# EUR-Lex - 52013SC0315 - EN

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# 52013SC0315

**COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT Accompanying the document Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on Money Market Funds /* SWD/2013/0315 final */**

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1.       PROCEDURAL ISSUES AND CONSULTATION OF
INTERESTED PARTIES  5

1.1.    Shadow banking context 5

1.2.    International work on MMFs. 5

1.3.    Related EU initiatives. 6

1.4.    Consultation of interested
parties. 6

1.4.1.     Consultation on shadow
banking. 7

1.4.2.     Consultation on asset
management 7

1.5.    Impact Assessment Steering
Group and IAB.. 7

2..... problem
definition.. 8

2.1.    Problem driver: MMFs offer features
equivalent to bank deposits. 8

2.1.1.     MMFs provide daily and
unlimited access to liquidity. 9

2.1.2.     MMFs offer stability. 10

2.2.    Problems. 12

2.2.1.     Contagion to the real
economy. 12

2.2.2.     Contagion to sponsors. 14

2.2.3.     Early redeemers are
advantaged over late redeemers. 16

2.3.    Consequences. 17

2.3.1.     Financial stability and
bail-out risk. 17

2.3.2.     Insufficient investor
protection. 18

2.4.    How would the problem evolve
without EU action? The base line scenario. 18

2.5.    Subsidiarity and
proportionality. 19

3..... objectives. 20

3.1.    General, specific and
operational objectives. 20

3.2.    Consistency of the objectives
with other EU policies. 21

3.3.    Consistency of the objectives
with fundamental rights. 22

4..... policy
options. 22

5..... analysis
of impacts. 24

5.1.    Options aimed at ensuring
that the liquidity of the fund is adequate to face investor's redemption
requests  24

5.1.1.     Policy option 1.1: take no
action at EU level (baseline scenario) 24

5.1.2.     Policy option 1.2: Impose a
hold back period for a proportion of the redemption order 25

5.1.3.     Policy option 1.3: Impose a
liquidity fee. 26

5.1.4.     Policy option 1.4:
Redemption in-kind. 28

5.1.5.     Policy option 1.5: Set
minimum liquidity thresholds for overnight and weekly maturing assets  28

5.1.6.     Policy option 1.6: Enhance the
quality of the portfolio. 30

5.1.7.     Policy option 1.7: MMF
managers should develop policies to anticipate large redemptions  32

5.1.8.     Impact summary. 33

5.2.    Options aimed at aligning the
structure of MMF so they can withstand adverse market conditions  34

5.2.1.     Policy option 2.1: take no
action at EU level 34

5.2.2.     Policy option 2.2: Increase
transparency. 35

5.2.3.     Policy option 2.3: require
all MMFs to value their assets marked to market 36

5.2.4.     Policy option 2.4: require
MMFs to value their assets mark to market except in the last three months. 40

5.2.5.     Policy option 2.5: introduce
a NAV buffer for CNAV MMFs financed by MMF's investors  41

5.2.6.     Policy option 2.6: introduce
a NAV buffer for CNAV MMFs financed by the manager 43

5.2.7.     Policy option 2.7: Require
bank-like regulation for CNAV MMFs. 46

5.2.8.     Policy option 2.8: Require
MMF to float their NAV, except when they can demonstrate a sufficient capital
buffer 48

5.2.9.     Policy option 2.9: Ensure
that managers no longer pay for credit ratings. 49

5.2.10.   Impact summary. 50

6..... the
retained policy options and instrument. 52

6.1.    The retained policy options. 52

6.2.    The choice of instrument 53

6.3.    The scope of legislation. 54

6.4.    The impact on retail
investors and SMEs. 55

6.5.    Social impact 55

6.6.    Environmental impact 55

6.7.    Impact on third countries. 55

7..... monitoring
and evaluation.. 56

Introduction

Money Market Funds
(MMFs[1]) serve as an important source of short-term financing for financial
institutions, corporates and governments. In Europe, around 22% of short-term
debt securities issued either by governments or by the corporate sector are
held by MMFs. MMFs hold 38% of short-term debt issued by the banking sector.

On the demand side,
MMFs provide a short-term cash management tool that provides a high degree of
liquidity, diversification, stability of value as well as market-based yield.
MMFs are mainly used by corporations seeking to invest their excess cash for a
short time frame, for example until a major expenditure, such as the payroll,
is due.

MMF, therefore, more
than any other investment fund, represent a crucial link bringing together demand
and offer of short-term money. Due to their central place in the money market,
MMFs are subject to close scrutiny from central banks. Their holdings are part
of the definition of the monetary aggregate M3. With assets under management of
around 1’000 billion Euros, MMFs represent a category of funds that is distinct
from all other mutual funds. The majority of MMFs, around 80% of the assets and
60% of the funds, operate under the rules of the Directive on Undertakings for
Collective Investment in Transferable Securities (UCITS), its implementing acts
and guidelines issues by Committee of European Securities Regulators (CESR) and
European Securities and Markets Authority (ESMA). Because of the systemic
interconnectedness of MMF with the banking sector on the one hand and with
corporate and government finance, on the other hand, MMFs are also subject to a
special set of ESMA guidelines. In addition, the average size of a MMF by far
exceeds the average size of a UCITS fund. For example, an individual MMF can reach
the size of € 50 billion[2].

The issue of
MMFs has been at the core of the international work on shadow banking. The
Financial Stability Board (FSB) and other institutions, such as International
Organization of Securities Commissions (IOSCO) and European Systemic Risk Board
(ESRB) have analysed the financial sector in the course of 2011 and concluded
that certain activities and entities were of systemic importance but had not
been addressed to a sufficient degree. In the asset management sector, MMFs were
singled out, especially those MMFs that maintain a stable share price,
providing the impression that fund holdings are equivalent to a bank deposit.
The above international bodies formulated policy recommendations designed to
help the regulators in tackling certain issues raised by MMF. This impact
assessment analyses the proposed policy tools and assesses their impacts,
taking into account the specificities of the European MMF market. The list of
options discussed in this report aim to address investor runs and the attached
systemic consequences of such runs on the short-term funding for the European
economy.

1. 
PROCEDURAL ISSUES AND CONSULTATION OF INTERESTED
PARTIES
1.1. 
Shadow banking context

The 2008 crisis was
global and financial services were at its heart, revealing inadequacies
including regulatory gaps, ineffective supervision, opaque markets and
overly-complex products. The response has been international and coordinated
through the G20 and the FSB. The European Union has shown global leadership in
implementing its G20 commitments. Overall, the reforms will equip the EU with
the tools designed to ensure that the financial system, its institutions and
markets are properly supervised.

However, there is an
increasing area of non-bank credit activity, called shadow banking, which has
not been the prime focus of prudential regulation and supervision. At the
November 2010 Seoul Summit, the G20 Leaders identified some remaining issues of
financial sector regulation that warranted attention. They highlighted “strengthening
regulation and supervision of shadow banking” as one of these issues and
requested that the FSB, in collaboration with other international standard
setting bodies, develop recommendations to strengthen the oversight and
regulation of the “shadow banking system”. The “shadow banking system” can
broadly be described as “credit intermediation involving entities and
activities (fully or partially) outside the regular banking system”.

The FSB's work
highlighted that the disorderly failure of shadow bank entities can entail
systemic risk, both directly and through their interconnectedness with the
regular banking system. The FSB has also suggested that as long as such
activities and entities remain subject to a lower level of regulation and
supervision than the rest of the financial sector, reinforced banking
regulation could drive a substantial part of banking activities beyond the
boundaries of traditional banking and towards shadow banking.

After the November 2011
G20 Cannes Summit, the FSB has initiated five work-streams tasked with
analysing the issues in more detail and developing effective policy
recommendations. These work streams include: (i) the Basel Committee on Banking
Supervision (BCBS) will work on how to further regulate the interaction between
banks and shadow banking entities; (ii) IOSCO will work on regulation to
mitigate the systemic risks (including run-type risks) of Money Market Funds
(MMFs); (iii) IOSCO, with the help of the BCBS, will carry out an evaluation of
existing securitisation requirements and make further policy recommendations;
(iv) a FSB subgroup will examine the regulation of other shadow banking
entities; and, (v) another FSB subgroup will work on securities lending and
repos. These work-streams bring together the EU and other major jurisdictions
including the US, China and Japan, who are each considering appropriate
regulatory measures.

1.2. 
International work on MMFs

Following a
public consultation of international stakeholders organised during the first
half of 2012, IOSCO published its final recommendations[3] in October 2012.
IOSCO issued a list of 15 recommendations aimed at addressing vulnerabilities
arising from the liquidity side as well as the issue of MMF valuation. These
recommendations serve as a basis for the definition of the options discussed in
this impact assessment. The FSB reviewed the IOSCO recommendations in November
2012 and endorsed them as an effective framework for strengthening the
resilience of MMFs to risks in a comprehensive manner.

The US authorities
decided to engage in a reform of their national market. A first proposal was
discussed throughout 2012 by the Securities and Exchange Commission (SEC) but
the project was finally abandoned in August 2012[4]. The Financial Stability and Oversight Council (FSOC) however
decided to continue the reform and proceeded with the publication of a
consultation[5] in November 2012 indicating the way the US authorities will follow.

The ESRB has decided to
set up an expert group on MMFs during the summer 2012 with the task to analyse
the European MMF market and formalize recommendations for an EU context. The
work started by gathering empirical data in the main EU jurisdictions hosting
MMFs. The recommendations have been finalized in December 2012 and have been
published the 18.02. 2013[6].

1.3. 
Related EU initiatives

The European Commission
will present in the first half of 2013 the key results from the Green Paper on
shadow banking issued in March 2012[7].

The European Parliament adopted a
resolution on shadow banking[8] in November 2012 where it "invites the Commission to submit
a review of the UCITS framework, with particular focus on the MMF issue, in the
first half of 2013, by requiring MMFs either to adopt a variable asset value
with a daily evaluation or, if retaining a constant value, to be obliged to
apply for a limited-purpose banking licence and be subject to capital and other
prudential requirements; stresses that regulatory arbitrage must be minimised;"
The document addresses all the topics related to shadow banking and takes
position regarding the way MMFs should be reformed in Europe.

Related to the specific topic of credit
ratings, the European Parliament adopted the Commission proposal aimed at
reducing the reliance on external credit ratings (CRA III[9]).

1.4. 
Consultation of interested parties

Since the beginning of
2012 the Commission has been engaged in extensive consultation with
representatives from a wide range of organizations. The interaction has taken
the form of bilateral and multilateral meetings[10], one written public consultation on shadow banking, one written
public consultation on asset management issues including MMFs and a public
conference on shadow banking. Through this process the Commission has obtained
a wealth of information about the functioning of the MMF market and its various
segments, as well as views on the issues to be solved and how to solve them. An
important part of this information has been used in the preparation of this
impact assessment.

1.4.1. Consultation on shadow banking

The responses to the Green Paper offered a
broad picture of the European shadow banking sector which permitted to develop
more targeted questions on MMF specific issues for the consultation on asset
management. It was followed by a public conference in April 2012 attended by
stakeholders from the EU and the US. Representatives from the regulator and
industry sides, forming the panel on MMFs[11], presented their views on the need to reform the EU MMF market.

1.4.2. Consultation on asset management

A MMF chapter has been
introduced in a broader consultation on various asset management issues[12] published on 26
July 2012 (it was closed on 18 October 2012). Stakeholders were informed about
the availability of the consultation on the website of DG MARKT through the
publication of a press release[13] and through electronic emails. The Commission services received 56
responses related to the MMF section[14]. All contributions have been thoroughly examined and relevant
information contained in them has been taken into account throughout the report[15].

1.5. 
Impact Assessment Steering Group and IAB

Work on the Impact Assessment started in
August 2012 with the first meeting of the Steering group on 28 September 2012,
followed by 2 further meetings, the last one taking place on 4 December 2012.
The following Directorates General (DGs) and Commission services participated
in the meetings: Competition, Economic and Monetary Affairs, Employment Social
Affairs and Inclusion, Health and Consumers, Industry and Entrepreneurship,
Legal Services, Secretariat General, and Taxation Customs Union. The report with the minutes of the
last steering group were sent to the Impact Assessment Board on 12 December
2012.

DG MARKT services met
the Impact Assessment Board on 16 January 2013. The Board analysed this Impact
Assessment and delivered its positive opinion on 18 January 2013. During this
meeting the members of the Board provided DG MARKT services with comments to
improve the content of the Impact Assessment that led to some modifications of
this final draft. These are:

· 
The problem
definition should provide greater detail on the MMF markets and underpin its
description with further EU examples illustrating, in particular, the
cross-border dimension of the problems.

· 
The report
should better link both the objectives and the options with the identified problems
and present a set of quantifiable operational objectives as a basis for robust
progress indicators.

· 
The report
should better assess the impacts on investors, and should strive to quantify
the compliance costs that the envisaged measures would entail. The impacts on
Member States and on international regulatory coherence should be also
explained.

· 
The report
should systematically present stakeholders views, in particular, in the
sections analysing and comparing the options.

2. 
problem definition

2.1. 
Problem driver: MMFs
offer features equivalent to bank deposits

MMFs are used by
investors to place their cash for short periods of time. They represent a
convenient tool for investors because they offer features analogous to bank
deposits: instantaneous access to liquidity and stability of value. When the
investors perceive that there is a risk that the MMFs may fail to live up to
these promises, they will start to redeem, possibly leading to a so-called
"run".

Investor runs are
characterized by massive and sudden redemption requests by a large group of
investors that want to avoid losses and be able to redeem at the highest
possible price. Investor runs are systemically relevant as they force the MMFs
to sell their assets rapidly in order to meet outstanding redemption requests. The spiral of redemptions itself
accelerates the decline in the fund's net asset value (NAV), thus exacerbating
declines in the NAV and the fear that the money market as a whole is unstable.

The MMF market is concentrated
in a few Member states with FR, IE and LU representing more than 95% of the
market in terms of assets under management. The market is nevertheless highly
interconnected with other countries due to the high proportion of cross border
investments and investors, and the cross border contagion links between the MMF
and their sponsor domiciled in other countries.

2.1.1. MMFs provide daily and unlimited access to liquidity

MMFs may hold
investment assets that may mature in a year or more but issue units or shares
that are redeemable daily on demand. As such, MMFs provide maturity
transformation, but in the absence of appropriate techniques and without any
explicit liquidity backstop, they may have little capacity to satisfy
redemptions once the value of their portfolio assets declines. Due to liquidity
mismatches between the fund's assets and its commitment to provide for daily
redemptions, the fund may be unable to meet all redemption requests, increasing
the tendency toward 'runs' on MMF among investors and thus market instability.

When the MMF is
confronted with redemptions, it will start to sell the most liquid assets which
have the lowest liquidity costs, before being obliged to dispose of less liquid
assets associated with higher liquidity costs when the redemption pressure
increases. Therefore the more the redemption pressure increases, the more the
MMF will sell assets with higher liquidity costs, the more the share price of
the MMF will decrease. Because investors know that there might be such a
mismatch between the asset's liquidity and the liquidity offered to them, they
prefer to redeem as soon as possible in order to profit from the most
favourable liquidity conditions, thus passing the liquidity cost to remaining
investors. This can be seen as a first mover advantage. Investors use MMFs due
to their high liquidity profile and once there are indications those MMFs may
fail to satisfy this criterion, investors prefer to redeem.

The liquidity cost of
an asset is mainly determined by its quality, basically its maturity and its
credit quality. If not properly managed, both factors contribute to the
liquidity mismatch. MMFs invest predominantly in money market instruments
issued by different types of issuers, such as banks, governments and
corporates. These instruments are in general short term and of good quality.
But during stressed market situations, as in 2007 and 2008, these instruments
can be affected by financial turmoil.

In 2007, several EU
funds encountered difficulties following the subprime crisis in the US. These
funds were sold to investors as MMF equivalents even if the majority of them
did not comply with the then prevailing national rules (absence of EU rules in
2007 on MMFs). The problem stemmed from the fact that these "dynamic"
or "enhanced" MMFs were invested in US Asset Backed Securities (ABS),
principally in Asset Backed Commercial Papers (ABCP) which proved to be
illiquid once the crisis started. The ABCPs are backed by different securities
representing different types of assets: student loans, credit card receivables,
auto loans or residential mortgages (including subprime). If there are any
significant negative developments in any of the underlying markets, the quality
and the risk of the ABCP will be affected. The 2007 crisis in the ABCP market,
and subsequently in the MMF market, was linked to a sudden deterioration in
liquidity due to the inability to price ABCP backed by US subprime residential
mortgages. The events listed in Annex 5.1 illustrate the consequences of this
drying up of liquidity on the MMF market. The fact that some MMFs that were
invested in ABS were unable to meet all redemption requests led to investor
runs on other MMFs.

In 2008, EU MMFs were
again confronted to a crisis after Lehman Brothers defaulted which led to MMFs
in several Member States having to face unusual large redemption requests.
Investors lost confidence in the ability of the fund to maintain its daily
liquidity because their investments in money market assets, especially the
commercial paper issued by banks, were turning into increasingly illiquid asset
classes.

Two academic papers[16]
demonstrate the link between portfolio risks and runs: they observe that funds
offering higher yields (thus higher liquidity risk and credit risk of the
assets) prior to the crisis were confronted with larger runs than funds
following a more conservative approach.

2.1.2. 
MMFs offer stability

The fact that MMFs
offer price stability, often accompanied by AAA rating awarded by the credit
rating agencies (CRA), gives the impression to investors that they are
investing in a guaranteed bank-like product.

Price stability: Two closely linked core ingredients make MMFs stand out from the
remaining universe of mutual funds as regulated in UCITS or alternative
investment funds as regulated in the AIFMD.

MMFs, as opposed to all
other investment fund vehicles, are structured as an investment that can be
redeemed at a stable share or unit price. The method to achieve this stable
price is the linearization of the value of investment assets (either for the
entire range of assets or for those that mature in less than three months),
often coupled with sponsor support in case the NAV of the investment assets
deteriorate beyond a certain point.

Because MMFs are
allowed to price investment assets using the amortized cost method, they avoid
the fluctuations inherent in valuing a financial asset. This valuation method
allows the MMF managers to linearize the value of the investment assets over
their lifecycle, thus maintaining a stable price for the assets. On the other
hand, a classic investment fund, not using amortized cost, uses the market
value of the assets to price its portfolio, thus the NAV of the fund fluctuates
in line with the market value of the underlying assets. Analysing the role that
amortised cost accounting plays in a MMF does not call into question the
overall usefulness of this accounting method for the remainder of the
investment fund universe. What is at issue in this impact assessment is whether
amortised cost, coupled with the promise of a stable share price, creates a
situation where MMFs are particularly prone to sponsor support.

The fact that investors
almost never observe movements in the NAV of their funds reinforces their
expectation to have invested in a guaranteed product whose share price will
always be stable. The stability of price contributes to the wide-spread
investor perception that MMFs are equivalent to risk-free cash equivalent bank
deposits. In stressed market conditions, investors begin to realise that MMFs
might not live up to this stability expectation and for the first time might
experience the loss of value of their shares. This realisation, coupled with
the wish not to lose money, reinforces the incentive to redeem as soon as
market stress begins to appear.

The use of amortized
cost is used at different degrees in Europe, some countries allowing the use of
this method for the entire portfolio and some others allowing it only for those
assets in a portfolio that mature in less than three months. The MMFs using this
method for their entire portfolio are usually called Constant NAV (CNAV) funds
because their price never fluctuates. The funds using the amortized cost only
for a proportion of their portfolio are usually called Variable NAV (VNAV),
because their share price is subject to fluctuation.

The fact that the price
of the CNAV MMFs never fluctuates and that the majority of CNAV MMFs maintain a
stable NAV at €1 or $1 per share issued by rounding the market value of their
shares to the nearest cent, further reinforces investors' perception to have
invested in a deposit-like (guaranteed) product. In addition, the providers of
such funds clearly state in their marketing material that the objective of
their funds is to preserve the capital[17]. Even if this guarantee is normally only "implicit",
investors in such MMFs often expect the sponsor to unconditionally support the
MMF to maintain its stable NAV, creating an ultimately false expectation in the
market that such investments are in a "guaranteed" vehicle. This
triggers false incentives and exacerbates runs once investors realise that
either there is no sponsor support after all or that sponsor support will be
too little, too late to prevent the MMF from "breaking the buck".

When the market value
of the fund's shares declines to € 0.9950, this situation is called
"breaking the buck" (breaking the dollar or breaking the euro)
because the fund must decrease its NAV from €1 per share to reflect current
market value. According to CESR guidelines[18], a MMF should avoid situations where discrepancy between the market
value and the value resulting from amortized cost accounting becomes material;
otherwise the MMF can no longer issue and redeem units at the stable price. In
the case of a fund that redeems all shares at €1, the permitted level of
material discrepancy is usually set at 0.005 cents, an amount equivalent to the
difference between €1 and €0.9950[19]. This means that the NAV will always be maintained at €1 or $1 as
long as the value of the fund's shares remains between 0.9950 and 1.0050. When
there is a material discrepancy between the market value and the rounded share
value, the fund is obliged to lower its NAV to reflect the current market value
of its portfolio.

In fact this rarely
happens because the sponsors step in to provide support: the sponsor will pay
for maintaining the difference between the stable value of €1 and the market
value at a level that becomes not material. The support may take different
forms, such as providing cash injections, liquidity facilities in the form of
loans or by buying units of the fund at a price higher than the market price.

Such an event occurred in 2008 in the US when the
Reserve Primary Fund was unable to maintain its stable NAV after Lehman
defaulted (the fund held assets issued by Lehman). During the week following
this event, the investors withdrew money amounting to 300 billion USD or 14% of
total US MMF assets out of a fear that other sponsors would not be able to
maintain the stable price[20]. In fact the outflows directly following the collapse of the
Reserve Primary Fund were more than two times larger than the initial outflows
triggered by the Lehman collapse. This tends to prove that the absence of
sponsor support is in itself a cause of runs. The European CNAV MMFs were also
affected by massive redemptions. According to data collected from the IMMFA
organization[21], the CNAV MMFs encountered redemptions amounting to 25% of their
total assets in a very short time period. Witmer, 2012, finds that CNAV funds
“are more likely to experience sustained outflows” and that these outflows
“were more acute during the period of the run on the Reserve Primary fund”. He
also notes that: “consistent with the theory that
constant NAV funds receive additional implicit support from fund sponsors, fund
liquidations are less prevalent in funds with a constant NAV following periods
of larger outflows”.[22] According to his findings, the outflows from European CNAV largely
surpassed the outflows from European VNAV in September 2008.

AAA rating of
funds: Credit
ratings play a key role in MMFs as both the fund and the assets in which the
fund invests may be rated. At the level of the fund, certain MMFs require the
highest possible note, AAA, in order to comply with the industry code of
practice[23]. AAA ratings create wrong expectations to investors that they are
investing in a guaranteed product which, in turn, leads to runs when the CRA
decides to put the AAA note on negative watch or to downgrade it. In addition,
the methodology used by the different CRAs creates ambiguities regarding the factors
taken into consideration for assessing the quality of a MMF. Basically S&P
rating relates to credit risk of the MMFs investment assets, Moody's to credit
and liquidity risk associated with these assets while Fitch's evaluates credit
and liquidity risk of the assets plus an additional assessment of the
likelihood of sponsor support. Therefore the ratings cannot be used
interchangeably as they do not refer to the same analysis.

The fact that one CRA
takes into consideration the ability of a sponsor to support their MMF also
creates wrong expectations. Investors may be reinforced in their belief that
they invest in a product that will be guaranteed whatever happens. When three
funds from Prime Rate Capital Management (PRCM), belonging to the UK based Matrix
group, were put on negative watch by Fitch in December 2011, they experienced
very high levels of redemptions in just 2 weeks: -50% for their Sterling fund,
according to IMMFA[24]. Matrix Group had over £4 billion of assets that were offered to
retail and institutional clients.

2.2. 
Problems

The problems linked to
investor runs are of a systemic nature due to: (1) MMFs close links to the real
economy (the role that MMFs play in satisfying the short-term financing needs
of entities using the money market as a funding tool), (2) their link to
sponsors. In addition, runs on MMF also have an investor protection angle,
since those that redeem late (usually private investors) are at an inherent
disadvantage when compared to early redeemers.

2.2.1. 
Contagion to the real economy

The liquidity level of
the funds has proven during the crisis not to be of a sufficient level which
led some funds to suspend redemptions or to use other restrictions. In 2007, it
is estimated that around 15 MMFs in the EU had to close, to suspend redemptions
or to apply haircuts on the valuation of their MMF. In 2008, some EU MMFs were
again obliged to suspend redemptions due to their inability to satisfy all
redemption requests while others chose to decrease the NAV of their MMF[25].

Depriving investors of
their short-term MMF investments may have repercussions on other entities that
rely on short time finance through MMF. As mentioned above, in Europe, around
22% of short-term debt securities issued either by governments or by the
corporate sector are held by MMF and MMF hold 38% of short-term debt issued by
the banking sector. The economy is therefore highly interconnected with the MMF
sector. This problem has a strong internal market angle since the investments
of the MMF are largely performed on a cross border basis, as evidenced in Annex
3.3. This is particularly true for the MMFs domiciled in IE and LU (less than
3% of the MMF’s assets domiciled in those two countries are invested
domestically according to the ESRB survey). A problem arising on a MMF domiciled
in a specific country could then rapidly affect the financing of entities
domiciled in other countries. The Reserve Primary failure illustrates this
cross border contagion: a US MMF caused a severe liquidity crisis affecting the
European MMFs and thus the European issuers of short term debt.

Because MMFs play a
central role in the short term funding of entities like banks, corporates or
governments, investor runs on MMFs may cause broader macroeconomic
consequences. During the financial crisis of 2008, MMFs were forced to sell
some of their investment assets in a declining market, fuelling a liquidity
crisis. In addition, managers of MMFs were obliged to put aside enough cash
resources in order to meet increased redemption requests. This prevented them
from investing in short term securities, or restricted them to investing only
in ultra-short term securities. In these circumstances, money market issuers
faced severe funding difficulties with respect to longer term debt. The markets
for longer-term commercial paper to be issued to MMF essentially dried up.
While financial institutions (mainly banks) account for the largest part
(around 85%) of the 1'000 billion EUR issued to MMFs, governments represent a
share of around 10% whereas corporates account for roughly 5%. Governments and
very large corporates use the money market as a means to obtain short term
financing, alongside bank credit lines. Any contagion to the short term funding
market could then also represent direct and major difficulties for the
financing of the "real economy".

In addition to this
system-wide event, an isolated event can also generate systemic implications.
When an AAA rated fund is confronted with a negative watch or a downgrade, this
can precipitate large redemptions. For example when Fitch Ratings placed three
Prime Rate Capital Management (PRCM) funds on negative watch rating, the PRCM
funds suffered significant redemptions, 50% in the case of its Sterling fund[26] 
A  single rating decision may have consequences for the whole money market.
Because the fund must sell its assets very quickly, a change in a single fund's
rating may provoke a general price decline in money market instruments. A run
on a fund with a larger size than the PRCM (the biggest EU fund has more than
€50 billion in assets under management) confronted with the same events could
have larger systemic implications, as described in the previous paragraph.

Another
aspect relates to the rating of the assets in which the MMFs invest. In order
to keep their AAA rating and avoid investor's runs, MMFs will invest only in
very high quality instruments that benefit from the highest possible rating.
Therefore once an issuer of money market instruments is put on negative watch or
downgraded, MMFs will sell these instruments as quickly as possible, out of a
fear that holding such 'downgraded' instruments may endanger the MMFs own AAA
rating. These fire sales may have grave consequences for the downgraded issuer
because its access to the money market funding may suddenly close, which may
affect its viability.
2.2.2. 
Contagion to sponsors

Under the heading of
sponsor support, this impact assessment will discuss contagion risks with
respect to two types of sponsors: asset managers or banks.

An MMF can be sponsored
either by an asset manager or by a bank. In case one MMF in a portfolio
encounters problems in terms of liquidity or the NAV, this could have
repercussion on the own funds of an asset manager or those of the sponsoring
bank. MMFs have historically relied on discretionary sponsor capital[27]
to maintain their NAV. In the case of CNAV, MMF sponsors may decide to provide
support in order to avoid 'breaking the buck'. Sponsors are often forced to
support their sponsored MMFs out of fear that their MMF is 'breaking the buck',
due to the reputational risk, may trigger a panic that could spread into the
sponsor other businesses. For bank sponsors, the risk is even more acute
because the panic could spread to the bank's retail client base which in turn
could lead the bank to default.

Sponsors are largely
unprepared to face such situations because the "implicit" guarantee
is not recorded as an explicit guarantee that would require the build-up of
capital reserves. Because banks do not build capital reserves directly linked
to their exposure to the risk of MMFs, , sponsor support may reach proportions
that exceed their readily available reserves, depending on the size of the fund
and the extent of redemption pressure. This, in turn, may provoke the failure of
the sponsor and risk contagion to other entities that sponsor MMF. Because most
of the sponsors in Europe are banks, it may create a contagion channel to the
whole banking sector if one bank were to face funding difficulties due to the
support provided to the MMF. As an example (Annex 5.2), European banks such as
Société Générale, Barclays or Deutsche Bank, made losses linked to their MMF
activities amounting to hundreds of millions of Euros. The exact magnitude of
the sponsor support is however difficult to estimate due to the lack of
communication from the sponsors.

Because MMFs and
sponsors are rarely domiciled in the same country, the sponsor support creates
cross border contagion channels. For example none of the sponsors of the MMFs
domiciled in IE and LU are domiciled in those jurisdictions.

The importance of
sponsor support can also be demonstrated by looking at the counterfactual; i.e.
the absence of sponsor support. In this case the balance sheet of the asset
manager may be largely insufficient for providing the support. The largest
sponsors manage over €250 billion in MMF assets worldwide while in some cases
their readily available cash in their balance sheet amount to only a few
hundred millions[28]. The example of the
Reserve Primary Fund is revealing: the manager announced that it will support
the fund with its own money, and actually did so until it lacked the resources
to continue redeeming all shares at $1. The sudden drying up of sponsor support
led the CNAV MMF to break the buck, which created the run and finally led to a
liquidation of the fund.

There is large evidence
that European CNAV MMFs benefited from sponsor support during the crisis. The
sponsor support has not been absent for VNAV MMFs during the crisis but
suspension of redemption and NAV decreases were used more widely than sponsor
support. In contrast to CNAV MMFs, VNAV MMFs do not need NAV support (i.e. loss
absorption). The motivations behind the sponsor support to VNAV were, according
to market participants that gave support, to indemnify clients in order to
avoid complaints about mis-selling practices.

Because the sponsor
support is so important for the ability of a MMF to maintain its stable price,
the quality of the sponsor has become a decisive criterion in the investment
choice of investors. According to a survey[29] made by Fitch
Ratings, 80% of the European treasurers that have been consulted consider the
financial standing of the sponsor when selecting a MMF. According to McCabe
(2010) a factor influencing the runs is the credit risk of the sponsor. McCabe
notices that sponsors with higher credit default spreads (measure of credit
risk) were encountering larger outflows. In some cases MMF run by asset
managers can be put at a disadvantage in comparison to a MMF run by banks.
Because banks have to comply with minimum capital requirements and have much
larger balance sheets than asset managers, investors have a tendency to switch
to bank sponsored MMFs when a crisis arises, further increasing the redemption
pressure on MMFs run by asset managers. In other cases, as highlighted by
Gordon (2012), the banks can be put at a disadvantage in comparison to asset
managers: during the 2008 crisis, when there was a complete loss of trust in
the US banking system, MMFs run by US banks were suffering larger outflows than
MMFs run by pure asset managers. This shows that there is a complete shift in
investor behaviour: instead of looking at the portfolio risk and reward profile
of the fund, they look at the sponsor ability to support the fund.

This is also
illustrated by the reasons advanced by Fitch after it changed its opinion on
PRCM funds, MMFs run by an asset manager. A statement from Fitch says: “The
sponsor’s financial resources are no longer consistent with a ’AAAmmf’ rating,
even after taking into consideration the funds’ conservative investment
guidelines.”[30] This rating agency puts
the emphasis on the financial strength of the sponsor instead on the intrinsic
risks of the portfolio. This indicates a clear shift that AAA rated MMFs (CNAV
MMFs) are no longer considered as classic investment funds but rather as bank
guaranteed products. The fact that a larger sponsor, Federated Investors,
announced during the week following the negative watch that it will buy the
manager of PRCM funds calmed investors who stopped their redemptions. Fitch
reaffirmed its earlier rating on that basis. While not downgraded, the MMFs
owned by the asset manager Henderson Global Investors have been sold to
Deutsche Bank in 2010 because the manager did not want to bear any longer the
risk attached to the "implicit" guarantee given to investors[31].
These events give evidence that small asset managers have difficulties to
provide the necessary guarantees for maintaining a stable share price.

Potential contagion
channels induced by MMFs

2.2.3. 
Early redeemers are advantaged over late
redeemers

The first mover
advantage creates a situation where late redeemers have to bear the costs
associated with early redemptions. There is thus a transfer of money from late
redeemers to early redeemers. In the case of VNAV funds, the cost of the
redemption generally amounts to the difference between the price at which the
fund sells the assets (the bid price) and the price at which the investor gets
redeemed (the mid-price). The difference between the bid price and the
mid-price is usually very low but tends to increase during stressed market
conditions. In the case of CNAV funds, the cost of the redemption may represent
a substantial disadvantage for the late redeemers because the difference
between the market value and the €1 price is usually higher[32].

The transfer of money
for CNAV funds is well illustrated by the following example, provided by
Chairman Shapiro in her testimony before the US senate, June 21, 2012:
"Assume, for example, a fund with 1,000 shares outstanding with two
shareholders, A and B, each of which owns 500 shares. An issuer of a security
held by the fund defaults, resulting in a 25 basis point loss for the fund—a
significant loss, but not one that is large enough to force the fund to break
the buck. Shareholder A, aware of a problem and unsure of what shareholder B
will do, redeems all of his shares and receives $1.00 per share even though the
shares of the fund have a market value of $0.998. The fund now has only 500
shares outstanding, but instead of a 25 basis point loss has a 50 basis point
loss and will have broken the buck. Shareholder A has effectively shifted his
losses to Shareholder B."

What the above example
shows is that the early redeemer, A, by taking out 500 shares at $ 1 has taken
the full value of its shares, thereby shifting all the losses onto the
remaining investor who now has to bear all of the loss when redeeming the
remaining 500 shares. In addition the late redeemers may have to support additional
inconvenience when the redemptions are temporarily suspended or even worse when
the fund is liquidated after having broken the buck. The access to the
liquidity is then stopped for the investor.

Another detrimental
effect affects the retail investors in particular. Studies demonstrate that
institutional investors are first to redeem as soon as stress appears in the
markets, often leaving retail investors to bear the losses. During the 2008 US MMF
crisis, redemptions were almost exclusively requested by institutional
investors because they often possess superior knowledge of the market and have
greater capacities and resources to react quickly, often on the basis of
insight that is not yet available in the public domain[33].

2.3. 
Consequences
2.3.1. Financial stability and bail-out risk

Because the money
market and sponsors are systemically relevant, investors may expect that, once
sponsors are unable to support the stable NAV of their MMFs, governments would
intervene and take the sponsors' place in providing financial assistance to
MMFs. Following the Reserve Primary Fund breaking the buck, the US authorities
had to provide unlimited guarantees in order to stop contagion. Once the US
authorities announced that they would guarantee the $3 trillion of money
invested in MMFs, the market calmed down and redemptions stopped. Without the
support of the US government, the US MMFs would have continued to suffer from
large redemptions[34].

The public authorities
in Europe had also to step in to stop the contagion. Germany (DE) passed a law
to stabilize the market with a specific article dedicated to the support of
short-term instruments[35] accompanied by the
intervention of their central bank. Luxembourg (LU) announced that it would
take all necessary steps needed to stabilize the national money market funds[36].
In addition, the European industry pushed the ECB to grant liquidity support to
MMF or their sponsors. Instead, the ECB decided to reduce the liquidity
pressure by lowering interest rates and by broadening the scope of eligible
collateral for banks (including usual money market instruments such as non-Euro
marketable debt instruments and certificates of deposit traded on non-regulated
markets).

The different reactions
from the European entities were not conducive to enhance the stability of the
European market as a whole. The fact that the DE authorities guaranteed their
national MMFs had consequences on other countries. The DE guarantee resulted in
flows from LU domiciled funds into DE domiciled funds, which led the LU authorities
to make an equivalent declaration. Ireland (IE) also experienced immediate
problems after the DE and LU announcements but the sentiment cooled down when
the ECB intervened.

2.3.2. Insufficient investor protection

MMFs are most of the
time not used for long periods of time but only for short period of time when
the investor wants to place its excess cash for a few days or a few weeks. If
the fund suspends redemptions for a few days or few weeks, this can put in
danger the cash management process of the investor. In the case of a corporate
using MMF to place their cash, a suspension can lead to the inability to
perform the planned operational expenditures such as paying salaries. The
consequences attached to liquidation may be extremely disruptive for the investor
since redemptions will remain suspended for a potentially very long period of
time and the precise amount recovered in the end will remain uncertain for an
equally long time. The viability of an investor having a substantial part of
their cash invested in a liquidated fund would then be put into question.

2.4. 
How would the problem evolve without EU action?
The base line scenario

Rules governing MMF are
currently scattered throughout different pieces of legislation, some taking the
form of EU directives, some the form of guidelines developed by CESR and some
the form of purely national legislation[37]. If no action
is taken to create a legislative framework applicable to MMFs, it is very
likely that the problems that have been identified will persist and could be aggravated
by future market developments.  Should investors be confronted to a new crisis
affecting MMFs, they may decide to definitely stop using MMFs, thus endangering
the existence of the money market and the issuers relying on it. Current rules
are inherently insufficient to address an issue that has such a systemic impact
for the whole EU. The EU is best placed to ensure a coherent response (please
refer to Annex 7.4 for a discussion of other alternatives).

