Opening Remarks
Aidan Carrigan
Oireachtas scrutiny hearing on MMF Regulations
Wednesday 4 June 2014
1.
Introduction
Thank you Mr. Chairman. I am Aidan Carrigan, Assistant Secretary in the
Financial Services Division and joined today by my colleagues Patrick Brennan
and Martin McDermott from the Department of Finance and Oliver Gilvarry,
Isla Cully from the Central Bank.
Much of the legislative reform programme on Banking Union has now been
completed in Europe. This work is designed to address the risks posed to
financial stability by the banking system. However, banking is only one part of
the picture when it comes to credit intermediation. A substantial and growing
element of credit is provided by the so-called “shadow banking” system – which
facilitates the provision of credit to business through the markets as an
alternative to Bank funding. As we near the conclusion of the new banking
union framework attention in Europe and across the world is now turning to the
large shadow banking regulatory agenda.
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2.
What is Shadow Banking?
Shadow banking is a broad term which covers a range of activities in the area of
non-bank credit intermediation1; It is important to note that shadow banking
activities which include securitisation, securities lending and repurchase
transactions, constitute an important source of finance for financial entities. It
includes entities which:
 raise funding with deposit-like characteristics;
 perform maturity and/or liquidity transformation;
 allow credit risk transfer; and
 use direct or indirect leverage.
It is broadly accepted that shadow banking needs to be regulated because of its
size, its close links to the regulated banking sector and the potential systemic
risks that it poses. There is already some regulation of the shadow banking
sector through the existing UCITS Directive, the Alternative Investment Fund
Managers Directive and othe EU legislation. However, some would argue that
this provides only partial regulation and further measures are required. It is in
this context that the European Commission has brought forward its proposal to
enhance the regulation of Money Market Funds which constitute possibly one
of the most prominent sectors of shadow banking.
3.
What are Money Market Funds?
Money Market Funds are collective investment schemes which bring together
demand and offer for short-term money. These funds act as an important source
of short-term financing for financial institutions, corporates and governments.
To corporate treasurers Money Market Funds offer a short-term cash
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From the Commission Green Paper on ShB
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management tool that provides a high degree of liquidity. Money Market Funds
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. In
Europe these are generally established as UCITS under the UCITS Directive
and so have a passport which allows their sale across the EEA. However they
can also be established under national laws of Member States and fall within the
scope of the Alternative Investment Fund Managers Directive. As UCITS, they
comply with European Securities and Markets Authority guidelines on Money
Market Funds.
4.
What is the difference between CNAV and VNAV?
There are two types of Money Market Funds, those whose net asset value (i.e.
that value of the assets held by the fund) is allowed to float – the Variable Net
Asset Value or “VNAV fund” - and those whose net asset value does not float the Constant Net Asset Value or “CNAV fund”.
A CNAV fund seeks to maintain a stable €1 per share through the amortisation
(or writing down) of any loss or gain in value over the life of the asset rather
than valuing at the market price on a daily basis. This kind of fund holds a
particular attraction for corporate treasurers beyond its usually limited yield.
The stability in the price of the fund allows for investments to be treated as
similar bank deposits in corporate accounts. In contrast a VNAV fund is priced
according to the market value of its assets at a particular point in time and so its
value floats in accordance with the markets for its underlying assets. It would
not be correct to say that it would be a straight-forward matter to require all
CNAV funds to convert to VNAV funds. There is evidence that most CNAV
investors would leave money market funds altogether rather than redirect their
funds into VNAV money market funds.
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5.
What do the Regulations do?
The intention behind the Money Market Fund Regulations is to deal with the
perceived risk of runs on the funds. In summary, the regulations propose the
following measures:
 that Money Market Funds will be required to have at least 10% of their
portfolio in assets which mature within a day and another 20% which
mature within a week;
 they may only invest in money market instruments, deposits with credit
institutions, financial derivative instruments and reverse repurchase
agreements;
 they will not be permitted to invest more than 5% of assets in money
market instruments issued by the same body or 5% of its assets in
deposits made with the same credit institution;
 they may not solicit or finance an external credit rating;
 they must identify the number of investors in the MMF, their needs and
behaviour and the amount of their holdings;
 they must put in place sound stress testing processes for the fund; and
 that CNAV funds must have a 3% a capital buffer or convert to a variable
NAV fund.
6.
What is the Irish interest?
The total Money Market Fund sector in Europe amounts to some €1.3 trillion of
funds. This is shared between VNAV and CNAV funds. CNAV funds are
favoured by US investors and the Irish Funds industry hosts some €3002 billion
of these, so the question of a specific regime for the regulation of CNAV funds
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This figure fluctuates
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is of particular interest to Ireland. As currently structured the proposals for the
added regulation of CNAV funds pose a risk to the future of the CNAV funds
sector of the Irish funds industry.
7.
How are the risks different for CNAV funds?
We have been advised by the European Commission that the additional
requirement for a CNAV buffer arises from a perception that these funds are
riskier. It is argued that the apparently fixed price of an investment in a CNAV
fund lulls investors into a false sense of security and that there is a market
perception that the value of these funds is guaranteed. In the event that assets
depreciate the fear is that the investment manager will no longer be able to hold
the net asset value steady and that investors might not get one Euro or one
Dollar back for each Euro or Dollar they put in. When that happens the CNAV
fund is said to have “broken the buck”. Such events are rare and seen as
dramatic and could be a cause of market instability. The Commission’s
intention is to require buffers which would require investment managers to
place aside a percentage of the value of the CNAV fund to act as safety net in
times when the fund’s assets devalue to such an extent that there is a risk of the
buck being broken.
