Response to consultation on draft RTS on criteria for the identification of shadow banking entities
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In terms of syntax, regarding Article 1(5) paragraph 1, we suggest replacing the word “either” with “any” (or a word or phrase with similar effect). “Either” suggests a choice between two definitions, whereas currently (and notwithstanding our recommendation to remove Article 1(5)(a) from the draft RTS) there are three definitions labelled (a), (b) and (c).
It is our view that the policy intention underpinning Recital 1 is undermined by Article 1(4) and (5) of the draft RTS in that the entities proposed to be designated as shadow banking entities provide services or perform activities included in their authorisation.
Regarding Article 1(4) and (5)(a) of the draft RTS in the case of money market funds (MMFs), we acknowledge that MMFs were included within the scope of the EBA's 2015 Guidelines [1]. However, the EBA stated in Section 4.3 of the Guidelines that it was appropriate for MMFs to be designated shadow banking entities at that time “pending the agreement of the European Commission’s proposal for a Regulation on MMFs”.
Indeed, not only are MMFs generally structured as undertakings for the collective investment in transferable securities (UCITS) or alternative investment funds (AIFs) and therefore their operations are generally governed by those regulatory and supervisory frameworks, but they now are also authorised, regulated and supervised under the EU’s Money Market Fund Regulation (MMFR), which came into effect in July 2017 as Regulation (EU) 2017/1131.
In view of the regulatory framework within which EU MMFs operate, and given the EBA’s stated objective as articulated in Recital 1, it would be inappropriate to designate MMFs as shadow banking entities. Indeed, it is our view that MMFs should be made exempt from such a designation through the removal of the provisions set out in Article 1(4) and (5)(a) and the inclusion of Regulation (EU) 2017/1131 in Annex I of the draft RTS.
Regarding Article 1(5)(c) of the draft RTS in the case of AIFs, we acknowledge that AIFs “which are allowed to originate loans or purchase third party lending exposures onto their balance-sheet pursuant to the relevant fund rules or instruments of incorporation” were included within the scope of the EBA's 2015 Guidelines. However, it is our view that the EBA’s proposed new definition for such AIFs, as a result of its negative scope, is so broad that it has the potential to capture AIFs even if they do not originate exposures in the ordinary course of business or purchase third-party exposures for their own account.
In our view, this is disproportionate, inappropriate, and potentially unclear, and could give rise to unintended consequences by potentially designating AIFs as shadow banking entities even if they do not undertake activities consistent with the EBA’s stated policy intention as set out in Recital 4 [2].
For example, just because an AIF’s incorporating documentation does not explicitly prevent it from originating or purchasing third-party exposures, it is not necessarily the case that said AIF is indeed originating or purchasing third-party exposures.
Even so, where an AIF does originate exposures, it is unclear what specifically the EBA means by an AIF which originates exposures “in the ordinary course of its business”. In our view, we do not believe it is proportionate to designate an AIF as a shadow banking entity where it undertakes such activity on a marginal scale relative to assets under management (AuM).
Finally, on the assumption that the EBA’s use of the word “exposures” in Article 1(5)(c) is defined as per Regulation (EU) No 575/201 [3], it is our view that the EBA’s proposal to update the definition to reference “exposures” in the draft RTS rather than “loans” or “lending exposures”, per the EBA’s 2015 Guidelines, is unnecessarily broad and would compound any unintended consequences that arise as a result of the negative scope of Article 1(5)(c), as outlined above.
Given the above, we recommend that the EBA reverts to the definitions used to define such AIFs in the EBA’s 2015 Guidelines.
Footnotes:
[1] EBA, Guidelines: Limits on exposures to shadow banking entities which carry out banking activities outside a regulated framework under Article 395(2) of Regulation (EU) No 575/2013, December 2015
[2] Recital 4 of the draft RTS states that AIFs “should be regarded as shadow banking entities except where they do not employ substantial leverage or where they do not originate exposures in the ordinary course of their business or where they do not purchase third-party exposures for their own account.”