The MMFs
would remain unprepared to face stressed market situations that are likely to
reoccur in the future. The liquidity level might still not be sufficient to
meet all redemption requests and the incentives to redeem first will still be
present. Overall the contagion channels will persist, continuing to represent a
threat for the European banking system and for the entities using the money
market as a financing tool. The responses from the EU national authorities to a
future crisis might still diverge to a large extent (e.g. by providing different
levels of State guarantee in an uncoordinated manner), endangering the
viability of the single market. The base line scenario is further developed in
sections 5.1.1 and 5.2.1.

Action is required now
to ensure harmonization of the EU law with the recommendations of the
international organizations and the rules already applied in other
jurisdictions. IOSCO, FSB or ESRB have finalized their conclusions and they
recommend a new regulatory framework for MMFs. Europe also needs to align its
rules with the higher standards that are already implemented in other
jurisdictions, as the ones on liquidity implemented in the US. There is also a
need to move forward by engaging the debate surrounding the issues linked to
the stability, as the US did with the publication of the FSOC recommendations[38].

2.5. 
Subsidiarity and proportionality

According to the
principle of subsidiarity (Article 5.3 of the TFEU), action on EU level should
be taken only when the aims envisaged cannot be achieved sufficiently by Member
States alone and can therefore, by reason of the scale or effects of the
proposed action, be better achieved by the EU. The aim of the proposal is to
ensure a level playing field across Europe among the different operators that
offer MMFs.

On account of their
systemic importance to finance sectors of the EU economy, the aim is also to
create a robust framework covering MMF as an essential source of short-term
financing for the European economy. As shown in this impact assessment, when
MMFs are confronted with large-scale redemption requests, the markets for
commercial paper to be issued to MMF can quickly dry up. Issuers depend on MMFs
as a financing tool and are evenly located throughout the EU. Governments and
very large corporate use the money market as a means to obtain short term
financing, alongside bank credit lines. Any contagion to the short term funding
market could then also represent direct and major difficulties for the
financing of the European "real economy".

In addition, as many
operators that offer MMFs in Europe are domiciled in Member States other than
those where the funds are marketed, the creation of a robust framework is
essential to avoid cross-border contagion between a MMF and its sponsor. This
is especially acute when the sponsor is located in a Member State that may not
have the budgetary resources to bail out a defaulting sponsor. As MMF are
predominantly domiciled in two EU jurisdictions (IE and LUX), both
jurisdictions in which no sponsor banks are domiciled, the cross-border
dimension of sponsor support becomes acute.  The cross border dimension is
further illustrated by the high proportion of non-domestic MMF investors in
certain countries (IE and LU) as well as the high proportion of investments in
money market instruments issued in other Member States.

By harmonising the
essential product features that constitute a MMF the proposal aims to establish
a uniform level of investor protection. Detailed rules on the daily or weekly
liquidity of assets held by a MMF, the accounting methods used to calculate the
NAV of money market instruments held in a fund, the calculation of a share
price, possible additional requirements on those offering a stable NAV,
policies on issuer concentration and 'know-your-customer' policies to
anticipate large-scale redemptions are examples of measures that would require
a uniform application across the EU in order to ensure their full effectiveness.
Individual action at Member State level would lead to confusion on the key
features of a MMF, its liquidity and the stability of its share price.
Uncoordinated action at national level also risks that Member States define
different liquidity ratios, different limits on issuer concentration and
different methods on how to calculate the NAV and the share price applicable
for redemptions. If each of these items were addressed in a different manner at
national level, the risk of runs and cross-border contagion between a MMF and
its sponsor would not be addressed effectively; especially when the issuers and
the MMFs are located in different Member States. As MMF invest in a broad range
of financial instruments across the EU, the failure of one MMF (for example due
to insufficient regulation at national level, evidenced by the uneven
implementation of the ESMA guidelines) would have repercussions on government
and corporate financing across the EU.

National regulatory
approaches are inherently limited to the Member State in question. Regulating
the product and liquidity profile of a MMF at national level only entails a
risk of different products all being sold as MMF. This would create investor
confusion and would impede the emergence of a Union wide level playing field
for those who offer MMF to either professional or retail investors. Therefore,
action at European level is needed.

All of the
above-mentioned product requirements are currently not part of existing UCITS
rules. Although UCITS rules contain requirements on the investment instruments
eligible to a UCITS funds, rules on measuring leverage and fund exposure as
well as detailed rules on the operation of UCITS managers, the specific product
profile of MMF –as described above – are not yet covered by the UCITS single
rule book. Nevertheless, and in order not to introduce regulatory divergences
in the harmonised UCITS universe, any update of the UCITS rules to account for
the special features of MMFs must be undertaken at European level as well. In
addition, and in order to avoid regulatory arbitrage, MMFs that are not covered
by the UCITS rules must also be included in the creation of a uniform rule-book
on the MMFs at European level.

The options analysed
below will take full account of the principle of proportionality, being
adequate to reach the objectives and not going beyond what is necessary in
doing so. Whenever possible we have ensured that the retained policy options
are compatible with the proportionality principle, taking into account the
right balance of public interest at stake and the cost-efficiency of the
measure. The requirements imposed on the different parties have been carefully
calibrated. Whenever possible, requirements have been crafted as minimum
standards (e.g., daily or weekly liquidity, issuer concentration limits) and
regulatory requirements have been tailored so as not to unnecessarily disrupt
existing business models (e.g., providing for appropriate transitional periods
before the NAV of a MMF has to be floated or leaving operators the choice
between stringent capital requirements and floating the NAV of their MMF). In
particular, the need to balance investor protection, avoidance of cross-border
contagion, efficiency of the markets, the financing of the European industry
and costs for the industry have all been balanced in laying out these
requirements.

3. 
objectives
3.1. 
General, specific and
operational objectives

In light of the
analysis of the risks and problems above, the general objectives are to:

(1) Enhance financial
stability in the internal market;

(2) Increase the
protection of MMF investors

Reaching these general
objectives requires the realisation of the following more specific policy
objectives:

(1) Prevent risk of
contagion to the real economy;

(2) Prevent risk of
contagion to the sponsor;

(3) Reduce the
disadvantages for late redeemers, especially with respect to redemptions in
stressed market conditions.

The specific objectives
listed above require the attainment of the following operational objective:

(1) Ensure that the
liquidity of the fund is adequate to face investor's redemption requests. This
objective will be measured against the level of liquidity reached by the MMFs.
This is linked to the natural liquidity that is independent from the secondary
market constraints, and to the quality of the assets. A MMF with enhanced
liquidity facilities and a portfolio of better quality will be able to face
more effectively the redemption requests.

(2) Transform the
structure of MMF so that the stability promise can withstand adverse market
conditions. The structure of the MMF offers stability through three main
aspects: the marketing material that promises a guarantee when this is not the
case, the sponsor support for maintaining the NAV and the AAA rating that gives
a false sense of security. According to these three features, this objective
will be measured against three criteria: change in marketing materials, reduced
events of sponsor supports and absence of massive redemptions following a
rating downgrade.

3.2. 
Consistency of the objectives with other EU
policies

The identified
objectives are coherent with the EU's fundamental goals of promoting a harmonised
and sustainable development of economic activities, a high degree of competitiveness,
and a high level of consumer protection, which includes safety and economic
interests of citizens (Article 169 TFEU).

3.3. 
Consistency of the objectives with fundamental
rights

The legislative
measures setting out rules for the provision of investment services and activities
in financial instruments, including sanctions need to be in compliance with
relevant fundamental rights embodied in the EU Charter of Fundamental Rights
("EU CFR"), and particular attention should be given to the necessity
and proportionality of the legislative measures.

The following
fundamental rights of the EU Charter of Fundamental Rights are of particular relevance:

• Freedom to conduct a
business (Art. 16)

• Consumer protection
(Art. 38)

Limitations on these
rights and freedoms are allowed under Article 52 of the Charter. The objectives
as defined above are consistent with the EU's obligations to respect
fundamental rights. However, any limitation on the exercise of these rights and
freedoms must be provided for by the law and respect the essence of these
rights and freedoms. Subject to the principle of proportionality, limitations
may be made only if they are necessary and genuinely meet the objectives of
general interest recognised by the Union or the need to protect the rights and freedoms
of others.

In the case of the fund
legislation, the general interest objective which justifies certain limitations
of fundamental rights is the objective of ensuring the market integrity and
stability. The freedom to conduct a business may be impacted by the necessity
to follow the specific objectives of ensuring sufficient liquidity, preventing
the risk of contagion and enhancing safeguarding of investor's interests. We
have focused our assessment on the options which might limit these rights and
freedoms. The proposed new rules will overall reinforce the right to consumer
protection (Art. 38), whilst respecting the fundamental rights and observing
the principles recognised in the Charter of Fundamental Rights of the European
Union as enshrined in the Treaty on the Functioning of the European Union.

4. 
policy options

In order to meet the
first operational objective, the Commission services have analysed a total of
seven different policy options. For ease of reference, these options are
grouped into different headings, such as options on redemption restrictions,
options on liquidity policies and options on MMF 'customer profiling'.

Policy options || Summary of policy options

1.1. No action || Take no action at EU level

Redemption fees and restrictions

1.2 Impose a hold back period for a proportion of the redemption order || MMFs would split the redemption in two phases. The investor would be able to redeem a substantial part (e.g., 95%) without restriction but would have to wait some time to receive the balance (5%). The held-back amount would serve to absorb any losses that may have occurred during the period.

1.3 Impose a liquidity fee || MMF managers may decide to implement a liquidity fee on redeeming shareholders during stressed market conditions. The fee would be based on the mark to market NAV.

1.4 Redemption in-kind || Under this option, the managers may decide to pass the liquidity cost of the redemption to the investor, by transferring the securities directly to the investor instead of the cash. This system would be applied to large redemption requests.

Increase the liquidity of portfolio assets

1.5 Set minimum liquidity thresholds for overnight and weekly maturing assets || MMFs would be obliged to hold minimum amounts of assets maturing overnight and in one week. This would allow the fund to have almost certain access to minimum amount of cash on regular basis.

1.6 Enhance the quality of the portfolio || MMFs would be obliged to ensure a high level of diversification by limiting the exposure to one single counterparty to 5% of the portfolio assets. In addition the exposure to certain ABS products will be prohibited.

Implement a "Know your shareholders" policy

1.7 MMF managers should develop policies to anticipate large redemptions || MMFs would have to adopt policies and procedures aimed at ensuring better knowledge of their customer base. This would allow better monitoring and anticipation of large redemption requests.

Options
1.2, 1.3 and 1.4 are mutually exclusive.

In order to meet the second operational objective, the Commission
services have analysed a total of 9 different policy options. For ease of
reference, these options are grouped into different headings, options on the
transparency, valuation of MMF assets, on capital buffers and bank status and
an option on rating.

Policy options || Summary of policy options

2.1. No action || Take no action at EU level

Increase transparency

2.2 Increase transparency toward investors || The managers of MMFs would be required to clearly state in their marketing material that their product does not benefit from any kind of guarantee.

MMF valuation methodology

2.3 Require all MMFs to have a fluctuating NAV: impose a full mark to market method and prohibit any method based on ‘rounding’ NAV or share prices. || MMFs would not be allowed to price their shares at a stable €1 per share net asset value (NAV). In order to convert to a floating NAV, two changes are necessary. First the amortized cost methodology should not be allowed anymore but the use of the mark to market methodology should be mandated for valuing all assets. The second change consists of requiring funds to publish their NAV at the detail of 1 basis point. This measure would stop the rounding method which permits MMF to publish a NAV of €1 when the true NAV could vary anywhere between 0.9950 and 1.0049.

2.4 Require all MMFs to have a fluctuating NAV:  impose a full mark to market method except in the last 3 months and stop the rounding method || The MMFs would not be allowed to use price at a stable € 1 per share but could still value their assets at amortized cost, as long as the latter have a remaining maturity of less than 3 months. For all other assets, the use of the mark to market method would be mandated. As under option 2.2, the detail of the NAV should go to 1 basis point in order to avoid rounding.

NAV buffers

2.5 Introduce a NAV buffer for CNAV MMFs financed by investors || MMF that offer price stability would be obliged to create a fund-level reserve as a potential backstop against falls in the 'real' or 'shadow' NAV. The reserve would be drawn upon if losses on assets caused the MMF NAV to deviate from the redemption price of the CNAV (€1). The financing by investors would require retention of a portion of the MMF income to fund the NAV buffer.

2.6 Introduce a NAV buffer for CNAV MMFs financed by the manager || As option 2.5 but the buffer would be funded by the MMF manager itself.

Conversion to a bank status

2.7. Require bank-like regulation for CNAV MMFs || CNAV MMFs would have to reorganize as special purpose banks and be subject to banking oversight and regulation. This would lead MMFs to adopt bank-like capital reserve requirements and grant them access to central bank refinancing.

Valuation methodology or capital buffers

2.8 Require MMF to float their NAV, except when they can demonstrate a sufficient capital buffer || Managers of CNAV MMFs would be required to float the NAV of their fund (option 2.3) or, if they prove to their regulator that they have built a 3% NAV buffer, they would be authorized to continue using CNAV MMFs (option 2.6).

Ratings

2.9 Ensure that the MMF manager no longer pay for credit ratings at fund level || Under this option, managers will be prohibited from paying CRAs to award a rating on their funds

Groups
of options (2.3-2.4), (2.5-2.6), 2.7 and 2.8 are mutually exclusive as are
sub-options 2.3 against 2.4 and 2.5 against 2.6..

5. 
analysis of impacts

This section sets out
the advantages and disadvantages of the policy options, measured against the
criteria of their effectiveness in achieving the specific objectives (prevent
risk of contagion to the money market, to the sponsors and create equitable
treatment for all MMF investors) and their efficiency in terms of achieving
these options for a given level of resources or at lowest cost. Impacts on
relevant stakeholders and their views (see the text boxes) are also considered.
The retained policy options should score the highest for each related specific
objective while at the same time have the least costs and least impacts on
stakeholders.

5.1. 
Options aimed at ensuring that the liquidity of
the fund is adequate to face investor's redemption requests
5.1.1. 
Policy option 1.1: take no action at EU level (baseline scenario)

The baseline scenario
for this set of options means that there will be no changes to all of the rules
that are currently governing the liquidity of the MMFs. These rules are mostly provided
by the CESR guidelines on MMFs which apply to all European funds that market
themselves as MMF. These guidelines have limited the maturity of the assets in
which the MMFs can invest and introduced maximum levels for the weighted
average life (WAL) and weighted average maturity (WAM) of the MMF portfolio.
These measures reduced the sensitivity of the MMFs to market risk which in turn
increased the global liquidity of the European MMFs.

However these
guidelines may not suffice to prevent large outflows in stressed market
conditions because investors would still have an incentive to redeem in order
to profit from the best conditions. In addition the secondary market of the
money market instruments might still suddenly dry up, leaving no other possibilities
to the fund than suspending redemptions. Suspensions are used by managers as a
last resort, after they have explored all other possibilities. Taking no
further action would imply that the funds would not be provided with
intermediary tools that could prevent immediate recourse to suspensions. This
would leave the problems of contagion and unfair treatment of investors
completely unaddressed.

The results from the consultation highlight the need (expressed by
the majority of the stakeholders from the MMF industry) to increase the
liquidity level of assets held in MMFs. Some managers, from the FR market;
consider that the liquidity should be enhanced for CNAV funds only while
others, predominantly from DE, consider that no additional rules are needed.

Redemption fees
and restrictions

The three following
options are aimed at reducing the redemption pressure by acting on the investor
side, by reducing some of the liquidity features of MMFs. The three possible
measures are discussed in the IOSCO recommendation 10.

5.1.2. 
Policy option 1.2: Impose a hold back period
for a proportion of the redemption order

Impact on
financial stability: By retaining a portion of
the redemption order (the 'hold-back'), the MMF keeps the possibility to adjust
the redemption price downwards, at least on the amount withheld at redemption.
This provides the MMF with some flexibility to revalue assets should the value
of its assets decline after fulfilling the main part of a redemption order. The
aim of this option would be to cause shareholders that redeem early to more
fully bear the costs of their early redemption – essentially by requiring that
they remain exposed to potential decreases in the NAV of the fund for some
period after their initial redemption has been fulfilled. MMF shareholders
would then be required to internalize the liquidity costs created by their
redemptions which would lessen their incentive to engage in a run. Because the
hold-back would apply irrespective of market conditions, it has the advantage
of addressing the liquidity issue in all market conditions.

Both the level of the
hold-back amount and the length of the hold-back period are critical for
correctly assessing potential impacts of this option on financial stability. A
hold-back amount set at a high level would fulfil its objective of reducing run
risk but could prove disruptive for investors. On the other hand, a hold-back
amount that would minimize the impacts for the investors could be less
efficient in tackling the run risk. The same principle applies to the length of
the hold-back period; the longer this period, the higher the negative impacts
for the investors. On the other hand, a longer hold-back would better address
liquidity bottlenecks.

Impact on MMF
investors: The main drawback of this option is
that it would impose redemption restrictions on MMF investors. This result
would appear counterintuitive as MMFs have always been associated with high
degree of liquidity; ease of redemption indeed represents one of the most
important reasons why investors chose MMFs in the first place. Limiting the
possibility of investors to redeem would automatically decrease the
attractiveness of the MMFs in comparison with other products such as bank
deposits.

A secondary effect for
investors is that retail investors would not be negatively impacted anymore if
institutional investors redeem first. As demonstrated during the crisis,
institutional investors were the first to react, potentially leaving the retail
investors to bear most of the MMFs loss in value. Removing the first mover
advantage would also remove the advantages (better knowledge and resources to
evaluate the risks) that institutional investors possess at the expense of
retail investors.

Impact on the MMF
sector and the economy: should the
attractiveness of the MMFs be reduced for investors, this would in turn
decrease the role played by MMFs in purchasing short term debt instruments,
thus decreasing the significance of MMFs as a financing tool for the European
economy.

Cash managers often
invest their excess cash resources for a few days or a few weeks only.
Therefore, retaining a portion of their investments on a longer period than
their primary investment period could seem disproportionate. This could
discourage cash managers to invest at all in MMF: cash managers know that they
would have less cash available to finance the daily operations of their company
or less cash to finance unexpected investments.

The responses to the consultation and interviews with industry
participants reveal that even a small hold-back amount could dramatically
impact the attractiveness of MMF as a flexible cash management tool. The
responses to the consultation were almost unanimously opposed to this
mechanism.

During the debate surrounding the work of the US SEC for reforming
MMFs, the Investment Company Institute (ICI) commissioned Treasury Strategies[39]
to undertake a study on the impacts of various proposals, including the
hold-back mechanism. The study has been realised with US investors only. 90% of
the investors that have been asked said that they would decrease or stop using
MMFs if such an option would be retained. The Association for Financial
Professionals (AFP), a US based association of cash treasurers, asked its
members on the same question[40]: 80% would stop or
reduce investing in MMF.

Impact on MMF
managers: Option 1.2 also raises operational
challenges for MMF managers who would need to adjust their redemption
processes. Bifurcating redemption into two phases and monitoring the retained
amount over an extended period could increase the costs and complicate the
operations at the MMF middle and back offices.

5.1.3. 
Policy option 1.3: Impose a liquidity fee

The envisaged mechanism
would impose a fee equivalent to the amount required to compensate for a
decline in the mid-value of a MMF's portfolio before and after any redemption.
This fee would be calculated taking into account the liquidity cost of the
whole portfolio, not just the most liquid assets[41].
The fee would be applied only during stressed market conditions and would
therefore avoid creating permanent disturbances for the investors. Different
trigger mechanisms can be envisaged for the application of the fee. It can for
example be linked to the amount of daily redemptions (expressed as a percentage
of the fund's total assets under management), to a point in time when
redemptions cause the bid value to substantially deviate from the mid-value or
when the bid value substantially deviates from the par.

Impact on
financial stability: A liquidity fee could
diminish the incentive of runs if investors know that they would have to pay
the cost of their redemption order. This could also incentivize them to remain
invested in the funds because if they decide to sell the MMFs they would
inevitably be subject to the liquidity fee. As the fee is dependent on stressed
market conditions, an investor that remains invested would still have a chance
to avoid the fee if the market conditions return to normal.

On the other hand,
since investors would know that a liquidity fee can be imposed, they will have
an incentive to start redeeming once they sense a slight stress in the markets
in order to redeem before the market situation deteriorates even further and
the fee is activated. In addition, the mere activation of a liquidity fee
(depending on the trigger point chosen) could then confirm the signal of a
stressed market and thus, by itself, give rise to a wave of panic among
existing MMF shareholders. This is because the activation of the fee indicates
either that the NAV has sunk below a certain threshold or that the MMF is
facing massive redemptions. This could ultimately result in a closure of the
fund as it is unlikely that new investors will subscribe once they become aware
of the situation. The existence of the fee has pro-cyclical effects.

Impact on MMF
investors: Because investors have been used to
a highly liquid and relatively inexpensive product, some of them could consider
switching from MMFs to other products. The frequency of the use of the
liquidity fee and its amount is however key to assess the exact impacts on the
investors. On the other side, the system would ensure a fairer treatment
between investors once the fee is activated: late redeemers would not have any
more to bear the costs of early redeemers. But it is not possible to exclude
that investors with better knowledge might still decide to redeem before the
activation of the fee.

Impact on the MMF
sector and the economy: negative impacts cannot
be ruled out but it is expected that, due to the temporary application of the
fee, the impacts would be less disruptive than under the permanent mechanism of
option 1.2.

Impact on MMF managers:
The liquidity fee could raise some operational
challenges for the managers. Once the fee is activated, managers would have to
perform calculations based on mark to market prices of the assets and apply the
fee equitably to all redeeming shareholders of the day. The mark to market
prices may not be easily accessible and may raise operational costs.

The liquidity fee mechanism is supported by three MMF providers: IMMFA,
HSBC and BlackRock, although BlackRock proposes to impose a
standard fee of 1%. IMMFA prefers to let the decision to implement the
fee to the Board of directors of the fund. HSBC and BlackRock
propose to base the activation of the fee on objective triggers. BlackRock
also proposes a liquidity trigger: when half of the daily or weekly liquidity
is reached, the fee should be activated.  Other respondents recommend applying
the fee to CNAV funds only but the majority of the stakeholders believe that a
fee would not be operationally achievable, that it would most likely increase
runs due to its pro-cyclical effect and that it will decrease the
attractiveness of the MMFs for the investors. In its response to the
consultation, the CFA Institute[42] presents the results of
a survey they conducted among their members on both sides of the Atlantic. Only
30% of the European respondents think that liquidity fees should apply to MMFs.

5.1.4. 
Policy option 1.4: Redemption in-kind

Large redemptions may
impose liquidity costs on other shareholders in the MMF by forcing the MMF to
sell assets in an untimely manner. A large redemption causes the MMF to sell
securities, possibly in a declining market and transfer the loss to all
remaining shareholders, instead of isolating the loss to the redeeming
shareholder.

Impact on
financial stability: A requirement that MMFs
distribute large redemptions in-kind would force redeeming shareholders to bear
their own liquidity cost and potentially reduce the incentive to redeem. This
would permit MMFs to distribute, at least to a large redeeming shareholder,
securities in-kind, in proportion to the redemption request and transfer to
that shareholder, and that shareholder only, the market risk of selling the
redeemed securities on in order to generate cash.

Impact on MMF
investors: While this option has the advantage
to almost eliminate the liquidity risk of the MMF, it does not eliminate this
risk completely but passes it on to the investor. An investor confronted with
urgent cash needs may still decide to sell-off the assets immediately after
having received the securities from the fund. This option would therefore not
prevent a general decline of the value of assets in a money market fund but
could just delay the systemic implications of large redemptions and it is not
granted that it could prevent runs since investors would still have an
incentive to redeem before such a mechanism is implemented. It is also
questionable that all investors would have the same operational capabilities to
properly sell the securities because the burden of valuing and liquidating
these assets would fall directly on the investors. Such a mechanism would have
to be implemented only for large institutional investors that have such
capabilities, potentially creating unfair treatment among investors.

Impact on the MMF
sector and the economy: Apart from the
operational challenges, this option could decrease the attractiveness of the
MMF sector as a whole as investors become aware that, at least in times of stressed
market conditions, they would have to sell redeemed securities themselves in
the market, thus bearing the 'cost of liquidity' that is normally assumed by
the MMF. This creates additional costs and delays and it is far from certain
that investors would be ready to bear these burdens. Reduced attractiveness
will tend to negatively impact the role played by MMFs in financing the
economy, even if the mechanism is applied during stressed market conditions
only.

This option receives very little support. Only two stakeholders (IMMFA
and HSBC) argue that it represents a useful tool to manage large
redemptions while acknowledging operational challenges. EFAMA and BVI
analyse that the valuation, operational and legal issues will be too high. In
the CFA Institute survey, only 19% of the EU respondents think that redemption
in-kind should apply to MMFs.

Liquidity of
portfolio assets

Both following options
are aimed at enhancing the liquidity profile of the MMFs by increasing the
natural liquidity and by enhancing the quality of the portfolio.

5.1.5. 
Policy option 1.5: Set minimum liquidity
thresholds for overnight and weekly maturing assets

Impact on
financial stability: When a MMF is confronted
with redemption requests; it faces pressure to sell assets as soon as possible
to meet these requests. Imposing minimum liquidity requirements could limit the
liquidity costs associated with the sale of assets. If a minimum portion of the
fund's holding is going to mature every day, respectively every week or month,
this would ensure minimum cash reserves are available at no additional cost to
redeem shareholders. The MMF would not be dependent on the secondary market -
which is the first to suffer in a liquidity crisis. By increasing the ability
of the fund to meet the redemption requests at no additional cost, it could
allow the MMF to be better equipped in facing investor's runs. Nevertheless the
positive impacts may not be overstated because, in stressed market conditions,
the liquidity may evolve quickly and defaults of issuers are not excluded, even
when exposure is confined to their short-term assets.

By decreasing the
average maturity of the instruments held by the fund, such liquidity limits
would also reduce the market risk of the MMFs since their portfolio would be
less sensitive to interest rate fluctuations.

Impact on
investors: Impacts on investors could prove to be
rather limited; it could maybe lightly decrease their return because of the
lower yields associated with very short term assets but at the same time
decrease the risk associated with their investment. Therefore the impacts will
be rather positive.

Impact on MMF
managers: Managers would have to closely
monitor their investments in order to follow these new requirements. They would
lose some discretion in selecting assets since they had to invest in very short
term assets in order to bring the portfolio composition in line with the new
standards. This option has the advantage to be already implemented to certain
MMFs through the IMMFA code of practice (see Annex 2.3), thus limiting any
impacts in relation to the CNAV funds domiciled in IE and LU. According to the
ESRB data, the MMFs already hold 20.6% of their portfolio in assets maturing
the next day and 28.3% in assets maturing in less than one week.

Impact on the MMF
sector and the economy: The trend toward
investing more in very short term assets may have potential implications on the
short term funding market. Because MMFs would be obliged to maintain very short
term liquidity ratios, they would invest less in securities maturing at the end
of the yield curve, potentially impacting entities that finance themselves
under this maturity range (mainly between 1 and 2 years). This option might
spawn a contraction of money supply in the yield curve range between mid-maturity
and 397 days. The impact on European MMF may, however, be limited since only a
very tiny proportion (only 1% of MMF assets are invested in the 1-2 years
maturity range) of such mid-maturity assets are held in short-term MMF. Issuers
of such short term debt instruments will therefore face very little impacts.

The vast majority of the respondents, being MMF managers, public
authorities or investors, to the consultation would favour the principle of
liquidity constraints. Some MMF managers however fears that it might decrease
portfolio returns and thus reduce the attractiveness of MMFs, or that it could
lead to a squeeze in the availability of very short term instruments.

This option is the
recommendation 7 of IOSCO and is already implemented in the US under the rule
2a-7.

5.1.6. Policy option 1.6: Enhance the quality of the portfolio[43]

The liquidity of the
MMFs is defined by the maturity of the assets (option 1.4) and the credit
quality of the assets. The quality is mainly measured by the credit risk of an
asset. An asset with high credit risk will usually be subject to larger price
fluctuations and less liquidity.

Impact on
financial stability: At the level of the
portfolio[44] the credit risk can be
mitigated to some extent through diversification: MMFs invest in assets issued
by different issuers in order to limit impact on the portfolio of one single
credit event. UCITS funds have currently the possibility to have a maximum
exposure of 40% towards one issuer (or to issuers belonging to the same group) by
combining the investments in money market instruments and deposits. Non-UCITS
funds do not have such rules. Under this option, the maximum exposure to one
issuer would be limited to 5% for the money market instruments and 5% for the
deposits. This would reduce the risks faced by the MMFs, thus preserving their
ability to perform the requested redemptions. On the other side, the MMFs that
use the extended portfolio limits allowed by the ESMA rules could benefit from
a higher limit set at 10% per issuer of money market instruments. These funds
are not in the ESMA “short-term” category, always use fluctuating pricing
methods and investors are aware of their longer term nature. For these reasons
they can sustain a higher exposure limit than the short-term MMFs that are more
prone to investor’s runs.

At the level of the
assets, the MMFs would be prohibited from investing in certain ABS products
such as Asset Backed Commercial Papers (ABCP) where the underlying assets do
not consist of corporate debt. Those products linked to residential mortgages,
student loans or other types of assets would be prohibited. Only securitized
products linked to corporate debt and subject to strong prudential rules will
be allowed up to a maximum of 10% of any single MMF portfolio. This option is
designed to perpetuate the useful role that ABCP may play in financing the
short term funding needs of small and medium companies that do not have the
required size to issue directly money market instruments. This sector of the
securitisation market was also less affected during the crisis.

The appropriateness of
other ABS products for a short term and very liquid vehicle, such as a MMF, is
questionable. The MMF managers have significantly reduced their exposure to the
asset-backed sector since 2007 and the CESR guidelines now require the manager
to take into account the operational and counterparty risk inherent in these
structured financial transactions. However, risk cannot be ruled out entirely.
Nothing prevents MMFs to increase again their investments in these kinds of
products and it is not granted that another crisis will not affect this sector
in the coming years. Because investors in MMFs are particularly risk-averse,
any concerns in some ABCPs might cause investor's runs. Furthermore not all
managers have the capabilities and resources to correctly assess the underlying
risks of such instruments: it requires thorough analysis for evaluating the
risk of each underlying security as well as the risks stemming from the
structuring process of ABS. This can lead to the selection of instruments that
are inappropriate for cash management purposes. In addition, the valuation of certain
ABS is inherently highly complex leading to opaque prices which undermine
investors trust. At the end this might impact the confidence that investors
have in the stability of the MMFs. The prohibition to invest in certain ABS
might represent a good solution to avoid any further problems linked to this
market. The clarity towards investors will be increased and the stability of
the MMF sector reinforced.

Impact on the MMF
sector and the economy: The impacts of reducing
the exposure limit would be rather limited for the CNAV funds domiciled in IE
and LU. Under the IMMFA rules (representing 50% of the EU MMF assets), CNAV MMFs
are already required to apply the 5% limit. Other funds will have in certain
situations to adapt to these new rules. According to a representative panel of
French VNAV funds, in some circumstances the exposure to a single issuer
exceeds the limit of 5%. This is mainly the case for issuers that are important
credit institutions. Some VNAV MMF managers argue that a 5% limit will have an
impact on the issuers of money market instruments and on the portfolio of the
MMFs itself. Different issuers of money market instruments may belong to a
larger group thus their exposure would fall under the 5% limit applying to the
whole group. This may reduce the possibility for a MMF to buy such instruments.
This may for example be the case for regional banks issuing instruments and
that belong to a larger banking group; the limit of 5% will include the
regional banks and the banking group together. On the other side managers of
VNAV MMFs argue that respecting a 5% issuer limit is difficult due to a
scarcity of eligible issuers. This would impact the portfolio management of
their fund.

These arguments may be
valid for some VNAV MMFs but it is difficult to prove to which extent these
managers cannot adapt to the new rule when half of the European market (CNAV
MMF) already follows the 5% issuer’s limit. In addition many VNAV MMFs already
follow the 5% limit without apparent difficulties. It should also be noted that
the 5% limit will apply to money market instruments and to deposits separately
which will enable the MMF to have a total exposure of 10% to a credit
institution, provided that half is invested in money market instruments and
half in deposits. The limit will not apply to government assets due to the
lower risk attached to sovereign issuers. In addition the non-short-term MMFs
will be able to use a higher limit of 10% which could bring the total limit to
15% by adding the 5% deposit limit. These funds represent around 50% of all
VNAV funds so the impact will be much more limited on these funds.

Such a measure would also
enhance international coherence because it is already implemented in the US,
under rule 2a-7.

The impacts of
prohibiting the use of ABCP will be limited because the managers invest only
marginally in these assets. According to the ESRB survey, only 0.7% of the
assets would be concerned. According to the data from IMMFA and concerning
IMMFA funds only, the proportion of ABS in the portfolio ranges between 2% and
4% (this is a bit more than the 1.2% observed in the ESRB survey for CNAV
funds). Issuers of ABCP should however be to some extent impacted, except the
ones that issue ABCPs linked to corporate debts.

This option has not been directly tested in the consultation but the
5% exposure limit goes in the same direction as existing US rules (rule 2a-7),
a policy often advocated by the stakeholders.

Impact on
investors: Impacts on investors are expected to
be very limited, their return should not be affected but the risk of their
investment would decrease.

5.1.7. 
Policy option 1.7: MMF managers should develop
policies to anticipate large redemptions

Impact on
financial stability: As
mentioned in the problem description, large and unanticipated redemptions may
endanger the viability of a MMF. Requiring the manager to actively monitor its
client base would permit the manager to anticipate large outflows and to adjust
the portfolio composition to this upcoming event. Policies and procedures
should be in place to ensure that appropriate efforts are undertaken to
identify risk characteristics of the shareholders. Important indicators could
be the identifiable pattern of investor's cash needs, the type of investor, and
their risk aversion, the client's concentration in the fund or the seasonality
of the flows. Particular attention should be paid to the main holders of the fund
who can destabilize by their redemption the liquidity of the fund. Active
monitoring of these holdings plus close relationship would help the manager to
detect any need of cash.

Impacts on MMF
investors: Impacts on investors would be rather
limited; they may need to communicate more with the MMF manager on their
investment horizon.

Impacts on MMF
managers: "Know your customer"
policies could increase some costs for the managers but this is mitigated by
the fact that most of the managers are already engaged in active monitoring
policies. According to a manager that already performs this task, the cost
would comprise the need to build up an IT infrastructure to automate the
provision of data which is estimated to amount to around €100’000, assuming that
no pre-existing IT infrastructure can be reused. A drawback of such a method is
that it would be impossible, without having an impact on data protection
rights, to identify all clients since large proportions of assets are held
through portals or omnibus accounts. There is no possibility to know the
identity of the clients behind these nominee accounts, a fact which reduces the
practicability of such an option. It is also doubtful that such an option could
address the liquidity risk in its entirety since the incentives to run would
still be present to a large extent as it would be difficult for the manager to
anticipate the irrational behaviour often linked with investor's runs.

Impacts would be larger
if clear client concentration limits would be imposed on top of client policies
and procedures. This would have the advantage to limit the redemption risk
arising from one single investor but would unduly impact the managers and the
investors in regard of the limited additional advantages. Such a mechanism would
be difficult to implement because it would be difficult to manage investor's
positions just around the limit. This could force managers to redeem investors
without their consent because they surpass the limit. The attractiveness of the
MMF could be damaged for the investors while the managers would face additional
burdens to manage the limits. Furthermore such a mechanism could not prevent
investor's runs because a limit can be set on single investors only.

This option is the
recommendation 8 of IOSCO and is already implemented in the US under the rule
2a-7.

This option was not directly tested in the consultation but was in
numerous occasions cited by MMF managers, mostly running CNAV funds, as an
appropriate option to anticipate large redemption requests.

5.1.8. Impact summary

Option 1.1 is not a
viable option as it leaves the core problems without a coordinated EU policy
response. Not acting at the level of EU rulemaking would entail that
potentially the entire EU money market sector might be exposed to systemic
risk.

Redemption fees
and restrictions: A comparison between options
1.2, 1.3 and 1.4 reveals that the permanent hold-back mechanism in option 1.2
represents the highest burden for investors. A permanent hold-back is complex
to administer and could have negative consequences for the viability of the
entire money market industry. Both options 1.3 and 1.4 have the advantage of
being temporary schemes, only triggered by stressed market conditions. This
reduces their possible negative impacts. Option 1.4 appears to be more incisive
than option 1.3, mostly due to the operational burden put on the investor who
cannot redeem in cash but carries the liquidity risk of having to find buyers
for the redeemed securities in a stressed market place. This might, in the end,
result in much higher costs for the investors than the liquidity fee envisaged
under option 1.3.

However none of these
three options can address, in a satisfactory manner, the entirety of the
problems, because none of these options would have any impact in preventing the
problems. Of the three, Option 1.2 would have most success in preventing runs
but its negative impacts are too large. The mechanisms of options 1.3 and 1.4
could help the fund to prevent a run by clearly indicating to investors that there
is no advantage of redeeming early since the costs will be equalized among all
investors. But there is a risk that the trigger will, in itself, convince
investors that it is time, in any case (and irrespective of the fee), to redeem
their investments with this particular MMF.

Increase the
liquidity of portfolio assets: Option 1.5 has
the advantage of increasing the ability of the fund to face redemptions by
increasing the global liquidity standards and thus reducing the incentive to
run to profit from better liquidity conditions. Impacts on investors and
managers appear manageable but the objective to stop runs may not be completely
achieved. Option 1.6 represents a good complement to option 1.5. It increases
the quality of the assets, thereby reducing the risk of a credit event that
could impact the liquidity profile of the fund.