8.
What is Ireland’s position?
We fully agree that shadow banking needs to be robustly regulated and the risks
to financial stability arising from it are recognised and addressed. There is no
room for complacency in markets regulation. We support the general approach
taken in the regulations and are keen to play a full part in the debate on all the
elements.
We will engage in the debate on each of the measures I have just mentioned.
The Department of Finance will approach the forthcoming Council working
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parties in a constructive and open-minded manner and with the hope of securing
a proportionate approach to the regulation of both CNAV and VNAV funds.
9.
What is Parliament’s position?
Members might recall that in the European Parliament recently there were
mixed views on the approach to the capital buffer for CNAV funds with MEPs
arguing in particular that the potential negative impact on the industry was not
fully understood. This resulted in consideration of the regulations being
postponed until the new Parliament. We will be highlighting this in the Council
and encouraging a greater focus on and assessment of the consequences of this
proposal.
10.
Buffers amount to bans
In particular, we will be making the point that the 3% capital buffer for CNAV
funds is seen by many as excessive and potentially dangerous. In a product
which operates on very tight margins and where interest rates are at an all-time
low, the cost of funding a 3% buffer could render these funds uneconomic.
Should this occur it would amount to an effective ban on CNAV funds.
Commissioner Gallagher of the SEC made this point well last year when he said
at an open meeting of the SEC:
“…our economists believe that in order to act as a bulwark against
default risk or run risk, a buffer would have to be so large that it
would not be economical for Money Market Funds to continue to
operate. And, conversely, if the buffer was small enough to be
economical, then it would provide no protection against events like
the ones experienced in 2008. This is not news.”
11.
Threat to liquidity in Europe
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We will also be reflecting concerns that the effective ban of CNAV funds may
damage both the funds industry and European markets generally. Indeed the
European Systemic Risk Board acknowledged this in its report on the regulation
of Money Market Funds. It said, in relation to the possible imposition of more
onerous conditions on CNAV funds that:
“…there could be a sudden outflow from European CNAV funds to
other jurisdictions or alternative products. The consequences of
this happening could result in a serious impact on the pricing and
availability of short-term funding for European borrowers, in
particular banks.”
Europe hosts some €400bn in CNAV Money Market Funds. If CNAV funds
were effectively prohibited it could have the effect of driving much of that
funding out of the European banking system or distort liquidity in unpredictable
ways which could include a withdrawal of liquidity from all other banks, and a
movement of liquidity outside of the EU. Demand for European short-term
paper could easily be undermined.
At a time when the EU is trying to broaden sources of funding for Europe’s
businesses and in particular SMEs we need to be very careful that we don’t
accidentally frustrate those attempts here through an overly narrow focus on
regulation.
12.
Alternative Proposals
There are alternative measures put forward to mitigate run risks which apply to
all open ended funds. These include liquidity fees and redemption gates to
prevent runs in either VNAV or CNAV funds.
 Liquidity fees would require a fund whose liquid assets fall below a given
percentage of its total assets to impose a fee on all redemptions to act as a
disincentive to redemptions, and
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 Redemption gates would permit the fund to restrict or suspend
redemptions for a period if the fund comes under particular stress.
We will be supporting these as better alternatives to the buffer approach for
CNAV funds in Council negotiations
13.
Coordination with the US
We will also be pointing to continuing developments in the United States where
the Securities and Exchange Commission is advanced in its deliberations on
how best to approach the regulation of Money Market Funds. It is looking at
several different approaches but has already made clear that it sees capital
buffers as the least effective way to achieve the goal of mitigating run risk in
Money Market Funds. The financial markets are global markets and both the
US and the EU have repeatedly said that the regulation of those markets should
be co-ordinated. It is important that we try to co-ordinate the EU/US approach
to the regulation of these funds.
The introduction of differing rules across jurisdictions may result in the
intentions of one set of legislators or regulators being frustrated or result in
unintended consequences, amplified by the international market for MMFs. A
case in point is the actions taken by the Federal Reserve in 2008 when it
introduced support mechanisms which eased pressures on the US MMFs and
improved the liquidity position of such funds but separately affected European
Money Market Funds which didn’t have similar support mechanisms. We
therefore will seek to align developments in Europe with those in the US.
14.
Conclusion
The Department of Finance has been consulting with a range of stakeholder
interests. We have also been in contact with the European Commission and with
other member states. It is clear to us that while some difference of view remains
on how best to enhance the regulation of Money Market Funds there is a
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growing appreciation for the concerns we are raising with the proposed
approach to CNAV funds.
In conclusion, our objective is to achieve enhanced regulation of money market
funds, as a first step towards the harmonisation of the regulation of Europe’s
shadow banking sector. Within this broader objective we are seeking to achieve
an outcome to the Council working party deliberations which ensures proper,
effective and proportionate regulation of both types of Money Market Funds, so
as to allow the safe development and growth of this market sector in Ireland and
Europe.
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