The European Securities and Markets Authority (ESMA) has published a Consultation Paper on the Money Market Funds Regulation (MMFR), which according to ESMA primarily will be of interest to MMF managers, alternative investment funds and UCITS managers and institutional and retail investors investing in a MMF. The paper represents a first stage in the development of technical advice regarding liquidity requirements and credit quality requirements for assets received through reverse repurchase agreements, technical advice on credit quality assessment, technical standards for reporting and guidelines on the stress tests performed within the MMFR framework. In this first post of two we cover the key regulatory requirements in regard to liquidity and credit quality whilst the second post continues with the review of reporting standards and stress testing compliance.
Liquidity and credit quality requirements
For the liquidity requirements ESMA proposes two options of technical advice going forward. The first is based on an approach where liquidity requirements of the collateral of a reversed repurchase agreement depend on the risk of default of the counterparties to the agreement as well as the applicable counterparty risk diversification limit. If a counterparty to a MMF faces a risk of default, the MMF might be forced to liquidate assets that have been received as collateral. This may endanger the liquidity profile of the MMF, wherefore ESMA suggests the following additional liquidity requirements to address that potential risk;
- If the counterparty is a European credit institution, European investment firm, any credit institution or investment firm subject to prudential regulation deemed equivalent to the European one, regulated central counterparties, the ECB, Member States’ central banks or non-EU central banks deemed equivalent under the requirements of the Article 114 of CRR, there is no further requirements needed than the MMF Regulation, as in such a situation the risk that a MMF have to liquidate collateral is reduced.
- When the above is not the case, in order to ensure sufficient overcollateralization of the reverse repurchase agreement as mentioned in Article 15(1)(b) of the MMF Regulation, the MMF shall consider; the time to maturity of the assets, the price volatility of the assets, and the appropriate stress-testing policy.
The second option to the liquidity requirements is to determine the collateral assets' liquidity profile based on the following requirements; reasonable expectations by the asset manager of the one business day conversion to cash with a marginal impact on the market value of the investment, that these expectations are continuously monitored and under both normal and exceptional liquidity conditions also in accordance with stress tests run in line with Article 28 of the MMFR, and taking into consideration various criteria as e.g. the bid-ask spreads, the average daily trading volume and the credit quality of the issuer.
Regarding the credit quality requirements, ESMA is of the view that there should not be any further requirements to be specified in the context of the Article 15 of the MMFR.