After three years of heated debate, the Money Market Funds Regulation (MMFR) was finally agreed by both the European Parliament and the Council at the end of 2016 and was issued as final in June 2017. We noted at the time that a number of questions remained as to how some of the rules would operate in practice or what the impact on the sector and MMF investors would be. A new issue, and very significant, issue has now emerged. A recent letter from the European Commission to ESMA describes the practice of share cancellation as incompatible with the MMRF. This has caused further uncertainty for funds and their investors.
The MMFR covers both UCITS and AIF MMFs. One of the key issues of contention was the future of constant net asset value funds (CNAVs). The final political agreement, which was hard-fought and finely balanced, resulted in the MMFR providing for low volatility NAV funds (LVNAVs), variable NAV funds (VNAVs) and public sector CNAVs.
Level 2 rules are still to be agreed. These will cover standards on liquidity and credit requirements for public debt reverse repos, standards on credit quality assessment for assets in which managers invest directly, and alignment with the regulation on simple, transparent and standardised securitisations (the STS Regulation). Also, various aspects will be covered by ESMA issuing Level 3 guidance and the industry is debating, for example, how to draw the line between MMFs and short-dated bond funds.
Meanwhile, a new and very significant concern has arisen. The MMFR is silent on the practice of share cancellation as a mechanism to preserve a fund's NAV level, which is commonly used when interest rates are negative. However, the European Commission's recent letter to ESMA says that, according to its legal analysis of the Regulation, the use of the reverse distribution mechanism, which is often referred to as “share cancellation” or “share destruction”, is not compatible with the MMFR.
Industry bodies reacted swiftly with counter views. The debate has intensified further by a letter from the MEP MMFR negotiating team to Commissioner Dombrovskis. It notes that Level 2 rules or Level 3 guidance should not cover issues that are not within Level 1. An explicit position was not taken on the practice of share cancellation as part of the Level 1 negotiations, it says. If there is evidence that the practice is problematic, the Commission has the power to act under the review clause in Article 46, but it should do so only after full consultation of all stakeholders.
At the time of writing, the MEPs and the industry awaited the Commission's response and ESMA's reaction. It is another incident in a series of disputes between the European Parliament and the Commission (or the ESAs) about opinions and guidance going beyond the intentions or coverage of Level 1 legislation. In this case, if the Commission's opinion holds sway, it could sound the death knoll for CNAVs and cause major disruption for investors and managers.