Implement a
"Know your shareholders" policy": By improving the information of the manager, option 1.7 could help
in identifying and anticipating future redemptions but in no case could
anticipate massive investor's runs or increase the ability of the fund to
respond to these requests. In that sense it doesn't fulfil the objective but
still represents a useful daily management tool that can be implemented at
little cost.

Each option is rated
between "---" (very negative), ≈ (neutral) and "+++" (very
positive) based on the analysis in the previous sections. The benefits are,
however, nearly impossible to quantify in monetary terms. The costs should be
understood in a broad sense, not only as compliance costs but also as all the
other negative impacts on stakeholders and on the market. This is why we have
assessed the options based on the respective ratio costs-benefits in relative
terms. The assessment highlights the policy option which is best placed to
reach the related objectives outlined in section 3 and therefore the preferred
one. The coherence with the US regulation is indicated in the effectiveness
column. The options with the highest rates are bold bordered.

|| Impact on stakeholders || Effectiveness || Efficiency

1.1 No action || 0 || 0 || 0

1.2 Impose a hold back period for a proportion of the redemption order || (--) Investors will be confronted to delayed redemptions (-) Operational cost for managers || (+) By internalizing liquidity costs, investors have no more first mover advantages, thereby reducing runs and contagion || (--) Delay costs for investors and monitoring costs for the managers, aggravated by the permanent basis of the hold back

1.3 Impose a liquidity fee || (-) Investors will have to pay a fee in stressed situations (+) Fairer treatment once the fee is applied || (≈) Reduces the runs once the fee is applied but increases the runs before the fee is applied. Contagion channel still exists. (-) Pro cyclical effects || (-) Additional costs not compensated by improved stability

1.4 Redemption in-kind || (+) Managers do not face anymore the liquidity risk (--) Investors bear the full liquidity risk || (≈) Could reduce the incentive of runs but cannot eliminate it || (-) Investors will bear the costs of liquidating the assets

1.5 Set minimum liquidity thresholds for overnight and weekly maturing assets || (++) Investors will benefit from increased daily liquidity and less market risk (-) Investors could see their yield diminishing (-) Middle range maturity issuers could be affected || (++) Probability of a liquidity crisis diminishes (+) Strong convergence with the US regulation || (+++) Should not lead to increased costs but would grandly increase the liquidity level

1.6 Enhance the quality of the portfolio || (++) Investors benefit from reduced investment risk (-) Issuers of securities in ABCP can be affected || (++) Lower risk of credit risk, thus reducing liquidity risk || (+++) Very limited costs for the diversification provided

1.7 MMF managers should develop policies to anticipate large redemptions || (+) Managers can better adapt their portfolio profile to upcoming events || (+) Better anticipation of liquidity risk (+) Strong convergence with the US regulation || (+++) Very limited costs largely compensated by the increased information

5.2. 
Options aimed at transforming the structure of MMF so that the
stability promise can withstand adverse market conditions
5.2.1. Policy option 2.1: take no action at EU level

If the risks associated
with the stable pricing model are not addressed, the risk could persist that
these MMFs could, in stressed market conditions, continue to represent a threat
for the financial stability. The sponsors will continue to provide support to
their MMFs without being prepared for it. This could still lead to situations
where contagion can spread to the sponsor and the economy. The stability of the
financial system would not have been increased.

In addition, no action
at EU level will most probably leave the current market as it is, with
countries allowing the use of amortized cost accounting for all MMF assets and
others allowing a partial use of this accounting model. If nothing were done, a
problem arising with a MMF domiciled in one country could destabilize its
national financial market but also spill over onto the EU financial market as a
whole. The risk of systemic spill-over is especially acute when the total
volume of MMF assets under management in some Member States can represent up to
five times the national GDP of that Member State[45].
In these circumstances, the issue arises whether all Member State would have
sufficient resources and capabilities to mitigate major stress in the MMF
sector or whether recourse to the resources of other Member States or the
European Central Bank might become necessary.

Most of the respondents to the consultation stressed the need to
ensure consistency of the rules at the EU level. Investors often operate across
national borders and would prefer a standard approach. In the absence of a
standard approach to MMF regulation, those same cross border investors may
allocate between different funds on the basis of their regulation. A
group of around 10 stakeholders from each category, managers, trade bodies or
the CZ authorities think however that no additional measures are required.

5.2.2. Policy option 2.2: Increase transparency

Impact on
financial stability and MMF investors: MMFs are
often considered as guaranteed products, although they are subject to credit,
interest-rate and liquidity risk. Recurrent sponsor support has taught investors
to look beyond disclosures that these investments are not guaranteed and can
lose value. Marketing material of MMF providers often implicitly recognizes
that MMFs are very stable: they promote the preservation of capital as a key
feature. They also often categorize MMFs in the lowest grade in their risk
scale, at the same place as bank deposits. The fact that MMFs, principally
IMMFA funds, maintain an AAA rating reinforces the sentiment that MMFs are
guaranteed.

All these indications
create confusion among investors about who owns the risk. Increasing the
transparency and disclosures that investors invest in normal investment funds
subject to market movements may reduce their incentive to run. Should investors
be prepared that losses in value are possible, they would not be surprised if
such an event happens. They would in this case not lose confidence and not rush
to redeem. The marketing material, including the Key Investor Information
Document (KIID) plus any factsheets distributed to clients, should contain in
plain and visible text a warning that MMFs are not guaranteed.

Currently the managers
perform mark to market valuations to assess if the discrepancies with the
amortized cost value are not becoming material but this market value is never
communicated to investors. Under this option, the managers would communicate
the true value of their portfolio to investors. Investors would then be aware
that the market value of MMF moves. In addition the sponsors would have to be
more transparent about the support they give to their MMF. Any occurrence of
sponsor support would have to be recorded and published by updating the KIID.
Managers would also have to communicate the exact composition of their
portfolio, including the list of the assets they hold plus any relevant
information that investors should know to evaluate the risk of the fund.

Such an option could
help to change the perception of investors but it is not granted that it will
suffice. Investors will still benefit from the stability of value and will
still engage in runs if the sponsor is not able to provide the support. And
nothing will prevent sponsors to continue supporting their fund. Another
drawback is that the disclosure of the true NAV might be an incentive to run in
itself if investors decide to redeem when the difference becomes material.

Impact on MMF
managers: The costs would be very limited
because UCITS managers are already obliged to produce KIID. The obligation to
disclose the support might not be welcomed by many managers, as they are often
reluctant to admit that they provide support.

The option to increase transparency has not been directly tested in
the consultation but it has been advocated by some stakeholders, mostly CNAV
managers, as a means to increase the awareness of investors that CNAV MMFs are
not a guaranteed investment.

This option is covered
by the IOSCO recommendations 13 and 14.

5.2.3. Policy option 2.3: require all MMFs to value their assets marked to
market
Impact on
financial stability: Short-term MMFs have
recourse to the amortized cost method to maintain a constant NAV. Requiring the
MMFs to use the marked to market accounting for all of their assets would lead
all MMFs to have a NAV that fluctuates with the value of the underlying
investment assets. Combined with a more accurate rounding method, the CNAV
would not be able anymore to maintain the NAV constant and would automatically
become VNAV funds. VNAV MMFs with all assets marked to market would provide
price transparency to investors regarding the actual value of their investment
assets held by the fund. The VNAV MMFs domiciled in France would also have to
adapt their valuation methodology. Currently they use the amortized cost method
for the assets having a remaining maturity of less than 3 months. In average
this represents a proportion between 60% and 80% of the portfolio. This means
that in practice the French VNAV do not move as much as VNAV would do if they
were not using amortized cost.

Mark-to-market
accounting would change investors' perception and re-establish the underlying
truth that MMF investments are investments into a fund vehicle and thus do not
comprise a capital guarantee. Despite their particular marketing, MMF
ultimately cannot escape the investment profile of an open end mutual fund.
Awareness of the current value of their holdings could reduce the heightened
run risk because a MMF would no longer hold out the promise that every share,
if redeemed before the 'buck is broken' would automatically be redeemed at € 1.
As demonstrated in the problem definition, it is not uncommon that MMFs receive
support from their sponsors to maintain a constant NAV. Because this creates
ambiguity among investors about who carries the risk of fluctuating value of
MMF investment instruments, removing the use of constant NAV pricing will
clearly indicate that the risks and rewards rest with investors. When investing
in VNAV MMFs, investors would understand and price the risks they are subject
to and would therefore be less inclined to expect sponsors to provide a 'guarantee'
against the risk of fluctuations in the value of MMF investment assets.

The option obliging all
MMF to price shares reflecting the fluctuations of the MMFs investments would
not automatically prohibit any form of sponsor support but a fluctuating NAV
lessens the incentives for sponsor support. The risk of contagion to the
sponsor would be reduced once the absence of a constant NAV accounting lessens
the incentive and need for sponsor support. This would in turn reduce the risks
that public authorities and central banks have to intervene when a systemically
important institution is facing difficulties. If investor's runs are minimized,
the contagion to the money market and thus the impacts on the real economy
would also be limited.

Impact on ratings: This option could indirectly address one aspect of the problem
linked to the rating of the fund. Because the price will start floating, the
incentive for the sponsor to support the fund diminishes or even disappears.
The CRAs could in this case not any longer take the financial strength of the
sponsor as a criterion for awarding a favourable rating. In this case Fitch
would have to change its methodology. It could then be assumed that the credit
event arisen on PRCM in 2011 could not happen in the future anymore.

Because all CRAs
include credit and liquidity criteria in their methodologies, a future
downgrade can however not be excluded. It could be mitigated by the fact that
investors would change their perception that they invest in a guaranteed
product, which could ultimately reduce the runs after a potential downgrade.
Such an argument could be valid to some extent but would not completely remove
the risk of runs following a downgrade. Most of the times, the rating criterion
is enshrined in the investment guidelines of the investors and whatever the
reason of the downgrade can be, they may be forced to sell.

Impact on MMF
managers: Managers of CNAV funds argue that the
impact of such a move would be disruptive for the business model of MMFs,
mainly for those domiciled in IE and LU. Indeed, by imposing mark-to-market
accounting, some MMF managers would have to implement new policies and
procedures to value their assets. Whereas the use of the amortized cost is
relatively straightforward from an accounting perspective, the use of a mark to
market accounting may prove challenging in some market situations. Because
money market instruments do not always benefit from accurate and transparent
market prices, managers may be obliged to use other methods to calculate the
fair value of their assets, such as the mark-to-model method. Price discovery
and price calculation may in a first stage increase some costs for a
non-experienced managers, at least for the time that it implements the new
procedures. This drawback should be mitigated by the fact that managers already
calculate the mark to market NAV in order to "shadow" the real price of
their CNAV MMF. This "shadow NAV" is calculated at least once a week
and compared with the stable NAV in order to anticipate discrepancies that may
develop between the two values. Difficulties of adapting to a floating NAV
should therefore not be overestimated. Managers of French VNAV MMF would have
to use market prices for their entire portfolio but as for CNAV managers, they
shall already calculate the mark to market price of the assets in order to
compare it with the amortized cost price. The impact should be therefore
limited. Impact on the MMF sector and the economy: Managers of
CNAV funds argue that the phasing out of the amortized cost method could lead
to a contraction of the whole MMF market because MMFs with constant NAV and
VNAV funds may not be perfect substitutes for certain investors. Investors such
as large cash managers (corporate treasuries) and pension funds[46]
may have to follow investment guidelines preventing them from investing in
fluctuating NAV MMFs because changing these guidelines could be impossible for
them (44% according to a recent study by Treasury Securities). The responses to
the consultation also highlight the different tax treatment that would apply to
VNAV funds in some jurisdictions (no European example was provided). The Fitch
survey of European treasurers identifies that 31% of the respondents think that
the simple treatment for accounting and tax is strength of the CNAV. Because
the movements of the NAV would have to be recorded as capital gains to the tax
authorities, this would decrease the attractiveness of the MMFs. In addition
investors very much praise the convenience of the €1 NAV for cash planning
purposes; a floating NAV would be more difficult to manage.

According to the ICI survey, 79% of the current MMF users state that
they would decrease or stop using MMFs in case constant NAV funds were to
disappear. In the AFP survey, it is indicated that 55% would decrease or stop
using MMFs. Treasury Securities conducted a survey among EU investors for the
account of Federated Investors: 69% of the CNAV investors in Europe would stop
or decrease their usage of CNAV should they disappear. 44% of the respondents
indicate that they have investment policy, law or other restriction preventing
them to invest in VNAV funds.

According to the Fitch survey of European corporate treasurers, the
results are a bit more balanced. This survey is the only one that identifies
the respondents as being European treasurers only (68 in total). 42% of the
treasurers using CNAV would have significant or material operational impact if
the regulation forces MMFs to move to a VNAV accounting model. 47% would have
marginal or none impacts whereas 11% are not sure. Asked about the strengths
and drawbacks of the CNAV and VNAV model, the respondents identify the clear
risk profile of CNAV as the main advantage (69%) whereas they identify the
false perception of guarantee as the main drawback (50%). The main advantage of
the VNAV is their true portfolio valuation (75%) and their main drawback is
that their NAV can be volatile (50%).

These results are backed by some responses to the consultation that
highlight that the consequences of such a measure could largely outweigh any
positive impact that may result from a fluctuating NAV. The stakeholders
arguing that this option will have negative impacts on managers and on the
sector as a whole are predominantly managers of CNAV MMFs, domiciled in IE and
LU. First they believe that CNAV are not more risky than VNAV, thus there is no
need to focus only on CNAV funds. Secondly they are convinced that the MMF
market will die in its current form because a large category of investors
cannot switch to VNAV MMFs, due to the above-mentioned constraints (investment
policies) that certain investor groups face. These investors will be forced to
go into less-regulated and less transparent investment products. The LU and IE
authorities are concerned that such a measure could reduce the importance of
the MMF industry in their country.

All of the above
arguments and survey results are, however, at least in the European context,
counterbalanced by other facts and arguments. The European investor base of
both CNAV and VNAV funds is largely similar, as evidenced in Annex 3.2.
Discussions with MMF users from the corporate sector and responses from the
consultation highlight that the CNAV / VNAV difference is not the only
criterion in the choice of investors. Other characteristics, such as
diversification, portfolio quality or level of return are also very important.

As fluctuations of a
CNAV or VNAV MMF are, in normal market conditions, insignificant (+/- 20 basis
points or +/- € 0.002 at best) the investor impact of a change in value
accounting should not be overstated. Investor impacts would only result in case
of a sudden decline in NAV and in these circumstances a floating NAV has
multiple advantages, most notably: equity in treating all investors alike.
While fluctuations in VNAV increase during stressed market conditions, even
during the sovereign debt crisis of the summer 2011 when VNAV MMFs experienced
increased volatility and larger than usual price fluctuations, there was little
increase in redemptions. This may suggest that investors accept temporary
negative fluctuations in the NAV of a MMF.

Impact on MMF investors: There is also little evidence that European CNAV clients could
satisfy their need for a short-term investment but highly diversified and
liquid investment with products roughly comparable to short-term MMF. While it
is often argued that bank deposits are a close substitute to MMFs - they
provide a guaranteed product and market-based yield – bank deposits lack the
high degree of diversification inherent in an MMF investment. Because MMFs
invest in numerous assets issued by a large number of different entities, they
provide much better diversification than a bank account where the depositor
carries the insolvency risk of a single banking counterparty. This risk is not
mitigated by a deposit guarantee scheme either, as corporate investors might
not be covered. Even if an investor had enough resources to open different bank
accounts to spread the risk, this practice would still not suffice to create
the high level of diversification inherent in an MMF investment. In addition,
managing bank accounts is costly and liquidity is often more restricted than
with MMFs. Therefore, bank deposits are not a viable alternative to a MMF.

The CFA survey shows different results: asked if they agree or
disagree that CNAV MMFs should be required to switch to a variable NAV, 39% of
US respondents agree and 45% disagree whereas 53% of EU respondents agree and
17% disagree. 16% in the US and 31% in Europe are not sure. According to the
consultation, this option is supported by a large majority of VNAV managers,
mainly domiciled in FR and also by public authorities such as DE and FR.

The results of the
above presented studies are mixed but they tend to indicate that some investors
might not be ready to accept investing in floating NAV funds.

Investors in French
VNAV MMFs are already used to see NAV fluctuations so that a full variability
should not impact too much their behaviour toward MMFs. To the contrary they
will benefit from additional clarity about the real value of their MMF. The
problems linked to CNAV investors, such as potential accounting or tax
constraints, are not present for French VNAV investors.

This option is the
IOSCO recommendation 4 on fair value and use of amortized cost.

5.2.4. 
Policy option 2.4: require MMFs to value their
assets mark to market except in the last three months

The amortized cost
method would be disallowed for all MMF assets whose maturity exceeds three
months.

Impact on
financial stability: Proponents of this
solution argue that the above-mentioned disadvantages associated with the CNAV
would be removed while preserving a certain degree of flexibility for valuing
assets with less than three months' remaining maturity. The rationale behind
this differentiation is that MMF assets (primarily debt instruments), in the
last three months of their life, are rarely subject to large fluctuations in
their value. This is because such short-term instruments present less
vulnerability to interest rate or credit risk. Therefore, the prices of these
assets would not be so different from those that result from amortized cost
accounting.

Impact on MMF
managers: Valuing all assets mark-to-market
could unduly increase the costs and complexity of the fund's valuation
processes. For many securities, mark to market pricing may just be an estimate
based on pricing models because secondary market may not exist for these
securities. The cost involved in requiring it for every security, even
securities with very short maturities, may therefore not be justified. But this
argument is largely discredited by the fact that managers already perform mark
to market valuations and there are no obvious cases for MMF assets that are
excessively difficult to value at fair market prices. This argument is also
backed by the results of the CFA Institute survey which shows that 81% of the EU
respondents think that it is feasible to calculate a fair value on a daily
basis for all assets held by MMFs.

Impact on the MMF
sector and the real economy: The risk with this
option is that MMF managers may decide to invest exclusively in securities that
have a remaining maturity of less than three months. Because they could not use
amortized cost accounting for the whole portfolio anymore, MMF might be tempted
to invest exclusively in very short-term assets who mature in less than three
months. Such an investment policy may lead to a contraction of money supply in
the yield curve range between three months and 397 days, which has detrimental
effects on the corporate sector wishing to issue debt with maturities exceeding
three months. Furthermore it is not certain that even very short-term
securities might not suffer from price deviations. In highly stressed market
conditions, as experienced in 2008, very short term assets can see their price
declining following a sudden increase in interest rates or a sudden decrease in
the credit quality of the issuer. The risk is much lower than a security above
three months but the risk is still present.

Option 2.4 has the
advantage of limiting some of the valuation costs for the CNAV MMFs (50% of the
market) while having no impact on current VNAV. But the drawback vis-à-vis
Option 2.3 is that the MMF's share price may still be overestimated, especially
in conditions of extreme market stress as during the events in 2008 (where even
short-term investments were prone to fluctuations beyond 20 basis points).

Because Option 2.4. is
already implemented in almost all Member States except IE and LU, it is
possible to supply empirical evidence: More than 80% of the portfolio of the
short term MMFs is invested in assets having a remaining maturity of less than
3 months. For non-short term MMFs, the proportion is 60%. This indicates that
in fact the French VNAV apply the amortized cost to the majority of their
portfolio. Therefore, their NAV moves very little and not to the extent that
would be required to reveal that MMFs shadow NAV.

Impact on ratings: As with option 2.3, requiring floating the NAV would reduce the
negative spill-overs when a fund is downgraded but it could not be completely
ruled out that investors engage in a run if investment guidelines continue to
mention the rating.

The consultation did not ask a specific question on this valuation method;
however those stakeholders that supported option 2.3 were mostly in favour of
maintaining the 90 days exemption. These stakeholders are almost exclusively
managers or trade associations representing them domiciled in FR.

This option is the
IOSCO recommendation 4 on fair value and use of amortized cost.

5.2.5. 
Policy option 2.5: introduce a NAV buffer for
CNAV MMFs financed by MMF's investors

The NAV buffer would
serve as a backstop in case the CNAV MMF is not able to maintain a stable NAV
(under this option, MMF managers could continue to apply a stable NAV to all
short-term MMF). Because the MMF is obliged to decrease the NAV when the market
price declines to 0.9950 per share ("breaking the buck"), it has an
in-built backstop of a mere 50 basis points. In addition, this ‘buffer’ is
entirely financed by those shareholders that do not redeem early.

The NAV buffer would be
added to this original backstop of 50 basis points to increase the safety
margin between the constant NAV of €1 and the 'shadow' market price. The amount
of the capital buffer is a key element in assessing its potential impacts: An
amount that is too low risks being insufficient in case of stressed market
situations, whereas an amount that is too high will be costly to fund and could
threaten the business model of the MMF.

Depending on the way
the buffer will be financed (by the investor under option 2.5 and by the manager
under option 2.6), the level of the buffer will be set at different levels for
the purpose of the analysis. Under option 2.5, the buffer will be set at a
level that would be realistic as regards the current economic situation, in
particular the yield currently achieved by an investment in a MMF.

A proposal made by some
industry participants[47] consists in applying
risk weights to the maturity range of the assets. Basically the more an asset
has a long remaining maturity, the higher will be the NAV buffer. The analysis
of current portfolio composition of CNAV MMFs reveals that the NAV buffer
would, on average, amount to 25 basis points, which would be added to the
existing 50 basis point in-built 'buffer' that results from the rounding
procedure.

Impact on
financial stability: An additional buffer of 25
basis points could increase the stability of the MMF to face large and
unexpected redemptions. The stability of the NAV would be recognized as a key
feature of the MMF but the investors would have to pay the price of it. It
could mitigate the incentive for investors to redeem early in a declining
market, as there would be a backstop dedicated to compensating for the 'first'
losses. This pre-funded loss absorption capacity would give time to investors
to moderate their reaction to small and temporary changes in the value of their
shares. The MMF would be in turn more resilient to market shocks and therefore
it would reduce the probability that the sponsor has to intervene to support
the MMF.

Option 2.5, however,
poses issues as regard the appropriateness of the method to calculate the
buffer and its adequacy to mitigate the run risk. Linking the risk of an asset
to its remaining maturity may not correctly capture all risks attached to an
asset. According to the general rule, the greater the exposure of an asset to
interest risk, the more the asset's value will fluctuate. Therefore, the price
of an asset with a long remaining maturity will fluctuate more than that of an
asset with a shorter maturity. While this rule is usually valid during normal
market conditions, it may prove inaccurate during stressed market conditions
when all assets are subject to larger than usual price fluctuations. This
method is also vulnerable to unexpected credit events because it does not
consider the credit quality of the assets as a factor of additional risk. Apart
from the method used to establish the buffer, the level of this buffer raises
some doubts regarding its capacity to mitigate the risk of runs. In the case of
the Reserve Primary Fund, when it was finally forced to re-price its NAV, the
latter decreased from $ 1 per share to $ 0.97 per share (a sudden drop of 300
basis points).

This 'real-life'
example is instructive as a fund is considered as 'breaking the buck' as soon as
the NAV decreases below $ 0.995, a decrease of 50 basis points. It is therefore
questionable that a buffer of a mere 25 basis points will prove sufficient to
absorb sudden (but realistic) losses in stressed market conditions. An
inadequate buffer could also give the erroneous impression that investor losses
have greater protection than they actually do. On the other side, if the buffer
would be set at higher levels, it could take too much time to implement and
prove too costly for investors.

Impact on MMF
investors: At the end of August 2012, European
CNAV MMFs were generating an annual net yield of 8 basis points[48].
In order not to deprive investors of their anticipated return, the build-up of
the buffer must be drawn out over an extended period. For example if we set the
time frame at seven years, as some industry participants propose, it would cost
the investors (shareholders) around one half of their annual return at current
levels to reach a level of 25 basis points. Even if this option were deemed economically
feasible, the buffer would not be operational for the next seven years. On the
other hand, an aggressive build-up, over a few months only, could potentially
cause disruptions to the financial markets due to the decline in MMF assets
that would result from returns being siphoned-off to establish the reserve. In
light of this situation, it is questionable that a buffer higher than 25 basis
points could reasonably be envisaged.

It should also be noted
that an additional drawback of this option is that it would create some
transfer of benefits from existing shareholders -- who would contribute to the
establishment of the buffer -- and future shareholders who may later benefit
from this buffer, although they did not contribute toward its build-up.

The option to impose buffers receives very little support in the
responses to the consultation, although it has not been asked directly how the
buffer would have to be funded, through the investor or through the sponsor. It
is important to recall that both the ICI and AFP surveys did not mention the
funding source in the question which significantly alters the results. In the
ICI survey, only 36% would decrease or stop using MMFs while 56% would continue
at current level and 8% would increase. In the AFP survey, 55% would stop or
reduce using MMFs.

The CFA Institute survey makes further distinctions. First, 54% of
the persons that have been asked in Europe agree that CNAV MMFs should have to
maintain capital reserves while 26% disagree. Asked if the capital reserves
should be financed by fund investors, 30% agree and 47% disagree.

This measure is one of
the proposed options of the IOSCO recommendation 10.

5.2.6. 
Policy option 2.6: introduce a NAV buffer for
CNAV MMFs financed by the manager

Under this option MMF
managers would be required to establish, fund and maintain the reserve for the
MMF that they manage. The level of the buffer would be set at 3% and would be
applied to all assets under management, irrespective of their nature. As
explained under option 2.5, applying different risk weights to the assets may
not capture entirely the risks posed by these assets. This takes into account
the largest loss of NAV that was ever suffered by a CNAV MMF (the Reserve
Primary Fund’s loss of 300 bps). This is also aligned with the proposal under
discussion in the US. It also takes into account that MMF assets (especially if
the reforms proposed in this IA on liquidity and credit quality are
implemented) are more liquid, more transparent and easier to value than the
assets held in a bank’s balance sheet.  For example, while banks invest many of
their assets in long-term loans, fixed-rate mortgages, residential, car or
small business loans, ABCP, as well as bonds with long maturities, MMFs must
limit their investments to short-term, highly rated and liquid instruments.
Because of the high quality of assets that are (and will be in future) eligible
for investment by MMFs, these assets are less risky and seek out a lower return
than assets held in a bank. This justifies limiting the NAV buffer to a
potentially lower percentage when compared to own capital to be required from a
bank.  In addition, the liquidity and maturity mismatch in banks is greater
than in MMFs that, as mentioned above are limited to investing in highly liquid
and short-term debt instruments.

Impact on
financial stability and MMF investors: The
buffer has many positive aspects for the financial stability: the manager, and
its sponsor behind, would no longer be obliged to provide support without being
prepared and having provisioned for it, which would reduce the probability of a
sponsor failure. The NAV buffer would also contribute to avoiding immediate
contagion to the sponsor, at least if the loss does not reach proportions above
3%. The buffer might fail to cover losses that rise even beyond those suffered
in the case of the Reserve Primary Fund. In this unlikely event, additional
sponsor support, above the NAV buffer, might again be required leading to
contagion toward other financial service providers and, ultimately, the public
purse. The systemic risk is therefore circumscribed to events that have an
impact of less than 3% of the NAV. The negative effects on the money market are
reduced and the probability of a bailout diminishes but is not completely
removed.

The buffer might also
serve to absorb the regular price movements inherent in financial instruments.
When MMFs are forced to sell assets in a declining market environment, for
example to satisfy redemptions, the buffer will be used to compensate the differences
between the stable NAV and the true market price of the asset sold. This means
that the buffer will not only be used to compensate for a default of an issuer
(the Lehman example) but also to compensate regular discrepancies between the
stable price and the mark to market price of an asset.

Impact on investors: A manager financed NAV buffer would not directly impact investors
and would bring clarity in the market. It could effectively bring some
additional confidence to investors that they invest in a "bank-like"
product, which could reduce the incentives for them to run at the first sign of
stressed market conditions. MMF will gain in stability and late redeemers will
not be impacted negatively by first movers. One side effect could be that some
of the increased costs of capital that fund managers incur in building up a NAV
buffer are passed on to investors. The cost of capital for the manager is
determinant for assessing the potential impact on the management fees paid by
the investors. According to various discussions with stakeholders, the annual
cost of capital would range between 3% and 10%, depending on the financial
situation of each manager. A cost of 3% makes sense
regarding the current interest rates for borrowing money in the market. A cost
of 10% would only make sense by reference to the opportunity cost, meaning that
a bank would achieve a rate of return of 10% should the money be used for
another purpose. With a 3% cost of capital, the cost
for the fund will amount annually to 3% of the 3% buffer, thus 0.09% of the
fund’s assets. With a 10% cost of capital, the cost will be 0.30%. This has to
be put in relation with the current management fees that range usually between
20bps and 50bps annually. It is however difficult to assess how much of this
cost will be passed to the investors as an increase of their management fees.

In a low yield
environment, these annual costs might appear as high but compared to historical
returns of a MMF it is relatively low. In addition some CNAV MMFs are already
yielding negative returns and this has not provoked massive outflows. This
tends to show that investors are more attracted by the security offered by the
MMFs through the diversification than the level of the yield offered. This
focus on security instead of yield is even more acute when the bank deposits, a
substitute of the MMF, may be impaired (example of the banks in Cyprus).

As mentioned above, the
precise percentage of a NAV buffer can always be contested. If the buffer is
set at a too low percentage, it might be insufficient to contain a run. On the
other hand, if the NAV buffer is set at too high a level, it may entail that
most MMFs that are not sponsored by a bank either float their NAV or exit the
MMF market altogether. While the former result would contribute to financial
stability and effectively ‘plug’ the contagion channel that currently exists
between CNAV MMF and their sponsors, the latter result would certainly be
unfortunate: the MMF sector would then become even more concentrated, easily reaching
concentration levels which themselves might raise systemic issues. This
argument has to be counterbalanced by the current situation in the CNAV market:
there are currently 23 providers of CNAV MMFs, the tenth largest share 85% of
the market and the 5 largest share 65% of the market. In that sense, the market
is already highly concentrated[49].

The chosen 3% buffer
has, apart from the reasons set out in the previous section, been chosen
because it would have been sufficient to absorb most of the losses that
occurred during the 2008 crisis. According to a study realized by the Federal
Reserve Bank of Boston (please see annex 6.2 for details), out of the 123
instances of support that occurred in the US MMFs during the crisis, only at
three occasions the amount was larger than 3%: two times it was close to 3%
(3.06% and 3.23%) and one time it was clearly larger (6.33%). If there is a
foreseeable risk that the potential loss of the NAV (e.g., due to an impairment
of a particular MMF asset) will exceed 3%, the manager will be required to take
appropriate measures, including raising the NAV buffer so that it covers the
foreseeable loss or potential impairment of a MMF asset.

For example, when the
Reverse Primary Fund broke the buck, it decreased its NAV first to $0.99 and
then to $0.97[50]. Although the exposure
to defaulted Lehman assets amounted to only 1% of its NAV, the higher losses in
NAV can be attributed to managerial errors committed by the fund after the
Lehman's default. The additional decrease in NAV was caused by the fund redeeming,
for a certain period of time, investors at par and thus above the shadow NAV.
Therefore, when the fund broke the buck, it had to adjust its NAV at a level
below that solely attributable to the fact that Lehman paper was re-valued at
zero. Therefore, with the 3% buffer, the fund would have been able not only to
face the losses of its Lehman paper falling to a value of zero but it would
also have been able to redeem all investors at par. In that scenario, the
entire run on the MMF sector might well have been avoided. This would not have
caused a panic among investors in other MMFs.

On the other hand, a
NAV buffer funded by the manager would de facto make the link between the MMF
and its sponsor official. The 3% buffer represents a clear and transparent
backstop. This is not to say that the buffer would be sufficient in all
circumstances to prevent a contagion to the sponsor’s other activities. Under
very extreme circumstances, especially when default of some MMF debt is coupled
with bad managerial decisions, losses might still exceed the buffer. It might
also be possible that a rapidly growing MMF would need to rapidly increase its
3% buffer to reflect the increase in NAV, although an impending ‘exhaustion’ of
sponsor support could be apprehended by limiting net inflows into this MMF.
Nevertheless, while systemic risk of any MMF would not be entirely eradicated
by a buffer, it would be better contained than in a situation marked by the
absence of a buffer.

Impact on the managers
and MMF sector as a whole: Undesirable effects
cannot be ruled out as financial 'firepower' may vary from one manager to
another. Managers that have a bank as a sponsor may finally rely on the
financial strength of their parent bank to build up the buffer. Independent
managers will have to finance the buffer on their own and raise capital on the
market. This might oblige independent managers to pay high returns to those
investors that invest in the share class issued to constitute the buffer. Bank
sponsors, for their part, will be forced to increase their capital reserves in
order to comply with the 3% buffer that would apply on all their MMF assets. In
a difficult environment where the banks have already to increase their capital
reserves to comply with upcoming Basel III rules, it is not certain that all
banks would have the capacity to absorb the MMF assets. The consequences for
them largely depend on the size of their current balance sheet and the size of
the MMF assets under management. Annex 7.3.2 estimates the amount of money to
be set aside plus its associated annual cost for European and US banks
maintaining a business of CNAV MMFs. European banks will have fewer
difficulties in building up the buffer when compared to their US counterparts
because European MMF have less assets under management.

Raising the capital may
also prove challenging for the asset managers that do not have a bank as
sponsor. In this case, the capital reserves would be built up directly at the
level of the manager. Their capital requirements are usually set at lower
levels and they have less access to funding sources than banks may have. It is
therefore not excluded that some small asset managers will decide to exit the
business of CNAV. The table in annex 7.3.2 demonstrates that the biggest
providers of CNAV MMFs in Europe are usually asset managers belonging to a
banking group. Pure asset managers generally manage lower amounts of assets and
small actors are not present in the business of CNAV MMFs. As described in the
problem definition, some small asset managers have already been forced to exit
the business because their financial strength was not enough to cope with the
"implicit" guarantee provided to CNAV.

In total, if all
managers decide to build up a buffer, the initial amount of the capital to be
raised will amount to around €14 billion in Europe. The asset managers that
belong to a banking group will represent 70% of that amount. From the other
30%, one pure asset manager, BlackRock, accounts alone for half of it;
other pure asset managers will have much lower amounts of buffer to finance.
Additional on-going capital inflows might be required to maintain the buffer
depending on the performance of the MMF and evolution of subscriptions and
redemptions.

Apart the financing
problem, the buffers may raise certain operational challenges for the asset
managers. They are generally not used to this kind of bank requirement and it
may be costly for them to implement and monitor the changes in the buffer.
Because the buffer will have to move with redemptions / subscriptions and with
losses / gains on the assets, the manager will have to adapt the buffer level
on a continuous basis.

To avoid disruptive
effects on the manager, a transition period should be necessary to give enough
time for building up the buffer and adapting the monitoring tools.

Both options, 2.5 and 2.6, received very little support in the
consultation. Almost all responses to the consultation highlight the danger on
the MMF’s viability should investors be required to pay for the buffer,
although the precise amount of buffer has not been tested. On the other side,
participants in the consultation questioned the ability of all sponsors to
raise the necessary capital. Only BlackRock, a pure asset manager,
supports the idea that sponsors should be able to set aside some reserves to be
used during “rainy days”. Although not their preferred option, the DE and UK
authorities reckon that it remains an option to consider.

The CFA survey shows that 76% of the EU respondents agree that MMF
sponsors that provide capital guarantees to investors should be subject to
capital requirements. Asked if the capital reserves should be financed by fund
sponsors, 32% agree and 44% disagree. This is almost the same result as for
investor funded buffers.

This measure is one of
the proposed options of the IOSCO recommendation 10.

5.2.7. 
Policy option 2.7: Require bank-like regulation
for CNAV MMFs

Impact on
financial stability: MMFs have been identified
by the FSB as belonging to the shadow banking universe because they perform
bank-like activities. MMFs accept funding with deposit-like characteristics,
perform maturity and liquidity transformation as banks do and undergo credit
risk transfer as banks. The only difference is that they do not have bank
status.

Transforming the stable
MMFs into special purpose banks would increase the oversight and supervision
they are subject to, will apply bank capital requirements and insurance
coverage. Central banks will be able to more closely monitor their financing
needs and would be able to provide direct support to MMF having liquidity
problems. Access of MMF to central banks facilities could almost completely
remove the incentive of investors to run if they know that the CNAV benefits
from such support. The impact of option 2.7 on financial stability therefore
rates as positive.

On the other hand,
subjecting MMF to banking regulation would impact central bank monetary
policies once the new 'bank' MMF would suddenly need large amount of liquidity.
Finally the contagion risk may not be completely ruled out, because the banking
sector would now be fully exposed to the risks of the MMF assets.

Impact on the manager
and MMF sector as a whole: The implementation
of such a model may prove challenging for a number of reasons. Depending on the
portfolio of the MMF, large amounts of equity would be necessary to capitalize
these new banks in order to meet the capital requirements. Because some MMF
sponsors are not very highly capitalized, raising substantial amount of equity
may be a large hurdle and may further reduce MMFs capacity to supply short-term
credit. The exact amount of the capital requirement would vary to a large
extent, according to the type and maturity of the assets held by the MMF. As an
example a MMF investing exclusively in assets issued by governments would
probably have a very low requirement. To the contrary, a MMF investing in
assets issued by banks or corporate and on a longer term basis (more than 3
months) would face a high requirement which could largely exceed the 3% level
foreseen under option 2.6.

Additional costs, which
are difficult to quantify exactly, will fall under MMF managers: they would see
a considerable increase in their operative costs if they have to comply with
the entire list of prudential rules faced by the banks.

Under this option the
asset managers that are not sponsored by a bank will most probably have to exit
the business. The capital requirements combined with the prudential rules that
apply to banks might be too costly for the asset managers, which could leave
the business of CNAV MMFs entirely in the scope of a few banks. This would lead
to increased concentration in the sector, thus less competition between the
actors of CNAV MMFs.