[3] Regulation (EU) No 575/201 defines an “exposure” as “any asset or off-balance sheet item”.
In our view, this is disproportionate, inappropriate, and potentially unclear, and could give rise to unintended consequences by potentially designating AIFs as shadow banking entities even if they do not originate exposures or purchase third-party exposures for their own account.
Moreover, the EBA’s use of the word “exposures” in the draft RTS rather than “loans” or “lending exposures”, per the EBA’s 2015 Guidelines, is unnecessarily broad and would compound any unintended consequences that arise as a result of the negative scope of Article 1(5)(c), as outlined above.
Section 5 of the consultation includes a short impact assessment in which the EBA concludes that “the benefits of the draft RTS compensate the costs”. However, we do not believe that the impact assessment takes account of the fact that the draft RTS takes a broader approach than the EBA's 2015 Guidelines with respect to the proposed scope of funds included as shadow banking entities. As such, it is our view that the quantitative analysis produced by the EBA is not representative of the impact that the draft RTS would have in terms of reporting and, therefore, cannot be used as a basis on which to submit the draft RTS to the European Commission for consideration and endorsement.
We believe that the EBA should undertake a more comprehensive impact assessment that is truly representative of the impact that the draft RTS would have in terms of reporting before moving forward as proposed in the consultation.
While we acknowledge the EBA references the work of the Financial Stability Board (FSB), International Organisation of Securities Commissions (IOSCO) and the European Securities and Markets Authority (ESMA) in paragraphs 82-89 of the consultation, the EBA does not consider some key points:
• While it is the case that MMFs, like other market participants and investors, faced difficulties as a result of the Covid-19-related March/April 2020 liquidity event, it is also true that, despite underlying market liquidity issues, MMFs met investor needs throughout the period. No MMF had to suspend dealings, use redemption gates, apply liquidity fees or utilise any other liquidity management tools affecting investors’ ability to redeem. Moreover, we note that no constant net asset value (CNAV) or low volatility net asset value (LVNAV) MMF breached their 20bps NAV collar.
• Central bank interventions assisted markets as a whole and EU MMFs did not receive direct assistance. Indeed, the European Central Bank’s (ECB) Pandemic Emergency Purchase Programme (PEPP) explicitly omitted financial commercial paper (CP) – an important asset class for e.g., LVNAV MMFs – from the scope of its purchases. Central bank interventions did, however, calm the short-term money markets more broadly and thus assisted, indirectly, MMFs in managing liquidity during the period in which the central bank initiatives operated. This point is made clear by IOSCO [4], which stated that “it seems reasonable to assume that these interventions were initiated to provide support to short-term money markets generally and not just the MMF portion of that market”.
• ESMA [5] acknowledges that MMFs, like other market participants and investors, faced difficulties in accessing liquidity in the underlying short-term money market during the Covid-19-related March/April 2020 liquidity event. ESMA also opined that these underlying market liquidity issues were, in part, linked to the “reluctance or inability by certain banks to act as dealer” during the period and that “it would be worth exploring options to improve the functioning of the secondary market and increase the attractiveness of money market instruments in order to incentivize dealers to provide liquidity”. It is certainly important to note that the Covid-19-related March/April 2020 liquidity event was a market-wide event and not specific to or as a result of perceived vulnerabilities in MMFs.
Given the above, and in addition to the points we make in response to Q5 in terms of the regulatory and supervisory framework governing MMFs, we believe that the EBA should reconsider its justification, as set out in Recital 5 [6] of the draft RTS, to include MMFs within the scope of the definition of shadow banking entities. Indeed, MMFs should be made exempt from such a designation through the removal of the provisions set out in Article 1(4) and (5)(a) and the inclusion of Regulation (EU) 2017/1131 in Annex I of the draft RTS.
Question 1: Do you agree with the conditions of Article 1 paragraph 2 for identifying an entity as a non-shadow banking entity? Please provide reasons if you do not agree with any of the conditions or have comments with regard to any of them.
