On February 18 new rules on UCITS from the European Securities and Markets Authority kick in, and could inadvertently increase the risk of money funds in the region. The rules limit collateral used to back derivatives – including repos – to be diversified by issuer and country, and no exposure to any one issuer can be more than 20 percent of a UCITS net asset value.
Problem is, government money funds that take exposure via government securities and repos of government securities could find themselves over the 20 percent limit quickly.
According to an analysis by Todd Zerega and Tom Watterson of the law firm Reed Smith, “As a result, those Government MMFs would likely increase their investment in direct holdings of obligations of the government issuer. Therefore, the ESMA collateral diversification requirements would have the counter-intuitive effect of increasing a Government MMF’s exposure to direct holdings of obligations of the particular governmental issuer.”
Zerega and Watterson note that the EC’s recent MMF reform proposal includes an exemption from its diversification rules for holding sovereign securities both directly and as collateral for repos. They argue that ESMA should take a page from the EC’s book and offer a similar exemption.