Impact on
investors: Investors will gain in stability
what they could lose in yield. It can be expected that the cost of investing in
MMFs will increase if managers face additional burdens. On the other side
investors will benefit from the stability of a bank deposit.

This option has not been directly tested in the consultation but the
opposition was strong among the MMF managers during the consultation process of
IOSCO.

5.2.8. Policy option 2.8: Require MMF to float their NAV, except when they
can demonstrate a sufficient capital buffer

Under this option, the manager of CNAV MMF will have the choice to
either float the NAV of the MMF (option 2.3) or, if floating the NAV would
entail massive investor redemptions from MMFs,  finance a 3% buffer on all
assets under management (option 2.6). Option 2.8,
therefore, takes into account that some respondents to the consultation have
voiced concern that not all investors would remain invested in MMF once the NAV
had to be floated. This concern, although limited to a minority of EU
respondents, is taken into account by allowing the manager to exceptionally
keep a CNAV.

While Option 2.3 has
the merit to address the systemic risks associated with a run on MMF in a very
effective and simple way, Option 2.8 acknowledges the fact that it may cause
some difficulties for certain MMF investors to continue to use this cash
management tool once the NAV is floated. Option 2.8 would address these
difficulties with the aim of keeping MMFs as a relevant tool for short-term
financing for the government, municipalities and Europe’s corporate sector.

In order to avoid
potential disruption associated with the general floating of all MMF’s NAV for
the financing of the real economy (the entities that depend on issuing
short-term debt to MMFs), Option 2.8 would allow continuation of CNAV
associated with a robust 3% NAV buffer to be financed by the MMF sponsor. On
the other hand, as floating the NAV would be much more effective in breaking
the link between sponsor banks and the MMF sector (and thus avoid contagion of
the banking sector),  the competent authorities will have to monitor that each
MMF manager that wishes to maintain the CNAV structure can demonstrate that the
buffer has been properly financed and set up in a segregated account. The
competent authorities should be satisfied that the CNAV MMF manager will be
able to maintain the 3% buffer at all times and that he has developed a clear
and effective governance structure for the use of this buffer.

Impact on
financial stability: Option 2.3 has the clear
merit of clarifying that investments in mutual funds are not to be confused
with bank deposits. Investments in mutual funds provide a high level of
diversification but the value of its assets fluctuates in line with market
prices and can be subject to losses. Floating the NAV will clearly indicate to
investors that they invest in a product whose stable value is not guaranteed.
Investors will get used to market fluctuations and will no longer expect that
the sponsor steps in every time the fluctuation of the NAV of the fund exceeds
a certain threshold. In this sense, option 2.3 removes the feature that makes
MMF a guaranteed product and removes the incentive for the sponsor to provide
discretionary support.

Option 2.6 adopts a
different approach. While it acknowledges the fact that CNAV MMFs are different
from guaranteed products, this option recognizes that only sponsor support
allows the MMF to promise a stable share price upon redemption. In order to
avoid the opacity that shrouds the current models of discretionary sponsor
support, this option aims to make sponsor support more predictable by means of
a minimum reserve that needs to be set aside in order to finance the sponsor
support. By requiring a 3% NAV buffer, option 2.6 allows managers to continue
supporting their funds but at the same time increases their proven capacity to
provide such support. To that extent, contagion risk is reduced, but not
entirely eliminated.

Impact on the MMF
sector as a whole and the economy: Both options
could generate additional burdens that could have negative impacts on the MMF
sector and on its funding capacity of the economy. Under option 2.3 it is not
excluded that certain investors may not wish to invest in fluctuating NAV MMFs,
thus possibly reducing the size of the MMF sector and, in consequence, its role
as a short-term financing tool for European issuers. Under option 2.6, it is
not excluded that certain managers may decide to exit the business of CNAV MMFs
due to the costs associated with the buffer. In this case this would also
impact the MMF sector and the real economy.

On the other hand,
option 2.3 has the advantage to be easier to implement: such a system already
exists in Europe and it would not generate costs as high as under option 2.6.
Option 2.6 has the disadvantage to be complex; it will require substantive costs
to adapt the systems of the managers that wish to build up a buffer.

Impact on investors: Under this option, the risk of investors switching to alternative
products is less pregnant than on the individual options 2.3 and 2.6 because
they will have the same choice as before but with expanded guarantees.

The choice foreseen under this option 2.8 between option 2.3 and
2.6, has not been tested among the stakeholders. The stakeholders’ views of
each option are discussed under their respective section.

5.2.9. Policy option 2.9: Ensure that managers no longer pay for credit
ratings

Under this option,
managers will be prohibited from paying CRAs to award a rating on their funds.
The aim of this option is to stop the rating at fund level without impacting
the liberty of opinion of the CRAs. However this option does not, and cannot,
prevent other actors, such as investors, to pay CRAs for awarding a rating on a
MMF. It is therefore not excluded that the rating at fund level will not be
perpetuated, but in a different manner. The right to conduct a business for
managers should not be impacted, considering that this measure does not impinge
on their ability to manage and market their products. There should be no impact
on the attractiveness of their funds since this measure will be evenly applied
by all managers at the same time.

It is to be expected
that the rating at fund level will most probably cease once the fund managers
stops paying the rating agency for this service. Nevertheless, no longer
allowing the manager to pay for a rating at fund level, does not impinge on the
rating agency's fundamental right to express a ratings opinion, should it find
others parties who are interested in such a rating. In any case, CRAs will
remain entirely at liberty to express their opinion on MMFs in whatever context
they may be called upon to do so. On the other hand, no longer allowing the MMF
manager to pay for a rating on his own MMF, might initially or permanently
decrease the revenue stream of CRAs.

Impact on
financial stability: Because investors place
too much emphasis on the ratings of a fund, one of the options would be to
prohibit the fund to use credit ratings. Sudden massive redemptions following a
downgrade would be in this case impossible. This would grandly contribute to
increase the stability of the whole MMF sector. The disappearance of AAA
ratings would also contribute to change the perception that investors do not
invest in a guaranteed product and thus lessens their incentive to run.

Option 2.9 will also
have positive impacts on the issuers of money market instruments. Because MMF
managers have to comply with a certain set of criteria in order to be awarded
the AAA rating, they only invest in very high quality assets. But the issuers
of these assets might be put under review or downgraded by the same CRAs that
award the AAA to the fund. There is therefore enormous pressure to keep the
assets in line with the criteria of the CRAs. The consequence is that, once an
issuer is downgraded, the fund will be obliged to sell all assets related to
this issuer. In this case credit ratings are not anymore an opinion but a form
of indirect regulation. If the incentive to ‘fire-sell’ assets is removed, the
negative effects on issuers of short-term debt will also be removed. An issuer would
no longer lose access to the short term funding market just because it was put
under review by a CRA.

Impact on
investors: Credit ratings have been useful for
investors since until recently there was no common definition of MMF in Europe.
It was very difficult to perceive the different risk characteristics of MMFs
subject to different national legislations which often imposed weak constraints
on credit, liquidity and interest rate risk. IMMFA requires its members to be
rated due to this situation. To the contrary MMFs domiciled in France are
usually not rated because the MMF sector has long been carefully delineated by
rules that prescribe the characteristics of a MMF asset. Fund ratings were
therefore not required to establish investor confidence in France.

The broadening and
strengthening of regulation of MMFs and increased transparency to investors on
the investments made by MMFs reduces the need for a fund rating. CNAV MMFs that
follow IMMFA  rules (domiciled in IE and LU) will be the almost only ones that
will have to adapt since French MMFs are usually not rated.

In its response to the consultation, IMMFA recognize the risks of
ratings but they do not think that MMFs should be prohibited from being rated.
They however support proposals to mitigate problems posed by fund ratings:
remove the criteria of sponsor support in the rating decision and give enough
time to managers to dispose of assets that have been downgraded in order to
avoid asset fire sales. They subsequently add that, if ratings were prohibited,
there would need to be a substantial lead time before implementation to allow
investors in MMFs to update their treasury policies and for fund sponsors to
provide additional transparency to investors. HSBC, a member of IMMFA, however
supports the prohibition of ratings if a transitional period is foreseen.

This option addresses
the IOSCO recommendation 12 and 13.

5.2.10. Impact
summary

Option 2.1 cannot be
retained as it would not address the problem of contagion to the sponsors and
the economy. Investors will continue to believe that they invest in a
guaranteed product and sponsors will continue to provide support without being
prepared for it.

Increase
transparency: By increasing the transparency,
option 2.2 can achieve some of the objectives but will never be sufficient to
completely isolate the risk of MMF from the money market and the sponsors.
Because the costs are relatively modest, it can still represent a good
complement to any other option.

MMF valuation
methodologies: Option 2.3, will have large
impacts on the industry because all short-term MMFs (with no exception) will be
caught by the new valuation policy. The costs may be higher to implement the
new valuation rules for all assets. On the other hand, option 2.3 may better
achieve the objectives to prevent the risk of runs linked to the stable price
and limit contagion to other financial service providers. Cost associated with
changing the valuation method on the money market cannot be ruled out. It is
not to be expected that all traditional MMF investors will readily switch to floating
NAV products. For this reason, Option 2.3 would require sufficient transition
time to allow investors to adapt to the new rules.

Option 2.4 represents
the status quo for the majority of VNAV MMFs (that use amortised cost for
assets maturing in less than three months) but would still be as disruptive for
CNAV MMF (that use amortised cost for their entire portfolio) as Option 2.3.
The cost of changing the valuation method would be the same for investors
invested in CNAV. Because option 2.4 would achieve the results of option 2.3
only partially and because the costs might not be so different, option 2.3
appears preferable.

NAV buffers: NAV buffers either financed by investors (2.5) or by the fund
sponsor itself (2.6) would increase the resilience of MMF. Option 2.5 has the
advantage that the investor pays, thus clearly indicating that the risk and
reward of the investment belongs to the investor. This has also the advantage
not to impact the sponsors' business model, as sponsors don't need to raise
additional capital. But on the other hand, the problem is that the buffers that
could reasonably be envisaged in the ‘investor-pays’ scenario would not be
enough to limit the contagion. Because it is impossible to raise the buffer
without reducing the attractiveness of the MMFs for the investors, this option
will not achieve the desired objectives. Even with a buffer at 25bps, it will
take 7 years to build up, thereby already decreasing any immediate benefits for
investors. Option 2.6 is the clear winner over option 2.5 because investors
will not be directly impacted. It may prove costly for managers to fund the
buffer and it is not sure that all managers will decide to do it but at least
the buffer level can be sufficient to prevent a future crisis and limit
contagion.

Conversion to a
bank status:  From all options considered,
option 2.7 (submit all CNAV MMF to banking regulation) appears as the most
incisive and thus represents the most challenging policy change. The impacts of
this option in terms of capital requirements and prudential supervision will be
enormous. In light of the large capital required and the ensuing increased cost
of sponsoring a CNAV MMF, it appears unlikely that the CNAV MMF sector will
survive in its current form if this option were chosen. Most likely, this
option will engender a significant concentration of the MMF sector in Europe.

This option also
entails a significant risk that the newly created banks, in order to respect
the mandatory capital ratios, would invest less in the money market, or would
invest only in very high quality assets demanding less capital. The essential
function of the MMF sector - satisfying short-term financing needs of banks,
corporation or governments - would be at peril.

Require MMF to
float their NAV, except they decide to build a buffer: Option 2.3 would be the clear winner in
terms of effectiveness of reducing systemic risk but negative impacts on
certain traditional CNAV investors cannot be excluded. As a second best option,
option 2.6 would be added as a fall-back for those MMFs that will decide to
build an appropriate 3% buffer for maintaining the CNAV feature of their MMFs.

Ratings: Prohibiting the use of ratings appears to be the only possible
measure to avoid future fire sale following a downgrade. Increasing the
transparency, floating the NAV would never completely remove the possibility of
a run.

|| Impact on stakeholders || Effectiveness || Efficiency

2.1 No action || 0 || 0 || 0

2.2 Increased transparency || (+) More information for investors || (+) Increased transparency could diminish investor expectations (-) Price transparency could increase runs || (+) Low implementing costs but low results

2.3 Require all MMFs to have a fluctuating NAV: impose a full mark to market method and prohibit any method based on ‘rounding’ NAV or share prices. || (---) Reduced attractiveness of MMFs for certain investors, thereby potentially affecting the money market (-) Managers will have to change their valuation procedures || (+++) Full price fluctuation eliminates the “guaranteed” feature (+++) Incentive for sponsor support is removed || (++) Increased financial stability attached with some costs for investors

2.4 Require all MMFs to have a fluctuating NAV:  impose a full mark to market method except in the last 3 months and stop the rounding method || (-) Reduced attractiveness of MMFs for certain investors, thereby potentially affecting the money market (≈) Managers will have to slightly change their valuation procedures || (+) Partial price fluctuation reducing the “guaranteed” feature (+) Incentive for sponsor support is limited || (+) More limited costs than 2.3 but less effectiveness

2.5 Introduce NAV buffers for MMFs financed by shareholders || (--) Investors will see their yields decreasing, reducing the attractiveness of MMFs || (+) Less risk of contagion to the sponsor but not to the money market || (-) Increased costs for investors, not compensated by increased safety

2.6 Introduce NAV buffers for CNAV MMFs financed by the sponsor || (--) Sponsors will have to bring money (-) Disadvantage for small sponsors || (++) The buffer eliminates the contagion channel (+++) Investors will benefit from a guaranteed investment || (++) Increased resilience at the cost of sponsor involvement

2.7 Require bank-like regulation for CNAV MMFs || (--) Spill over effects on banks (--) Asset managers will be forced to exit the business || (+++) Complete stability of the MMF (++) Investors will benefit from a bank deposit safety || (+) Costs too high in comparison to the results achieved

2.8 Require MMF to float their NAV, except when they can demonstrate a sufficient capital buffer || (+) Market participants will have the choice (+) Regulators would be able to control whether the 3% buffer has been properly implemented || (+) Both options would increase, albeit to different degrees,  financial stability || (+++) Costs compensated by increased stability

2.9 Ensure that the MMF manager no longer pay for credit ratings at fund level || (-) Less information for investors (++) Managers are less dependent from CRA decisions (--) CRA lose a business || (+++) Removal of runs following a downgrade || (++) Costs compensated by increased stability

6. 
the retained policy options and instrument
6.1. 
The retained policy options

The first objective is
best fulfilled by a combination of options 1.5, 1.6 and 1.7. None of the three
first options can be retained due to the detrimental effects they would cause
on the attractiveness of the MMFs for the investors. Increasing the liquidity
of the fund and enhancing the redemption monitoring will increase the ability
of the fund to face large redemption orders. This will in turn reduce the
probability to use the suspension of redemptions, thereby reducing the
contagion risks. Furthermore the early redeemers will not anymore cause undue
costs that would have to be paid by late redeemers.

The second objective is
best achieved through a combination of option 2.2, 2.8 and 2.9. Because there
subsists some doubts that some disruptive effects cannot be excluded under
option 2.3 (the easiest and most effective way to fulfil the second objective),
it is preferable to retain option 2.8 and give a tightly circumscribed choice
to market participants. A CNAV could be maintained only if managers set aside an
appropriate capital buffer not inferior to 3% of NAV in order to limits the
risk of uncontrolled contagion. Some managers will not decide to pay and will
prefer to fluctuate the NAV. This may result in some asset declines for these
managers, which could be compensated by asset increases by the managers who
decide to build up a buffer. Because the choice would be left to the manager,
he will have to inform the investor of the valuation method chosen. In case a
fluctuating NAV is adopted, the fund manager would have to specifically
emphasise that there is no capital guarantee. Therefore option 2.2 will be
required to increase the transparency, regardless of whether a floating NAV or
a capital buffer is chosen. Option 2.9 would come as a complement in order to
stop the risk of runs following a downgrade.

The retained policy Option
2.8 mirrors recent FSB conclusions: “The FSB has reviewed the IOSCO
recommendations and endorsed them as an effective framework for strengthening
the resilience of MMFs to risks in a comprehensive manner. In particular, the
FSB endorses the Recommendation 10 requirement that stable NAV MMFs should be
converted into floating NAV where workable. The FSB believes that the
safeguards required to be introduced to reinforce stable NAV MMFs’ resilience
to runs where such conversion is not workable should be functionally equivalent
in effect to the capital, liquidity, and other prudential requirements on banks
that protect against runs on their deposits.”

After this kind of
optimization procedure, the preferred combination of options is therefore: 1.5,
1.6, 1.7, 2.2, 2.8 and 2.9. Other combinations that have been advocated by
stakeholders would not achieve the same results as this combination.

6.2. 
The choice of instrument[51]

The proposed legislative measure is not
concerned with the taking up of the activity as fund manager, but aims to
ensure market integrity and stability in relation to managers' activities
involving a specific type of funds because of the specific characteristics of
such funds. The taking up of activities as fund manager is regulated either by
the UCITS directive or by the AIFM directive. The activities of the managers
will continue to be subject to AIFMD and UCITS Directive but the product rules
contained under UCITS framework will be supplemented by the product rules
contained in a new Regulation.

Currently around 60% of the funds and 80%
of the fund’s assets are regulated as UCITS, the rest falls under AIFMD as of
July 2013. Reforming only the UCITS Directive is therefore not an option as it
would leave out of its scope a substantial part of the MMF sector. In pursuit
of the objective of the internal market integrity the proposed legislative
measure will create a regulatory framework for MMFs in view of ensuring an
increased protection of investors in MMF, as well as enhancing financial stability
by preventing contagion risk. The proposed provisions will specifically target
to ensure that the liquidity of the fund is adequate to face investor
redemption requests and to render the structure of MMFs safe enough to
withstand adverse market conditions. The provisions envisaged will deal,
amongst others with the scope of eligible assets, with diversification rules,
rules related to exposures to credit, interest rate and liquidity risks. These
are prudential product rules that aim to render the European MMFs more secure
and efficient, mitigating hereto related systemic risk concerns.

Article 114(1) TFEU provides the legal
basis for a Regulation creating uniform provisions aimed at the functioning of
the internal market. Prudential product rules establish the limits of the risks
linked to MMFs. They underpin the correct and safe functioning of the internal
market. In the absence of a Regulation setting out rules on MMFs, diverging
measures might be adopted at national level, which are likely to cause significant
distortions of competition resulting from important differences in essential
investment protection standards.

Currently, there are no specific prudential
rules for MMFs laid down in EU law[52], but only some generic guidance contained in CESR guidelines[53]. This results in
large divergence and legal uncertainty, especially as regards action needed
once MMFs are in trouble, with the crisis showing different reactions in
different Member States. That creates an unlevel playing field impeding the
internal market.

The proposed Regulation streamlines
prudential requirements related to MMFs creating a common framework directly
applicable to managers of MMFs. It would clearly demonstrate that MMFs are
subject to uniform rules in all EU markets. This would boost stability of this
product as a source of short-term finance for government and the corporate
sector across the EU. It would also ensure that MMFs remain a reliable vehicle
for the cash management needs of European industry.

6.3. 
The scope of legislation

The legislation will
apply to all MMFs currently marketed and used as such in Europe. For this
purpose, the definition of MMFs should be broad and precise enough to capture
all funds that are MMFs in the European Union. For this purpose, the definition
of the ECB plus the one of the CESR will be used plus the recommendation 1 of
the IOSCO which specify that "the definition should ensure that all
Collective Investment Schemes which present the characteristics of a MMF or
which are presented to investors or potential investors as having similar
investment objectives are captured by the appropriate regulation even when they
are not marketed as a "MMF" (e.g. "liquid" funds,
"cash" funds)".

The new regulation will
apply to all managers of MMFs, irrespective of whether these managers are
authorised according to the rules on management companies contained in UCITS or
under the AIFMD.

6.4. 
The impact on retail investors and SMEs

The strengthening of
the provisions to better deal with first mover advantages will give retail
investors a fairer treatment. Because the losses were often borne by the retail
instead of the institutional investors, this will re-equilibrate the balance.
By increasing the safeguards, more retail investors will be attracted to these
markets.

With regard to SMEs,
their protection will be enhanced when acting as investors. SMEs, as other
corporates of larger size, may use MMFs to place their excess cash for short
periods. Reducing the probability to face limits or suspensions of redemptions
will prevent SMEs from suffering cash shortfalls.

6.5. 
Social impact

To the extent that the
proposed policies will help contain the effects of future financial crises on
the real economy, they will also help reduce the social costs of those crises
(e.g. unemployment). Regarding the impacts on the asset management sector’s
employment, should the assets under management be maintained at current levels,
no further impact would be expected.

6.6. 
Environmental impact

Nothing would suggest
that the proposed policy will have any direct or indirect impacts on
environmental issues.

6.7. 
Impact on third countries

As described in section
1.2, the work surrounding shadow banking is international. The G20 Members have
all agreed to request the FSB to undertake a review of the sector and to make recommendations.
The IOSCO recommendations have been endorsed by the FSB in November 2012. The
US, as the largest MMF market in the world, requires special attention in order
to avoid regulatory arbitrage with the EU. At this stage it is difficult to predict
which option will be chosen in the US but their consultation document proposes
only 3 options: floating NAV, capital buffers at 1% with hold-back mechanisms
or capital buffers at 3% coupled with additional rules. The outcome of this IA
goes in the same direction by requiring either a floating NAV or buffers. It is
also fully aligned with the IOSCO and FSB recommendations. At this stage it is
therefore possible to claim that there are no significant risks of regulatory
arbitrage between the US and the EU. Whether this will remain the case after
all consultative and legislative processes will have been concluded, it is very
difficult to predict. To this effect, the Commission services are engaged in a
dialogue with the US to prevent that major divergences develop in the next
phase of rulemaking.

According to existing
data and dialogue with industry participants, MMF investors from outside the EU
represent only a minority share. It is not easy for an EU based investor to use
US based MMFs, or inversely for a US based investor to use EU MMFs. This is
explained by time lags and currency hedging that would become expensive. In
this regard, only the investors in USD denominated MMFs may wish to move
between MMF domiciles from one continent to the other. According to the
Securities and Exchange Commission (SEC)[54], the use of
European MMFs in the US is very limited. No EU fund has received the
authorization to be publicly sold to US investors but some EU funds could still
be privately offered. This is however difficult because US investors would face
in this case significant adverse tax implications. This information is
confirmed by IMMFA figures that say that US investors account for only 10% of
the investors in IMMFA funds.

Regarding the asset
side, US MMFs are large investors in European assets and inversely EU MMFs are
important investors in US assets. As such MMFs on both sides of the Atlantic
represent an important financing source not only for corporates and banks in
their own continent but for those entities in the other continent as well.

Since the asset
management sector is a global market, it is important to monitor not only the
actions of the US, but also those of other G20 members. Particular attention
will also need to be given to countries that are not part of the G20, as they
are not bound by the Group's commitments and may therefore be tempted to
attract businesses to their jurisdiction. This could have a negative impact on
the competitiveness of the EU (market participants may simply move their business
to a jurisdiction that has either weaker rules or none at all), although it is
hard to judge what the magnitude of this impact could be.

However, any potential
loss of competitiveness or opportunities for regulatory arbitrage will have to
be taken into account when deciding on the best way to implement the desired
policy initiatives.

7. 
monitoring and evaluation

Ex-post evaluation of
all new legislative measures is a priority for the Commission. Evaluations are
planned about 4 years after the implementation deadline of each measure. The
forthcoming Regulation will also be subject to a complete evaluation in order
to assess, among other things, how effective and efficient it has been in terms
of achieving the objectives presented in this report and to decide whether new
measures or amendments are needed.

In terms of indicators
and sources of information that could be used during the evaluation, the data
provided from the national central banks, the national regulators, European
bodies such as the central bank, ESMA and ESRB and from international
organizations such as IOSCO and FSB. By centralizing the data at the EU level,
the ECB is able to give a broad and detailed picture of the key features of the
European MMF market. This will be used to monitor the liquidity level, the
types of assets, the issuers of the assets and the investors of the MMFs. Occurrences
of sponsor supports, redemptions linked to rating downgrades and change of
marketing practices will be monitored for following the attainment of the second
operational objective. Based on these indicators it will be possible to draw
conclusions regarding the impacts of the reform on financial stability. The
impacts on the MMF industry will also be carefully followed through the
monitoring of the assets under management, the number of MMFs or the
participation in the financing of the economy.

The international
organizations plan to conduct peer review of the implementation of their
recommendations in the different jurisdictions. The European Commission will
closely monitor the reviews in order to ensure that the recommendations have
been evenly applied by all G20 Member States.

ANNEX

1..... Annex 1: glossary.. 60

2..... Annex 2: definition of
european mmfs. 65

2.1.    MMF definitions. 65

2.2.    Definition of money
market instruments. 67

2.3.    IMMFA Code of practice. 68

3..... Annex 3: facts and
figures of the European MMF industry.. 69

3.1.    List of EU countries
where MMFs are domiciled. 69

3.2.    Type of investors. 71

3.3.    Portfolio composition
by sector 72

3.4.    Portfolio composition
by asset type. 72

3.5.    Systemic significance
of the MMFs in Europe. 73

4..... annex 4: marketing
practices. 74

5..... Annex 5: european mmfs
through the crisis. 76

5.1.    List of known 2007
events on European MMFs. 77

5.2.    List of known 2008
events on European MMFs. 77

5.3.    Graphs of MMF assets
in Europe. 78

5.3.1.     France. 79

5.3.2.     Luxembourg. 79

5.3.3.     IMMFA MMFs. 81

5.4.    Governmental support 83

6..... Annex 6: us mmfs
through the crisis. 83

6.1.    Description of 2007
and 2008 events. 83

6.2.    Sponsor support 84

6.3.    Governmental support 85

6.4.    Graphs of MMF assets
in USA.. 85

6.5.    Post crisis events. 86

7..... annex 7: explanation
of some mechanisms. 86

7.1.    Price mechanism of the
MMF. 87

7.2.    Liquidity fee
mechanism.. 87

7.3.    Capital buffer 88

7.3.1.     Capital buffer mechanism
paid by investors: Fidelity proposal 88

7.3.2.     Capital needs of the
NAV buffers. 88

7.4.    Choice of instrument 90

8..... Annex 8: European
Parliament resolution on Shadow Banking.. 93

9..... Annex 9: iosco
recommendations and fsb endorsment. 93

10... Annex 10: feedback of the consultation.. 96

11... Annex 11: bilateral and multilateral meetings. 113

12... annex 12: cfa institute survey.. 125

1. Annex
1: glossary

Alternative Investment Fund Managers Directive (AIFMD) || Directive 2011/61/EC of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010.

Amortised cost / Amortised cost accounting || An accounting method that takes the purchase price of the financial instrument and adds the cumulative amortisation, that is, the difference between the purchase price and the value of the financial instrument at maturity. Cumulative amortisation is calculated by equally spreading or discounting estimated future cash payments throughout the life of the financial instrument.

Asset Backed Commercial Paper (ABCP) || A form of secured Commercial Paper issued by a short-term investment vehicle or conduit (such as a special purpose vehicle (SPV)) with a maturity between 90 and 180 days. The Commercial Paper is backed by assets such as trade receivables and is used for short-term financing needs.

Asset Backed Security (ABS) || A security whose value and income payments are derived from and collateralised by a specified pool of underlying assets which can be receivables such as mortgage or credit cards credits.

Breaking the buck || Breaking the buck alludes to the fact that a Constant NAV (CNAV) is not guaranteed. A MMF 'breaks the buck' whenever there is a material discrepancy between the market value and the amortised cost value of the portfolio and the MMF can no longer issue and redeem units at the stable NAV of $1/€1 per unit.

Capital buffer || Cash or securities held above minimum capital requirements that serve the special purpose of a safety-net from which losses incurred are first depleted.

Certificate of deposit (CD) || A commitment to deposit a fixed sum of money for a fixed period of time at a bank in exchange for interest. A depositor may withdraw the amount deposited before maturity by paying a penalty.

Commercial paper (CP) || An unsecured short-term debt instrument normally issued by large companies to finance their short-term liabilities.  Maturities on commercial paper typically range from 1 to 270 days. CP is usually issued at a discount, reflecting prevailing market interest rates.

Committee of European Securities Regulators (CESR) || CESR is the predecessor of ESMA.

Competent authority || Any organisation that has the legally delegated or invested authority, capacity, or power to perform a designated function.

Constant NAV (CNAV) || CNAV MMFs seek to maintain an unchanging face value NAV (for example $1/€1 per unit/share). Income in the fund is accrued daily and can either be paid out to the investor or used to purchase more units in the fund. Assets are generally valued on an amortised cost basis. (Compare with VNAV)

Credit Default Swap (CDS) || A contract between a buyer and a seller of protection to pay out in the case that another party (not involved in the swap), defaults on its obligations. CDS can be described as a sort of insurance where the purchaser of the CDS owns the debt that the instrument protects; however, it is not necessary for the purchaser to own the underlying debt that is insured.

Directive || A legislative act of the European Union, which requires Member States to achieve a particular result without dictating the means of achieving that result. A Directive therefore needs to be transposed into national law contrary to regulation that have direct applicability.

European Securities and Markets Authority (ESMA) || The successor body to CESR, continuing work in the securities and markets area as an independent agency and also with the other two former level three committees.

European Systemic Risk Board (ESRB) || Was set up in response to the de Larosière group's proposals, in the wake of the financial crisis. This independent body has responsibility for the macro-prudential oversight of the EU.

European Union (EU) || An economic and political union of 27 member states.

Financial Stability Board (FSB) || It brings together national financial authorities and international standard setting bodies to coordinate, develop and promote the implementation of effective regulatory, supervisory and other financial sector policies at an international level. The FSB was mandated by the G20 Leaders to promote financial stability.

Floating Rate Note (FRN) || A debt instrument that has a floating coupon.

Hedging || The practice of offsetting an entity's exposure by taking out another opposite position, in order to minimise an unwanted risk. This can also be done by offsetting positions in different instruments and markets.

Idiosyncratic event || An event that causes the value of a financial instrument to change more or less than the market in general (but not in an abrupt or sudden way). In other words, it is an event that is uncorrelated to the overall market.

Institutional Money Market Funds Association (IMMFA) || The Institutional Money Market Funds Association is the trade association which represents the European triple-A rated CNAV money market funds industry.

Interest rate swap || A financial product through which two parties exchange flows; for instance, one party pays a fixed interest rate on a notional amount, while receiving an interest rate that fluctuates with an underlying benchmark from the other party. These swaps can be structured in various different ways negotiated by the counterparties involved.

International Organization of Securities Commissions (IOSCO) || A global cooperative body that promotes international cooperation amongst securities regulators. IOSCO facilitates cross-border cooperation and seeks to reduce global systemic risk, the protection of investors and to ensure fair and efficient securities markets.

Investor run || A large amount of redemption requests by investors in MMF. The cause is typically an expectation of large losses by the MMF. Losses are exacerbated as assets may need to be sold at sub-optimal prices due to the daily liquidity promised by MMFs to investors. These events trigger a downward spiral that increases the amount of investor redemption requests as no investor would want to remain invested in the MMF and bear the losses.

Liquidity || A complex concept that is used to qualify market and instruments traded on these markets. It aims at reflecting how easy or difficult it is to buy or sell an asset, usually without affecting the price significantly. Liquidity is a function of both volume and volatility. Liquidity is positively correlated to volume and negatively correlated to volatility. A stock is said to be liquid if an investor can move a high volume in or out of the market without materially moving the price of that stock. If the stock price moves in response to investment or disinvestments, the stock becomes more volatile.

Liquidity transformation || Similar to the concept of Maturity Transformation, liquidity transformation refers to the situation where a MMF accepts investments by investors in the form of cash and, in turn, invests the invested cash into less liquid assets.

M3 || A “broad” monetary aggregate that comprises M2 plus repurchase agreements, money market fund shares and units as well as debt securities with a maturity of up to two years. A monetary aggregate is the currency in circulation plus outstanding amounts of certain liabilities of monetary financial institutions (MFIs) that have a relatively high degree of liquidity and are held by non-MFI euro area residents outside the central government sector. The Governing Council has announced a reference value for the growth of M3.

Mark-to-market || Accounting for the value of an asset or liability based on the current market price. The value of an asset or liability therefore fluctuates in accordance with the changes in market conditions.

Mark-to-model || Accounting for the value of an asset or liability on the basis of internal assumptions or financial models.

Maturity transformation || The situation where a MMF accepts investments by investors that mature or are redeemable in the short-term (daily) and, in turn, invests the invested amount into assets that have a longer term maturity date (such as 3 months).

Maximum residual maturity || The maturity until legal redemption, that is, the maturity used for calculating the WAL. The maximum residual maturity is the date at which the fund manager has certainty that the instrument will be reimbursed (maturity date).

MMF[55]      || There are two categories of MMFs in the EU:  ‘Short-Term Money Market Funds’ and ‘Money Market Funds’.  This approach distinguishes between short-term money market funds, which operate a very short weighted average maturity (WAM) and weighted average life (WAL), and money market funds which operate with a longer weighted average maturity (WAM) and weighted average life (WAL). For both categories of MMFs, CESR guidelines establish a list of criteria with which funds must comply with to use the label ‘Money Market Fund’.

Money Market || The market, in which short-term funds are raised, invested and traded, using instruments which generally have an original maturity of up to one year.

Net Asset Value (NAV) || The term used to describe the price or value of the fund on a per share basis. The NAV is calculated by dividing the total value of all the assets in a portfolio, less any liabilities, by the number of outstanding shares in the fund.

Prime money market fund || A fund that may invest in high-quality, short-term money market instruments including Treasury and government obligations, certificates of deposit, repurchase agreements, commercial paper, and other money market securities.

Regulation || A form of European Union legislation that has direct legal effect on being passed in the Union.

Repurchase agreement (Repo / Sale and repurchase agreement) || Short-term secured loans, obtained by borrowers to fund their securities portfolios, and by lenders as a source of collateralised investment. A contractual agreement whereby one agrees to sell a security at a specified price with a commitment to buy the security back at a later date for another specified price.

Shadow NAV || The MMF price per share, calculated on the basis of mark-to-market valuation of the MMF assets. The shadow NAV reflects the current market value of the securities rather than the amortised cost of those securities. Because markets are constantly changing, the shadow NAV is constantly changing too. As a result, the shadow NAV normally differs from the NAV calculated on the basis of amortised cost (CNAV).

Sponsor support || Financial assistance provided to a MMF by its fund manager or a parent company or any other affiliated company. Sponsor support is typically provided to prevent disruptions to the operation of the MMF, such as to maintain a stable NAV and in the event of an investor run, in order to re-assure investors that they will not bear any losses by remaining invested in the MMF.

Time deposit (TD) || A time deposit is money that is deposited for a fixed period of time at a bank and cannot be withdrawn before such period of time has elapsed.

Treasury bill (T-bill) || A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations of $1,000 up to a maximum purchase of $5 million and commonly have maturities of one month (four weeks), three months (13 weeks), or six months (26 weeks).

Undertakings for Collective Investment in Transferable Securities Directives (UCITS) || Undertakings for Collective Investment in Transferable Securities Directive, a standardised and regulated type of asset pooling.

Variable NAV (VNAV) || VNAV MMFs value their assets on the basis of the mark-to-market model, therefore, unlike CNAV MMFs, they allow for fluctuations in the NAV to reflect the current market value of the securities in the fund.

Volatility || The change in value of an instrument in a period of time. This includes rises and falls in value, and shows how far away from the current price the value could change, usually expressed as a percentage.

Weighted Average Life (WAL) || The weighted average of the remaining life (maturity) of each security held in a fund, meaning the time until the principal is repaid in full (disregarding interest and not discounting). Contrary to what is done in the calculation of the WAM, the calculation of the WAL for floating rate securities and structured financial instruments does not permit the use of interest rate reset dates and instead only uses a security’s stated final maturity. WAL is used to measure the credit risk, as the longer the reimbursement of principal is postponed, the higher is the credit risk. WAL is also used to limit the liquidity risk.

Weighted Average Maturity (WAM) || A measure of the average length of time to maturity of all of the underlying securities in the fund weighted to reflect the relative holdings in each instrument, assuming that the maturity of a floating rate instrument is the time remaining until the next interest rate reset to the money market rate, rather than the time remaining before the principal value of the security must be repaid. In practice, WAM is used to measure the sensitivity of a money market fund to changing money market interest rates.

2. 
Annex 2: definition of european mmfs
2.1. 
MMF definitions

Rules governing MMF are
currently scattered throughout different pieces of legislation, some taking the
form of EU directives, some the form of guidelines developed by CESR and some
the form of purely national legislation. All of these rules have a particular impact
on the way the MMFs are structured and operate in Europe.

Commission Directive
2007/16/EC on assets that are eligible for UCITS funds introduces the
possibility that UCITS funds can value money market instruments using either
market data (mark-to-market method) or alternative valuation models including
systems based on amortized costs. This implies that all UCITS funds can value
MMF instruments on an amortized cost basis, as long as they respect the
criteria defined in the Eligible Assets Directive, as well as an additional
range of criteria defined in CESR guidelines on eligible assets. CESR
guidelines introduced two conditions for allowing the use of amortized cost:
either the asset has a maturity of less than 3 months; or the fund invests only
in instruments with a remaining maturity of less than 397 days and has a
Weighted Average Maturity (WAM) of less than 60 days. This distinction is at
the origin of the separation between MMF businesses models that currently
prevail in Europe.

When CESR decided to
develop guidelines on MMFs, it based its definition on short-term MMF on the
above mentioned CESR guidelines on eligible assets: short-term MMF have to
invest in assets with a remaining maturity of less than 397 days and a maximum
WAM of 60 days. Short term MMF can maintain either a constant or a fluctuating
NAV. This decision has the following consequences:

1. As the
CESR definition of a short-term MMF coincides with the earlier CESR conditions
for using the amortized cost (397 days and WAM of 60 days), all short-term MMF
may use amortized cost to value their assets.

