meet the requirements:

• short-term MMFs, whose objective is to offer money market rate returns while ensuring the highest possible level of safety.;
• standard MMFs, whose objective is to offer returns slightly higher than money market returns;

The Regulation sets three different categories of MMFs:

• The Constant Net Asset Value MMF (CNAV MMF)
• The Low Volatility Net Asset Value MMF (LVNAV MMF)
• The Variable Net Asset Value MMF (VNAV MMF)

All these categories may take the form of a Short-Term MMF, whereby a CNAV MMF and a LVNAV MMF cannot take the form of a Standard MMF.

Although not prohibited as initially expected, CNAV MMFs will be subject to a restricted scope of application, to the extent that they will mainly be required to invest 99.5% of their assets in public or public-secured debt instruments including reverse repurchase agreements secured with government debt as well as in cash.

In order to limit the recourse to the CNAV, the Regulation has set up a hybrid vehicle between the CNAV MMF and the VNAV MMF, namely the LVNAV MMF, which can follow, to a large extent, the same investment policy and valuation rules as those for CNAV MMFs.

II. Investment policy rules

MMFs will be allowed to invest in:

• money market instruments (including public debt, eligible securitizations and asset backed commercial papers ("ABCPs");
• deposits with credit institutions;
• financial derivative instruments;
• repurchase agreements and reverse repurchase agreements subject to further requirements;
• units or shares of other MMFs.

The following activities will however be prohibited for MMFs:

• investing in assets other than those mentioned above;
• short-sale of money market instruments, securitizations, ABCPs and units or shares of other MMFs;
• having direct or indirect exposure to equities or commodities, including via derivatives, certificates representing them, indices based on them or any other means or instrument that would give rise to exposure to them;
• entering into securities lending agreements or securities borrowing agreements, or any other agreement that would encumber the assets of the MMF;
• borrowing and lending cash.

The Regulation further sets out criteria regarding the eligibility of the assets in which MMFs are allowed to invest.

In addition, several diversification rules will apply to MMFs, depending on their category. The following points set out the important aspects:

1. An MMF is basically not allowed to invest more than 5% of its assets in money market instruments, securitizations and ABCPs issued by the same body, or 10% of its assets in deposits made with the same credit institution, unless that the MMF's Member State is such that there are insufficient viable credit institutions to meet that requirement, and it is not economically feasible for the MMF to make deposits in another Member State, in which case up to 15% of its assets may be deposited with the same credit institution.
2. A VNAV MMF may invest up to 10% of its assets in money market instruments, securitizations and ABCPs issued by the same body as long as the total value of the those assets held by the VNAV MMF in the issuing bodies of which it invests more than 5% of its assets does not exceed 40% of the value of its assets.Until the date of application of a delegated act to be issued, the aggregate of all exposure to securitizations and ABCPs, must be limited to 15% of the assets of a MMF.
3. The aggregate risk exposure to the same counterparty of the MMF arising from OTC derivative transactions in which the MMF is authorised to enter into must not exceed 5% of its assets.
4. The aggregate amount of cash provided to the same counterparty of a MMF in reverse repurchase agreements must not exceed 15% of its assets.
5. Moreover, a MMF must not combine, where this would lead to investment of more than 15% of its assets in a single body, any of the following:

• investments in money market instruments, securitisations and ABCPs issued by that body;
• deposits made with that body,
• OTC financial derivative instruments giving counterparty risk exposure to that body.

With respect to concentration, an MMF will in principle not be allowed to hold more than 10% of the money market instruments, securitisations and ABCPs issued by a single body, whereby this limit shall not apply to public debt instruments.

III. The internal credit quality assessment procedure

According to the new Regulation, a rigorous and prudent internal credit quality assessment procedure deeming to determine the credit quality of money market instruments. The following factors should be considered:

• the quantification of the credit risk of the issuer and the relative risk of default of the issuer and the instrument;
• qualitative indicators about the issuer of the instrument and the macro-economic and financial market situation;
• the short-term nature of money market instruments;
• the nature of the asset class represented by the instruments;
• the type of issuer;
• regarding structured financial instruments, the operational and counterparty risk inherent within the structured financial transaction;
• the liquidity profile of the instrument.

The procedure must be documented, and detailed in the fund's constitutional documents. Furthermore, there must be no mechanical reliance on external ratings. The procedure must be revised as soon as material changes occur, for instance if a financial instrument is downgraded below the two highest short term credit ratings provided by a credit rating agency.

IV. Risk management

Weighted average maturity ("WAM") and weighted average life ("WAL") are the leading measures for the MMF portfolio rules regarding the Risk Management.

In this respect, short-term MMFs must have:

• WAM of no more than 60 days; and
• WAL of no more than 120 days.

Standard MMFs must have:

• WAM of no more than six months; and
• WAL of no more than twelve months.

V. Other significant measures

Valuation rules

Assets of a MMF must be valued at least on a daily basis. For the purpose of valuation, the mark to market method should be used, failing which, the mark to model should be used, excluding subsequently the reliance on amortized costs. Only CNAV MMFs and the LVNAV MMFs are allowed, to a limited extent, additionally, to use the amortized cost method.
External support

External support is defined as direct or indirect support offered by a third-party that is intended for or in effect would result in, guaranteeing the liquidity of the MMF stabilising the NAV per unit or share. This includes, among other things:

• cash injections from third parties;
• purchase by a third party of assets of the MMF at an inflated price;
• any guarantee given by a third party or any action by a third party deeming to maintain  the liquidity profile and the NAV per unit or share.

The new Regulation forbids external support of MMFs.