China’s Money Market Reforms Aim to Stem Risk, Allow Funds to Thrive in Fintech Era
The systemic risk implications of the money market fund industry has been a subject of interest to a number of regulators around the world since the financial crisis of 2008 exposed its vulnerability to market stress.
The US Securities and Exchange Commission (SEC) adopted a package of reforms in 2014 and the European Securities and Markets Authority (ESMA) issued a follow-up peer review on February 2016 to look into the state of compliance with the money market fund guidelines published since April 2013 among market participants. In line with this global trend, Chinese regulators are not far behind.
The China Securities Regulatory Commission (CSRC) rolled out a series of money market funds provisions in December 2015 to strike a balance between the need for innovation and risk minimization in our new, fintech-dominated global capital markets. The new provisions take into account public feedback, and are the first refinements to a previous set of rulings drafted in 2004.
CSRC defines a money market fund as a type of treasury product that has:
- High potential for preservation of capital
- Ample transactional liquidity
- Low transactional cost
CSRC sought public consultation on the reforms on 15 May 2015, and by the closing period, 70 feedbacks were received from 37 financial institutions.
The reform highlights include a complete revamp of the scope of asset class that money market mutual funds can invest in. For a start, they offer intrinsic protection (minimization) against potential default where money market funds are restricted from investing in the following financial instruments:
- Convertible bonds, transferable bonds
- Adjustable rate bonds whose interest rate is based on the interest rate of a fixed-period certificate of deposit, except where the bond has already entered its last period of interest rate adjustment
- Any bond or nonfinancial corporate debt financing instrument with a credit rating of AA+ or less
- Any other financial instrument where investment is prohibited by the China Securities Regulatory Commission or the People’s Bank of China.
They also offer protection against concentration risk where bonds issued by the same institution, nonfinancial corporate debt financing instruments, and asset-backed securities of the originator combined shall make up no more than 10% of the fund’s net asset value, except in the case of government bonds, central bank bills, or policy financial bonds.
In addition, a money market fund’s investments in bank deposits of the same commercial bank or in interbank deposits from qualified custodians of the fund shall not exceed 20% of the fund’s total net assets, while investments in bank deposits of the same commercial bank or in interbank deposits from those not qualified as custodians of the fund shall not exceed 5% of the fund’s total net asset value.
New measures to Ensure Fund Managers Have the Ability to Manage Liquidity Risk
Protection against redemption run where a money market fund’s investment in fixed-term bank deposits may not exceed 30% of the fund’s net assets, but investments in term deposits where there is an agreement allowing for early withdrawals are not subject to the above ratio limits. A money market fund should maintain a sufficient proportion of liquid assets to satisfy potential redemption requests.
Greater Degree of Transparency on What Constitutes Misrepresentation, Mis-selling, and Insufficient Disclosure
- Those money market funds that adopt an amortized cost method of accounting should adopt a shadow pricing risk-management method and a procedure for evaluating the fairness of calculating fund asset net worth by the amortized cost method.
- Money market funds that are either not receiving purchase applications or redeeming fees may in a proportion of no greater than 0.25% of the fund’s assets set aside necessary fees specifically for sales of the fund and fund-holder servicing. The fund’s annual report should include specific explanations of the charges so incurred.
- Fund managers should include in a prominent place in the money market fund’s recruitment pamphlets and promotional material a statement that investors’ purchases in the money market fund are not held as deposits in a bank or deposit-taking financial institution, and that the fund manager cannot guarantee the fund’s profitability, nor guarantee a minimum level of earnings.
- The promotional activities must not cause confusion by comparing the investment profits of the money market fund with bank deposits or other products, and must not include public promotional behavior that advertises financial management, bank account, or other services under a false name for the money market fund.
Measures to Encourage Innovation in Fintech while Ensuring Risks Are Properly Managed
- To protect fund shareholders, the fund manager may, in accordance with relevant statutory law and the fund contract’s provisions, during specific market declines suspend or refuse to accept more than a certain amount of money market purchases.
- To ensure the fund’s smooth operation, and to avoid inciting systemic risk, the fund manager should, for any fund shareholder applying in a single day to redeem fund shares equaling more than 1% of the fund’s total assets, impose a mandatory redemption fee of 1% and fully credit the above-mentioned redemption fee to the fund’s assets.
- Nonbank payment companies that engage in fund sales payment settlement services must strictly adhere to the “Payment Company Client Funds Management Method” relating to withdrawals and deposits, use, and transfers of client funds, but must not use client funds to pay advance fund redemptions.
- Fund managers should establish and improve an internal credit rating system for bond investments, integrate use of external credit ratings together with those internal credit ratings, and in accordance with principles of caution define investment restrictions for distinct credit levels of financial instruments. For financial instruments that the money market fund has already invested in, fund managers should establish an internal system to track their credit class as well as mechanisms to assess and guard against risk, and retain related information for future reference.
The entire set of 2015 revised provisions was 13 pages long, relatively more detailed and complete compared to the 2004 provisional rulings two-pager.
Time will tell if these new reforms play a sufficient role in maintaining the delicate balance between minimizing systemic risk while allowing financial innovation to flourish. In the meantime, we’ll be monitoring the issue and translating it for you.
If you are keen to know more about US money market reforms to appreciate how differently they have been conducted in China, download our issue brief and check out two posts on our Market Integrity Insights blog. The first post examines the two approaches that were highlighted by SEC in its proposal for public consultation regarding money market funds in 2013; the second one looks at the state of money market fund regulation five years after the global financial crisis.
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