Originally published in A Guide to UCITS in Ireland
Whilst many UCITS will invest principally in money market instruments and may consider themselves to be money market funds, there are only certain funds which are permitted by the Central Bank to refer to "money market fund" in its title.
Previously, only UCITS established as constant NAV Funds or accumulating NAV funds, with the principal objective to preserve principal and maintain liquidity and which obtained a triple A rating from an internationally recognised rating agency together with a supplementary market risk rating (or which had management companies / investment managers with demonstrable expertise in the operation of money market funds, which used amortised cost valuation) were permitted to use the term "money market fund" in their title and follow an amortised cost valuation methodology.
The Central Bank now distinguishes between "short-term money market funds" and "money market funds". The new rules are set out in UCITS Notice 17, which sets out the terms and basis upon which a UCITS may label itself or market itself as a money market fund.
Under the new rules, a UCITS money market fund must classify itself as either a "Short-Term Money Market Fund" or as a "Money Market Fund". Short-Term Money Market Funds may have either a constant or fluctuating NAV and are permitted to follow an amortised cost valuation methodology, as further set out below.
Money Market Funds must have a fluctuating NAV and are not permitted to follow an amortised cost valuation methodology.
A number of conditions apply to both Short-Term Money Market Funds and Money Market Funds as set out below:
Disclosure Requirements
A UCITS money market fund must indicate in its prospectus whether it is a Short-Term Money Market Fund or a Money Market Fund. It must also include a risk warning drawing attention to the difference between the nature of a deposit and the nature of an investment in a money market fund with particular reference to the risk that the principal investment in a money market fund is capable of fluctuation.
A UCITS money market fund must provide appropriate information to investors on the risk and reward profile of the fund so as to enable investors identify any specific risks linked to the investment strategy of the money market fund. In the case of a UCITS classified as a Money Market Fund, this must take into account the longer WAM and WAL (see further below). In the case of all UCITS money market funds, the information provided must take account, where relevant, investment in new asset classes, financial instruments or investment strategies with unusual risk and reward profiles.
Investment Objective
The primary investment objective of a UCITS money market fund structured either as a Short-Term Money Market Fund or as a Money Market Fund must be to maintain the principal of the fund and aim to provide a return in line with money market rates.
Eligible Assets
The following conditions apply to both types of UCITS money market funds:
- Investments must be limited to "high quality" money market instruments which comply with the criteria for money market instruments as set out in the UCITS Regulations and deposits with credit institutions.
- Direct or indirect exposure to equities or commodities, including through financial derivative instruments, is not permitted.
- Financial derivative instruments which give exposure to foreign exchange may only be used for hedging purposes and investment in non-base currencies is not permitted unless the exposure is fully hedged.
- Investment in other collective investment schemes is not permitted unless the underlying scheme satisfies the following: (i) if the investing fund is a Short-Term Money Market Fund, the underlying scheme must be structured as a Short-Term Money Market Fund (ii) if the investing fund is a Money Market Fund, the underlying scheme must be structured as either a Short-Term Money Market Fund or a Money Market Fund.
Daily NAV and Dealing
Both Short-Term Money Market Funds and Money Market Funds must provide daily NAV and price calculations and provide daily subscription and redemption of units/shares.
Residual Maturity
Investments are limited to securities or instruments with a residual maturity until the legal redemption date of less than or equal to 397 days, in the case of Short-Term Money Market Funds, and 2 years (provided that the time remaining until the next interest reset date is less than or equal to 397 days), in the case of Money Market Funds.
Weighted Average Maturity ("WAM")
The WAM of the portfolio of a Short-Term Money Market Fund must not exceed 60 days, whereas the WAM of the portfolio of a Money Market Fund must not exceed 6 months.
Weighted Average Life ("WAL")
The WAL of the portfolio must not exceed 120 days, in the case of a Short-Term Money Market Fund, or 12 months, in the case of a Money Market Fund.
In either case, when calculating the WAL for securities, the UCITS must base the maturity calculation on the residual maturity until the legal redemption of the instruments. However, when a financial instrument embeds a put option, the exercise date of the put option may be used instead of the legal residual maturity only if the following conditions are fulfilled at all times: (i) the put option can be freely exercised by the UCITS at its exercise date, (ii) the strike price of the put option remains close to the expected value of the instrument at the next exercise date; and (iii) the investment strategy of the UCITS implies that there is a high probability that the option will be exercised at the next exercise date.
When calculating the WAM and WAL, the impact of financial derivative instruments, deposits and efficient portfolio management techniques must be taken into account.
Short-Term Money Market Funds - Valuation on the basis of amortised cost
Valuation on the basis of amortised cost is permitted in the case of Short-Term Money Market Funds, subject to the following conditions:
Expertise
Short-Term Money Market Funds are permitted to follow an amortised cost valuation methodology provided the UCITS or, where relevant, its delegate have demonstrable expertise in the operations of money market funds which follow this method of valuation.
This condition is satisfied where:
- the Short-Term Money Market Fund has obtained a triple-A rating from an internationally recognised rating agency; or
- the management company or investment manager is engaged in the management, or has been engaged in the management of a triple-A rated money market fund; or
- in exceptional circumstances, where the management company or investment manager has provided sufficient information to the Central Bank to demonstrate appropriate expertise in the operation of this type of money market fund.
The UCITS must be satisfied that the persons responsible for the operation of the Short- Term Money Market Fund including under any delegation arrangements have and continue to have the necessary expertise.
Weekly review of discrepancies
The UCITS Short - Term Money Market Fund must carry out a weekly review of discrepancies between the market value and the amortised cost value of its money market instruments. Escalation procedures must be in place to ensure that material discrepancies between the market value and the amortised cost value of a money market instrument are brought to the attention of the relevant personnel charged with the investment management of the UCITS.
If discrepancies in excess of 0.3% between the market value and the amortised cost value of the portfolio occur, a daily review must take place. The UCITS must also notify the Central Bank with an indication of the action, if any, which will be taken to reduce such dilution.
The trust deed, deed of constitution or articles of association of the UCITS must provide for the escalation procedures set out above or, alternatively, provide that a review of the amortised cost valuation vis-à-vis market valuation will be carried out in accordance with the requirements of the Central Bank. Weekly reviews and any engagement of escalation procedures must be clearly documented.
Monthly Stress Testing
The UCITS must engage in monthly portfolio analysis incorporating stress testing to examine portfolio returns under various market scenarios to determine if the portfolio constituents are appropriate to meet pre-determined levels of credit risk, interest rate risk, market risk and investor redemptions. The results of the periodic analysis must be available to the Central Bank on request.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
