Caught in the EU FINREG WAKE

Citi Custody & Fund Services – Caught in the EU FinReg Wake 21 20 NEW RULES The regulation introduces a number of new rules for European MMFs and their managers. Some of the key provisions are: Credit Quality Checks Managers are required to have a credit quality assessment procedure in place, with credit rating agencies used for reference only. Stress Testing Managers must have stress testing processes to identify possible events or changes in economic conditions that could have unfavorable effects on the fund. The stress testing results must be submitted to the fund’s regulator and ESMA. Assets with a maturity of over 75 days must be valued using the mark-to- market methodology. Valuation and Pricing All MMFs must be valued at least daily with: • VNAV MMFs valued using mark-to- market prices where possible. • Public Debt CNAV MMFs able to use the amortized cost method. • LVNAV MMFs able to use the amortized cost method to value assets with a maturity of 75 days or less, and a price that does not deviate from the mark-to-market price by more than 10 basis points. Assets with a maturity of over 75 days must be valued using the mark-to-market methodology. External Support Prohibition No MMF can receive external support to guarantee liquidity or stabilize the NAV. Diversification Rules MMFs are limited to holding a maximum of 10% of the money market instruments, securitizations, and asset-backed commercial paper issued by a single issuer, with the exception of government and public securities, where there is no limit. Fees and Gates While VNAV MMFs are not subject to prescriptive rules on the use of redemption fees, gates, or suspension, Public Debt CNAV and LVNAV MMFs have specific rules about their use: • Public Debt CNAV and LVNAV MMFs must implement assessment procedures for determining weekly liquidity thresholds. If weekly liquid assets fall below 30% of the fund’s value, it must decide either to take no action or apply: — liquidity fees on redemptions — gates limiting redemption to a maximum of 10% of the shares in issue — suspend redemptions for a maximum of 15 days • If weekly liquid assets fall below 10%, the fund must: — apply liquidity fees on redemptions — suspend redemptions up to a maximum of 15 days If the total period of suspension exceeds 15 days in a 90-day period, the fund must cease to be a Public Debt CNAV or LVNAVMMF. KEY CONSIDERATIONS Managers impacted by the regulation must make some key decisions. Those that operate an existing CNAV MMF will need to determine if they can comply with the new rules for Public Debt CNAV funds. If not, managers must decide if they want to transition these funds to VNAV or LVNAV MMFs. Alternative Investment Fund Managers (AIFMs) intending to establish, market, or manage AIF MMFs must ensure they have the correct authorization to manage an AIF MMF in the EU. This includes non-EU AIFMs, who must contact their Member State of reference prior to obtaining authorization for any AIF MMF. Additionally, managers will need to ensure all required documentation is in place and compliant, including marketing, risk assessments, reporting, and internal processes and procedures. KEY DATES 21 July 2018: All new MMFs must be authorized under the new rules. 21 January 2019: All existing MMFs must have applied for authorization under the new rules. The share destruction issue for money market funds still remains open. Share destruction was a mechanism developed for CNAV MMFs to maintain their constant NAV in a negative interest rate environment. Normally, a CNAV MMF fully distributes its net income and allocates that income to each investor in the form of new shares. Share destruction is this reverse process, where investors’ shares are reduced by the amount of the daily negative net income. In a letter to ESMA, the European Commission confirmed that that share destruction was inconsistent with the EU MMF regulations and advised ESMA to take steps to harmonize the rules across the EU. ESMA is expected to move to end the practice of share class destruction this year but the industry is unlikely to go down without a fight. There has already been intense lobbying for the practice to be allowed to continue. Nonetheless, many asset managers will be looking at a Plan B for their Euro denominated CNAV MMFs. It will be nearly impossible to maintain a Euro CNAV funds without share destruction in Europe’s negative interest rate environment. If this is the case, managers will have to convert their Euro CNAV MMFs to a VNAV MMF or shut their Euro CNAV MMFs down. SO LONG SHARE DESTRUCTION