ESMA tackles MMF resilience
17 February 2022 EU
Image: AdobeStock/Ricochet64
The European Securities and Markets Authority (ESMA) has proposed changes to the EU regulatory framework for money market funds as part of its plans to make the MMF segment more resilient.
In doing so, the European securities markets regulator is responding to experience during the early stages of the COVID-19 pandemic, when some MMFs were subject to significant liquidity pressures. Under stress conditions triggered by the pandemic, redemptions accelerated from investors while, at the same time, the liquidity position of MMFs deteriorated on the asset side.
ESMA launched a market consultation process in March 2021 to examine the impact of market stress on MMFs during the COVID-19 crisis and potential changes to improve their resilience.
In its consultation document, ESMA indicates that MMFs are exposed to three interconnected areas of vulnerability relating to liquidity on the asset side. First, they have a sizeable footprint in the asset classes in which they invest. Second, those markets are not particularly liquid, even under standard trading conditions. And, third, depending on their type and currency, MMFs often have a high level of portfolio overlap.
The combination of these factors, ESMA notes, leaves MMFs particularly susceptible to symmetric shocks.
Thirty-eight respondents replied to the consultation process, including 16 asset management firms and seven industry associations.
Respondents to the ESMA consultation indicated that the COVID-19 crisis presented a major challenge for all market participants, including MMFs, particularly owing to a lack of liquidity in secondary markets. However, on the positive side, respondents indicated that the crisis had affirmed the resilience of MMFs under stress conditions, given that no MMFs had been forced to apply redemption fees, gates or to suspend redemptions.
On the back of industry feedback, ESMA has put forward a package of reforms to improve the resilience and functioning of the MMF sector.
ESMA’s proposed reforms include steps to tackle threshold effects for constant NAV MMFs by decoupling regulatory thresholds from suspensions, gates and redemption fees.
It also puts forward measures to address liquidity-related vulnerabilities, ensuring that funds have adequate liquidity management tools at their disposal during times of market stress and revising daily liquid asset or weekly liquid asset ratios — as well as widening the pool of eligible assets which can be used to satisfy these liquidity requirements.
Sitting alongside these recommendations, ESMA highlights a need to strengthen MMFs’ preparedness for stress conditions — including better stress testing frameworks and the addition of new disclosure requirements that will improve the ratings process for MMFs.
ESMA has now forwarded its Opinion, detailing these recommendations, to the European Commission and indicates that it will work closely with the Commission as it reviews the MMF Regulation.
ESMA will also be conducting a review of MMF stress testing frameworks during 2022 and aims to publish its findings by the year end.
Commenting on the process, ESMA chair Verena Ross says: “ESMA is today proposing a number of changes to the MMF regulation intended to make MMFs more resilient. These reforms will help to improve the overall stability of financial markets by reducing the risk of liquidity stress.
“In March 2020, MMFs faced difficulties brought on by increases in redemption demands while the assets that they held became difficult to sell. Our proposals today, which are consistent with those of the ESRB, aim to ensure that MMFs will be able to meet investors’ redemption requests and that this will continue to be the case.”
In October, the Financial Stability Board also released a report and a set of policy proposals designed to improve resilience in MMFs.
In doing so, the European securities markets regulator is responding to experience during the early stages of the COVID-19 pandemic, when some MMFs were subject to significant liquidity pressures. Under stress conditions triggered by the pandemic, redemptions accelerated from investors while, at the same time, the liquidity position of MMFs deteriorated on the asset side.
ESMA launched a market consultation process in March 2021 to examine the impact of market stress on MMFs during the COVID-19 crisis and potential changes to improve their resilience.
In its consultation document, ESMA indicates that MMFs are exposed to three interconnected areas of vulnerability relating to liquidity on the asset side. First, they have a sizeable footprint in the asset classes in which they invest. Second, those markets are not particularly liquid, even under standard trading conditions. And, third, depending on their type and currency, MMFs often have a high level of portfolio overlap.
The combination of these factors, ESMA notes, leaves MMFs particularly susceptible to symmetric shocks.
Thirty-eight respondents replied to the consultation process, including 16 asset management firms and seven industry associations.
Respondents to the ESMA consultation indicated that the COVID-19 crisis presented a major challenge for all market participants, including MMFs, particularly owing to a lack of liquidity in secondary markets. However, on the positive side, respondents indicated that the crisis had affirmed the resilience of MMFs under stress conditions, given that no MMFs had been forced to apply redemption fees, gates or to suspend redemptions.
On the back of industry feedback, ESMA has put forward a package of reforms to improve the resilience and functioning of the MMF sector.
ESMA’s proposed reforms include steps to tackle threshold effects for constant NAV MMFs by decoupling regulatory thresholds from suspensions, gates and redemption fees.
It also puts forward measures to address liquidity-related vulnerabilities, ensuring that funds have adequate liquidity management tools at their disposal during times of market stress and revising daily liquid asset or weekly liquid asset ratios — as well as widening the pool of eligible assets which can be used to satisfy these liquidity requirements.
Sitting alongside these recommendations, ESMA highlights a need to strengthen MMFs’ preparedness for stress conditions — including better stress testing frameworks and the addition of new disclosure requirements that will improve the ratings process for MMFs.
ESMA has now forwarded its Opinion, detailing these recommendations, to the European Commission and indicates that it will work closely with the Commission as it reviews the MMF Regulation.
ESMA will also be conducting a review of MMF stress testing frameworks during 2022 and aims to publish its findings by the year end.
Commenting on the process, ESMA chair Verena Ross says: “ESMA is today proposing a number of changes to the MMF regulation intended to make MMFs more resilient. These reforms will help to improve the overall stability of financial markets by reducing the risk of liquidity stress.
“In March 2020, MMFs faced difficulties brought on by increases in redemption demands while the assets that they held became difficult to sell. Our proposals today, which are consistent with those of the ESRB, aim to ensure that MMFs will be able to meet investors’ redemption requests and that this will continue to be the case.”
In October, the Financial Stability Board also released a report and a set of policy proposals designed to improve resilience in MMFs.
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