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MMFR_The investor knowledge paradigm

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The Money Market Funds Regulation (MMFR) intends to transform the risk management framework of the managers of Money Market Funds (MMF) by introducing a new funds categorisation, a dedicated filing and a complete review of the risk and credit management processes.
This regulation will also change the way the liquidity of funds is managed and can be viewed the first regulation to enhance the knowledge of the funds’ investors.

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MMFR_The investor knowledge paradigm

  1. 1. 1 MMFR – ‘Know your customer’ policy The final investor knowledge paradigm The Money Market Funds Regulation (MMFR) intends to transform the risk management framework of the managers of Money Market Funds (MMF) by introducing a new funds categorisation, a dedicated filing and a complete review of the risk and credit management processes. This regulation will also change the way the liquidity of funds is managed and can be viewed the first regulation to enhance the knowledge of the funds’ investors. About Money Market Funds Regulation The text of the Money Market Funds Regulation (MMFR) was published in the official journal of the European Union on June 30th, 2017, for application by July 2018 for new Money Market Funds (MMFs) that were established, managed or marketed in the European Union. Existing MMFs were granted with a grandfathering period and were allowed to transition to the new regime byJanuary 21st, 2019. MMFR regulatory timeline Source: ESMA MMFR was created to mitigate liquidity and stability risk. It eventually aims to bring answers to issues revealed during the financial crisis of 2008. For instance, when the US reserve primary fund faced massive and sudden redemption requests, which resulted in the fund “breaking the buck” and no longer being able to preserve a constant Net Asset Value (NAV). The text lays down a consistent set of rules significantly impacting existing organizational setups, through:  new funds authorisation, classification and filing;  new set of investment constraints and valuation rules;  implementation of liquidity ratios monitoring;  strengthening of the risk management framework through new patterns for stress testing;  mandatory criteria and extensive documentation of internal credit quality assessment;  and, more protection and transparency towards the investors. MMFR affects most aspects of the fund lifecycle, for both the manager of the fund and its providers. It comes to the fore that the regulator is now strongly interested in the liquidity of the fund on the liabilities side, simultaneously with the assets. Stakes of the regulation The stakes of MMFR are numerous especially when managing Constant NAV funds, that are clearly targeted by this new regulatory package. Apart from the transparency requirement (requesting the disclosure of the Top 10 holdings in the fund for instance) and the regulatory reporting one, the strengthening of the risk management framework is mainly focused on the assets part of the fund. From our point of view, the concealed topic from this regulation is summed up in the article 27
  2. 2. 2 “‘Know your customer’ policy”. This specific article stands out from the whole regulatory package in order to deal with the liabilities of the fund while stressing out new needs in terms of final investors knowledge. Although this requirement seems not to be very binding at first glance, it appears more complex to implement than initially expected. It should be taken all the more seriously as it is likely to be rolled out to other funds categories afterwards. A new regulatory constraint Putting aside the confusion of the “Know your customer” term, the main objective of this requirement is to ensure that the MMF or the manager of the MMF is able to provide sufficient liquidity to withstand potential massive redemptions from a pool of investors. In order to anticipate “the effect of concurrent redemptions by several investors”(MMFR article 27.1), the MMF or the manager of the MMF shall perform a global investor due diligence at sub-fund level. Gathering all the requested figures should enable to evaluate the risk of a run while profiling the fund investors in terms of concentration, risk profile and historical behaviour. These figures are qualitative information that could be deemed difficult to gather at investor level, especially when the fund is not having a nominative registrar. Where should it come from? How to ascertain the quality of the information provided by intermediaries? This is as well an important challenge also since this kind of specific information is disseminated across several intermediaries. More broadly, this MMFR article should be placed in a context of:  Having a vision on the liquidity of fund liabilities requested by the FSB / IOSCO, which applies here to MMFs but tomorrow will certainly affect other funds within the framework of the current UCITS / AIFMD redesign;  The regulator's deeper desire to move towards a flattening of the custody chain in order to target the final investor beyond the intermediation chain. This is the case for liquidity management reasons obviously, but also to have an overview on who actually holds the securities (e.g. identification of shareholders on SRD2), or for fiscal purpose as per FATCA / AEOI. The final objective of this requirement is to evaluate, as far as possible, the fund dependency to a restricted number of investors that entails a concentration risk, and the redemption triggers that could destabilize the liquidity of the fund. Due diligence challenges The challenges to implement MMFR are diverse and complex. The KYC requirement is not exempt from the rule. While this requirement overlapped with already existing regulations (such as UCITS or AIFMD for the reporting side), it raises many difficulties in its implementation. First there is a real open question about the definition of “single investor” (article 27.1 and 27.2). The only investor that a Management Company is aware of is the shareholder nominee at the Transfer Agent (TA) level. Even if no nominative registrar exists, the TA is often able to provide some more detailed breakdowns (especially when working with platforms). If the “single investor” is the beneficial owner (like in any other regulations), the due diligence at nominee level could not be considered sufficient. There can indeed be intermediaries behind the platforms or behind the intermediaries themselves … which will definitely not ease the look through. From our point of view, the overall stakes are of different kinds and can be classified into four categories summed up hereafter: market, operational, technical and regulatory.