2. As CNAV
MMF rely on amortised cost to reflect a stable share value, the latter must
comply with the short-term MMF definition.

3. Variable
or fluctuating NAV (VNAV) MMFs, which do not rely on amortized cost accounting
to reflect a stable NAV, do not need to comply with the definition of
short-term MMF. Nevertheless many VNAV MMFs are structured as short-term MMFs.

The current
structure of the CESR guidelines has led to the following result:

1. Some Member States, such as France (FR), allow short-term VNAV funds
to employ amortized cost for those assets with a remaining maturity inferior to
three months.

2. Some other Member States, such as IE and LU, allow short-term MMFs
to value all of their assets at amortized cost.

The second category of
MMF developed by CESR, MMF, can invest in assets having a remaining maturity of
up to two years and a WAM of six months. This means that the MMFs cannot apply
amortized cost accounting to all their holdings but only to assets with a
remaining maturity of less than three months. Thus CNAV MMFs are de facto
excluded from this category. MMFs that are not structured as UCITS funds have
only to respect the CESR guidelines on MMFs and their national rules since they
are not subject to the provisions laid down in the Eligible Assets Directive or
the CESR guidelines on eligible assets that apply only to UCITS.

Main
characteristics of CESR distinction:

|| Short Term MMF || MMF

Use of amortized cost || Assets with less than 3 months or entire portfolio || Assets with less than 3 months

NAV || Constant or Variable || Variable

WAM || 60 || 6 months

WAL || 120 || 12 months

Maximum residual maturity || 397 days || 2 years

Minimum rating || Two highest short term ratings || Two highest short term ratings Investment grade rating for sovereign issuance

These
MMF characteristics as laid down in the CESR guidelines will serve as a basis
for defining the core set of rules that will apply to MMFs in the new
legislative text.

· 
Use of amortized cost and NAV: these two points
will be modified according to the conclusions from the impact assessment.

· 
WAM, WAL, maximum residual maturity: these
provisions will be maintained. They are already applied in almost all Member
States where MMFs are domiciled; therefore there should be no impacts.

· 
Minimum rating: the high quality requirement for
the money market instruments will be maintained while at the same time over
reliance on ratings will be avoided, in accordance with the general policy of
the Commission.

According
to an ESMA peer review of the application of the guidelines on MMFs, 12 Member
States have fully applied all provisions contained in the guidelines. These 12
Member States also coincide with the Member States where the MMFs are mostly
domiciled. At the end of July 2012, 8 Member States have not transposed the
guidelines in their national system and the rest of the Member States have
applied the guidelines only partially.

2.2. 
Definition of money market instruments

MMFs invest in
short-term instruments, usually referred as money market instruments (MMI).
There are 4 different layers of definition:

1. UCITS directive
(85/611/EEC), article 1(9): instruments normally dealt in on the money market.

2. The definition of
MMI in the eligible asset directive (2007/16/EC), article 3, precise the
meaning of instruments: instruments that are admitted to trading on a regulated
market or not. The meaning of "normally dealt in the money market"
shall be understood as a reference to financial instruments which fulfil one of
the following criteria:

a. they have a maturity at issuance of up to and including 397 days,

b. they have a residual maturity of up to and including 397 days,

c. they undergo regular yield adjustments in line with money market
conditions at least every 397 days,

d. their risk profile, including credit and interest rate risks,
corresponds to that of financial instruments which have a maturity as referred
to in points (a) or (b), or are subject to a yield adjustment as referred to in
point (c).

3. The CESR guidelines
on eligible assets (CESR/07-044) add the following precisions: no exposure to
precious metals and prohibition of short selling. They give a list of
instruments that usually comply with the criterion "normally dealt in on
the money market": treasury and local authority bills, certificates of
deposit, commercial paper and banker's acceptances.

4. The last layer of
definition is contained in the CESR guidelines on MMFs (CESR/10-049):

· 
Deposits with credit institutions are added to
the eligible assets for MMFs

· 
MMI must be of high quality, which is assessed
according to the credit quality, nature of the asset class, for structured
financial instruments the operational and counterparty risk and the liquidity
profile.

· 
To assess the credit quality, the fund must
refer to the two highest available short-term credit ratings awarded by each
recognized credit rating agency.

· 
The assets must have a residual maturity until
the legal redemption of less than 397 days (2 years for non short-term MMFs)

· 
Not take direct or indirect exposure to equity
or commodities, including via derivatives; and only use derivatives in line
with the money market investment strategy of the fund. Derivatives which give
exposure to foreign exchange may only be used for hedging purposes. Investment
in non-base currency securities is allowed provided the currency exposure is
fully hedged.

· 
Limit investment in other collective investment
undertakings to those which comply with the definition of a Short-Term Money
Market Fund.

These 4 layers of
definition represent the current scope for defining the eligibility criteria of
the assets in which MMFs can invest.

In order to define MMI
and precise the contours of the eligibility criteria in the law, most of these
rules will be maintained and inserted in the new legislative framework that
will apply to MMFs. These rules are mostly adequate to ensure that MMFs invest
in assets in line with their low risk profile. There will be no impact because
all Member States already apply the rules contained in the UCITS directive and
the Member States where the MMFs are usually domiciled apply also the CESR
guidelines.

2.3. 
IMMFA Code of practice

In addition to the
previous rules, certain MMFs (only the CNAV) adhere to the code of practice
established by the Institutional Money Market Funds Association (IMMFA). The
rules contained in the code are mostly aligned with the 2a-7 rules in the US.

Concentration || Max 5% exposure to a single "family", may be raised to 10% for 5 days Max 25% for one single repo counterparty, except for sovereign and AAA Max 5% in illiquid assets (deposits and repos with more than 5 days maturity)

Liquidity || Min 10% of daily assets Min 20% of weekly assets

Redemption || Possibility to use in-kind redemptions

Valuation || Amortized cost and shadow mark to market NAV calculated once a week Escalation procedure when both values differ by a marginal amount (guidance provides 10bps, 15bps and 25bps difference)

Rating || Min AAA rating

The
assets under management by IMMFA funds amount to around €515 billion,
representing a bit more than 50% of all European MMFs. IMMFA makes a
distinction, as in the US, between prime MMFs that invest in assets from all
types of issuers and government MMF that invest in assets issued by sovereign
entities. The breakdown is as follows:

In millions of EUR || Prime MMF || Government MMF

USD denominated MMFs || 163'059 || 70'994

EUR denominated MMFs || 96'432 || 6'912

GBP denominated MMFs || 171'825 || 7'518

Source:
IMMFA, October 2012

3. 
Annex 3: facts and figures of the European MMF
industry

The European MMF
landscape is covered by different institutions that provide statistical data.
The European Central Bank (ECB) closely monitors the MMF as part of its
monetary policy. MMFs are classified as marketable instruments in the broad
monetary aggregate M3. The ECB collects data on all MMFs domiciled in the EU
but puts the emphasis on MMFs domiciled in Eurozone countries only. The
provider of fund data, Morningstar, collects data on all investment funds
worldwide and therefore has a detailed database for all EU domiciled MMFs. Data
from IMMFA represents a good proxy for MMFs domiciled in LU and IE since the
majority of their MMFs follow their code of practice.

The European Systemic
Risk Board (ESRB) conducted a survey of the European MMF industry in September
and October 2012. The survey covers approximately 70% of the MMFs in Europe.
The data are very useful as they permit to complement other data or to gain
access to data that were not previously available.

3.1. 
List of EU countries where MMFs are domiciled

|| Total assets in € || EU share || Number of funds || % of MMFs' assets under UCITS regime || % of MMFs registered as UCITS

France || 381,676,240,628 || 40.00% || 455 || 71.83% || 44.40%

Ireland || 284,551,725,662 || 29.82% || 108 || 85.67% || 75.00%

Luxembourg || 240,294,204,306 || 25.19% || 262 || 92.60% || 73.28%

Sweden || 11,869,036,737 || 1.24% || 28 || 97.48% || 96.43%

Spain || 11,073,501,828 || 1.16% || 111 || 70.71% || 66.67%

UK || 9,363,817,338 || 0.98% || 34 || 27.79% || 64.71%

Germany || 4,722,223,477 || 0.49% || 14 || 99.83% || 92.86%

Finland || 4,255,528,408 || 0.45% || 12 || 90.33% || 75.00%

Portugal || 1,947,879,298 || 0.20% || 12 || 11.62% || 33.33%

Italy || 1,398,696,481 || 0.15% || 6 || 100.00% || 100.00%

Poland || 1,098,031,440 || 0.12% || 14 || 20.32% || 14.29%

Belgium || 869,273,837 || 0.09% || 11 || 19.67% || 27.27%

Austria || 724,803,397 || 0.08% || 10 || 84.60% || 60.00%

Netherlands || 152,663,642 || 0.02% || 1 || 0.00% || 0.00%

Greece || 37,359,042 || 0.004% || 2 || 100.00% || 100.00%

Latvia || 21,897,119 || 0.002% || 1 || 0.00% || 0.00%

Lithuania || 12,029,091 || 0.001% || 1 || 100.00% || 100.00%

Denmark || 2,819,086 || 0.000% || 1 || 100.00% || 100.00%

Slovenia || 869,959 || 0.000% || 1 || 100.00% || 100.00%

|| 954,072,600,776 || || 1,084 || 81.09% || 59.59%

Source:
Morningstar, Commission own calculation, September 2012

The above table shows
FR, IE and LU as the three leading domiciles for MMFs in Europe, enjoying
around 95% of the EU share. Assets under the UCITS regime in the whole EU
represent more than 80% of the total whereas funds registered as UCITS account
for around 60% of the total. Around the three main domiciles, we notice a
higher proportion of UCITS assets and funds in IE and LU than in FR.

The MMF characteristics
differ between the three main jurisdictions. IE and LU almost entirely host
MMFs following a CNAV model, allowing the use of amortized cost for the entire
portfolio of short-term MMF, whereas all MMFs domiciled in FR can use amortized
cost only in the last three months of an asset. In the CESR definition, CNAV
funds are only in the short-term category. The VNAV are split between the
short-term MMF category and the MMF category. They appear according to these
categories in the ESRB survey.

The data from the ESRB
survey match more or less the data collected by Morningstar regarding the total
size of the European MMF sector (954 billion vs. 978 billion) and the size of
each fund domicile. The table below is interesting because it adds a further
layer of information: the split between CNAV, short term VNAV and VNAV.

Another source
of data can be used to identify the weight of MMFs in each Member State. ESMA
conducted a peer review of the application of the CESR guidelines on MMFs and
Member States were asked to provide data regarding their own market. They are
provided in the following table. The assets are generally have been measured at
mid 2012.

|| Short-Term MMF || MMF || Amount of assets under management || Amount of assets under management

ST-MMF || MMF

|| UCITS || Non-UCITS || UCITS || Non-UCITS || UCITS || Non-UCITS || UCITS || Non-UCITS

AT || 0 || 0 || 7 || 0 || 0 || 0 || 405 || 0

BE || 2 || 0 || 4 || 3 || 165 || 0 || 411 || 96

BG || 0 || 0 || 7 || 0 || 0 || 0 || || 0

CY || 0 || n/a || 0 || n/a || 0 || n/a || 0 || n/a

CZ || 0 || 0 || 1 || 2 || 0 || 0 || 3 || 101

DE || 0 || 0 || 24 || 0 || 0 || 0 || 4,089 || 0

DK || 0 || 0 || 1 || 1 || 0 || 0 || DKK 1,412 || n/a

EE || 0 || 0 || 0 || 0 || 0 || 0 || 0 || 0

EL || 5 || n/a || 17 || n/a || 52 || n/a || 673 || n/a

ES || 1 || 3 || 36 || 31 || 47 || 160 || 4,630 || 4,127

FI || 3 || 0 || 10 || 0 || 843 || 0 || 2,925 || 0

FR || 91 || 204 || 90 || 256 || 140,465 || 81,471 || 132,090 || 43,298

HU || 0 || 32 || 0 || 25 || n/a || n/a || n/a || n/a

IE || 89 || 8 || 4 || 1 || 295,741 || 7,769 || 1,037 || 929

IT || 0 || 0 || 12 || 0 || 0 || 0 || 8 || 0

LI || n/a || n/a || n/a || n/a || n/a || n/a || n/a || n/a

LT || 0 || 0 || 1 || 0 || 0 || 0 || 12 || 0

LU || 60 || 35 || 70 || 38 || 214,204 || 32,963 || 39,506 || 12,677

LV || 0 || 0 || 2 || 0 || 0 || 0 || || 0

MT || 0 || 4 || 0 || 2 || 0 || 32 || 0 || 197

NL || 0 || 0 || 1 || 0 || 150 || 0 || 150 || 0

PL || 0 || 0 || 2 || 0 || 0 || 0 || 196 || 0

PT || 0 || 0 || 0 || 9 || 0 || 0 || 0 || 275

RO || 0 || 0 || 1 || 0 || 0 || 0 || 3,690 || 0

SE || 10 || 3 || 10 || 1 || 18bn SEK || 0.2bn SEK || 52bn SEK || 1bn SEK

SI || 0 || 0 || 3 || 0 || 23 || n/a || 23 || 0

SK || 0 || 0 || 2 || 0 || 0 || 0 || 17 || 0

UK || 7 || 3 || 7 || 1 || n/a || n/a || n/a || n/a

Source:
ESMA (amounts in Millions of Euros unless otherwise specified). n/a indicates
that the Member State has not provided the information.

3.2. 
Type of investors

|| Financial sector || Non-financial companies || Direct private investors || Others

France || 49% || 26% || 9% || 12%

IMMFA || 49% || 28% || 5.3% || 17.7%

Source: France: "Ce que détiennent les OPCVM français" Banque de
France

IMMFA: IMMFA and HSBC response to the EC consultation.

The financial sector classification includes in FR:
banks, insurances, MMFs, other investment funds

The
category "Others" in IMMFA data include wholesale distributors for
7.2% and portals for 5.6%

IMMFA further notices
in its response to the consultation that the percentage of non-financial
companies (corporate treasurers) listed at 28% underestimate their true
proportion because they often use financial institutions, portals and
distributors. Therefore they believe that the majority of their clients are
corporate.

IE and LU MMFs are
predominantly held by non-domestic investors, their domestic investor base is
very small (around 5%). Other countries have to the contrary a large domestic
investor base (around 80-90%) and only a minor proportion of assets detained by
non-residents.

Regarding the domicile
of investors, IMMFA[56] indicates that European
investors represent 78% of their investor base, as of December 2010.

3.3. 
Portfolio composition by sector

Allocation
of investments by type of fund and by counterpart sector

Source: ESRB survey.

This table shows that
each type of fund performs almost the same investments. Around 75% is invested
in monetary financial institutions (mainly banks), the rest being split between
corporate and government assets.

Selected breakdown of
MMF investment by region and sector

Source:
ESRB survey. MFI=Monetary Financial Institution, NFC=Non Financial Corporation,
Gov= Government, OFI=Other Financial Institution, RoW=Rest of the World

This table shows that
funds in IE and LU are mostly invested in non-domestic assets (domestic assets
represent 2.5% for IE and 2.8% for LU) whereas funds in other countries play a
large role in buying domestic debt. This also confirms that monetary financial
institutions are the main issuers of instruments bought by MMFs.

3.4. 
Portfolio composition by asset type

Regarding IMMFA only,
IMMFA provides this classification in its response to the consultation:

|| Fund count || Assets (currency millions) || Treasury || Govt Other || Repo || TDs || CDs || CP || ABCP || FRNs || Other

USD Prime funds || 22 || 210,562.0 || 2 || 3 || 17 || 13 || 18 || 35 || 4 || 7 || 1

EUR Prime funds || 22 || 98,721.5 || 5 || 3 || 7 || 26 || 18 || 33 || 4 || 4 || 0

GBP Prime funds || || 136,735.3 || 1 || 2 || 7 || 22 || 28 || 33 || 2 || 5 || 0

Treasury: US Treasury
securities, Govt Other: securities issued by other governments, Repo:
repurchase agreement (usually collateralized with government assets), TD: Time
Deposit, CD: Certificate of Deposit, CP: Commercial Paper, ABCP: Asset Backed
Commercial Paper, FRN: Floating Rate Note

The ESRB survey has
collected the information for each type of MMF:

Source: ESRB survey.

Breakdown
of assets by type of fund and by maturity bucket:

Source:
ESRB survey

3.5. 
Systemic significance of the MMFs in Europe

In average the MMFs are
much larger and much more concentrated than any other type of investment fund.
According to EFAMA the net assets of the European fund industry reached 8'658
billion EUR at the end of August 2012, which makes the proportion of MMFs
around 11% of that total. But from the biggest EU open end investment funds,
the MMF proportion rises considerably, as evidenced in the following graph.
Almost 50% of the assets of the 100 biggest EU open end funds are held by MMFs.

Source: Morningstar, Commission own calculation, September 2012

The
horizontal axis represents the 500, 300, 100, 50 and 10 biggest EU funds. The
vertical axis shows the proportion of MMF assets and funds in that total.

According to the
Morningstar database, the MMF assets are also extremely concentrated because
the 200 biggest MMFs totalize more than 86% of the entire MMF assets, 22 MMFs
have assets surpassing 10 billion Euros and the biggest MMF has more than 50
billion Euros of assets. As listed in the following table, the size of the
biggest European MMF providers is very significant. These figures do not take
into account the US market where some of these providers are also engaged in
MMF activities and which would largely inflate some figures.

|| MMF provider || Total EU MMF assets in EUR

1 || JPMorgan || 118,414,166,972.99

2 || Amundi || 83,695,650,747.26

3 || BNP Paribas || 74,207,688,909.29

4 || Goldman Sachs || 59,758,792,060.69

5 || BlackRock || 58,040,252,658.05

6 || Natixis || 39,426,042,403.29

7 || CM-CIC || 37,155,834,834.34

8 || HSBC || 32,448,445,062.33

9 || Deutsche Bank || 27,624,299,858.37

10 || BNY Mellon || 27,509,914,850.55

Source: Morningstar, Commission own calculation, September 2012

The
different MMF providers have been grouped under the heading of their parent
company.

4. 
annex 4: marketing practices

One of the reasons that
make believe the investors that they invest in a product as stable and liquid
as bank deposits is linked to the definition of MMF and the message used by the
providers.

· 
Definition contained in the CESR guidelines on
MMFs: "A short-term Money Market Fund or a Money Market Fund must have the
primary objective of maintaining the principal of the fund and aim to provide a
return in line with money market rates."

· 
IOSCO (27 April 2012) describes MMF as "an
investment fund that has the objective to provide investors with preservation
of capital and daily liquidity"

· 
IOSCO describes investor's expectations as
follows: "investors have come to regard MMFs as extremely safe vehicles
that meet all withdrawal requests on demand and are in this sense, similar to
bank deposits"

Here below are examples
of investment objectives written in the marketing documents of the funds
(examples chosen among the 10 biggest European MMFs). All these funds follow
the CNAV system.

· 
Investment objective of JPMorgan Liquidity
Funds: "To achieve a competitive level of total return in the reference
currency consistent with the preservation of capital and a high degree of
liquidity."

· 
Investment objective of Goldman Sachs Liquid
Reserves Fund: "For investors seeking to maximise current income to the
extent that it is consistent with the preservation of capital and the
maintenance of liquidity by investing in a diversified portfolio of high
quality money market securities."

· 
Investment objective of BlackRock Institutional
Sterling Liquidity Fund: "The Institutional Sterling Liquidity Fund (the
Fund) seeks to maximise current income consistent with the preservation of
principal and liquidity through the maintenance of a portfolio of high
quality short-term “money market” instruments."

· 
Insight Investment ILF GBP Liquidity fund:
"The investment objective of the Fund is to provide investors with stability
of capital and of Net Asset Value per Share (in the case of the Stable Net
Asset Value Shares) and daily liquidity with an income which is comparable
to sterling denominated short dated money market interest rates."

· 
Legal & General Investment Management
Sterling Liquidity Fund: "To provide an income whilst offering daily
access to liquidity and maintaining the value of the investment."

Here below are other examples provided during the
regulatory debate:

· 
Fidelity's 2011 survey reveals that retail and
institutional investors overwhelmingly indicated that they first and foremost
invest in US MMF for safety of principal and liquidity"

· 
BlackRock Lobbying and investor brochure (August
2011) 'the principle focus of MMF is capital preservation, liquidity
management and operational ease of use – not yield

· 
BlackRock, same brochure, short-term MMF managed
to the same objectives: capital security, liquidity, operational ease

· 
ICI, MMF brochure 2012: ''throughout the history
of MMF, investors have benefitted from the convenience, liquidity, and
stability of these funds. Individual or retail investors use money market
funds as savings vehicles to amass money for future investments and
purchases".

· 
HSBC, Proposal for MMF reform, November 2011:
'there are important differences between the operation of a MMF and a typical
investment fund .... First, the pricing mechanism of a MMF means that an investor
who invests today and then experiences a sudden need for cash tomorrow can
redeem at minimal risk of loss of principal, even if interest rates have
risen in the intervening period."

· 
JP Morgan, MMF Strategy review, September 2011:
"This growth [UCITS MMF] is partly a result of further maturity of the
European market, as more investors become familiar with the product in their
search for security and liquidity".

· 
ICI, Testimony before the US Senate (June 2012):
"Today over 57 million retail investors, [....] rely on the MMF industry as
a low cost, efficient cash management tool that provides a high degree of
liquidity, stability of principal value, and market based yield".

5. 
Annex 5: european mmfs through the crisis

Different studies have
been conducted and some information is available that gives an illustration of
the consequences of the crisis in Europe. These data should be analysed
carefully as they are not representative of the entire magnitude of the crisis.
Some problems such as liquidation and suspension of redemptions were avoided
due to the support provided by some sponsors. It is difficult to give a broad
picture of this support but there is a study conducted by Moody's and some
individual known supports.

5.1. 
List of known 2007 events on European MMFs

Date || Domicile || Name of the funds || Cause || Event || Source

Summer 2007 || LU || Axa IM US Libor Plus Strategy || 100% invested in ABS that fall in value || AXA bailed out the 740m fund || "Axa picks up tab on sub-prime fund", Financial News, 02/08/2007

Summer 2007 || FR || Oddo 3 fonds monétaires dynamique || Valuation problems in certain assets || Suspension and liquidation: guarantee for retail investors (cost: 25mio) and low redemption levels for others || ODDO press communiques

Summer 2007 || DE || Union Investment ABS Invest Fund || Investment in subprime mortgage loans || Suspension of redemptions after 100mio of redemptions from 950mio total || "Union Investment Halts Redemptions From Bond Fund", Bloomberg, 04/08/2007

Summer 2007 || DE || Frankfurt Trust - ABS Plus || Investment in ABS and CDOs || Suspension of redemptions following redemption requests amounting to 1⁄4 of the fund || "Frankfurt Trust freezes fund on investor fears", FT, 07/08/2007

Summer 2007 || LU || WestLB Mellon Compass ABS fund || Investment in ABS || Suspension of redemptions after inability to calculate the NAV || "WestLB Mellon venture freezes assets", FT, 07/08/2007

Summer 2007 || LU & FR || Different BNP ABS funds || Investment in ABS || Suspension of redemptions after inability to calculate the NAV: 400m redemption from 2bn || BNP Paribas Press release 09/08/2007

Summer 2007 || LU & FR || DWS ABS Fund || Investment in ABS || Haircut of 2.6% after 900m of redemptions from 2.1b || "DWS keeps ABS fund open as US sub-prime crisis ebbs", IPE 13/08/2007

Other funds suffered
troubles during the ABS crisis. At least 5 other funds (known from our
services) encountered similar problems. In addition to the 2 identified sponsor
supports (AXA and Oddo), at least two others are known for 2007:

Date || Name of the sponsor || Cause || Event || Source

2007 || Société Générale || Lack of liquidity in dynamic MMF || 200m of money provided to ensure liquidity for the clients || 4ème actualisation du document de reference 2007, SG

2007 || Barclays || Lack of liquidity || £276m of money provided to guarantee difference between mark to market and par || “Shadow Banking and Financial Stability: European MMFs in the global financial crisis”, Bengtsson, 2012

The 2007 events were
entirely driven by the difficulties encountered in the ABS market in the US. At
that time, a lot of MMFs were invested in ABS in order to offer returns above
the normal money market rate. They were usually designed as dynamic or enhanced
MMFs. Most of these funds were not classified as MMF according to the national
legislations but were considered by investors as MMF equivalent. Especially in
France, none of the funds that had to suspend redemptions did comply with the
then applicable regulation on money market funds[57].
Nowadays these funds do not exist anymore.

5.2. 
List of known 2008 events on European MMFs

---------------------------CONFIDENTIAL-----------------------------------------------------------

CESR /08-837: responses
to the questionnaire on the impact of recent market events on money market
funds

CESR sent a
questionnaire during the 2008 turmoil to assess the situation on MMFs in Europe.
15 Member States responded:

AT || 8 funds currently suspended. Inability to face redemption orders. One fund suspended since 2007

BE || No identified problems

DK || No identified problems

ET || Problems with the use of amortized cost

FI || Increasing amount of redemptions combined with liquidity crisis. Fall in NAV of the funds.

DE || Secondary market for MMI is illiquid. Use of mark to model to value assets. Significant redemption requests. Scarcity of short term government bonds, only few short term securities. Will lead soon to suspension of redemptions.

GR || Decline of 6.35% in domestic UCITS NAV and 20.15% decline in foreign UCITS NAV due to redemptions

HU || No identified problems

IE || Increased redemptions but only 3 funds suspended redemptions (3 Lehman funds). a certain flight to quality was observed.

IT || No major difficulties. Steady increase of redemptions but funds was able to face them.

LU || 3 funds suspended redemption due to illiquidity and valuation problems.

PT || Asset valuation issues

ES || Temporary partial redemption for one MMF because investments in CDOs

SE || No identified problems

UK || No identified problems even if higher redemptions

Some funds have
benefited from support from their parent company:

IE || Cash injections, direct credit support to cover realized and unrealized losses, or direct purchase of assets at amortized cost rather than market value

DE || direct purchase of fund units

PT || Injection of cash or lending

UK || Support from depositary to a number of institutional funds

The Member States did not
give precise number on the number of occurrences and the total amount of such
support.

It is difficult from
this information to draw precise conclusions. The most evident one is that
funds suffered from a sudden dry of liquidity in money market instruments
associated with troubles to precisely value the assets. This crisis was not
anymore only driven by the problems on the ABS market but more by a general
liquidity crisis of all money market instruments, especially the commercial
papers issued by financial institutions.

------------------------------------------------------------------------------------------------------------

Some public information
exists on the sponsor support provided in 2008 by European asset managers.

· 
Moody's, "Sponsor Support Key to Money
Market Funds": the study has analysed the
support received by CNAV funds enabling them to maintain the stable value. The
main conclusion is as follows: "even well-managed money market funds
investing in high quality short-dated securities may experience a material
decline in their mark-to-market value and/or shortage of liquidity within their
underlying securities". Over the history of MMFs, more than 200 CNAV MMFs
in Europe and the US received sponsor support. Before the crisis Moody's tracked
69 European CNAV MMFs and identified one occurrence of sponsor support in 2002.
In the US Moody's recorded 145 MMFs that would have broken the buck without the
support of their sponsor. During the financial crisis (August 2007 to December
2009), 26 funds in Europe received support and 36 in the US. At least 20
managers were identified in the US and in Europe that have provided support for
an estimated amount of $12.1 billion.

· 
CSSF 2008 annual report: "Pursuant to Article 50(2) of the law of 20 December 2002
on undertakings for collective investment as amended, certain money market
funds had to temporarily take out short-term loans to finance their redemptions."
However the exact amount of support is not provided.

· 
Société Générale (reference document 2009): the precise amount of support is not provided but it is indicated
that the negative results of the bank include support to the liquidity of
dynamic MMFs and valorisation adjustments of certain assets.

· 
Deutsche Bank (2008 annual report): €150 million injected into consolidated MMFs

5.3. 
Graphs of MMF assets in Europe

Central banks provide
data on the evolution of MMF assets over the past. Data from FR, LU and ECB
have been retrieved but it was impossible to find equivalent data from the
Central Bank of Ireland. Data from the IMMFA MMFs (CNAV funds) are also
available. There is a general trend of asset increase till 2009 followed by a
continuous decline till now. We see that French MMFs did not experience a
decline in 2008 (but a decline in the second semester of 2007 linked to the ABS
crisis) and we also see that IMMFA MMFs suffered an important decline in the
fourth quarter of 2008. This shortfall is not visible in LU data but would
maybe be observable in IE data. Since data from IE are missing, we can
extrapolate the following:

|| Sep-08 || Dec-08 || Change

FR || 467.7 || 483.2 || +15.5

LU || 326.6 || 340.2 || +13.6

IE || 387 || 347 || -40

ECB || 1261.3 || 1250.4 || -10.9

We know the data from
FR, LU and ECB. From the hypothesis that other Member States did not experience
a massive outflow (which is unlikely due to their relative small proportion in
total MMF assets); we can assume that IE MMFs suffered a loss of around €40
billion during the last quarter of 2008. This would make sense with IMMFA data.
The difference between these €40 billion EUR decline and the 25% decline observed
in IMMFA graph may be explained by the difference in the selected time frame.
The 25% decline was directly followed by an equivalent increase, therefore over
the quarter the loss is less than 25%. These data give an indication that the
funds domiciled in IE experienced a run whereas the funds domiciled in LU and
FR did not.

7.1.1. 
France

Source:
Banque de France, numbers in billion

This graph highlights
that the French MMFs registered declines in assets during the second semester
of 2007. This corresponds to the time where some "dynamic" MMFs
triggered panic among investors which spreads to the classic MMFs. The 2008
crisis is not marked by any decline but rather by an increase of the assets.
This is evidence that the French MMFs were not affected by the US turmoil
following the collapse of Lehman Brothers.

7.1.2. 
Luxembourg

We provide two graphs
for the LU MMFs since the Banque Centrale du Luxembourg provides two series of
data that are not directly comparable. The first series of data does not
integrate the new CESR definition whereas the second one does, which
substantially decrease the assets of the LU MMFs. However we can observe a
pattern equivalent to France where the assets were growing till 2009 before
declining till 2012.

Source:
Banque Centrale du Luxembourg, numbers in million

As shown in the graph,
the MMFs in Luxembourg were not materially impacted by the different crisis. We
cannot detect any substantial decline in the assets of the MMFs.

Source:
Banque Centrale du Luxembourg, numbers in million

Euro area

Source:
European Central Bank, number in million

The ECB collects the
MMF data from the 17 Member States that have adopted the Euro as currency. Units
of these MMFs detained by Euro area residents are included in the definition of
the M3 monetary aggregate. The Euro area figures represent more than 97% of all
MMF assets in the European Union. From the chart we can notice the same pattern
observed for FR and LU, with an increase in assets till the beginning of 2009
followed by a continuous decline till 2012. This may be explained by the
sovereign crisis that started in 2009 that may have altered the confidence of
the investors in the stability of the European market as a whole. The decline
between mid-2011 and 2012 is explained by a new statistical definition of the
MMFs.

Following the adoption
by CESR of new MMF guidelines, the Governing Council of the ECB decided in
August 2011 to adopt the new CESR definition by the means of an ECB regulation[58].
According to the ECB[59] the new definition
"significantly alters the picture of the money market fund industry in
some Member States". The ECB evaluates the drop since July 2011 in the
reporting population of €193.7 billion (18% of the assets), mainly coming from
drops in Ireland (-28%) and Luxembourg (-22%). This may be explained by the
fact that some funds did not want to comply with the new CESR guidelines and
preferred to be reclassified in the bond fund category, not subject to these
new guidelines.

7.1.3. 
IMMFA MMFs

In its response to the
EC consultation, HSBC and IMMFA provided a graph explaining that there is no
clear relationship between the deposit rates and the flows in MMFs. But this
graph also tells us that the IMMFA funds suffered approximately a 25% decline
in assets following the US events. This decline is further confirmed by the
subsequent IMMFA graph.

MMF quarterly asset
flows and yield variance versus EONIA

Assets under
management in billions of Euro

Source:
IMMFA

5.4. 
Governmental support

The ECB has taken
concrete actions since the summer 2007 to mitigate the liquidity problems. In
2008 it extended the list of assets eligible as collateral for ECB credit
operations. This expanded the estimated outstanding collateral available for
ECB credit from about €10 trillion to around €11.5 trillion. A key element of
the broadening of eligible collateral is the inclusion of certificates of
deposits traded on non-regulated markets. Finally the reduction of interest
rates such as the marginal lending facility rate to 3.75% was also providing
significant relief to most participants.

On 19th
November, Jürgen Stark, member of the executive board of the ECB said: "The
mandate of the ECB is to maintain price stability over the medium term. This
mandate must be adhered to both in normal times and times of crisis (...) There
is absolutely no reason to deviate from this approach during times of crisis.
This being said, the ECB, in cooperation with other central banks, has shown
remarkable flexibility in terms of liquidity provision. This flexibility was
necessary in order to avoid the breakdown of the interbank market, which is a
very important transmission channel for monetary policy."

Germany: "Die
Bundesbank wird rasch Schritte ergreifen, die Liquidität von nach deutschem
Recht errichteten Geldmarktfonds und geldmarktnahen Fonds sicherzustellen. Dies
kann über die befristete Bereitstellung von Sonderliquiditätshilfen gegen
Sicherheiten bei der Deutschen Bundesbank erfolgen."

6. 
Annex 6: us mmfs through the crisis
6.1. 
Description of 2007 and 2008 events

The US market
experienced only one occasion before the crisis where a MMF broke the buck.
Otherwise no major event was recorded, except the supports provided from time
to time from the sponsor. The US MMFs were able to withstand the 2007 subprime
crisis more easily than their European counterparts. Despite investments in
structured vehicles, the MMFs had enough cash to face the valuation problems
and also benefited from support from their bank sponsor.

The collapse of Lehman
in 2008 was followed by dramatic consequences for the US money market. The
funds that detained Lehman assets were confronted with heavy redemption
requests. One of them, the Reserve Primary Fund suffered massive runs that
conducted the fund to break the buck and close because the sponsor was not able
to provide the needed money to support the NAV, as the other funds did. Despite
having announced to investors that the family's owner money will be used to
support the fund "to whatever degree is required", the sponsor did
not provide the announced support[60]. This event led many
investors to redeem their positions in prime MMFs. During the week of September
15, 2008, investors withdrew approximately $300 billion from prime MMFs
representing around 14% of the total assets held by those funds[61].
Between September 9 and September 23, the value of holdings in prime MMFs
decreased by $410 billion.[62]

In order to face the
large amount of redemptions, managers started to retain cash instead of buying
money market instruments such as commercial papers (CPs). This had the effect
to reduce the maturity of CPs to only a few days and to increase the credit
spreads to unsustainable levels. Issuers relying on this source of funding were
grandly affected when this source of short term funding suddenly was not
accessible anymore.

6.2. 
Sponsor support

The Federal Reserve
Bank of Boston produced a very detailed analysis of the support provided from
2007 to 2011[63]. The paper analyses only
the direct support (cash contributions and purchase of securities above market
price) but excludes other forms (like sponsor engagements) that played also a
significant role in stabilizing the NAV of the funds. Only the losses are
recorded, not the amount of money injected to buy the distressed assets. In
this case, it would have been much higher: for example Credit Suisse disclosed
sponsor purchases in the amount of $5.69 billion during 2007. This is important
as it is the indicator of the ability of the sponsor to support the fund or
not. The main results are listed below:

· 
123 instances of support for a total lost amount
of $4,414,916,361.

· 
In 21 instances the support was higher than 0.5%
of the assets which permitted the fund not to break the buck. Adding the
supports on the full period, 31 funds received more than 0.5% of support. The
largest support represented 6.3% of the MMF assets.

· 
These figures do not take into account that a
support of less than 0.5% often prevented an increased redemption pressure
which would have materialized without the support.

The paper makes the
following conclusion regarding the impact of such support:

"Investors in
MMMFs choose these funds because of the stability and liquidity that they
provide. This is precisely why these investors are prone to run during a
financial crisis when either or both of these product features may be compromised.
If investor losses resulted from market events more frequently, it is possible
that the investor base and level of interest in the funds today would be very
different. But, as this paper shows, such outcomes are not frequent, as even in
times when market events would have caused losses to many investors, the
voluntary actions of sponsors has negated this impact.

It is unclear
whether MMMFs, as currently structured, are really pass-through entities. Fund
investors see no fluctuations in their share values based on changing interest
rates or credit spreads. When fund losses materialize, it is usually the
sponsors rather than investors who absorb them. And in the only recent example
of investors being required to absorb a loss, a run was triggered on other
funds that may have significantly impacted the broader economy absent
government intervention.

If sponsor support
were explicitly required and planned for, and all sponsors had the consistent
ability to provide support, such a business model might not be viewed as
problematic. But the current model is concerning in that it reinforces investor
confidence in the stability of the product without the ability of all sponsors
to consistently deliver."

The SEC made its own
research and estimates that throughout their history the MMFs in the US were
supported on more than 300 occasions (with 100 funds only in September 2008)[64]
and estimates that during the period from August 2007 to December 31, 2008,
almost 20% of all MMFs received support[65].

6.3. 
Governmental support

The sponsor support was
not enough to resume the redemption pressure. Therefore the US authorities set
up different programs aimed at stabilizing the market. The Treasury department
guaranteed the $1 NAV for more than $3 trillion of MMF assets and the Federal
Reserve Board provided facilities to support the money market. Two other
programs were created: the Asset Backed Commercial Paper Money Market Mutual
Fund Liquidity Facility (AMLF) for the ABCP and the Commercial Paper Funding
Facility (CPFF) for the issuers of CPs. These actions permitted to ease the
pressure on MMFs and money market instruments.

