Irish central bank has UCITS worries
07 August 2014 Dublin
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The Central Bank of Ireland has claimed that there are strong grounds for limiting the collateral diversification relaxation set out in the revised version of the European Securities and Markets Authority (ESMA) Guidelines on exchange-traded funds and other UCITS issues.
The relaxation, initially intended to apply to UCITS money market funds (MMFs), was extended to all UCITS funds in ESMA’s final report in March, following market support for the move.
But the Central Bank of Ireland believes that the extension could result in funds holding on to sovereign collateral of deteriorating credit quality in stressed market conditions.
ESMA’s guidelines require all collateral to be of “high quality” and no UCITS fund can have exposure of more than 20 percent of its collateral basket to any single issuer.
UCITS MFFs are exempt from this, as long as they receive securities from at least six different issuers, and no single issuer accounts for more than 30 percent of the collateral received.
The Central Bank of Ireland, in its 28 July consultation paper, said ‘high quality’ is not adequately defined to warrant the relaxation being extended to all UCITS funds.
“UCITS MMFs are subject to quite specific requirements with regard to credit quality, which means that even where collateral is not diversified, a UCITS MMF will still be required to hold collateral which if rated will have been awarded one of the two highest available short-term credit ratings by the credit rating agency that has rated the instrument or, if the instrument is not rated, it is of an equivalent quality as determined by the management company’s internal rating process.”
“The effect of the disapplication to all UCITS is that the only protection in place with regard to the kind of sovereign debt collateral a non-UCITS MMF can take is an undefined requirement that it be of ‘high quality’.”
“The vagueness of that requirement was acceptable under the original guidelines because it was counter-balanced by the precision of the 20 percent diversification requirement.”
The Central Bank of Ireland wants a rule introduced requiring a UCITS fund to only be able to accept high quality collateral. A determination of whether the collateral is sufficiently ‘high quality’ would be made before accepting it.
Any acceptance that would mean that more than 20 percent of the UCITS fund’s total collateral comes from the specific issuer would require a more detailed assessment of credit quality.
In the event of deteriorating credit quality, the UCITS fund would have to put into place and execute an action plan to deal with its exposure to the collateral, and cease holding and receiving collateral that does not have one of the two highest available ratings.
The Central Bank of Ireland stated: “We recognise that this would mean that Irish rules on UCITS collateral would be substantially different from other member states. If we can achieve a satisfactory risk mitigation effect without creating that difference we prefer to do so.”
The central bank has invited all stakeholders to provide comments, with the responses to be assessed following 17 October.
The relaxation, initially intended to apply to UCITS money market funds (MMFs), was extended to all UCITS funds in ESMA’s final report in March, following market support for the move.
But the Central Bank of Ireland believes that the extension could result in funds holding on to sovereign collateral of deteriorating credit quality in stressed market conditions.
ESMA’s guidelines require all collateral to be of “high quality” and no UCITS fund can have exposure of more than 20 percent of its collateral basket to any single issuer.
UCITS MFFs are exempt from this, as long as they receive securities from at least six different issuers, and no single issuer accounts for more than 30 percent of the collateral received.
The Central Bank of Ireland, in its 28 July consultation paper, said ‘high quality’ is not adequately defined to warrant the relaxation being extended to all UCITS funds.
“UCITS MMFs are subject to quite specific requirements with regard to credit quality, which means that even where collateral is not diversified, a UCITS MMF will still be required to hold collateral which if rated will have been awarded one of the two highest available short-term credit ratings by the credit rating agency that has rated the instrument or, if the instrument is not rated, it is of an equivalent quality as determined by the management company’s internal rating process.”
“The effect of the disapplication to all UCITS is that the only protection in place with regard to the kind of sovereign debt collateral a non-UCITS MMF can take is an undefined requirement that it be of ‘high quality’.”
“The vagueness of that requirement was acceptable under the original guidelines because it was counter-balanced by the precision of the 20 percent diversification requirement.”
The Central Bank of Ireland wants a rule introduced requiring a UCITS fund to only be able to accept high quality collateral. A determination of whether the collateral is sufficiently ‘high quality’ would be made before accepting it.
Any acceptance that would mean that more than 20 percent of the UCITS fund’s total collateral comes from the specific issuer would require a more detailed assessment of credit quality.
In the event of deteriorating credit quality, the UCITS fund would have to put into place and execute an action plan to deal with its exposure to the collateral, and cease holding and receiving collateral that does not have one of the two highest available ratings.
The Central Bank of Ireland stated: “We recognise that this would mean that Irish rules on UCITS collateral would be substantially different from other member states. If we can achieve a satisfactory risk mitigation effect without creating that difference we prefer to do so.”
The central bank has invited all stakeholders to provide comments, with the responses to be assessed following 17 October.
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