No response provided.Question 2: Have you got any comments regarding the list of entities that, being exempted or optionally excluded from those four legal acts in Annex I, should not be considered as shadow banking entities?
No response provided.Question 3: Conversely, what are your views concerning other entities exempted or optionally excluded from the other legal acts in Annex I and that would be identified as shadow banking entities? Please provide reasons in case you view that any of those entities should fall under the exemption in Article 1 paragraph 3 and therefore not be treated as shadow banking entities.
No response provided.Question 4: Have you got any other comments with regard to the content of Article 1 of the draft RTS? In your view, is it clear and easy to implement for the purposes of the reporting obligation of Article 394(2) of Regulation (EU) No 575/2013?
Please refer to our responses to Q5 and Q6 in respect of the European Banking Authority’s (EBA) proposed drafting of Article 1(5)(c).In terms of syntax, regarding Article 1(5) paragraph 1, we suggest replacing the word “either” with “any” (or a word or phrase with similar effect). “Either” suggests a choice between two definitions, whereas currently (and notwithstanding our recommendation to remove Article 1(5)(a) from the draft RTS) there are three definitions labelled (a), (b) and (c).
Question 5: In general, what are your views on the treatment of funds in these draft RTS? Do you agree with the approach adopted in these draft RTS, that follows the approach in the EBA Guidelines on limits on exposures to shadow banking entities, or alternatively should it be extended to capture those funds as shadow banking entities?
Recital 1 of the draft Regulatory Technical Standards (RTS) states that “This Regulation determines that entities authorised and supervised in accordance with Union legal acts (“regulated framework”) should not be identified as shadow banking entities, to the extent that these entities provide services or perform activities included in their authorisation.”It is our view that the policy intention underpinning Recital 1 is undermined by Article 1(4) and (5) of the draft RTS in that the entities proposed to be designated as shadow banking entities provide services or perform activities included in their authorisation.
Regarding Article 1(4) and (5)(a) of the draft RTS in the case of money market funds (MMFs), we acknowledge that MMFs were included within the scope of the EBA's 2015 Guidelines [1]. However, the EBA stated in Section 4.3 of the Guidelines that it was appropriate for MMFs to be designated shadow banking entities at that time “pending the agreement of the European Commission’s proposal for a Regulation on MMFs”.
Indeed, not only are MMFs generally structured as undertakings for the collective investment in transferable securities (UCITS) or alternative investment funds (AIFs) and therefore their operations are generally governed by those regulatory and supervisory frameworks, but they now are also authorised, regulated and supervised under the EU’s Money Market Fund Regulation (MMFR), which came into effect in July 2017 as Regulation (EU) 2017/1131.
In view of the regulatory framework within which EU MMFs operate, and given the EBA’s stated objective as articulated in Recital 1, it would be inappropriate to designate MMFs as shadow banking entities. Indeed, it is our view that MMFs should be made exempt from such a designation through the removal of the provisions set out in Article 1(4) and (5)(a) and the inclusion of Regulation (EU) 2017/1131 in Annex I of the draft RTS.
Regarding Article 1(5)(c) of the draft RTS in the case of AIFs, we acknowledge that AIFs “which are allowed to originate loans or purchase third party lending exposures onto their balance-sheet pursuant to the relevant fund rules or instruments of incorporation” were included within the scope of the EBA's 2015 Guidelines. However, it is our view that the EBA’s proposed new definition for such AIFs, as a result of its negative scope, is so broad that it has the potential to capture AIFs even if they do not originate exposures in the ordinary course of business or purchase third-party exposures for their own account.
In our view, this is disproportionate, inappropriate, and potentially unclear, and could give rise to unintended consequences by potentially designating AIFs as shadow banking entities even if they do not undertake activities consistent with the EBA’s stated policy intention as set out in Recital 4 [2].
For example, just because an AIF’s incorporating documentation does not explicitly prevent it from originating or purchasing third-party exposures, it is not necessarily the case that said AIF is indeed originating or purchasing third-party exposures.