  3. 3. 3 Major identified stakes regarding the KYC requirement Source: Cognizant Consulting The manager of the MMF shall therefore be ready to face some challenges in the operational implementation as well as encounter some technical issues. A solution on a best effort basis The article 27 is actually tolerating a solution on a best effort basis since the regulator is not specifying any outcome or sanction for non- complying. It is indeed a first step for the local National Competent Authorities (NCAs) to assess how the market is reacting and answering to this simple requirement ; and surely broaden the scope of impacted funds in the coming years (through the overhaul of existing regulations). Anyway the manager of the MMF shall adapt its internal organisation to comply with this requirement. We believe that the minimum improvements should be the following:  Efficient investor database It seems mandatory that the Asset Manager maintains an accurate investor database with records from the intermediary banks and its providers (TA, processing agent, distribution network, etc.). In order to being able to create alerts and controls on an ongoing basis on investor holdings thresholds, it is vital that the Manager of the MMF holds an in-house consolidated database of all investor data that can be harnessed smoothly.  Transparent communication In order to smoothen the process the best possible way and take into account the internal organisation and external dependency, it is compulsory to foster a transparent communication with all the stakeholders before and after the Go Live of the regulation. Collaboration between the teams and with the intermediaries is critical.  Well-organized internal process A clear ownership of the overall KYC / Due diligence process and a comprehensive distribution of the tasks and responsibilities between several internal teams is a must. Dependencies on information received from the outside (TA, intermediaries) is strong and the communication between the teams must be as transparent as possible to enrich the different files. Market Operational Technical Regulatory Lack of technical readiness of the European market (especially CSD models) in terms of marked orders Ownership of the process. Which team shall be respsonsible of the delivery and coordination? Many different channels of distribution, therefore many sources of information (distribution platforms, wholesale, intermediaries, direct clients, mandates, etc.) Regulation opacity. No specific guidelines on this requirement so far No market standards to gather investor breakdown information from the intermediaries Process effectiveness and automation due to numerous internal (and external) teams involved No market standard in terms of format and content raising consistency issue. No stringent regulatory constraints appart from the quarterly regulatory reporting (requirement on a best effort basis) Strong dependency to securities services provider (TA, FA) Governance around the fund liquidity profile impact assessment Liabilities information consolidation Overlap with UCITS, AIFMD and GDPR to a lesser extent
  4. 4. 4 High level MMFR due diligence process Source: Cognizant Consulting It seems essential to implement a sustainable and easily replicable process since this requirement for a deeper investor knowledge could spread to other funds’ type (see Shareholder Rights Directive for Equity Funds for instance) with MMFR as a regulatory pilot model. In our opinion, this remains one of the requirements that can serve the business and more specifically encourage a more tailored management of MMFs. Once the challenge of gathering data from multiple sources has been achieved, this is an outstanding and worthwhile sum of information about your investors. Indeed, thanks to data management and new technology like data analytics or data visualization, those highly qualitative investor data can be harnessed, for instance, to:  Forecast in and out flows depending on the market context;  Streamline the distribution channel for each of the MMF;  Adapt the fund strategy to the demand with relevant assets allocation;  Predict and try to minimise the investor churn rate thanks to well adapted actions from the marketing or the product team. A business opportunity Like all past regulations, MMFR can be seen as an important constraint but it is also a real chance for managers able to implement its requirements sustainably. This improved knowledge of liabilities is critical in a competitive environment where one’s funds’ track record is a key to commercial success. With hindsight, this is one of the only requirement from the MMFR regulatory package that can be deemed a business opportunity for the manager of the MMF to better mastering their liabilities and leverage on their existing distribution network. Other MMFR requirements like Liquidity monitoring, valuation or Credit Quality Assessment strengthening are also compelling in a way that they are upgrading controls and security for the investors in MMFs. But the enhancement of the liabilities monitoring is an actual move towards a strict traceability of the funds’ investors, for which the market must be better structured. It is a revolution in the world of funds to be able to monitor and control efficiently the liquidity of its liabilities. And we are convinced that this stringent requirement will soon apply to funds allocated with more illiquid assets; and even to every kind of funds in a near future. ROMAIN MALOUVIER Zürich office, Switzerland M. : + 41 (0)79 397 65 30 @ : romain.malouvier@cognizant.com

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