Against this backdrop, the European Parliament and the Council adopted the Money Market Funds Regulation on 14 June 2017. The aim of the Regulation is to make MMFs more stable and less susceptible to runs. The Regulation will be directly applicable to newly issued MMFs from 21 July 2018 and to existing MMFs from 21 January 2019.

Specification of requirements, templates and guidelines

In addition to the Regulation, the European Securities and Markets Authority (ESMA) has published a report containing technical advice, draft implementing technical standards and guidelines, which provide further specification regarding the Regulation.

Most notably, the report contains liquidity and credit quality requirements applicable to assets that may be accepted as collateral as part of reverse repurchase agreements, in addition to a reporting template, which can be used in future by money market funds to submit the requested information to the supervisory authorities electronically, and, finally, guidelines for implementing stress tests, which are intended to demonstrate the effects of hypothetical changes to interest rates, exchange rates, the redemption rate and to the liquidity of the fund’s assets.

What are money market funds?

MMFs are funds that invest in short-term assets and that aim to offer returns in line with money market rates and/or to preserve the value of the investment. Money market funds are regularly used by institutional investors such as industrial companies, asset managers and financial institutions for short-term liquidity management. European MMFs hold over 1 billion euros.

As funds with segregated assets (Sondervermögen), money market funds have an advantage over bank deposits: their investors are not exposed to any direct bail-in risks, meaning there is no danger they may be involved in losses incurred by a bank in the event that the bank needs to be rescued or wound up. The flip side of this advantage, however, is that money market funds are financial instruments whose value is subject to market fluctuations.

Key specifications of the Regulation

One of the key specifications contained in the Regulation is the prohibition of any form of financial support for money market funds. This is intended to prevent from the outset any risk of contagion for banks and for the financial system as a whole. In future, neither banks nor governments will be permitted to bail out or support MMFs that get into financial difficulties.

MMFs will be required to comply with stricter liquidity requirements in order to improve their quality and their resilience. For instance, a certain percentage of their assets must be convertible into cash within one business day and a further percentage within one week without any notable price losses. In addition, the Regulation requires that MMFs know their investors and their liquidity requirements and risk tolerances and that they adjust their liquidity profile accordingly.

Furthermore, the Regulation contains numerous requirements concerning risk diversification and credit quality alongside extensive reporting and stress testing obligations.

Three types of money market funds

It is worth noting that the Regulation distinguishes between three types of money market funds and attaches different requirements, varying in stringency, to each of these three types. The spectrum ranges from Variable Net Asset Value MMFs (VNAV MMFs), whose value fluctuates with the value of the assets they hold, to Low Volatility Net Asset Value MMFs (LVNAV MMFs) and Constant Net Asset Value MMFs (CNAV MMFs).

CNAV MMFs may, in principle, recognise their assets according to a formula based on the purchase price (amortised cost accounting). As a result, the value of a fund unit or share generally remains constant. However, CNAV MMFs are particularly susceptible to runs in times of financial crisis when the "true" value of a fund unit or share, i.e. the sum of all assets according to their market value divided by the number of outstanding units or shares, deviates from the constant net asset value (CNAV). There were calls to ban CNAV MMFs for this reason.

The Regulation did not meet this request but does place particularly stringent requirements on CNAV MMFs with regard to their liquidity reserves and the quality of the assets they hold: these have to be 99.5% composed of public debt.

This includes financial market instruments that are issued or guaranteed by governments or other public bodies and institutions and cash.

The Regulation also introduces three options for CNAV MMFs to respond to a lack of liquidity: they may collect liquidity fees, set redemption gates or suspend redemption altogether. The latter option is already possible in accordance with the Directive on Undertakings for Collective Investments in Transferable Securities (UCITS Directive) and the Alternative Investment Fund Managers Directive (AIFM Directive), which are still applicable to money market funds. However, the Money Market Funds Regulation provides further specification regarding the requirement to review the necessity of this measure and links it to falling below certain liquidity thresholds. Furthermore, CNAV MMFs must publish the "true" value of their fund units or shares alongside the CNAV. This is intended to ensure transparency and to serve as an early warning system.

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