Proposed Changes To The Central Bank’s Rules On Money Market Funds, Closed-Ended And Limited Liquidity Funds And Professional Investor Funds - Fund Management/ REITs

From our recent bulletin ("Central Bank launches Consultation, February 2011") you will be aware of the consultation process (CP 50) initiated by the Central Bank on the proposed changes to the UCITS Notices and Guidance Notes to implement UCITS IV. In addition to the UCITS IV-related changes, the Central Bank has taken the opportunity to propose a number of unrelated changes, in some cases of a significant nature, to the UCITS and non-UCITS Notices. Below is a summary of those changes. The deadline for the submission to the Central Bank of comments on the proposed changes is 15 March 2011.

Revised Guidance Note 2/97 - Proposed Changes to Closed-Ended Collective Investment Schemes

At present, the Central Bank's Guidance Note only addresses its requirements relating to the establishment of closed-ended funds. The Central Bank proposes to amend this Guidance Note to address changes to existing closed-ended funds. The draft amended Guidance Note sets out the criteria to be met where the following changes are proposed:

1. A change to the duration of the fund

The votes required to approve this change depend on the availability of redemption facilities to investors. Where there are no redemption facilities, votes in favour of the change must represent 75% of the shares in issue and where there are redemption facilities, at least 50% of the votes cast must vote in favour of the change.

2. Amendments to the investment objectives and policies

where amendments to the investment objective and/or material amendments to the investment policies are proposed and:

no redemption facilities are available to investors, votes in favour of the amendments must represent at least 75% of the shares in issues; or
redemption facilities are available to investors, at least 50% of the votes cast must be in favour of the amendments.

where non-material amendments to the investment policies are proposed and:

no redemption facilities are available to investors, at least 50% of the votes cast must be in favour of the change; or
redemption facilities are available to investors, investors should be provided with a reasonable notification period prior to the implementation of the change.

3. Increases to redemption fees, management or investment management fees

The level of votes required to approved this change depends on the availability of redemption facilities to investors. Where there are no redemption facilities, votes in favour of the increase must represent at least 75% of the shares in issue and where there are redemption facilities, at least 50% of the votes cast must vote in favour of the increase.

Significantly, the Central Bank has indicated that it intends to apply the same requirements to limited liquidity funds. As these proposed changes would considerably impact upon the operation of closed-ended and limited liquidity funds, the Irish funds industry intends to raise issues on those changes which are considered to be disproportionate in nature.

Revised UCITS Notice 14.3 - Dealings by Promoter, Manager, Trustee, Investment Adviser and Group Companies

The Central Bank proposes to amend its requirements with regard to transactions carried out with a UCITS by the promoter, manager, trustee, investment adviser and group companies. The draft revised Notice introduces an obligation to disclose any related party transactions during the reporting period in the annual and semi-annual reports. This report must include a list of all transactions by type; the name of the related party; and, where relevant, fees paid to that party in connection with the transaction. The Central Bank proposes that corresponding changes be made to the non-UCITS Notices.

Revised Notices on Money Market Funds

A UCITS or non-UCITS fund which labels itself as a money market fund must now classify itself as a "Short-Term Money Market Fund" or a "Money Market Fund" and this must be indicated in the prospectus of the fund. The Central Bank requires that these revised prospectuses must be submitted for review by 29 April 2011.

The amended prospectus must provide appropriate information to investors on the risk and reward profile of the fund highlighting, where relevant, investment in new asset classes, financial instruments or investment strategies with unusual risk and reward profiles. The risk and reward profile information for a Money Market Fund must also take account of the longer Weighted Average Maturity and Weighted Average Life (discussed below).

1. Distinguishing between a Short-Term Money Market Fund and a Money Market Fund

WAM and WAL

To be classified as a Short-Term Money Market Fund, the weighted average maturity ("WAM")¹ of the fund's portfolio must not exceed 60 days. This time period is extended to six months for the portfolio of a Money Market Fund.

The Notices also introduces the concept of the Weighted Average Life or "WAL"².