6.4. 
Graphs of MMF assets in USA

The following graph
shows the aggregate daily net flows in prime US MMFs during the 2008 crisis. Event
1: Lehman bankruptcy, Event 2: Reserve breaks the buck, Event 3: Treasury
guarantee.  We can see that following the Reserve Primary breaking the buck,
the outflows have been more than doubled in comparison to the outflows
following the Lehman collapse. The two days following the Lehman collapse, the
outflows amounted to around $50 and $30 billion whereas the two days following
the Reserve event, the outflows amounted to around $100 and $90 billion. In the
third day, governmental support was announced. This tends to indicate that the runs
were larger following a MMF breaking the buck than following the collapse of a
major bank.

Source:
The Cross Section of Money Market Fund Risks and Financial Crises, Patrick E.
McCabe

Institutional versus
retail investors: as mentioned in the problem
definition, the investors are not equally exposed to the risk of runs. Because
institutional investors often possess better knowledge and capacity, they
anticipate the risks to a larger extent than retail investors do. For that
reason, we have noticed during the 2008 crisis a sharp decline of institutional
investors holding of MMFs whereas the retail investors remained massively
invested. This distinct behaviour is accompanied by negative impacts on retail
investors since they have to bear the run's costs provoked by the institutional
investors.

6.5. 
Post crisis events

The US SEC undertook
after the crisis to reform the MMFs in order to increase their stability. This
resulted in an updated rule 2a-7 which, as a principal measure, forces US MMFs
to hold minimum amounts of daily (10%) and weekly (30%) liquid assets. This has
increased the overall liquidity of the funds but did not address the structural
features of MMFs. As highlighted by Chairman Shapiro in its testimony before
the US Congress, "the events of last summer [2011] demonstrate
that money market fund shareholders continue today to be prone to engage in
heavy redemptions if they fear losses may be imminent." During a 3
week period (beginning June 14, 2011), outflows of $100 billion were recorded,
representing 6% of the total assets of the prime MMFs. The major difference
with 2008 is that there were no real credit losses.

The sponsor support did
not stop after the reform. The study of the Federal Reserve Bank of Boston has
identified 13 instances of support in 2011. During meetings held with
stakeholders (HSBC, Fidelity and Federated), it was indicated to the Commission
services that the support was mainly driven by the credit downgrade of a
Norwegian bank, Eksportfinans[66]. This event highlights
that peripheral events such a downgrade of a non-major bank triggers the need
for the sponsor to support their MMFs.

7. 
annex 7: explanation of
some mechanisms 
7.1. 
Price mechanism of the MMF

The following graph
shows the price movements of a CNAV MMF compared to the evolution of its
portfolio value. Because the fund is able to round to the nearest cent, the NAV
is only moving at 0.995 and 1.005. The sudden price decrease at 0.995 is called
"breaking the buck". It is clear from the graph that investors make a
gain in redeeming when the red line is above the blue line and that investors
make a loss in redeeming when the blue line is above the red line. This
demonstrates the valuation mechanism behind the rationale to redeem early.

7.2. 
Liquidity fee mechanism

The liquidity fee mechanism
should reduce the incentive to run by equalizing the mid-price before and after
the redemption. The following example describes how it should work in practice.
For a matter of convenience, we will assume that both VNAV and CNAV MMF trades
around 1 EUR and that the fund of 10 million units faces a redemption request
of 1 million units. The mid-price of the fund is set at 0.9985 EUR but the
price at which the assets can be sold in the case of redemption is only 0.9975
(bid price).

The VNAV MMF accepts
redemptions at a price 0.9985 EUR which is equivalent to its mid-price but the
price at which the assets can be sold in the case of redemption is only 0.9975
(bid price). This 10 bps difference is equivalent to an advantage of 1'000
Euros for the redeeming investor. Because this advantage has to be paid
somehow, the remaining investors will have to bear it since the mid-price will
move downward to 0.99838 ((9'000'000-1'000) * (0.9985 / 9'000'000)).

In order to pay out the
investor at 1 Euro, the CNAV fund will need to sell assets with a value of
1'002'506 (=1'000'000 / 0.9975). The mid-price will move down to 0.99822
((9'000'000-2'506) * (0.9985 / 9'000'000)). There is therefore a first mover
advantage of around 25 bps, equivalent to 2'506 Euros, paid by the remaining
investors.

The proposal to
introduce liquidity fees is based on this principle. The fee should equalize
the mid-price before and after the redemption. Therefore the investor in CNAV
would have to pay 25 bps which would bring the mid-price from 0.9982 back to
0.9985. In the case of the CNAV the investor would have to pay a fee of 10 bps,
which would bring the mid-price from 0.99838 back to 0.9985.

7.3. 
Capital buffer

7.2.

7.3.

7.3.1. 
Capital buffer mechanism paid by investors:
Fidelity proposal

Different types of
mechanism exist but one industry participant has proposed to introduce the
following method to calculate the buffer level. The idea was presented by Nancy
Prior, Head of Fidelity MMF business, at two occasions, the 03rd of
October 2012 at a meeting with the Cabinet of Commissioner Barnier and the 04th
of October at a meeting with the Commission services in charge of asset
management. The weighting of each security should be calculated as follows:

Government assets, including repos with government asset as collateral || 0%

Assets having a remaining maturity of less than 7 days || 0%

Assets having a remaining maturity of more than 7 days || 100bps * time remaining * par amount Example for an asset having a par amount of 1 and 250 days till the maturity: 100bps * (250/360) * 1 = 69bps

According to a sample
from the largest CNAV MMFs domiciled in Europe, the average proportion of
assets with less than 7 days is about 40%. The average proportion of government
securities is about 10%, meaning that the assets without risk weighting amount
to 50% of a CNAV MMF portfolio. Further assuming that the assets above 7 days
are evenly dispersed around the mean of 180 days, it means that they contribute
for 50bps (100bps * (180/360) * 1). Since it represents only 50% of the portfolio,
the average buffer would amount to 25bps. This amount was considered as
representative by the participants from Fidelity. Fidelity further mentioned
that the buffer should be built over a period of 7 years in order to limit the
impacts on investors. Based on an average yield of 8bps per year, this would
currently deprive investors of almost 50% of their annual yield. The negative
impact would be almost completely removed if the yields were, as in the past,
around 3% per year but there is no indication that the monetary policy of the
central banks will change in the next years.

7.3.2. 
Capital needs of the
NAV buffers

Here below is a table
representing the impacts of different levels of capital buffers on the Core
Tier One (CT1) ratio of major banks involved in the business of CNAV MMFs.
First the table lists the Asset Under Management (AUM) of each bank, both in
the US and the EU. Then according to their current CT1, the foreseen decrease
in their CT1 is calculated if the banks were forced to build buffers. The
impacts might be substantial, especially for US banks that manage larger
amounts of MMFs than their European counterparts. It is important to keep in
mind that the impacts are measured taking into account all AuM, in Europe and
in the US. This would suggest that US would implement such an option too.

Bank || AUM of sponsored MMFs ($m) || CT1 ratio || Change in CT1 ratio given required MMF capital buffer size

US || EU || Sum || 0.5% || 1.0% || 2.0% || 3.0% || 5.0%

HSBC || 13,381 || 42,610 || 55,991 || 9.10 || -0.08 || -0.16 || -0.32 || -0.47 || -0.79

Lloyds || || 27,862 || 27,862 || 10.78 || -0.03 || -0.05 || -0.10 || -0.15 || -0.25

RBS || || 19,057 || 19,057 || 10.56 || -0.01 || -0.03 || -0.06 || -0.08 || -0.14

Deutsche Bank || 41,616 || 39,301 || 80,917 || 9.52 || -0.08 || -0.16 || -0.33 || -0.49 || -0.82

UBS || 52,816 || 377 || 53,193 || 10.80 || -0.07 || -0.13 || -0.26 || -0.39 || -0.65

BNY Mellon || 152,944 || 36,387 || 189,331 || 13.43 || -0.93 || -1.85 || -3.70 || -5.55 || -9.26

State Street || 67,979 || 30,660 || 98,639 || 12.09 || -0.50 || -1.00 || -2.00 || -3.00 || -5.01

Northern Trust || 26,042 || 11,979 || 38,021 || 12.06 || -0.34 || -0.67 || -1.34 || -2.01 || -3.35

Goldman Sachs || 133,776 || 77,136 || 210,912 || 12.07 || -0.23 || -0.46 || -0.92 || -1.38 || -2.31

JP Morgan || 252,827 || 167,849 || 420,676 || 10.07 || -0.17 || -0.34 || -0.69 || -1.03 || -1.72

Morgan Stanley || 78,040 || 4,751 || 82,791 || 13.01 || -0.13 || -0.26 || -0.53 || -0.79 || -1.31

Source:
Bank of England, October 2012

The preceding table did
not include asset managers that were not sponsored by a bank. The table here
below includes all operators of CNAV MMFs in Europe. The cost of a 3% buffer is
calculated on European assets only. There might be some discrepancies in the
AuM in comparison to the preceding table but this is explained by the different
date taken and by the currency chosen.

If everything remains
constant, the 3% buffer will require European managers to raise around €14
billion of capital. This amount has been calculated taking into account the
assets under management by CNAV funds that adhere to the IMMFA code of
practice. BlackRock is the only pure asset manager in the top 5 and it is also
the one that has indicated in its response to the consultation that managers
should be able to set aside enough resources to face "rainy days".
Other pure asset managers (e.g. Ignis, Insight or Federated) will face lower
amounts of buffer in comparison to banks (e.g. JPMorgan, Goldman Sachs or
Deutsche Bank). The cost of the capital would depend on the required return
demanded by investors.

The annual cost of
capital is also provided for different, ranging from 3% to 11%. These amounts
represent the cost that the different sponsors will have to pay every year for
maintaining the 3% NAV buffer. The cost of capital is dependent on every
sponsor, meaning that some sponsors will have fewer costs than others.

|| AuM in mio EUR || Money set aside in mio EUR || Annual cost of capital for a 3% buffer in mio EUR

3% || 5% || 7% || 9% || 11%

JPMorgan || 118,460 || 3,554 || 107 || 178 || 249 || 320 || 391

BlackRock || 71,961 || 2,159 || 65 || 108 || 151 || 194 || 237

Goldman Sachs || 60,227 || 1,807 || 54 || 90 || 126 || 163 || 199

Deutsche Bank || 30,787 || 924 || 28 || 46 || 65 || 83 || 102

HSBC || 26,702 || 801 || 24 || 40 || 56 || 72 || 88

BNY Mellon || 25,232 || 757 || 23 || 38 || 53 || 68 || 83

State Street || 20,482 || 614 || 18 || 31 || 43 || 55 || 68

Ignis || 19,964 || 599 || 18 || 30 || 42 || 54 || 66

Insight || 17,075 || 512 || 15 || 26 || 36 || 46 || 56

BNP Paribas || 16,462 || 494 || 15 || 25 || 35 || 44 || 54

RBS || 13,122 || 394 || 12 || 20 || 28 || 35 || 43

Northern Trust || 9,728 || 292 || 9 || 15 || 20 || 26 || 32

Federated Investors || 9,349 || 280 || 8 || 14 || 20 || 25 || 31

Amundi || 6,594 || 198 || 6 || 10 || 14 || 18 || 22

Fidelity || 5,533 || 166 || 5 || 8 || 12 || 15 || 18

Invesco || 5,485 || 165 || 5 || 8 || 12 || 15 || 18

Morgan Stanley || 5,061 || 152 || 5 || 8 || 11 || 14 || 17

Western AM || 3,512 || 105 || 3 || 5 || 7 || 9 || 12

Aberdeen AM || 3,441 || 103 || 3 || 5 || 7 || 9 || 11

Société Générale || 2,041 || 61 || 2 || 3 || 4 || 5 || 7

Bank of America || 1,434 || 43 || 1 || 2 || 3 || 4 || 5

Scottish Widows || 701 || 21 || 1 || 1 || 1 || 2 || 2

UBS || 115 || 3 || 0 || 0 || 0 || 0 || 0

TOTAL || 473,469 || 14,204 || 426 || 710 || 994 || 1,278 || 1,562

Source:
IMMFA data, Commission own calculation, October 2012

7.4. 
Choice of instrument

There are some industry
initiatives[67] currently under way,
many of which have already delivered improvements in the way MMF market works.
However, the self-regulatory approach lacks consistence as it is not
universally adhered to by all market participants. Rather, the existing
initiatives can serve as a starting point for legislative action because they
provide useful information on the detailed measures that may be targeted. Since
the IMMFA rules are mostly inspired by US legislation on MMFs, they also help
to harmonize legislation at international level and reduce regulatory
arbitrage.

ESMA might also propose
improvements to the CESR's guidelines (on eligible assets and on MMFs). Doubt
remains, however, whether all promising options can be achieved at the level of
ESMA guidelines. Coherence in how the new set of uniform rules is applied on
the ground may also suffer as ESMA guidelines are not legally binding.

Therefore guidelines
developed by ESMA may not be the appropriate tool. Whereas competent
authorities and market participants are expected to make every effort in order
to comply with guidelines or recommendations issued by ESMA in accordance with
Article 16 of the ESMA regulation, competent authorities are also allowed to
disregard such guidelines and recommendations provided they state their reasons
("comply or explain"). Hence guidelines adopted by ESMA cannot warrant
the observance of harmonised rules. The same applies to a Commission
recommendation.

An advantage of
choosing a Recommendation is certainly the high flexibility that this
instrument gives to Member States -- the latter may decide whether or not to
make the rules of the recommendation binding at national level. In other words,
a Recommendation would simply provide the national policy makers with the
Commission's suggested course of action and express certain policy preferences.
But a recommendation would have no immediate effect on the situation to be
addressed as Member States' legislators would then be left to decide whether to
make the Commission's policy recommendation legally binding or not at national
level. In case they would choose to do so, they would need to translate the
recommendation into self-executing and mandatory rules in their jurisdictions.

In the context of the
problems and objectives that are defined above such flexibility is actually a
severe drawback.

(1) The identified
problems concern areas that are of critical importance for the smooth
functioning of money markets and therefore the European economy as a whole,

(2) The cross-border
effects of diverging national rules addressing the MMF market constitute a
severe drawback for the efforts to create a safe and efficient money market,
and

(3) Solving the
identified problems requires a high level of harmonisation of rules (and thus
legal certainty). A legally non-binding instrument, such as a Recommendation,
turns out to be inadequate. It may lead to a situation in which i) no action is
taken by Member States, ii) action is undertaken only by some of them
(potentially on different subsets of the issues), or iii) action is undertaken,
but the Recommendation is not followed by all Member States that decided to
act, leading to potentially contradicting solutions that could actually worsen
the situation. Due to the seriousness of the identified problems, neither
outcome is acceptable.

This means that the
basic policy choice - should action be considered necessary at EU level - for
introducing these changes is through a harmonising legal instrument at the EU
level. For this there are two options, namely to a directive or a regulation.

While it is correct to
say that the main type of legislative instruments introducing EU financial
services legislation has traditionally been Directives, this choice reflected
the contents and the objectives pursued with those instruments. Directives
approximated national rules on the taking up of business and the provision of
services and in a gradual manner. They also allowed a first step at integrating
those rules in the legal systems of the Member States that were essential to
achieve the states aims while providing Member States with many options on how
to best achieve those aims.

The basic foundations
of an internal market for asset management were created by means of the UCITS
directive and the AIFM directive, which harmonised the rules on the
authorisation and supervision of fund managers. Yet, the gradual evolution of
an internal market for asset management showed the limits inherent in trying to
create a level playing field by means of a Directive. As many details were left
to national discretion, the transposition of a Directive often resulted in
significant room for divergences at national level. As the market for asset
management becomes more integrated, cross-border competition between asset
managers and fund domiciles has increased. Often, the more intense level of
cross-border marketing of investment funds has created appeals that the
applicable EU rules should not only facilitate free movement of services but
should also strive to create a more level playing field and equal conditions
for competition among fund managers.

Against the background
of existing access to the fund management activity, as provided by the UCITS
and AIFM directives and their implementing measures, additional regulatory
concerns regarding the level playing field among MMF need now to be considered.
At this stage of maturity of asset management rules in the internal market,
legislative measure on MMF is no longer concerned with the taking up of the
activity as fund manager or marketing a fund across national borders, but aims
to ensure market integrity and stability in relation to managers' activities
involving a specific type of funds. This is because MMFs are closely
intertwined with the real economy on the one hand and the banking sector on the
other hand. .

In view of the
objectives of the current proposal, a directive does not seem to be the right
choice of instrument. A proposal regulating the essential features of a MMF
requires that the legislative framework is applied throughout the EU with
exactly the same scope, without any gold-plating and without allowing residual powers
to national legislators. In fact, the objectives to limit the risk of runs and
stop contagion would require absolute clarity and uniformity as to the personal
and material scope of application, the conditions of its application throughout
the EU without exceptions or diverging implementations by national authorities
and jurisdictions.

It is these
characteristics of this legislative instrument that in a sense dictate the
choice of a regulation as the most appropriate form, since:

(1) directly applicable
regulations are the only way to have effectively uniform rules throughout the
EU, to the recognised benefit of industry and the users of these rules. They
eliminate divergences in applicable law between Member States. At the same
time, uniform rules do not mean "one size fits all" and are not
incompatible with a certain degree of flexibility for national supervisors in
the application of those rules.

(2) Regulations reduce
legal uncertainty: in case of directives national law provisions have to be
interpreted in the light of the underlying directives, which themselves may
require interpretation, whereas regulations are applicable without a second
layer of national legislation.

(3) Regulations ensure
that European law is applicable immediately and to its full extent in the whole
Union after its adoption by the legislator. They avoid the resource-intensive
and time-consuming transposition of directives by Member States and the
monitoring of timely and correct transposition by the Commission.

(4) The numerous
infringement cases against Member States for late, non- or incorrect
transposition of directives are evidence that the transposition of EU law is
ineffective in many instances. Depending on the content of the regulations,
adaptations of national legislation may continue to be necessary in some cases.
But this is much more limited than the transposition of a directive, and in
most cases application of a regulation in the markets will not depend upon it.

(5) The transposition
process has proven particularly inappropriate for quick responses needed in
times of crisis and to implement G20 commitments within the timeframes
committed to at the international level.

(6) Regulations can be
directly invoked by the parties concerned before national administrations and
courts, whereas this applies only in very limited circumstances for Directives.

For all these reasons,
the Commission services consider that a regulation is the preferred option.

8. 
Annex 8: European Parliament resolution on Shadow
Banking

MMFs are discussed
under the points 31 and 32 of the resolution.

31. Recognises the
important role played by money market funds (MMFs) in the financing of
financial institutions in the short run and in allowing for risk
diversification; recognises the different role and structure of MMFs based in
the EU and the US; recognises that the 2010 ESMA guidelines imposed stricter
standards on MMFs (credit quality, maturity of underlying securities and better
disclosure to investors); notes, however, that some MMFs, in particular those
offering a stable net asset value to investors, are vulnerable to massive runs;
stresses, therefore, that additional measures need to be taken to improve the
resilience of these funds and to cover the liquidity risk; supports the October
2012 IOSCO final report in its proposed recommendations for the regulation and
management of MMFs across jurisdictions; believes that MMFs that offer a stable
net asset value (NAV) should be subject to measures designed to reduce the
specific risks associated with their stable NAV feature and internalise the
costs arising from these risks; considers that regulators should require, where
workable, a conversion to floating/variable NAV, or, alternatively, safeguards
should be introduced to reinforce stable NAV MMFs’ resilience and ability to
face significant redemptions; invites the Commission to submit a review of the
UCITS framework, with particular focus on the MMF issue, in the first half of
2013, by requiring MMFs either to adopt a variable asset value with a daily evaluation
or, if retaining a constant value, to be obliged to apply for a limited-purpose
banking licence and be subject to capital and other prudential requirements;
stresses that regulatory arbitrage must be minimised;

32. Invites the
Commission, in the context of the UCITS review, to explore further the idea of
introducing specific liquidity provisions for MMFs, by setting minimum
requirements for overnight, weekly and monthly liquidity [20 %, 40 %, 60 %] and
to charge liquidity fees upon a trigger which also leads to a direct
information obligation to the competent supervisory authority and ESMA;

9. 
Annex 9: iosco recommendations and fsb endorsment

|| IOSCO Recommendations || EU response

1 || Money market funds should be explicitly defined in CIS regulation || UCITS, AIFMD, MMF regulation

2 || Specific limitations should apply to the types of assets in which MMFs may invest and the risks they may take || UCITS, MMF regulation

3 || Regulators should closely monitor the development and use of other vehicles similar to money market funds (collective investment schemes or other types of securities). || UCITS, AIFMD

4 || Money market funds should comply with the general principle of fair value when valuing the securities held in their portfolios. Amortized cost method should only be used in limited circumstances. || Option 2.8

5 || MMF valuation practices should be reviewed by a third party as part of their periodic reviews of the funds accounts. || Obligation to appoint a depositary in UCITS and AIFMD

6 || Money market funds should establish sound policies and procedures to know their investors. || Option 1.7

7 || Money market funds should hold a minimum amount of liquid assets to strengthen their ability to face redemptions and prevent fire sales. || Option 1.6

8 || Money market funds should periodically conduct appropriate stress testing. || Will be included in MMF regulation (already present in AIFMD and IMMFA rules)

9 || Money market funds should have tools in place to deal with exceptional market conditions and substantial redemptions pressures. || UCITS rules on suspensions of redemption

10 || MMFs that offer a stable NAV should be subject to measures designed to reduce the specific risks associated with their stable NAV feature and to internalize the costs arising from these risks. Regulators should require, where workable, a conversion to floating/ variable NAV. Alternatively, safeguards should be introduced to reinforce stable NAV MMFs’ resilience and ability to face significant redemptions. || Option 2.8

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. || Option 2.9

12 || CRA supervisors should seek to ensure credit rating agencies make more explicit their current rating methodologies for money market funds. || Option 2.9

13 || MMF documentation should include a specific disclosure drawing investors’ attention to the absence of a capital guarantee and the possibility of principal loss. || Option 2.2

14 || MMFs’ disclosure to investors should include all necessary information regarding the funds’ practices in relation to valuation and the applicable procedures in times of stress. || Option 2.2

15 || When necessary, regulators should develop guidelines strengthening the framework applicable to the use of repos by money market funds, taking into account the outcome of current work on repo markets. || ESMA guidelines on repos

Extract from
the FSB document: "Strengthening Oversight and Regulation of Shadow
Banking, An integrated Overview of policy recommendations, 18 November 2012

Money market
funds (MMFs) form a large element within the shadow banking system: they
provide short-term non-deposit funds to the regular banking system, and also
fund separate non-bank chains of credit intermediation. During the crisis,
moreover, certain types of MMFs experienced investor runs, some of which
necessitated large scale support from sponsors or the official sector to
maintain stability in the MMF sector. The MMFs that faced runs typically
offered stable or constant net asset value (NAV) to their investors, fostering
an expectation that their claims were similar to bank deposits. Thus, when a
large loss due to holdings of asset-backed securities (ABSs) and other
financial instruments caused some MMFs’ net asset values to drop below their
promised par value (i.e. they “broke the buck”), this prompted investor
redemptions across MMFs, destabilising the sector as well as the borrowers that
rely on funding from MMFs.

Given the
demonstrated potential for systemic run risk among MMFs, the FSB requested
IOSCO in October 2011 to develop policy recommendations for MMFs. IOSCO issued
a consultation report in April 2012 that provided a preliminary analysis of the
systemic importance of MMFs and their key vulnerabilities, including their
susceptibility to runs.

Based on this
analysis, the consultation report set out policy options that could reinforce
the soundness of MMFs and address the identified systemic vulnerabilities.
These possible policy options included: a mandatory move from stable NAV to
floating (or variable) NAV; enhancements to MMF valuation and pricing
frameworks; enhancement of MMF liquidity risk management; and reduction in the
reliance on ratings in the MMF industry.

The
consultation period ended in June 2012, after a one-month extension of the
initial deadline. Based on the comments received, IOSCO issued 15 policy
recommendations intended to provide the basis for common standards for the
regulation and management of MMFs across jurisdictions in October 2012.9 The recommendations
cover a range of issues associated with MMFs including:

i. 
General (regulatory framework) – MMFs should be explicitly
defined in collective investment schemes (CIS) regulation as they present
several unique features. Such regulation should include specific limitations on
the types of assets MMFs may invest in and the risks they may take. Regulators
should closely monitor the development and use of other vehicles similar to
MMFs so as to reduce regulatory arbitrage. (recommendations 1-3)

ii. Valuation –
MMFs should comply with the general principle of fair value when valuing their
assets. Amortised cost method should only be used in limited circumstances.
Such MMF valuation practices should be reviewed by a third party as part of
their periodic reviews of the funds accounts. (recommendations 4-5)

iii. Liquidity
management – MMFs should establish sound policies and procedures to know their
investors (e.g. cash needs, sophistication, concentration). MMFs should hold a
minimum amount of liquid assets to strengthen their ability to face redemptions
and prevent fire sales. They should periodically conduct appropriate stress
testing and have tools in place to deal with exceptional market conditions and
substantial redemption pressures. (Recommendations 6-9)

iv. MMFs that
offer a stable NAV – MMFs that offer a stable NAV should be subject to measures
designed to reduce the specific risks associated with their stable NAV feature
and internalise the costs arising from these risks. Regulators should require,
where workable, a conversion to floating NAV. Alternatively, additional
safeguards should be introduced to reinforce stable NAV MMFs’ resilience and
ability to face significant redemptions. (Recommendation 10)

v. Use of credit
ratings – Regulatory obligations of the responsible entities regarding internal
credit risk assessment practices should be strengthened and mechanistic
reliance on external credit ratings should be avoided. Credit rating agencies
should make more explicit their rating methodologies for MMFs. (recommendations
11-12)

vi. Disclosure to
investors – MMF documentation should include the absence of a capital guarantee
and the possibility of principal loss. MMFs’ disclosure to investors should
include all necessary information regarding their practices in relation to
valuation and the applicable procedures in time of stress. (Recommendations
13-14)

vii. MMFs’
practices in relation to repos – When 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 repos.10 (recommendation 15)

The FSB has
reviewed the IOSCO recommendations and endorsed them as an effective framework
for strengthening the resilience of MMFs to risks in a comprehensive manner. In
particular, the FSB endorses the Recommendation 10 requirement that stable NAV
MMFs should be converted into floating NAV where workable. The FSB believes
that the safeguards required to be introduced to reinforce stable NAV MMFs’
resilience to runs where such conversion is not workable should be functionally
equivalent in effect to the capital, liquidity, and other prudential
requirements on banks that protect against runs on their deposits.

10. 
Annex 10: feedback of the consultation

Here below is the list
of respondents to the MMF questions contained in the UCITS consultation.

|| Name || Nationality || Category

1 || Amundi || FR || Financial firm

2 || Association Française de gestion (AFG) || FR || Trade organization

3 || Association française des investisseurs institutionels (AF2I) || FR || Trade organization

4 || Association of British Insurers (ABI) || UK || Trade organization

5 || Association of private client investment managers and stockbrokers (APCIMS) || UK || Trade organization

6 || Association of the Luxembourg Fund Industry (ALFI) || LU || Trade organization

7 || Assogestioni || IT || Trade organization

8 || Austrian Authorities || AT || Public authorities

9 || Aviva Investors || UK || Financial firm

10 || AXA Investment Managers || FR || Financial firm

11 || Baillie Gifford || UK || Financial firm

12 || Barclays (Confidential) || UK || Financial firm

13 || BlackRock || UK || Financial firm

14 || BNP Paribas Asset Management || FR || Financial firm

15 || Bundesarbeitskammer Österreich (BAK) || AT || Trade organization

16 || Bundesverband Deutscher Investment-Gesellschaften (BVI) || DE || Trade organization

17 || CAMGESTION (BNP) || FR || Financial firm

18 || CFA Institute || EU || Non-profit organization

19 || Czech authorities (CZ) || CZ || Public authority

20 || Danish authorities (DK) || DK || Public authority

21 || Deutsche Bank AG || UK || Financial firm

22 || European Federation of Financial Services Users (EuroFinuse) || EU || Trade organization

23 || European Fund and Asset Management Association || EU || Trade organization

24 || Federated Investors || US || Financial firm

25 || Fidelity Investments || US || Financial firm

26 || Finance Watch || EU || Non-profit organization

27 || Finish authorities (FI) || FI || Public authority

28 || French authorities (FR) || FR || Public authority

29 || German authorities (DE) || DE || Public authority

30 || German Insurance Association (GDV) || DE || Trade organization

31 || HSBC Global Asset Management || UK || Financial firm

32 || Insight Investment || UK || Financial firm

33 || Institutional Money Market Funds Association (IMMFA) || UK || Trade organization

34 || International Capital Markets Association (ICMA) || UK || Trade organization

35 || Investment Company Institute (ICI) || US || Trade organization

36 || Investment Company Institute Global (ICI Global) || UK || Trade organization

37 || Investment Management Association (IMA) || UK || Trade organization

38 || Irish Funds Industry Association || IE || Trade organization

39 || Katarzyna Putra || n/a || Individual

40 || La Banque Postale || FR || Financial firm

41 || Law society of England and Wales || UK || Trade organization

42 || Luxembourg authorities (LU) || LU || Public authority

43 || M&G || UK || Financial firm

44 || Moody's || UK || Financial firm

45 || Morgan Stanley (Confidential) || UK || Financial firm

46 || Natixis Asset Management || FR || Financial firm

47 || Natwest Trustee & Depositary Services || UK || Financial firm

48 || SOMO || NL || Non-profit organization

49 || Standard & Poor's || FR || Financial firm

50 || State Street Corporation || US || Financial firm

51 || Swedish authorities || SE || Public authority

52 || THEAM (BNP) || FR || Financial firm

53 || UBS AG || CH || Financial firm

54 || Union Investment || DE || Financial firm

55 || UK authorities || UK || Public authority

56 || World Economy, Ecology & Development (WEED) || DE || Non-profit organization

Geographical origin
of the respondents

The geographical origin
has been attributed according to the address provided in the response.
Therefore some stakeholders are classified as coming from the US while they
have also operations in the EU. The EU origin indicates the EU wide nature of
the activities of the respondent.

Category of the respondents

The consultation on
MMFs was divided in 4 sections for a total of 21 questions.

10.1. 
General questions

(1) What role do
MMFs play in the management of liquidity for investors and in the financial
markets generally? What are close alternatives for MMFs? Please give indicative
figures and/or estimates of cross-elasticity of demand between MMFs and
alternatives.

Most of the respondents
indicate that MMFs represent a useful tool to manage short-term cash. Investors
are attracted by their high degree of liquidity and their low risk due to a
large diversification. Most of the investors are institutional, only a small
proportion of retail investors are invested. MMFs serve as safe short-term
liquid asset class for investing cash. MMFs are also used by risk-averse long
term investors that are seeking for safe harbour.

As buy side entities,
MMFs contribute to the demand of securities issued by companies, offering them
the possibility to diversify their financing from bank loans to securities. The
same applies to governments and financial institutions. In this way MMFs
constitute alternative funding for the real economy. Because MMFs have
substantially lower operating costs than commercial banks, the cost to
borrowers of obtaining financing through MMFs is much lower than is available
from commercial banks.

Bank deposits or
Certificates of Deposits (CDs) were often cited as the closest alternative to
investments in MMFs. However it is not evident that it represents a viable
alternative. Due to their counterparty risk, direct investments in deposits
require time and expertise that MMF managers offer at low cost (Amundi).
HSBC, IMMFA mention that institutional investors have cash assets
exceeding the amount of deposit guarantee schemes which would expose investors
to the full credit risk of the bank. HSBC, IMMFA have conducted a
historical analysis between the level of the deposit rates and the flows into
MMFs (graph in Annex 3.3.3). They conclude that investors are not driven by
returns of bank deposits but that investors choose MMFs for their diversification,
liquidity, security of capital, ease of use and transparency.

One stakeholder, UBS,
notices that substitutes depend on the type of MMF and type of investors. For
an institutional investor, the closest substitute is a money market mandate,
with capital guarantee for replacing CNAV and without capital guarantee for
replacing VNAV. Retail clients have insured bank deposits as substitute. They
see a cross elasticity of -0.9 for institutional, respectively -0.7 for retail
investors.

AF2I, one of the few contributions from the investor side, indicates
that the cross elasticity between MMFs and bank deposits mainly relies upon
interest rate levels and creditworthiness in banks. In the portfolio of the
French institutional investors represented by AF2I, MMFs represent 4.5%
of their assets, where it is more pregnant for small insurance and retirement
institutions.

A second alternative is
the direct investment in the money market instruments. But again this is not
seen as a viable solution as it requires a large degree of expertise (due to
credit analysis and sizes required) to invest on its own that only few
investors possess. MMFs represent a much easier way to achieve the desired
level of diversification.

(2) What type of
investors are MMFs mostly targeting? Please give indicative figures.

MMFs are mostly used by
institutional investors, retail investors representing only a small percentage.
Please refer to the table in Annex 3.2 on the type of investors.

(3) What types of
assets are MMFs mostly invested in? From what type of issuers? Please give
indicative figures.

MMFs are investing in
all types of short term products: commercial papers, treasury bills, floating
rate notes, short term bonds, repos or deposits. Issuers are banks, financials,
corporate issuers, sovereigns, agencies and supranational. Please refer to the
table in Annex 3.3 on portfolio composition.

(4) To what extent
do MMFs engage in transactions such as repo and securities lending? What
proportion of these transactions is open-ended and can be recalled at any time,
and what proportion is fixed-term? What assets do MMFs accept as collateral in
these transactions? Is the collateral marked-to-market daily and how often are
margin calls made? Do MMFs engage in collateral swap (collateral
upgrade/downgrade) trades on a fixed-term basis?

The majority of MMF
managers that responded use reverse repurchase agreements only as a manner to
place cash on a short term basis (mostly callable on a 24 or 48 hours basis) against
the exchange of extremely safe collateral (often government assets, otherwise
highly rated securities).

Securities lending is
very uncommon due to the counterparty risk. However some German stakeholders
engage in such transactions: according to the response from the DE
authorities, 2 out of 30 MMFs perform securities lending transaction. BVI,
GDV and Union Investment also mention the use of both.

All IMMFA MMFs
do not make use of securities lending. Repos are used to place cash for short
periods, mostly overnight, and are backed by high quality collateral, mostly
government securities (see table in Annex 3.3 for their proportion).

(5) Do you agree
that MMFs, individually or collectively, may represent a source of systemic
risk ('runs' by investors, contagion, etc...) due to their central role in the
short term funding market? Please explain.

Yes || Only CNAV || No

7 || 5 || 21

The majority of the
respondents do not think that MMFs are systemically relevant. They did not
cause the crisis but were affected by it. The runs observed in 2008 were mainly
caused by a loss of confidence in the solvency of the banking system which
decreased the investor confidence since MMFs were extensively invested in bank
assets. Therefore the MMFs were not the cause of the problem but were affected
by it. The 2008 crisis is sometimes explained by a "flight to
quality" because investors decided to sell their exposures to prime MMFs
invested in bank assets in order to buy government securities. Investors feared
that the objective to preserve capital and daily liquidity would not be ensured
anymore which leaded investors to redeem.

Another argument often
advanced is linked to the size of the European MMF industry. Banks represent a
much bigger risk; they continue to keep a preponderant role in financing the
economy. MMFs, with 4% of the balance sheets of monetary financial
institutions, represent only a small proportion in comparison to the 96% for
the banks. As such banks are much more risky than MMFs in Europe. BVI further
notes that the size of the European MMF market has been reduced with the
introduction of the CESR's guidelines. It is another sign that the MMFs, due to
their small size, are not systemic.

In addition, some
pointed out that MMFs, as investment vehicles, are already largely regulated
through UCITS and the attached CESR guidelines. The CESR guidelines on MMFs
have represented a major and decisive step towards greater transparency and
increased clarity. They provide a robust framework to limit the main risks to
which MMFs are exposed.

On the other side some
(HSBC, Finance Watch, WEED, BAK, FR and DE authorities) believe that
MMFs are systemically important due to their exposure to investor's runs and
the contagion channels to the banking system and the money market.

The UK authorities
believe that both CNAV and VNAV funds have characteristics that make them
appear bank-like in some respects. They offer relatively immediate liquidity
and undertake credit transformation by generating investor returns through
credit, liquidity and maturity mismatches. They are also large and potentially
systemic compared to other elements of the shadow banking system.

Some stakeholders (Amundi,
AXA, AF2I, UBS, FR, SE and DE authorities) make a distinction
between CNAV and VNAV funds. They recognize that CNAV MMFs may face additional
challenges than VNAV MMFs.

(6) Do you see a
need for more detailed and harmonised regulation on MMFs at the EU level? If
yes, should it be part of the UCITS Directive, of the AIFM Directive, of both
Directives or a separate and self-standing instrument? Do you believe that EU
rules on MMF should apply to all funds that are marketed as MMF or fall within
the European Central Bank's definition?

Yes || No

27 || 8

It was mostly agreed
that Europe needs a harmonized response for reforming the MMFs but the opinions
varied regarding the appropriate tool to implement the changes. Whatever the
tool chosen, it must however ensure that all funds that use the MMF label must
comply with the new set of rules. Many stakeholders encourage regulators to
codify the key features and principles of MMFs by including them directly in
the definition of MMF.

· 
Some (IMMFA, EFAMA, Deutsche Bank, FI
authorities) recommend creating a common definition of European MMFs in
both UCITS and AIFMD directives in order to apply the new rules on all MMFs,
irrespective of their legal status. ESMA should then be empowered to develop
technical standards using the CESR guidelines as a starting point.

· 
A self-standing piece of legislation should be
avoided (EFAMA, State Street, Morgan Stanley) as this would lead to a
propagation of separate legislative instruments covering different segments of
the investment fund industry. Therefore new rules should be accommodated within
the UCITS framework.

