Money Market Fund Regulation

Abstract

MMFs provide short-term finance to financial institutions, corporations and governments thereby contributing to the financing of the EU economy. Those investors use investments in MMFs as an efficient way to diversify their credit risk and exposure, rather than relying upon bank deposits. On the demand side, MMFs are a crucial link bringing together demands and offers of short-term cash that provides a high degree of liquidity, diversification and stability of value of the principal invested, combined with a market-based yield. During the subprime mortgage crisis in 2008, one of the US oldest and largest MMFs - the Reserve Primary Fund - ‘broke the buck’ . The sequence of events caused by this in the MMF domain shed light on several features of MMFs that make them vulnerable when there are difficulties in financial markets in which case MMFs could spread or amplify risks throughout the financial system. The Reserve Primary Fund showed that when the prices of the assets in which a MMF has invested, start to decrease, especially during stressed market situations, MMFs cannot always maintain their promise to redeem immediately and to preserve the principal value of a unit or share issued by the MMF to its investors. Furthermore, large redemption requests during the 2008 financial crisis forced MMFs to sell some of their investment assets in a declining market that fuelled a liquidity crisis. Money market issuers faced funding difficulties as a result of the market for commercial paper and other money market instruments that dried up. This led to contagion within the short-term funding market and resulted in direct and major difficulties in the financing of financial institutions, corporations and governments, and thus the real economy. Following the 2008 financial crisis, the FSB and IOSCO identified that substantial and sudden redemption requests can be particularly serious for constant or stable net asset value (CNAV) MMFs potentially triggering broader macroeconomic issues. In the absence of European regulation setting out rules on MMFs, diverging measures would have been adopted at the national level. Such measures would have continued to cause significant distortions of competition resulting from significant differences in essential investment protection standards, leading to different levels of investor protection throughout the EU. For that reason, the MMFR introduced a ‘top-up’ harmonized European framework for UCITS and AIFs whose characteristics correspond to those associated with an MMF. This harmonized framework applies, in addition to, the regulation imposed by the AIFMD and UCITSD as it intends to promote the integrity and stability of the internal market by ensuring a mandatory investment policy that enables MMFs in the form of an AIF of UCITS to immediately redeem investors. The MMFR does not allow any collective investment undertaking to be established, marketed or managed in the EEA as a MMF, unless it has been authorized as AIF or UCITS under the regulation and complies with the mandatory MMFR requirements related to its managers, product and sales/distribution. These ‘lex specialis’ MMFR requirements will now be subsequently discussed.