Citi 2018 FinReg Outlook

MMF can only be made by managers that already have authorization to operate AIF MMFs from an EU national regulator. 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. 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 tobe aPublicDebt CNAVor 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. 21 July 2018: All new MMFs must be authorized under the new rules. 21 January 2018: All existing MMFs must applied for authorization under the new rules. THE SHARE DESTRUCTION ISSUE The issue of share destruction is the item of the new money market fund regulation that 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. ESMA’s original guidance for the new money market regulation stated that share destruction was not consistent with the rules and should be prohibited. The industry pushed back, arguing that it was a necessary tool to deal with negative interest rates. The industry also noted that the practice had been approved by several local EU regulators. Ultimately, ESMA pulled back from banning share destruction. However, the debate is not over. In its final guidance, ESMA said it had referred the matter to the European Commission’s legal service. What action ESMA takes on the issue will depend on the outcome of the legal assessment. Since there is no timeline for when this issue will be resolved, the industry will have to wait and see. Citi Custody & Fund Services – FinReg Outlook 2018 33 32