· 
Some others (HSBC, IMA, Morgan Stanley, State
Street, Federated, BlackRock, ABI) would prefer to amend the UCITS
directive and the CESR guidelines.

· 
ALFI proposes to
regulate the MMFs in UCITS only and any entity operating outside the UCITS
regime as a MMF should then be considered as a bank and regulated as such.

· 
Aviva, SOMO
recommend creating a stand-alone instrument in order to ensure that there is
harmonized regulation for MMFs at an EU level for both UCITS and AIFs. The SE
authorities recommend creating a single harmonized regulation on MMFs in
order to promote a level playing field.

· 
Others (Amundi, AFG, Barclays, BNP, Natixis,
ICMA) believe that a change in law (e.g. UCITS) is not necessary. Updating
CESR guidelines represents a good solution because these guidelines have the advantage
to apply on all types of MMFs, being UCITS or not. AF2I think that the
CESR guidelines accomplished a very good job and they don't need to be
reviewed.

· 
Union Investment
and the AT authorities recommend upgrading the CESR rules in the UCITS
directive.

· 
Finance Watch
proposes to keep the CESR distinction but by including a stronger difference by
asset type, preventing short term MMFs from investing in structured financial
instruments or ABCP. The categories should be renamed and provide a difference between
"Money Market Fund" and "Short Term Investment Fund".

· 
La Banque Postale thinks that CNAV MMFs should not be in UCITS.

· 
Fidelity urges
the regulators to expand their focus beyond MMFs, to examine investment
products that remain unregulated and non- transparent in the money market.
Pools, structured vehicles and other funds that offer cash investment without
the strict rules under which MMFs operate should be regulated at the same level
than MMFs.

· 
Finally a group of stakeholders (IFIA, BVI,
Insight, GDV, UBS, CZ authorities, Baillie Gifford, NatWest) believes that
Europe does not need to reform the MMFs.

(7) Should a new
framework distinguish between different types of MMFs, e.g.: maturity (short
term MMF vs. MMF as in CESR guidelines) or asset type? Should other definitions
and distinctions be included?

Maintain CESR distinction || Focus on short-term only

17 || 5

Most of the answers
highlight the need to have consistency in the definition of MMF at the EU
level. Investors often operate across national borders and would prefer a
standard approach. In the absence of a standard approach to MMF regulation,
those same cross border investors may allocate between different funds on the
basis of their regulation.

Regarding the current
definition of short-term MMF and MMF used in the CESR guidelines, the opinions
are split.

· 
The current distinction introduced by the CESR
guidelines should be maintained (Amundi, IMA, Deutsche Bank, Barclays,
Aviva, BlackRock, AFG, BVI, Insight, Union Investment, ABI, EFAMA, BNP, Natixis,
UBS, State Street, LU authorities) because investors are now used to it and
because it gives the choice to the investors.

· 
HSBC, IFIA, Morgan Stanley, Federated,
Fidelity believe that the CESR classification is
confusing and would need different naming conventions. They argue that MMFs not
classified as short-term MMFs are in fact short term bond funds, not MMFs.

· 
One noted (AF2I) that the definition of
MMF provided in the CESR guidelines is misleading because it introduces the
notion of preservation of capital. MMFs should not implicitly or explicitly
deliver any type of guarantee. In that sense, the only objective a MMF can
achieve is to seek an investment return linked to the money market.

· 
GDV recommends
introducing a distinction between MMFs investment goals, liquidity requirements
and investors.

10.2. 
Valuation and capital

(1) What factors do
investors consider when they make a choice between CNAV and VNAV? Do some
specific investment criteria or restrictions exist regarding both versions?
Please develop.

Most of the responses
make the observation that CNAV and VNAV MMFs have been offered in parallel in
Europe for many years. Many investors find it convenient and efficient to
diversify their assets in CNAV MMFs for tax reasons and because the variability
in the price of a VNAV complicates their cash‐flow planning. In
some countries, the availability of CNAV MMFs provide investors with the same
tax and accounting treatment that would apply if they invested directly in
their own cash management portfolios and thus reduces the administration costs
for investors, providing ease, as the return is qualified as income and not
capital gain. The responses did not contain any specific example of tax regimes
being favourable for CNAV or VNAV funds.

· 
It is often argued (Aviva, ICMA, AFG, Amundi,
Natixis, BNP) that from a commercial point of view there is a major
difference between CNAV and VNAV funds in the way they are perceived. CNAV are
viewed as deposit like instruments with a stability of value that refers to the
accounting of a deposit. In that sense, it may be that investors would choose a
CNAV MMF rather than a VNAV MMF base on the misconception that the capital
value is guaranteed. On the contrary VNAV MMFs are understood to be investment
schemes.

· 
The CNAV / VNAV distinction is for some
stakeholders (IMMFA, HSBC) not seen as a key driver in the choice of
investors. They are more focused on funds that meet their objectives of
diversification, security of capital and liquidity. After that only investors
will start looking at the price mechanism or at the rating of the fund.

· 
Deutsche Bank
analyses that most investors in Europe are used to CNAV funds which maintain a
constant value and have a monthly dividend payment. Those who invest into VNAV
funds (mainly French investors) are usually buying daily income accumulating
funds. They do not see a real difference in the type of MMF other than
difference in income recognition. Investors choose different funds for
different accounting requirements, tax reasons, cash flow planning (which is
complicated by VNAV valuation) and administration costs.

· 
BlackRock makes
an historical explanation. In the two largest MMF markets, the USA and France,
there is in effect little investor choice between CNAV and VNAV MMFs on an
on-going basis. CNAV MMFs have become engrained in the USA and VNAV MMFs in
France driven by a mixture of regulation, tax and accounting regulations and
product familiarity. In France, CNAV MMFs are prohibited and investors have
developed a strong preference for VNAV MMFs although their investments in CNAV
MMFs did increase during the Eurozone crisis. BlackRock’s experience is
that the original decision was rarely taken on the basis of the accounting
treatment of one fund or another but because CNAV MMFs were rated by CRAs and
that this rating was required by the investing entity in the absence of MMF
regulation or guidelines.

· 
A difference in settlement practices is noted by
UBS. Units of CNAV MMFs are generally settled the same day or the day
after whereas units of VNAV MMFs are settled within two or three days. UBS
further notes that another important consideration might be the strength of the
(implicit) capital guarantee by the fund sponsor for the CNAV.

(2) Should CNAV
MMFs be subject to additional regulation, their activities reduced or even
phased out? What would the consequences of such a measure be for all
stakeholders involved and how could a phase-out be implemented while avoiding
disruptions in the supply of MMF?

Yes || No

16 || 15

The responses to this
question are mostly linked to the responses to the question 1. When both types
of funds were considered as being merely equivalent, the stakeholders do also
believe that CNAV MMFs should not be subject to additional rules. But numerous
responses highlight the fact that CNAV MMFs are more prone to runs and should
be subject to additional regulation.

· 
The range of possible options for increasing the
rules on CNAV varies to a large degree. AF2I and Banque Postale
argue that CNAV must be prohibited; Aviva thinks that regulators should
require, where workable, a conversion to VNAV; SE authorities believe
that additional regulation or reduction of activities should be considered; Amundi,
BNP, Natixis, AFG, FR authorities require
additional measures such as reducing the amortized cost to the last 3 month of
an asset; ABI thinks of imposing capital buffers; and ICMA, LU
authorities would see a need for increased transparency and disclosures.
Barclays think that CNAV exacerbate runs but they don't see any appropriate
measure, apart increased liquidity rules for all MMFs. Finance Watch
thinks that the amortized cost method is misleading for investors.

· 
DE authorities
are in favour of requiring a full variability of the NAV using mark to market
valuation for all funds. Because the investor base of VNAV and CNAV is mostly
equivalent, they do not expect significant disruptions.

· 
In order to ensure level playing field between
VNAV and CNAV, UBS favours a requirement to make the implicit capital
guarantee of CNAV MMFs explicit, by requiring the sponsor to record a deferred
liability on its balance sheet and to disclose actual support given to any CNAV
MMF in the annual report.

· 
The rest of the respondents stress the fact that
no distinction should be made between CNAV and VNAV (this includes Fidelity,
Federated, Deutsche Bank, EFAMA, BlackRock, Insight, BVI, ALFI, State Street,
IMA). Runs affected both types of funds during the crisis therefore
requiring CNAV funds to move to a VNAV system will not reduce the probability
of future runs. It has never been proven that CNAV were more dangerous than
their VNAV counterparts. If a conversion to VNAV was required by regulators,
this could undermine the utility of MMFs to a large number of investors. It may
have the perverse effect of driving investors toward less-regulated and less
transparent investment products, thus increasing the systemic risk.

· 
According to an analysis performed by HSBC and
IMMFA (6 VNAV MMFs were surveyed), the NAV of French VNAV did not move so
much during the crisis, indicating that both types of funds are largely
similar. Furthermore the incentives to support funds are not linked to CNAV
only but also to VNAV: HSBC indicates that they decided to support their
own VNAV funds offered in France during the crisis.

· 
IFIA stresses the
need to adopt a coordinated approach among all global regulators. Any change
must be globally consistent regarding the approach and the timeframe in order
to avoid market distortion and investor confusion.

(3) Would you
consider imposing capital buffers on CNAV funds as appropriate? What are the
relevant types of buffers: shareholder funded, sponsor funded or other types?
What would be the appropriate size of such buffers in order to absorb first
losses? For each type of the buffer, what would be the benefits and costs of
such a measure for all stakeholders involved?

Yes || No

4 || 21

The support to this
option is very modest. The largest majority of the stakeholders doubt that it
could reduce incentives of runs and increase the overall stability of the
market. The design and implementation of capital buffers on CNAV funds would
give rise to numerous questions which will be difficult to answer, including
the potential size of the buffer and whether it is high enough. Moreover the
way the buffer should be founded poses questions. An investor's funded buffer
would reduce the yields that investors receive from their investments while a
sponsor's funded buffer would create disadvantages between sponsors that have
access to capital and others that do not. It would also increase the ambiguity
of risk ownership. Moreover some worry that imposing capital buffers on
investment funds would drive the investment fund industry toward adopting
bank-like regulation. Investment funds are not banks and there is no reason
that it should change in the future.

BlackRock expresses another opinion in this respect. While they believe that
buffers are not a panacea due to numerous reasons, they continue however to
support the idea that sponsors should be able to set aside some reserves in a
tax-efficient manner for a "rainy day" to be used in support of their
funds. They recall that they were among the first ones in 2011 to advocate for
treating MMFs as special purpose banks that would hold capital and have access
to central bank money.

ABI believes that CNAV should introduce capital buffers. The buffer
would be established within each MMF by siphoning a small amount of income from
the portfolio to be set aside as an NAV cushion. The buffer capital would be
regarded as an asset of the portfolio and, as such, would be calculated into
the NAV and results in a higher NAV for the MMF. The siphon would be turned on
and off depending on the size of the buffer relative to the pre-determined
minimum capital requirement. Shareholders of the MMF would “own” the buffer.

Capital buffers could be seen as a second
best solution for the German authorities, after the change of accounting
rules. Capital requirements could be imposed on the manager / sponsor but they
must be high enough to protect the funds against runs. The UK authorities
believe that capital buffers should be explored as an option for CNAV funds.
They further point out that any further action in this area should be informed
by the work of the FSB and IOSCO.

(4) Should valuation
methodologies other than mark-to-market be allowed in stressed market
conditions? What are the relevant criteria to define "stressed market
conditions"? What are your current policies to deal with such situations?

Most of the respondents
recognize that MMF managers should have the flexibility to choose the most
appropriate solution to value their assets in stressed market conditions. Each
type of model, amortized cost, mark to market and mark to model may be used
according to different circumstances.

· 
The use of amortized cost is appropriate most of
the times because it gives an accurate picture of the true value of an asset (IMA,
State Street, EFAMA, Fidelity, BlackRock).

· 
IMMFA and HSBC
mention that market prices are a mix of traded, quoted and evaluated prices.
Money market instruments are usually marked to market with evaluated prices
since they are generally held to maturity. Evaluated prices are generally
calculated mark to model taking into consideration factors such as interest
rates or credit spreads. In that sense this method is not superior to the
amortized cost.

· 
Amundi, Natixis, Aviva, AFG stress the need to apply the general principle of fair value and
ensure that the assets are valued according to current market prices. Where
market prices are not available or reliable, funds may value the securities
held in their portfolios using the fair value principle. In particular, in the
case of many short term instruments held by MMFs, valuation models based on
current yield curve and issuer spread, or other “arm’s length” valuation method
representing the price at which the instruments could be sold, could be used.
Amortised cost accounting may provide an accurate estimate of market price for
certain short-term instruments, assuming that they will mature at par. However,
sudden movements in interest rates or credit concerns may cause material
deviations between the mark-to-market price and the price calculated using the
amortisation method. In addition to the risk of mispricing of individual
instruments, the use of amortised cost accounting could create opacity for
investors regarding the actual net asset value of the funds. Therefore they
recommend that the amortised cost accounting should be subject to strict
conditions (e.g. less than 90 days).

· 
Some respondents (Amundi, Natixis, AFG)
consider that valuing assets at bid during stressed situations can be
appropriate. Using the technique of swing price may also be useful to let the
redeemer pay for the impact of its order. Some (AF2I, UBS) believe that
only the use of mark to market should be allowed in stressed market conditions.

10.3. 
Liquidity and redemption

(1) Do you think
that the current regulatory framework for UCITS investing in money market
instruments is sufficient to prevent liquidity bottlenecks such as those that have
arisen during the recent financial crisis? If not, what solutions would you
propose?

Most of the respondents
underline that liquidity is the key feature of the MMFs. The possibility to
invest and redeem at all time is essential for all investors. That being said,
most of the stakeholders see a need to improve the general liquidity of the
MMFs in order to avoid future liquidity bottlenecks. The range of possible
measures is large: liquidity fees, different types of restrictions and
liquidity constraints.

· 
EFAMA (plus many
other stakeholders that express the same opinion) notes that the vast majority
of MMFs are UCITS which means that their managers must, amongst other things,
employ a risk management process that enables them to monitor and measure at any
time the risk of the positions and their contribution to the overall risk
profile of the portfolio. The crisis has however highlighted the importance of
a uniform European definition of MMFs based on defensive portfolio strategies
and liquidity risk management system for being prepared for a long‐lasting
liquidity shock. The CESR guidelines have rightly addressed this concern on a
pan‐European basis. Hence, at this stage, the reform of MMFs should
focus on the fund’s internal liquidity risk, by requiring MMFs to adhere to
certain liquidity requirements and to take into account investor concentration
and segments, industry sectors and instruments, and market liquidity positions.

· 
The liquidity requirements should take the form
of minimum liquidity levels at the level of the MMF to enable funds to be able
to meet redemption requests without relying on secondary market liquidity.
Those requirements need to be proportionate to the role of MMFs in providing
short term funding to the banks, companies and governments. The liquidity
requirements receive some support (please refer to question 4).

· 
The introduction of a "know your
customer" policy is also favourably welcomed by some stakeholders (IMMFA,
EFAMA, ALFI, HSBC, Federated, Fidelity, BlackRock). MMFs should be required
to know their clients, in order to enable them to monitor
subscription/redemption cycles and manage risks arising from shareholder
concentration. Such measures may need to be accompanied by requirements on
intermediaries to disclose the identity of underlying investors to MMFs.

· 
Some stakeholders (Amundi, AFG, Natixis, BNP,
SE authorities) consider that current rules are enough to prevent liquidity
problems on VNAV and that CNAV may require additional measures.

· 
A group of respondents (AF2I, BVI, Insight,
GDV, Deutsche Bank and Union Investment, UBS, Aviva) is not convinced that
there is a need to reform the liquidity profile of the MMFs. The current rules
contained in UCITS plus the rules on WAL and WAM that have been added by the
CESR guidelines are sufficient.

· 
Any additional rules on liquidity should apply
to AIFs only (AF2I).

· 
IMA is in favour
of reviewing the liquidity rules but supports a common approach for all UCITS
funds.

· 
Deutsche Bank
recalls that MMFs, as UCITS funds, have already the possibility to take up to
10% credit / leverage which makes sense to use in times of stress: the fund
could place repo transactions and use the cash received to fulfil extraordinary
redemptions.

(2) Do you think
that imposing a liquidity fee on those investors that redeem first would be an
effective solution? How should such a mechanism work? What, if any, would be
the consequences, including in terms of investors' confidence?

Yes || Not on VNAV but maybe on CNAV || Other methods || No

6 || 6 || 5 || 13

Only 6 stakeholders formally
recommend the introduction of a liquidity fee mechanism and 2 recommend it for
CNAV funds only. It is seen by other stakeholders as potentially dangerous if
it decreases the general liquidity of the fund and because of possible runs
once the fee is applied.

· 
is recommended to introduce a liquidity fee
applied during stressed market conditions in order to disincentive investors to
run. The decision to activate such a fee could be left to the board of the fund
(IMMFA, EFAMA, Barclays). Some objective triggers are also envisaged:
when there is a 25bps deviation from the par (HSBC) or when certain
liquidity thresholds are reached (BlackRock). The amount varies in size;
for some it should cover the difference between the par and the shadow NAV, for
another (BlackRock) it should be fix at 1%.

· 
For Deutsche Bank, liquidity fees would
undermine the benefits of MMF, which stand for daily redemptions. Such an
approach could undermine stability as it would give an incentive to engage in a
pre-emptive run if investors fear that the liquidity fee may be imposed in the
event of market stress. Deutsche Bank thinks however that the Board of
Directors should have the right to impose liquidity fees if deemed necessary to
protect remaining investors.

· 
Some stakeholders (AFG, Natixis, BNP)
think that VNAV MMFs do not need liquidity fees because they already value
their assets marked to market. Only CNAV should be subject to such a fee (EFAMA,
ALFI).

· 
Aviva makes a
distinction between CNAV and VNAV funds. They have concerns regarding the
introduction of a liquidity fee for VNAV as they believe that it may be
difficult to identify a suitable set of parameters that would trigger the
activation of the liquidity fee and this would leave such a decision open to
question. They are also concerned that the imposition of a liquidity fee could
lead to a mass transfer of institutional investors into other investment
vehicles, especially in cases where the liquidity fee is perceived to be too
high. They think that with regards CNAV MMFs, these funds are able to maintain
both their stable price and provide liquidity in normal market conditions, so
liquidity fees should only be introduced, in principle, during stressed market
conditions. But overall they are of the view that a liquidity fee would be
unpopular with investors.

· 
A group of stakeholders think at imposing other
methods, such as swing prices (Amundi), dilution levies (AXA),
partial single swinging pricing (UBS), or a dual approach like in the UK
(IMA). The LU authorities recommend the use of gating mechanisms.

· 
The rest of the stakeholders (ABI, State
Street, Federated Investors, DE authorities, SE authorities, Union Investment,
GDV, AF2I, Insight, BVI, Finance Watch, Amundi, Morgan Stanley) believe
that a liquidity fee would not be operationally achievable and would most
likely increase the runs due to its pro-cyclical effect. This would also reduce
the attractiveness of the product for the investors which at the end would be
detrimental for the whole sector.

(3) Different
redemption restrictions may be envisaged: limits on share repurchases,
redemption in kind, retention scenarios etc. Do you think that they represent
viable solutions? How should they work concretely (length and proportion of
assets concerned) and what would be the consequences, including in terms of
investors' confidence?

Restricting the
liquidity of a MMF is seen as a dangerous option by almost all respondents.
This is a key feature of the MMFs and the investors might decide to stop
investing in MMFs if such mechanisms were to be introduced. The hold-back
mechanism was categorically opposed because it would decrease too much the
attractiveness of the MMFs.

· 
It was noted that UCITS funds have already the
possibility to suspend redemptions which is seen as an appropriate tool to
manage stressed situations. They also have the possibility to limit the
redemptions at 10% per day in certain circumstances in order to protect the
investors.

· 
Some, like IMMFA and HSBC, think
that MMFs should be allowed to perform redemptions in-kind but see some
challenges in the practical implementation. Furthermore HSBC proposes to
limit the total redemptions in one day at 10%.

· 
Other stakeholders (BVI, EFAMA),
categorically reject the redemption in-kind, seeing a lot of drawbacks. It is
difficult to divide assets into very small positions and the valuation of
assets could be complicated. Furthermore it could lead to a decline in the
market price of the securities received by the investors if they decide to sell
them.

· 
Finance Watch
suggests introducing a uniform one month gate of 50% of the assets used in
exceptional circumstances. This would limit the run risk and contagion risk and
preserve investor confidence.

(4) Do you consider
that adding liquidity constraints (overnight and weekly maturing securities)
would be useful? How should such a mechanism work and what would be the
proposed proportion of the assets that would have to comply with these
constraints? What would be the consequences, including in terms of investors'
confidence?

Yes || No

21 || 8

The majority supports
the introduction of minimum daily and weekly liquidity levels. It is seen as a
good mean to increase the overall liquidity of the portfolio. They further
point out that this system is already implemented in the US since 2010 and that
it has proven to work.

· 
HSBC, Morgan Stanley, Fidelity, Federated,
ALFI, Morgan Stanley, ABI, State Street, BlackRock
are in favour of 10% daily and 30% weekly thresholds (based on US model and
definition).

· 
IMMFA notices
that their members are currently required to have at least 10% / 20%.

· 
BNP, Natixis, AFG, Amundi are in favour of 10% daily and 15% weekly thresholds (based on the
definition of maturing assets).

· 
Aviva, IFIA, EFAMA, Union Investment, La
Banque Postale support the idea of liquidity
constraints but do not mention any specific limits.

· 
Barclays, AXA are
not opposed to minimum liquidity levels but it should be dynamically decided by
the manager.

Some drawbacks cannot
be ruled out because it could force MMFs to shorten their investments, thus
reducing the range of maturities available for issuers. The definition of the
liquidity is also seen as a challenge.

· 
Finance Watch
prefers imposing stricter rules on the maturity and weighted average life of
the assets.

· 
BVI, Deutsche Bank, GDV, Assogestioni, AF2I doubt that the negative implications of the liquidity constraints
(decreasing portfolio returns and shrinking attractiveness) could be
compensated by any gain in investor confidence.

· 
IMA fears that
requiring minimum amounts of investments with short realization period could
lead to a squeeze in the availability of such investments and push prices up
which is not in the interests of investors.

· 
Insight Investment considers that rating criteria and WAL / WAM limits are enough;
other limits may steer investors toward enhanced cash products not having the
MMF label.

(5) Do you think
that the 3 options (liquidity fees, redemption restrictions and liquidity
constraints) are mutually exclusive or could be adopted together?

The responses are
intrinsically linked to the responses to both precedent questions. The biggest
majority of the responses indicate that only one measure is needed. The
stakeholders that supported the imposition of a liquidity fee (or the methods
of swing prices and dilution levies) think that it could work together with
liquidity constraints.

(6) If you are a MMF
manager, what is the weighted average maturity (WAM) and weighted average life
(WAL) of the MMF you manage? What should be the appropriate limits on WAM and
WAL?

The vast
majority of the stakeholders believes that CESR Guidelines provide a robust
framework to limit the main risks to which MMFs are exposed, i.e. interest rate
risk, credit/credit spread risk and liquidity risk. Specifically, the reduction
in the WAM to no more than 60 days for short-term MMFs and 180 days for MMFs,
limits the overall sensitivity of the funds’ NAV to changing interest rates.
The reduction of the WAL to less than 120 days for short-term MMFs and less
than 397 days for MMFs, limits credit and credit spread risk.

10.4. 
Investment criteria and rating

(1) Do you think
that the definition of money market instruments (Article 2(1)(o) of the UCITS
Directive and its clarification in Commission Directive 2007/16/EC16) should be
reviewed? What changes would you consider?

Yes || No

6 || 15

Most of the respondents
do not think that the definition of money market instruments should be
reviewed. The UCITS directive, the Eligible Asset directive plus the CESR
guidelines provide already a solid definition.

· 
HSBC, IMMFA, BlackRock believe that the definition in UCITS should better reflect that the
majority of money market instruments are not traded on an exchange but are
traded between entities.

· 
Morgan Stanley
would welcome a review that clarifies what is not eligible.

· 
The LU authorities are of the view that the definition should be reviewed in order to
include a reference to the maturity feature of the money market segment. They
give the example of a 20 years floating rate note re-fixing the interest rate
every year with significant spread risk that should not qualify as money market
instrument.

(2) Should it be
still possible for MMFs to be rated? What would be the consequences of a ban
for all stakeholders involved?

Prohibit ratings || Mixed views || No prohibition

2 || 14 || 7

The views are mixed on
this issue. While the majority of the respondents recognize added value of the
ratings, they also see a risk when the funds are downgraded. It is indicated
that ratings provide an external source of information very useful for
investors.

· 
The rating of a fund conveys useful information
but the way CRAs have performed during the last years pose question. Therefore
the methodology used by CRAs could be reviewed (IMA, Barclays, State Street,
IMA, EFAMA, ALFI, Federated).

· 
EFAMA and ALFI
note that CRAs have lost credibility because their forecasts were generally
wrong. Therefore it is doubtful that a rating of MMFs offers any additional
information value to investors.

· 
BNP, Natixis, AFG, Amundi, ICMA believe that rating is a commercial activity and nothing should
prevent CRAs from offering their services. However a rating of MMF should not
be expressed on the same scale as issuance ratings in order to avoid
misinterpretation.

· 
A ban of rating could have possible
repercussions on investors that might not be able to rapidly change their
investment guidelines. Furthermore it would increase the burden on investor's
due diligence procedures although the investors may lack the capacity and
resources to conduct detailed investigations prior the investment (AXA, Aviva,
ABI, BlackRock, Insight, Individual, LU authorities)

· 
Deutsche Bank
acknowledges a lot of benefits to credit ratings and would see increased
burdens for investors without them. But it should not be an issue to ban MMF
ratings if enough interim-period is granted.

· 
Morgan Stanley
underlines that ratings would become less important to clients if there were a
robust, detailed and regulator-monitored set of European-wide MMF definition
similar to US SEC rules.

· 
Some stakeholders recognize that ratings pose
some additional risks to the stability of the MMFs. HSBC and Union
Investment are in favour of prohibiting the MMFs to be rated.

· 
IMMFA recognises the risks of ratings but does
not think that MMFs should be prohibited from being rated. They support
proposals to mitigate problems posed by MMFs fund ratings. If ratings were
prohibited, there would need to be a substantial lead time before
implementation to allow investors in MMFs to update their treasury policies and
for fund sponsors to provide additional transparency to investors to provide a
credible alternative to a MMF rating.

(3) What would be
the consequences of prohibiting investment criteria related to credit ratings?

Delete reference to ratings || Do not delete reference to ratings

12 || 11

The stakeholders are
again split on this issue. One part strongly supports the prohibition of credit
rating criteria for the investments of MMFs while others fear that a deletion
of credit rating criteria might decrease the quality of the assets detained by
the fund.

Credit ratings are
widely accessible and useful filter for the initial assessment of the
creditworthiness. Ratings ensure the existence of a valuable minimum
industry-wide benchmark. In the absence of a uniform minimum standard, more
aggressive MMF managers may be encouraged to take on additional risk in the
pursuit of higher returns. Without ratings this would bring more subjective
explanation of the risk profile, bring ambiguity and less harmonisation of
rules between managers.

· 
AXA, State Street, Aviva, UBS, Fidelity,
Morgan Stanley, BlackRock, Federated and Insight do
not support the deletion of the reference to ratings even if some deficiencies
are sometimes observed. Internal assessment should be done in parallel.

· 
IMMFA and HSBC
think that ratings are not the perfect solution but that no other credible
alternative exists for defining the quality of an asset. Deleting any reference
to ratings would cause great uncertainty to investors.

· 
AXA anticipates
that it could be harder for some issues to be accepted by investment managers
if information is less readily available for internal credit assessment. Some
managers may not have the numbers and quality of staff to perform a full range
of credit assessments, which may reduce the demand of certain securities.

· 
ABI believe that managers should be able
to make their own assessment but the credit ratings represent a useful filter.

The significance of
ratings in CESR guidelines on MMFs is overstated. What matters is that
management companies employ a risk-management process which enables them to
monitor and assess the credit quality of the money market instruments they
invest in. The manager should be responsible and should be able to overwrite
the credit rating of an instrument if it can conclude that the instrument is of
high quality. Currently the CESR guidelines require that the manager must check
the ratings awarded by each recognized CRA which is unworkable due to the high
number of CRAs (28).

· 
La Banque Postale, BNP, Natixis, AFG, Amundi,
Barclays, IMA, EFAMA, ALFI, ICMA, Assogestioni and BVI think that any reference to credit ratings must be deleted in the
CESR guidelines.

(4) MMFs are deemed
to invest in high quality assets. What would be the criteria needed for a
proper internal assessment? Please give details as regards investment type,
maturity, liquidity, type of issuers, yield etc.

An internal credit
process can only be carried out with proper resources, policies and procedures
in place to monitor credits and set credit limits. Having parameters that only
permit certain investment types, maturity, liquidity, and types of issuer does
not constitute a credit process. There should be controls on factors such as
maximum maturity, liquidity and investment types. Coverage of issuers should be
carried out by experienced credit analysts who perform fundamental research of
issuers based on quantitative and qualitative factors. There should be a
regular review processes in place for each issuer, and a credit oversight
process.

Many factors can be used internally to
assess the quality of an issuer or a specific paper:

· Fundamentals: regulatory and economic environment, management and
corporate strategy, balance sheet dynamics, earnings previsions....

· Technicals: supply/demand, Central Bank eligibility, Commercial
Paper program size, back up lines, public issue/private placement, FRN/asset
swaps...

· Relative value: sector peers, similar maturities, instrument type
comparison...

11. 
Annex 11: bilateral and multilateral meetings

03.10.2012

Unit concerned: G4 –
Asset management

Stakeholder: HSBC

Topic: Regulation of
Money Market Funds (MMF)

Purpose of this
report: Fact finding for an impact assessment

Stakeholders
present:

Jonathan Curry, Chief
Investment Officer – Liquidity

Simon Jowers, Head of
European Financial Sector Policy

Members of unit G4
present

Tilman Lueder

Olfa Ben Jamaa

Franck Conrad

Members of unit 02
present

Reinhard Biebel

Key points: MMFs are considered as systemically important. HSBC presented their
whole list of regulatory reforms for increasing the stability of the European
MMFs.

Liquidity: The overall liquidity of the fund must be increased by requiring
MMFs to adopt minimum daily and weekly liquidity thresholds. The IMMFA levels
are a good basis (10% and 20%).

The MMF must develop an
internal policy for better knowing the customers and introduce client
concentrations (for example max 5%).

The fund should be able
to limit the redemptions at 10% per day (above use of gates).

It should also be
possible to perform redemptions in-kind when the amount is too large.

Runs: Floating the NAV should not be the response for stopping runs.
During the crisis French VNAV did not move more than CNAV. They also offer a
kind of guarantee.

Liquidity fees are more
appropriate. It would be activated once objective triggers are reached (such as
a shadow NAV of 0.9975) and in this case a fee should cover the loss caused by
the redemption.

Sponsor support: Sponsor support must be prohibited because it is not clear who
owns the risk. It creates false incentives from investors that the MMF will be
always guaranteed. It can take several forms: cash, liquidity facility, buying
of units. HSBC provide support to its French VNAV too.

Credit ratings: It is dangerous to keep the ratings. It should be prohibited in
order to avoid negative effects of a downgrade. It would also reduce the
pressure on the MMF to maintain their ratings.

Scope: The dual system of CESR is not granular enough, the split between
short term MMF and MMF is confusing. Only short term MMFs should be allowed to
be MMFs.

04.10.2012

Unit concerned: G4 –
Asset management

Stakeholder: Fidelity

Topic: Regulation of
Money Market Funds (MMF)

Purpose of this
report: Fact finding for an impact assessment

Stakeholders
present:

Nancy Prior,
President of Money Markets

James Febeo, Senior
vice president, Head of regulatory affairs

Members of unit G4
present

Tilman Lueder

Olfa Ben Jamaa

Franck Conrad

Fidelity: Fidelity is the largest provider of MMF in the US with $490 billion
but in Europe only $7 billion through Fidelity Worldwide. They see Europe as a
market with great potential and want to expand.

Liquidity: The overall liquidity of the fund must be increased by requiring
MMFs to adopt minimum daily and weekly liquidity thresholds. The IMMFA levels
are a good basis (10% and 20%). With the US 2010 reform, the portfolio risk has
been considerably reduced.

If a fee were to be
introduced, it should be triggered by a board decision, not on objective
triggers and should be fixed amount.

Buffers: The stable price did not cause the crisis, the MMF were caught by a
banking crisis. Floating the NAV is not a solution since the incentive to
redeem still exists.

But in order to find a
solution, they propose to introduce a buffer. This would absorb the first
losses. It would be calculated as follows. It would be paid by investors over a
period of 7 years.

Government assets,
including repos with government asset as collateral: 0%

Assets having a
remaining maturity of less than 7 days: 0%

Assets having a
remaining maturity of more than 7 days: 100bps * time remaining * par amount.
Example for an asset having a par amount of 1 and 250 days till the maturity:
100bps * (250/360) * 1 = 69bps

Sponsor support: Faced with our concern regarding the 2011 sponsor support in the
US, after the 2010 reform, they indicated that it was caused by a negative
watch from Fitch on a Norwegian bank, "Export Kredit". They pointed
out the fact that the support was driven by capital support agreements
negotiated before the reform.

Know your customers: It is very important that the managers know their client base in
order to anticipate redemptions. The proportion of liquid assets must be
increased if the concentration of clients increases.

Scope: The split between short term MMF and MMF is confusing. The European
MMF definition is equivalent to short term bond funds in the US. Only short
term MMFs should be allowed to be MMFs.

14.10.2012

Unit concerned: G4 –
Asset management

Stakeholder:
BlackRock, Inc, London

Topic: Regulation of
Money Market Funds (MMF)

Purpose of this
report: Fact finding for an impact assessment

Stakeholders
present:

Bea Rodriguez,
Managing Director, cash team

Joanna Cound,
Managing Director, Government affairs

European
Commission

Tilman Lueder

The company: BlackRock is the second largest manager of global MMF – the largest
is JP Morgan. In Europe, BlackRock is also No 2 (behind JP Morgan) running
approximately $ 100 billion in MMF denominated in euro, sterling and dollars.  
BlackRock's MMF client base is largely institutional, with retail clients
amounting to less than 10% of assets under management.  BlackRock MMF's NAV
normally oscillates between € 0.999 and 1.001 (+/- 10 basis points).

The MMF market: In BlackRock's view runs on MMF reflect lack of confidence in the
underlying securities not on MMF as a sector. The events of September 2008
demonstrate that investors were in fact redeeming the prime MMF due to their
exposure to commercial paper issued by banks. In light with other stakeholders
BlackRock argues that almost the entirety of funds that were redeemed from
prime MMF were reinvested into government MMF (flight to quality). Therefore,
if there was a run in September 2008, it was a run on commercial paper issued
by the banking sector not on MMFs themselves.

BlackRock argues that
an analysis of MMF in- and outflows shows that the major outflows in US MMF in
September 2008 were linked to exposure to bank paper, the general impression
that US banks were insolvent coupled with political uncertainty about the US
Government's response. On the other hand, as the UK Government quickly
nationalised RBS and Lloyds, outflows in sterling denominated prime funds
(exposed to bank paper) were minimal.

Main arguments:

· 
Ms Rodriguez did not believe that the stable vs.
variable NAV was particularly relevant in the organisation of a MMF.  Runs on
funds could never be avoided altogether and were exclusively triggered by
credit events pertaining to invested securities. In that case the NAV would
oscillate beyond the range of +/- 10 basis points and investors would be
incentivised to redeem early whether the redemptions are at par or slightly
below.

· 
Investors in BlackRock funds are aware that
asset values are volatile – for them the quality and liquidity of the
underlying investment assets are much more important than the method of
valuation used to value the daily NAV of these assets. According to BlackRock,
the problems with MMF arise when they invest in illiquid and hard-to-value
assets such as ABS, ABCP or MBS.

· 
An additional threat for MMF was their exposure
to EU domiciled sovereign debt, BlackRock funds would nowadays only invest in
DE, NL or FR bonds.

· 
In relation to corporate issuers, MMFs have
become more modest, the 'single A' was the new standard.

· 
In any case, BlackRocks MMF often were a cash
management tool for hedge funds, sudden drawdowns were therefore to a large
extent unavoidable and appropriate 'know-your-customer' policies were in place
to anticipate large redemptions.

The stakeholders'
policy preferences:

· 
BlackRock favours (in line with IOSCO) a
separate definition of MMF in EU regulations.  BlackRock also believes that
only funds that comply with UCITS should be eligible to be MMFs.

· 
BlackRock does not favour capital buffers,
whether sponsored by the provider or investors.

· 
It has some sympathy for liquidity or redemption
fees as long as these fees would compensate those investors that do not redeem
early in times of stressed markets. But BlackRock believes that current
proposals on liquidity fees do not go far enough, the withdrawal fees should
even penalise early redeemers and benefit the NAV of the fund (standby
liquidity fees). Therefore, BlackRock advocates a liquidity fee which is
calculated as twice the difference between the stable NAV and the floating NAV
at the time of redemption. For example, if the floating NAV is at 0.9975, the
fee would be 50 basis points. The penalty of 25 basis points would accrue to
investors that remain in the MMF.

· 
BlackRock is opposed to hold-backs, such a
system would be disastrous for the image of the industry. This begs the
question why a withdrawal penalty would not be equally 'disastrous' but
BlackRock argues that investors would be more accepting toward the latter.