The WAL of a Short-Term Money Market Fund must not exceed 120 days while the WAL of a Money Market Fund portfolio must not exceed 12 months. The Notices contain guidelines for the calculation of WAL for securities.

When calculating WAM and WAL, the impact of financial derivative instruments, deposits and efficient portfolio management techniques must be taken into account.

Investment Objectives and Policies

Both Short-Term Money Market Funds and Money Market Funds must have a primary objective of maintaining the principal of the fund and aim to provide a return in line with money market rates. Similarly, for both Short-Term Money Market Funds and Money Market Funds investments are limited to high quality money market instruments and deposits with credit instruments. The Notices set out the factors to be taken into account in determining "high quality", which are (i) the credit quality of the instrument (an instrument must have one of the two highest available short-term credit ratings by each recognised credit agency that has rated the instrument, or, if the instrument is not rated, it is of an equivalent quality); (ii) the nature of the asset class represented by the instrument; (iii) the operational and counterparty risk; and (iv) the liquidity profile.

Permitted Investments

Investments held by Short-Term Money Market Funds are limited to securities or instruments with a residual maturity until the legal redemption date of less than or equal to 397 days. This is extended to two years for Money Market Funds, provided that the time remaining until the next interest reset date is less than or equal to 397 days.

Direct or indirect exposure to equities or commodities, including through financial derivative instruments, is not permitted for either type of money market fund. Financial derivative instruments may only be used when these are in line with the money market investment strategy of the scheme. Financial derivative instruments which give exposure to foreign exchange may only be used for hedging purposes. Investment in non-base currencies is not permitted unless the exposure is fully hedged.

Investment in other Collective Investment Schemes

A Short-Term Money Market Fund may only invest in other collective investment schemes which themselves are Short-Term Money Market Funds. A Money Market Fund may only invest in other collective investment schemes if those collective investment schemes are Short-Term Money Market Funds or Money Market Funds.

Calculation of NAV

Both Short-Term Money Market Funds and Money Market Funds must provide daily NAV and price calculations and have daily subscriptions and redemptions. A Short-Term Money Market Fund may have either a constant or a fluctuating NAV, while a Money Market Fund must have a fluctuating NAV.

2. Short-Term Money Market Funds - valuation on the basis of amortised cost

The Notice sets out the conditions for valuation on the basis of amortised cost for Short-Term Money Market Funds. These conditions track the Central Bank's existing Guidance Note on the valuation of money market funds with the addition of the statement that Money Market Funds are not permitted to follow an amortised cost valuation methodology to value NAV.

New Rules relating to Professional Investor Funds

Following the recent change in the eligibility criteria for qualifying investors funds, which saw the reduction of the minimum subscription amount for a qualifying investor fund from €250,000 to €100,000, the minimum subscription amount for a professional investor fund has similarly been reduced from €125,000 to €100,000.

Conclusion

The proposed changes, particularly those in relation to closed-ended funds and limited liquidity funds and more comprehensive disclosure of related party transactions in the periodic reports, are significant. If you wish to discuss any of these changes or wish to respond to the Central Bank's consultation on these changes, please do not hesitate to contact us. We will continue to update you on these developments.

Footnotes

1 The Notices define Weighted Average Maturity or "WAM" as: "a measure of the average length of time to maturity of all of the underlying securities in the money market fund weighted to reflect the relative holdings in each instrument, assuming that the maturity of a floating rate instrument is the time remaining until the next interest rate reset to the money market rate, rather than the time remaining before the principal value of the security must be repaid. In practice, WAM is used to measure the sensitivity of a money market fund to changing money market interest rates."

2 WAL is defined as: "the weighted average of the remaining life (maturity) of each security held in a money market fund, meaning the time until the principal is repaid in full (disregarding interest and not discounting). Contrary to what is done in the calculation of the WAM, the calculation of the WAL for floating rate securities and structured financial instruments does not permit the use of interest rate reset dates and instead only uses a security's stated final maturity. WAL is used to measure the credit risk, as the longer the reimbursement of principal is postponed, the higher the credit risk. WAL is also used to limit the liquidity risk."

This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.