EUROPE: ESMA Updates Guidelines on Stress Tests for Money Market Funds

Wednesday December 16 2020

The European Securities and Markets Authority (ESMA) has published the 2020 update of guidelines on MMF stress tests under the Money Market Funds Regulation (MMFR). The updates take account of MMFs recent experience during March 2020, particularly in relation to redemption scenarios.

The COVID-19 crisis has been challenging for MMFs. Risks have increased for MMFs and the money market instruments in which they invest. Several EU MMFs faced significant liquidity issues during the period of acute stress in March 2020.

For some parameters, the 2019 scenarios were exceeded by the extreme market movements observed during the COVID-19 crisis and the relevant factors have been updated accordingly. This is notably the case of the redemption scenario, as some funds exceeded the 25% redemption rate for professional investors specified in the guidelines.

Therefore the risk parameters will be modified in light of recent market developments. ESMA, in calibrating the new risk parameters, has worked closely with the European Systemic Risk Board and the European Central Bank

Purpose

The purpose of the guidelines is to ensure common, uniform and consistent application of the provisions in Article 28 of the MMF Regulation. In particular, and as specified in Article 28(7) of the MMF Regulation, they establish common reference parameters of the stress test scenarios to be included in the stress tests taking into account the following factors specified in Article 28(1) of the MMF Regulation:

1. a) hypothetical changes in the level of liquidity of the assets held in the portfolio of the MMF;
2. b) hypothetical changes in the level of credit risk of the assets held in the portfolio of the MMF, including credit events and rating events;
3. c) hypothetical movements of the interest rates and exchange rates;
4. d) hypothetical levels of redemption;
5. e) hypothetical widening or narrowing of spreads among indexes to which interest rates of portfolio securities are tied;
6. f) hypothetical macro systemic shocks affecting the economy as a whole.

In accordance with Article 28(7) MMF Regulation, the guidelines will be updated at least every year taking into account the latest market developments. In 2020, section 5 of the guidelines has been updated so that managers of MMFs have the information needed to fill in the corresponding fields in the reporting template referred to in Article 37 of the MMF Regulation, as specified by Commission Implementing Regulation (EU) 2018/70811 . This information includes specifications on the types of stress tests mentioned in section 5 and their calibration.

Scope of the effects on the MMF of the proposed stress test scenarios

Article 28(1) of the MMF Regulation requires MMFs to put in place “sound stress testing processes that identify possible events or future changes in economic conditions which could have unfavourable effects on the MMF”.

This leaves room for interpretation on the exact meaning of the “effects on the MMF”, such as:

• impact on the portfolio or net asset value of the MMF,
• impact on the minimum amount of liquid assets that mature daily or weekly as referred to in Article 24(c) to 24(h) and Article 25(c) to 25(e) of the MMF Regulation,
• impact on the ability of the manager of the MMF to meet investors’ redemption requests,
• impact on the difference between the constant NAV per unit or share and the NAV per unit or share (as explicitly mentioned in Article 28(2) of the MMF Regulation in the case of CNAV and LVNAV MMFs),
• impact on the ability of the manager to comply with the different diversification rules as specified in Article 17 of the MMF Regulation.

Next steps

The Guidelines will now be translated into the official EU languages and subsequently published on ESMA’s website. They will become applicable two months after the publication of the translations.

The new 2020 parameters set out in the updated guidelines will have to be used for the purpose of the first reporting period following the start of the application of the updated guidelines.

Click on the link for further information.