05.11.2012

Unit concerned: G4 – Asset management

Stakeholder: Federated Investors Inc.,
Pittsburgh, USA

Topic: Regulation of Money Market Funds (MMF)

Purpose of this report: Fact finding for an
impact assessment

Stakeholders present:

John W. Mc Gonigle, Vice Chairman,
Federated

Deborah Cunningham, Chief Investment
Officer, Federated

Gregory Dulski, Corporate Counsel,
Federated

David Freeman, Luc Gyselen,
Arnold&Porter LLP

Members of unit G4 present

Christiane Grimm

Franck Conrad

Tilman Lueder

The company: Federated,
active in MMFs since 1974, states that their range of MMF 'cover the
waterfront', that is they comprise Government funds, municipal funds (which are
tax exempt in the US) and prime funds (which focus on short-term corporate
debt). Federated is a big player in the US (No 5 with $ 256 billion in
short-term MMF).  In Europe, Federated is rather small, managing $ 7 billion in
Irish domiciled funds and around $ 4 billion in the funds domiciled in the UK. 
All of the MMF managed by Federated are so-called 'stable NAV' (CNAV) funds, as
this corresponds to overwhelming client demand. It also appears that the EU
customer based is mostly comprised of US companies that have euro or sterling
denominated treasury needs. Federated never broke the dollar; its investment
portfolio (all short term maturities included) oscillates between $ 0.998 and
1.002 per share.  This, in Federated's view, justifies recourse to amortised
cost accounting for the entirety of its short term MMF portfolio. Federated's
cost ratio for MMFs amounts to between 10 and 40 basis points (0.1-0.4%). Bank
deposits, in the US, would generate costs of between 3-4%.

The MMF market: In
the US, MMFs hold around 40% of short-term securities issued by the corporate
sector (both financial and non-financial companies). MMFs are also purchasers
of 70% of short-term securities issued by the federal government, federal
agencies and municipalities.  A company like Federated (representative of the
MMF sector) is usually exposed to both government and corporate debt: Federated
has around $ 120 billion invested in government securities, $ 125 billion in
corporate debt and $ 25 billion in municipal debt. Compared to the industry
standard, Federated has a high exposure to municipal debt as it claims to
specialise in this area.

Federated was unable to
provide a comparable level of detail for the European market. In the course of
the meeting it became clear that there is less municipal issuance in Europe
(certainly on the Continent) and that Federated seems to specialise more on
corporate debt (to be confirmed).

Main arguments: Like
many other US fund advisers, Federated argues that the week of September 8,
2008 was highly unusual with the collapse of Lehman, the disappearance of
Merill Lynch as an independent entity and the need for the Fed to step in and
inject over $ 85 billion into AIG, the biggest US insurer. These difficult
market conditions, rather than the method of asset valuation used by a MMF,
resulted in a drop in confidence in respect of prime funds (and notably those
that invest in short term debt issued by financial institutions). Nevertheless,
out of 850 MMF operating in the US, only one MMF (Reserve Primary) broke the dollar
and this exclusively on account of its exposure to commercial paper issues by
Lehman (this exposure generated a $ 750 million loss in the MMFs portfolio).

Federated also argues
that even this loss would not necessarily have led to the MMF breaking the
dollar: diligent management by the board would have prevented the MMF from
breaking the dollar. Instead of redeeming shareholders at par, despite known
losses on the Lehman paper, the Primary Reserve board should have immediately
frozen the fund and liquidated its otherwise unimpaired holdings in an orderly
manner. Federated argues that it was precisely the board's unwillingness to
immediately freeze redemptions at par (even as the Lehman losses were known)
that caused the run on the Reserve Primary Fund.

Federated also states
that the week of September 8, 2008 did not lead to overall net outflows from
MMFs. What they observed was rather investors recalibrating their exposure away
from prime funds toward government funds ("flight to safety").  Federated
remarks that, even in the best of circumstances, there was high turnover
between government and prime MMF as some investor engage in 'window dressing'
at certain junctures (demonstrating that they have solid holdings in government
debt).

The stakeholders' policy
preferences: Federated is not against MMF reform. Essential
ingredients, from their perspective, are stricter rules on overnight and weekly
liquid assets. They propose a rule that 10% of an MMF's holdings should be in
securities that can be converted into cash overnight and at least 30% must be
convertible into cash in 5 business days. In their view, this requirement alone
would have avoided the Reserve Primary Fund from breaking the dollar. In
addition, Federated argues that the liquidity rules should be complemented by a
'know-your-client' rule. For each client that accounts for more than 10% of the
fund's shares, the above liquidity thresholds should be adjusted by 10%. That
means, a MMF with a single client that accounts for more than 10% of shares,
the daily liquidity should increase to 20% and the weekly liquidity to 40%. The
latter is an interesting idea not mentioned in their written submissions. Other
events that increase the demand for redemptions at certain predictable periods
in time (payroll or tax at the end of a month, quarter, etc.) should also be
factored into the fund's liquidity planning.

Overall conclusion: Very
informative meeting - very focused in the US situation and debate. Federated
was invited to submit more granular data for Europe addressing a variety of
scenarios, such as:

(i) 
customer reaction to
floating the NAV for EU domiciled funds;

(ii) 
customer reaction to an
obligation that all CNAV funds need to publish the shadow NAV on a daily/weekly
basis;

(iii) 
granular data comparing the
performance of CNAV and VNAV funds in situations of market stress;

(iv) in case comparable data under (iii) cannot be
obtained, anecdotal evidence of CNAV vs. VNAV MMF investors redemption
behaviours in stressed market conditions; and

(v) 
evidence on close substitutes
for CNAV funds in Europe (e.g., bank deposits, unregulated funds, CNAV funds
overseas, etc.).

12.11.2012

Unit concerned: G4 –
Asset management

Stakeholders: Amundi
Asset Management, CM-CIC Asset Management, AXA Investment Managers, Association
Française de la Gestion financière

Topic: Regulation of
Money Market Funds (MMF)

Purpose of this
report: Fact finding for an impact assessment

Stakeholders
present:

Mikaël Pacot, AXA IM,
Head of Money Markets

Luc Peyronel, CM CIC
AM, deputy CEO

Patrick Simeon, Head
of monetary business

Sabine de Lépinay,
AFG

Members of unit G4
present

Tilman Lueder

Olfa Ben Jamaa

Rostia Roszypal

Franck Conrad

Key points: All stakeholders see the need for a reform of European MMFs and
would prefer a transversal approach, focusing on both UCITS and AIF funds. The
liquidity profile of the MMFs must be enhanced, the reliance on credit ratings
reduced and the linearization over 3 months maturity forbidden.

MMFs through the
crisis: Some funds invested in ABS suffered
valuation and liquidity problems in 2007. While most of these funds were not
classified as MMF, they however provoked negative repercussions on classic
MMFs. Most of the French MMFs passed through the crisis without specific
problems due to their prudent investment approach: lowering of asset's maturity
and reduction of duration. The mark to model has been authorized by the AMF to
value the assets that had no market price anymore. French MMFs were not exposed
to toxic assets such as German MMFs did; therefore there was no need, as in
Germany, to receive support from the public authorities. Such a crisis would
not be possible anymore since the rules on MMFs have been strengthened.

The 2008 crisis was
linked to the global loss of confidence in US banks. This was again managed through
a reduction in maturity and duration. The French MMFs recorded inflows during
the 3rd and 4th quarter of 2008 because investors sold their exposure to US
banks (IE MMFs) in order to buy MMFs exposed to European banks.

The VNAV funds were
able to absorb most of the daily losses in value thanks to the then prevailing
high yields (4%). Therefore they did not record large price fluctuations. Some
funds benefited however from sponsor support but the rationale was to avoid
reputational risk, not to maintain a stable price as CNAV did. Because some
MMFs have been sold as daily liquid investments and in fact had more than 800
days of WAL, sponsors preferred to inject cash in the MMF instead of having to
deal with misselling complaints. Such a situation could not happen today
anymore since MMF rules limit WAL and WAM.

Liquidity: The overall liquidity of the fund must be increased. They propose
to introduce a ratio of 10% of daily maturing assets and a ratio of 15% of
weekly maturing assets for short-term MMFs. For MMFs, the ratio should be again
10% daily but 15% monthly. They made some the proposal to implement the
technique of swing prices: once the amount of daily redemptions / subscriptions
exceeds 10%, the fund must use the bid, respectively the ask instead of the
mid-price. This method is already used in LU. If they consider this option as
theoretically appealing, they see some risks in its application. Once the
technique is activated, it could trigger a wave of redemptions. Therefore the
regulator should take the decision to apply it to all funds at the same time,
but it is seen as not possible with 27 different regulators.

Credit ratings: Credit ratings are seen as an aggravating factor, both at the
level of the fund and at the level of the asset. Once a fund loses its AAA
rating, it can be systemic since all investors want to redeem. It is always
more complicated to maintain the AAA rating because the CRAs impose always more
stringent criteria. Some investors require a rating from all 3 biggest CRAs in
order to invest in a MMF. More generally the future of MMF rating is seen as
problematic: investors put into question the necessity to invest in AAA rated
MMF because the criteria to be awarded the AAA are so constraining that the
yield is approaching 0. AFG indicates that ratings are not so important when
there are clear rules on MMFs.

The reference to
ratings in CESR guidelines must be removed: use a reference to investment grade
instead of two highest ratings. Very high quality issuers (e.g. BBVA) are often
downgraded which forces the MMF to sell all the assets issued by this issuer.
Managers are better able to evaluate the risk, through an internal rating
process.

Linearization

· 
(CNAV MMFs are seen as misleading the client:
they offer a kind of guarantee. They are dangerous because the discrepancy
between the amortized price and the market price can be substantial. This
creates liquidity problems when the fund is forced to sell its assets in order
to meet redemption requests. They prefer a linearization limited to the last 3
months, but only if the asset does not represent material risk.

· 
The funds that maintain a stable price at 1 are
seen as convenient for many investors and represent advantages when their
country of domicile applies a tax on capital gains. Some investors might not
easily convert to a VNAV system for these reasons. A system where the fund
maintains a share price of 1 while using amortized cost in the last 3 months
already exists (e.g. some Amundi funds) but it is challenging to keep the AAA
rating as there is a strong pressure from CRAs to invest only in less than 3
months assets.

Scope: Any new regulation should be based on the dual system developed by
CESR: short-term MMF and MMF. Investors are now used to it and appreciate the
flexibility to switch from one category to the other in order to meet their
different needs. A better denomination could however be found.

Impact of a change
in EU legislation: They do not think that the US
funds represent any kind of competition for EU funds. Both markets are
hermetic. The time lag between the two zones is seen as two important for
corporate treasurers that manage their cash on a daily basis. Furthermore it is
more costly to invest in € share classes of US funds due to the currency swap
between EUR and USD.

15.11.2012

Unit concerned: G4 –
Asset management

Stakeholder:
BlackRock

Topic: Regulation of
Money Market Funds (MMF)

Purpose of this
report: Fact finding for an impact assessment

Stakeholders
present:

Barbara Novick, Vice
Chairman, Head of Government relations and public policy

Joanna Cound,
Managing Director, Government relations

Members of unit G4
present

Tilman Lueder

Franck Conrad

US situation: BlackRock explained the situation in the US with the launch of a
MMF consultation by the FSOC. It was awaited but it is seen as worrying by the
US industry since it represents a major political push for a reform. They
regretted that some industry representatives (ICI) were engaged in a conflict
with the SEC, which leaded the SEC to abandon the project. They preferred the
negotiation approach, in order to avoid being overruled by the FSOC.

They are unsure about
the future of such a reform, if the SEC will really act on the basis of FSOC
recommendations or not. They pointed out that several key regulators, including
Mary Shapiro and Tim Geithner, are going to leave in the next weeks, which
could change the situation. Everything will depend of the new Commissioners
appointed to the SEC.

The consultation report
published by the FSOC is basically the report that the SEC wanted to issue in
August. They regret that unworkable options are still discussed, like the
Minimum Balance Requirement. It is seen as extremely complex and not
applicable.

MMFs through the
crisis: They explained that MMFs with stable value
are not more prone to runs than MMFs with a variable price. The most important
criteria for the investors are the quality of the assets and the liquidity.
Once there is a doubt that the MMF may hold poor quality assets, investors will
run, irrespective of their pricing model. They pointed out the example of
France in 2007 and Germany in 2008.

The Commission pointed
out the fact that a lot of MMFs received sponsor support in order to avoid
losses. BR acknowledges the fact that MMFs receive regularly support; this is
mainly driven by credit events.

Liquidity: The overall liquidity of the fund must be increased. The European
MMFs could adopt the same rules as the US but it was recognized that the
definition would differ a little bit because it is difficult for Europe to
include government assets. When the US introduced such thresholds, they noticed
that issuers of short term debt (above 3 months maturity) tended to increase
the maturity of the instruments in order not to depend anymore from MMF funding
because MMFs were almost exclusively buying very short term assets.

Credit ratings: Opinions were sought on the riskiness of the credit rating of some
MMFs. BR mentioned the example of the Prime Rate in the UK. They are not sure
if the risks of a downgrade are of a systemic or only idiosyncratic nature.

Runs: Floating the NAV should not be the response for stopping runs.
Liquidity fees are more appropriate. It would be activated once objective
triggers are reached (such as liquidity levels) and in this case a fee of 1%
applies on redeeming shareholders. Confronted with our concern that the
activation of the fee may be the trigger of a run in itself, they argued that
most probably such a fee would be imposed at the same time to all other MMFs.

Scope: We explained the European dual system, Short Term MMF and MMF, and
explained our need not to exclude any type of MMF from the definition. A dual
system, with maybe a new denomination, could be seen as workable.

29.11.2012

Unit concerned: G4 – Asset management

Stakeholders: KBC

Topic: Regulation of Money Market Funds (MMF)

Purpose of this report: Fact finding for an
impact assessment

Stakeholders present:

Chris Vervliet, KBC

Members of Unit G4 present:

Tilman Lueder

Franck Conrad

Andrea Fenech Gonzaga

CESR Guidelines: KBC finds that although certain parts of the CESR Guidelines are
sufficiently prescriptive, other parts, such as those requiring
'diversification' allow significant room for interpretation. In fact,
'diversification' is nowhere defined in the CESR Guidelines. For this reason,
KBC has its own internal diversification rules that are based on credit ratings
combined with a maximum counterparty concentration limit (per issuer). The
concentration limits KBC imposes are generally more strict than those in UCITS
and vary according to the type of counterparty (Corporates; Sovereigns;
Hybrid). For corporates, the limit is 2.5 to 5% per issuer, while for
sovereigns it can be higher. KBC imposes concentration limits both at the level
of each fund, as well as on an overall basis, that is, taking into account the
positions held by all their MMFs.

KBC does not have CNAV MMFs. KBC does not
make use of amortised cost accounting, they instead use different methods
depending on the type of instrument and the existence of a secondary market for
that instrument. For Term Deposits they use mark-to-model because of the lack
of market prices, whilst for bonds they use markt-to-market. KBC uses
markt-to-model also for Commercial Paper. KBC does not take counterparty risk
of default in valuing Term Deposits.

By bringing its funds in line with the
CESR Guidelines on WAM and WAL, KBC has to a large extent eliminated negative
values of its MMFs, particularly for short-term MMFs.

KBC's Client base: KBC's investors are primarily Belgian medium-size corporates and
SMEs. Their investors are not large multi-national companies. Investors use
MMFs for short-term investments or to park their money prior to longer-term
investments.

Eastern Europe: KBC has a number of Eastern European MMFs, particularly in Hungary.
Reference was made to the different diversification practices in Eastern Europe
as the assets of MMFs in the CZ or HU are more concentrated than those of  BE
or LUX (continental) MMFs. An important part of the Eastern European MMF market
is therefore Non-UCITS.

Financial Crisis: KBC has not encountered any problems with its MMFs during the
crisis. During the crisis KBC monitored the prices of their MMFs very closely
and made shorter-term investments.

Although KBC only has VNAV MMFs, it
argued that their MMFs have a long history of stability and their model has
never been tested in a crisis scenario. It is therefore not possible to know
whether a CNAV or VNAV would be better in terms of investor runs.

Reference was made to the Axon case, an
Asset Backed Commercial Paper vehicle that defaulted notwithstanding its strong
AAA rating and in which many MMF managers were invested in. In Axon case,
managers decided to support their MMFs.

Sponsor Support: KBC could not provide an answer as to whether they would provide
sponsor support to their MMFs. They however emphasised that investors are well
aware that they are investing in a fund and that they bear the risk. If KBC
were to provide sponsor support this would most likely be for their S&P AAA
rated MMF, according to KBC.

Minimum maturity requirements (The US
solution): KBC does not believe that imposing
minimum maturity requirements, similar to those in the US, would be a good
idea. They are of the opinion that maturity limits combined with other
criteria, such as diversification, would be too stringent and would
significantly reduce the investable portfolio of securities available.

Single Rule Book: KBC is in favour of introducing a single rule book for MMFs (both
UCITS and non-UCITS), particularly with the inclusion of the CESR definitions
on WAM and WAL. They believe the distinction between Short-term MMFs and MMFs
should be retained as investors are well aware of this distinction. KBC does
not agree with changing the name of Short-term MMFs to 'Short-term bond funds'
as the latter is associated with another category of funds, this would also
ensure consistency with EFAMA's new international classification of investment
funds according to KBC.

Credit Ratings: KBC does not agree with the removal of ratings for MMFs. Given that
CRAs prescribe very strict investment guidelines for MMFs to be awarded a good
rating, ratings are seen as a quality label by investors.

KBC found the awarding of high ratings by
certain CRAs on the basis of the potential availability of sponsor support by a
large parent, to be very alarming. They are of the opinion that this distorts
the market to the disadvantage of smaller MMF providers and also poses systemic
risks.

30.11.2012

Organisation: Autorité des Marchés Financiers et
Trésor

Sujet: Fonds monétaires

Objet du rapport: Information

Participants:

Natasha Cazenave, AMF

Frédéric Pelèse, AMF

Emmanuel Doumas; Trésor

Commission européenne

Olfa Ben Jamaa

Christiane Grimm

Franck Conrad

Message général: Les autorités françaises soutiennent fortement l'initiative de la
Commission de revoir le cadre applicable aux fonds monétaires. Les fonds
monétaires font peser un risque systémique sur l'économie européenne et il est
important d'apporter une réponse commune aux problèmes posés.

Outil législatif: Seule une initiative transversale, incluant les fonds OPCVM et AIF,
peut être envisagée. La France a 550 fonds monétaires et 1/3 sont des OPCVMs et
2/3 sont des fonds alternatifs. Donc uniquement une révision de la directive
OPCVM n'est pas une solution. Un règlement doit être créé qui s'appliquerait
aux gestionnaires OPCVM et AIF qui vendent des fonds monétaires. D'ailleurs une
telle architecture devrait s'appliquer à chaque type de fonds: un règlement
produit (ex: long terme) au-dessus des directives gestionnaires.

Actifs éligibles: Les règles CESR sont pour la plupart de bonne qualité et
mériteraient d'être introduites dans le niveau 1.

Les mesures de WAL et WAM sont adéquates et
permettent de bien limiter les risques. La distinction short-term MMF et MMF
doit être gardée, au risque de perdre un outil d'investissement utile. La
problématique du nom des fonds a été soulevée pour savoir si un nom plus
approprié serait possible à trouver. Les règles de diversification de la
directive OPCVM mériteraient de la clarté, un nouveau règlement devrait les
définir. Les produits ABCP ne sont plus beaucoup utilisés mais peuvent
représenter un risque. Les règles CESR n'ont pas traité ce point.

Rating: La
référence dans les règles CESR aux 26 agences de notation n'est pas
opérationnelle. La référence aux ratings devrait être substituée par des
critères qualitatifs. Il serait souhaitable d'enlever toute référence aux
ratings dans les critères d'investissement. Cela n'est pas pratique pour les
gestionnaires qui doivent contrôler 26 agences de notation différentes. Une
analyse interne peut s'avérer suffisante. Concernant le rating au niveau du
fonds, les ratings sont dangereux car ils provoquent des mouvements de panique
lors d'une baisse de la note. De plus ils créent de la confusion chez les
investisseurs qui assimilent AAA - CNAV - IMMFA.

CNAV – VNAV: Le modèle CNAV n'est pas approprié pour les fonds monétaires. Il
serait préférable d'adopter un modèle VNAV. Les autorités françaises ont
précisées que la linéarisation est utilisée uniquement en cas d'absence d'une
valeur de marché (même pour les instruments à maturité résiduelle inférieure à
90 jours). Si jamais, les autorités françaises sont prêtes à descendre à 60
jours (voire 0 jour pour l'AMF) pour l'utilisation du cout amorti. La solution
d'introduire du capital au niveau du fonds n'est pas bien vue. Cela représente
une "usine à gaz", difficile à mettre en œuvre et surtout très
difficile à négocier au Conseil (Trésor).

Liquidité: Soutien
à une définition basée sur la maturité, à la différence de la définition US qui
se base sur la liquidité. Ils estiment que des planchers de 10% / 15% seraient
adéquats. Le trésor envisagerait des planchers différents entre les fonds short
term et non short term.

Date :
04.12.2012

Stakeholders:
German regulator BaFin

Topic:
MMF, among other things

Stakeholders present:

Thomas
Neumann

Anahita
Sahavi

Jaga
Gaenssler

Stephanie
Kremer

Members of Unit G4 present:

Tilman
Lueder

Franck
Conrad

Larisa
Dragomir

Christiane
Grimm

BaFin inquired about the
procedure and state of play regarding the MMF proposal. COM provided an
overview over the IA procedure and the different options. BaFin then provided
an overview concerning the discussions in the working group of the ESRB. They
prefer the V-NAV compared to the C-NAV approach for reasons of addressing the
systemic risk of MMFs. Therefore capital buffers for C-NAV would be regarded as
the second best option.

12. 
annex 12: cfa institute survey

The text and the
results have not been modified from the version provided by the CFA Institute.

Background and Purpose

Following the financial crisis and the
first wave of regulation, global regulators are focusing on other areas of
financial services that may create systemic risk including “Shadow Banking,”
which was introduced by the Financial Stability Board in 2011. The International
Organization of Securities Commissions (IOSCO) and the European Commission have
consulted on Shadow Banking and Money Market Funds (MMFs), and the European
Commission is currently consulting on the regulation of UCITS funds, which
include MMFs and ETFs.

Many of the proposed reforms take different
shapes, but share a common approach: they would impose variable net asset
values (VNAVs), capital requirements and/or forms of capital guarantees. MMFs
are either “CNAV” funds, i.e. funds with constant Net Asset Value (for example
at $1.00), or are “VNAV” funds whose NAV is variable and fluctuates on a daily
basis. In some jurisdictions (the US, for example), the market is dominated by
CNAV funds, while in others VNAV funds are much more prevalent. In the European
Union, CNAV funds represent approximately half of the MMF market and target
institutional investors.

Some regulators consider that CNAV funds
are inherently prone to “runs” by investors in case of market stress due to
their constant value, and therefore require more profound reform. In the US, in
response to the Prime Reserve money market fund “breaking of the buck” in
October 2008, the Chairman of the SEC is currently proposing to require either
a floating net asset value or a stable-NAV coupled with capital requirements
and redemption restrictions.

To inform a response to the European
Commission, CFA Institute conducted a survey of a sample of members on the
issue of money market funds and proposed reforms.

Methodology

On 27 September 2012, all CFA Institute
members in the European Union plus a random sample of 15,000 members in the
United States were invited via email to participate in an online survey. One
reminder was sent to non-respondents on 3 October and the survey closed on 9
October 2012. 637 valid responses were received, for a response rate of 2% and
a margin of error of ± 3.8%.  As the number of valid
responses per question varies (due to survey logic, drop-offs and no opinion
responses), the margin of error also varies by question.  Valid responses for
each question (N) are noted on each chart.

Respondent Profile

Of the 637 members that responded, 57% are
from the Americas and 43% from the European Union.  92% of respondents are CFA
Institute charterholders. Global (total) results have been re-weighted to
accurately reflect the population (83% from the United States and 17%% from the
European Union). Statistically significant regional differences are noted
throughout the report. Significance
testing (z-test) was conducted at the 95% confidence level to determine
statistically significant differences by region.

The top job functions of respondents are
portfolio manager (24%), research Analyst (12%), financial Advisor (7%),
consultant (6%) and risk manager (6%). 39% of respondents listed other occupations
(less than 6% each) and 4% of respondents did not provide an occupation.

Money Market Funds and Systemic Risk

39
percent of respondents think MMFs are a source of systemic risk and 39 percent
do not think they are a source of systemic risk.

Money Market Fund Reform

Slightly more than half of respondents (55
percent) think MMF regulation needs to be reformed. Of the 45 percent who do
not think MMF regulation needs to be reformed, 72 percent say it is because
they are appropriately regulated and 32 percent say recent reforms in the
United States mitigate systemic risk.

Proposed Money Market Fund Reforms

59 percent of respondents think
modification of fund regulation would be the most appropriate approach to
reform MMF regulation. 9 percent think the application of banking regulation
would be most appropriate, and 32 percent think a combination of applying
banking regulation to MMFs and modifying fund regulation would be most
appropriate.

The top three proposed reforms that
respondents agree with include ‘All MMFs should have liquidity risk management
mechanisms to manage “runs” on the funds’ (85 percent), ‘Disclosure to retail
investors regarding investment risks and the lack of guarantees for all MMFs
should be strengthened, particularly for CNAV MMFs as they may provide a false
sense of security’ (78 percent), and ‘MMF sponsors that provide capital
guarantees to investors should be subject to capital requirements’ (75
percent). Significant differences between respondents in the United States and
European Union are highlighted in purple.

Please indicate whether you agree or disagree with each of the following proposed reforms:

|| Agree || Disagree || Not sure

|| Total || USA || EU || Total || USA || EU || Total || USA || EU

All MMFs should have liquidity risk management mechanisms to manage “runs” on the funds || 85% || 85% || 86% || 6% || 7% || 3% || 8% || 8% || 11%

Disclosure to retail investors regarding investment risks and the lack of guarantees for all MMFs should be strengthened, particularly for CNAV MMFs as they may provide a false sense of security || 78% || 77% || 82% || 16% || 17% || 6% || 7% || 6% || 12%

MMF sponsors that provide capital guarantees to investors should be subject to capital requirements || 75% || 75% || 76% || 13% || 13% || 11% || 12% || 12% || 13%

CNAV MMFs should have to maintain capital reserves || 61% || 62% || 54% || 25% || 25% || 26% || 14% || 13% || 20%

All MMFs (CNAV and VNAV) should have to maintain capital reserves || 47% || 48% || 43% || 37% || 37% || 40% || 15% || 15% || 17%

MMF capital reserves should be financed by fund sponsors || 42% || 44% || 32% || 35% || 33% || 44% || 23% || 23% || 23%

CNAV MMFs should be required to switch to a Variable NAV || 41% || 39% || 53% || 41% || 45% || 17% || 18% || 16% || 31%

Investors in CNAV MMFs should benefit from protection by insurance or guarantee schemes, and  the fund/investors should make contributions towards such coverage || 33% || 32% || 36% || 39% || 39% || 41% || 28% || 29% || 23%

The use of amortized cost should be prohibited for all MMFs || 30% || 28% || 42% || 29% || 31% || 21% || 40% || 41% || 37%

MMF capital reserves should be financed by fund investors || 29% || 28% || 30% || 47% || 47% || 47% || 25% || 25% || 23%

Investors in all MMFs (CNAV and VNAV) should benefit from protection by insurance or guarantee schemes, and  the fund/investors should make contributions towards such coverage || 24% || 24% || 25% || 51% || 51% || 51% || 25% || 25% || 25%

Private insurance should be used instead of capital reserves, but only to wind up a fund || 23% || 24% || 17% || 45% || 44% || 54% || 32% || 33% || 28%

Private insurance should be used instead of capital reserves to provide a liquidity facility in case of “runs” || 15% || 15% || 11% || 57% || 56% || 62% || 29% || 29% || 27%

MMFs in the European Union already dispose of sufficient liquidity risk management mechanisms || 9% || 6% || 25% || 16% || 15% || 23% || 75% || 79% || 53%

Only institutional investors should be allowed to invest in CNAV MMFs || 7% || 5% || 19% || 78% || 81% || 61% || 15% || 14% || 21%

Liquidity Risk Management

78 percent of respondents think liquidity
risk management mechanisms should apply only in the case of heavy redemptions
or in stressed markets, with a higher proportion of those in the European Union
(81 percent) than in the United States (77 percent).

The potential forms of liquidity risk
management respondents think should apply to MMFs include valuation at bid
price (41 percent), minimum balance requirements (40 percent), extension of
advance notice period for redemptions (36 percent), liquidity fees (26
percent), redemptions-in-kind (24 percent) and gates (22 percent). 5 percent of
respondents listed other potential forms of liquidity risk management and 12
percent indicated none of the forms listed should apply to MMFs.

Other Issues Related to Money Market Funds

54 percent of respondents think the
imposition of capital requirements would have a negative effect on MMFs and 37
percent think it would have a positive effect. 10 percent do not think capital
requirements would have an effect on MMFs.

If the use of amortized cost is prohibited,
73 percent of respondents think it would be feasible to calculate a fair value
on a daily basis for all assets held by MMFs. A higher proportion of those in
the European Union (81 percent) than in the United States (71 percent) think
this is feasible.

[1] Please see Annex 1
for a glossary of certain terms and notions contained in this report.

[2] The biggest MMFs in the EU are operated by JPMorgan (€50 & €30
billion); BlackRock (€30 billion) and BNP (€30 billion). As of September 2012,
22 EU MMFs had assets under management exceeding €10 billion.

[3] Policy
recommendations for Money Market Funds, Final report, FR07/12 – presented in
Annex 9

[4] http://www.sec.gov/news/press/2012/2012-166.htm

[5] Proposed
recommendations regarding money market mutual fund reform, FSOC

[6]http://www.esrb.europa.eu/pub/pdf/recommendations/2012/ESRB_2011_1.en.pdf?2d1004d0e636912dd9458d9368499761

[7] See http://ec.europa.eu/internal_market/bank/docs/shadow/green-paper_en.pdf

[8]European Parliament resolution of 20 November 2012 on Shadow Banking
(2012/2115(INI)) –
Annex 8

[9]http://www.europarl.europa.eu/sides/getDoc.do?type=TA&reference=P7-TA-2013-0013&format=XML&language=EN#BKMD-11

[10] Please see Annex
11 for the reports of the meetings with stakeholders.

[11] See http://ec.europa.eu/internal_market/bank/docs/shadow/programme_en.pdf

[12] See http://ec.europa.eu/internal_market/consultations/docs/2012/ucits/ucits_consultation_en.pdf

[13] See
http://europa.eu/rapid/press-release_IP-12-853_en.htm?locale=en

[14] Responses: http://ec.europa.eu/internal_market/consultations/2012/ucits/index_en.htm

[15] A detailed
summary of the responses can be found in Annex 10.

[16] "The Cross
Section of Money Market Fund Risks and Financial Crises", Patrick E.
McCabe (2010); "Money Market Funds Run Risk: Will Floating Net Asset Value
Fix the Problem?", Jeffrey N. Gordon (2012)

[17] Please see Annex 4
for examples.

[18] CESR's guidelines
concerning eligible assets for investment by UCITS, CESR/07-044

[19] Please refer to
Annex 7.1

[20] Please see graph
in Annex 6.4.

[21] Institutional Money Market Funds Association (IMMFA), IMMFA is the
organisation regrouping the European CNAV MMFs

[22]« Does the
Buck Stop Here ? A Comparison of Withdrawals from Money Market Mutual
Funds with Floating and Constant Share Prices” Bank of Canada working paper,
Jonathan Witmer, 2012

[23] IMMFA Code of practice. European VNAV MMFs are usually not rated.

[24] IMMFA response to
the EC consultation

[25] Please see Annex
5.1 and 5.2

[26] IMMFA response to the EC consultation, page 22

[27] Please refer to
Annexes 5.1 and 5.2 for Europe and 6.2 for the US.

[28] For example, Federated Investors manages $285 billion of MMF assets
while having $366 million of current assets (2011 Annual Report).

[29] “European
Treasurer Survey 2013”, Fitch Ratings, 26 February 2013.

[30]"Fitch puts Matrix-owned funds on review due to firm's
financial resources", Money Marketing, 12 December 2011. It further adds
in its statement: "The review does not reflect any negative development
in the funds’ investment portfolios, which continue to be conservatively
managed and fully meet the ’AAAmmf’ portfolio guidelines set forth in Fitch’s
rating criteria for money market funds.”

[31]"Deutsche
Bank scoops £3bn cash mandate", Financial News, 06 October 2010

[32] Please refer to
Annex 7.2 for a concrete example of calculation.

[33] Please refer to
Annex 6.4

[34] Please refer to Annex 6.3 for the details of the different programs
put in place by the US authorities and to Annex 5.4 to see the redemptions
stopping after the announcement of the support.

[35]Gesetz zur Umsetzung
eines Maßnahmenpakets zur Stabilisierung des Finanzmarktes (Finanzmarktstabilisierungsgesetz
– FMStG). See Annex 5.4.

[36] "Summary of
government interventions in financial markets – Luxembourg", Mayer Brown,
2009

[37] Please see Annex
2.1 for a full description of the current rules

[38]http://www.treasury.gov/initiatives/fsoc/Documents/Proposed%20Recommendations%20Regarding%20Money%20Market%20Mutual%20Fund%20Reform%20-%20November%2013,%202012.pdf

[39] www.treasurystrategies.com/sites/default/files/TSI_MMF_ReformFindings.pdf

[40] "2012 AFP
Liquidity Survey – Report of survey results", July 2012

[41] Please refer to
Annex 7.2 for further explanation and concrete examples.

[42] Please see Annex 12 for the details of the CFA Institute survey.

[43] Regarding the issue of asset encumbrance, MMFs are less exposed to
that problem. They do not make use of practices such as securities lending
(except in two identified cases) or repurchase agreements (repos); they only
make use of reverse repos on a daily or maximum two days basis. Therefore the
analysis of this section will only focus on measures that will have a direct
impact.

[44]As a general rule, the provisions applying to the portfolio of a MMF
will also apply to the collateral received by the MMF (same eligibility and
diversification rules) in order to ensure the same degree of liquidity for all
assets. This may have an impact for MMFs receiving collateral that has long maturities
or is of poor credit quality. For example a 10 years bond will not be eligible
anymore for the collateral. Government assets would not be subject to such a
rule provided that they comply with certain liquidity and credit criteria.

[45] According to Eurostat,
the national GDP in 2011 of one Member State was 42.6 billion EUR whereas the
total assets of CNAV MMFs domiciled in that country amount to about 150 billion
EUR while total assets of all MMFs amount to around 240 billion EUR.

[46] Pension funds
were mentioned by a UK manager of CNAV as a typical class of investors that
would have difficulties in investing in VNAV due to their investment
restrictions. No precise figures exist on the share of pension funds in CNAV
funds but this argument is backed by the results of the survey showing that 44%
of the investors are subject to investment restrictions. However this argument
makes little sense when we look at the proportion of pension funds in MMFs in
the Euro area: they hold only €5.9 billion of shares representing less than
0.005% of their total assets (ECB monthly Bulletin November 2011).

[47] Proposal made by
Fidelity Investments, please refer to Annex 7.3.1 for the details

[48] "Fitch:
Potentially Negative Euro Yields Won't Impact MMF Ratings", 18 September
2012

[49] This has to be put in relation with the number of 285 providers
that offer MMFs in Europe. The providers often operate with different asset
management subsidiaries. In this case the number would be higher.

[50] The day after Lehman was forced to declare bankruptcy – September
15, 2008 – all of the Lehman position, accounting for 1% of the Reserve Primary
Fund’s NAV, was priced at zero. This led to the NAV declining to $0.99 per
share. Subsequent redemptions caused an additional decline of around 2 cents.
Finally, the fund was liquidated and all shareholders in liquidation received
99 cents per share.

[51] Please refer to
Annex 7.4 for the full analysis.

[52]The UCITS Directive and AIFMD foresee only capital requirements rules
for ensuring the creditworthiness of managers, as well as other authorisation
requirements and conduct of business rules. The UCITS Directive also contains
some rules defining the features of a UCITS. However neither the AIFMD nor the
UCITS Directive contains any prudential rules concerning MMFs. An MMF
irrespective whether it is a UCITS or an AIF has specific risk characteristics
that are not covered by prudential requirements neither in the AIFMD nor in the
UCITS Directive.

[53] See the description of the baseline scenario (section 5.1.1) and
annexes 2.1 and 2.2 for details about the CESR guidelines.

[54] Response to
Questions Posed by Commissioners Aguilar, Paredes, and Gallagher, Division of
Risk, Strategy, and Financial Innovation, U.S. Securities and Exchange
Commission, November 30, 2012, footnotes 61-66.

[55] As prescribed by the CESR Guidelines on a Common Definition of
European Money Market Funds (Ref. CESR/10-049).

[56] "Money Market Funds in Europe and Financial Stability",
ESRB, June 2012

[57]Consultation report
of the IOSCO standing committee 5, Working group on Money Market Funds

[58] Regulation
ECB/2011/12

[59] ECB Monthly
Bulletin April 2012

[60] "Court drama
puts focus on money funds", Financial Times, 14 October 2012

[61] Consultation
report of the IOSCO standing committee 5, Working group on Money Market Funds

[62] ESRB: Occasional
Paper no. 1, Money Market Funds in Europe and Financial stability, June 2012

[63] "The
Stability of Prime Money Market Mutual Funds: Sponsor Support from 2007 to
2011", August 13, 2012

[64] Testimony on “Perspectives on Money Market Mutual Fund Reforms” by
Chairman Mary L. Schapiro, U.S. SEC, before the Committee on Banking, Housing,
and Urban Affairs of the United States Senate, June 21, 2012

[65] Consultation
report of the IOSCO standing committee 5, Working group on Money Market Funds

[66] "Eksportfinans downgraded to junk", Financial Times,
November 22, 2011

[67] IMMFA code of practice: http://www.immfa.org/About/Codefinal.pdf.
See Annex 2.3 for more details.