Even so, where an AIF does originate exposures, it is unclear what specifically the EBA means by an AIF which originates exposures “in the ordinary course of its business”. In our view, we do not believe it is proportionate to designate an AIF as a shadow banking entity where it undertakes such activity on a marginal scale relative to assets under management (AuM).
Finally, on the assumption that the EBA’s use of the word “exposures” in Article 1(5)(c) is defined as per Regulation (EU) No 575/201 [3], it is our view that the EBA’s proposal to update the definition to reference “exposures” in the draft RTS rather than “loans” or “lending exposures”, per the EBA’s 2015 Guidelines, is unnecessarily broad and would compound any unintended consequences that arise as a result of the negative scope of Article 1(5)(c), as outlined above.
Given the above, we recommend that the EBA reverts to the definitions used to define such AIFs in the EBA’s 2015 Guidelines.
Footnotes:
[1] EBA, Guidelines: Limits on exposures to shadow banking entities which carry out banking activities outside a regulated framework under Article 395(2) of Regulation (EU) No 575/2013, December 2015
[2] Recital 4 of the draft RTS states that AIFs “should be regarded as shadow banking entities except where they do not employ substantial leverage or where they do not originate exposures in the ordinary course of their business or where they do not purchase third-party exposures for their own account.”
[3] Regulation (EU) No 575/201 defines an “exposure” as “any asset or off-balance sheet item”.
Question 6: What would be the advantages and disadvantages of taking a broader approach with respect to the scope of funds included as shadow banking entities?
When compared against the EBA’s 2015 Guidelines, it is our view that the EBA does take a broader approach with respect to the proposed scope of funds included as shadow banking entities in the draft RTS. This point is made clear in our response to Q5.In our view, this is disproportionate, inappropriate, and potentially unclear, and could give rise to unintended consequences by potentially designating AIFs as shadow banking entities even if they do not originate exposures or purchase third-party exposures for their own account.
Moreover, the EBA’s use of the word “exposures” in the draft RTS rather than “loans” or “lending exposures”, per the EBA’s 2015 Guidelines, is unnecessarily broad and would compound any unintended consequences that arise as a result of the negative scope of Article 1(5)(c), as outlined above.
Section 5 of the consultation includes a short impact assessment in which the EBA concludes that “the benefits of the draft RTS compensate the costs”. However, we do not believe that the impact assessment takes account of the fact that the draft RTS takes a broader approach than the EBA's 2015 Guidelines with respect to the proposed scope of funds included as shadow banking entities. As such, it is our view that the quantitative analysis produced by the EBA is not representative of the impact that the draft RTS would have in terms of reporting and, therefore, cannot be used as a basis on which to submit the draft RTS to the European Commission for consideration and endorsement.
We believe that the EBA should undertake a more comprehensive impact assessment that is truly representative of the impact that the draft RTS would have in terms of reporting before moving forward as proposed in the consultation.
Question 7: What are your views with regard to the consideration of money market funds as shadow banking entities?
Per our response to Q5, we believe it would be inappropriate to designate MMFs as shadow banking entities. Notwithstanding the fact that, as MMFs are highly regulated and supervised, designating MMFs as shadow banking entities would undermine the EBA’s central policy intention set out in Recital 1, we believe that it is important to provide the EBA with a practitioner’s perspective regarding the performance and resilience of MMFs during the Covid-19-related March/April 2020 liquidity event.While we acknowledge the EBA references the work of the Financial Stability Board (FSB), International Organisation of Securities Commissions (IOSCO) and the European Securities and Markets Authority (ESMA) in paragraphs 82-89 of the consultation, the EBA does not consider some key points:
• While it is the case that MMFs, like other market participants and investors, faced difficulties as a result of the Covid-19-related March/April 2020 liquidity event, it is also true that, despite underlying market liquidity issues, MMFs met investor needs throughout the period. No MMF had to suspend dealings, use redemption gates, apply liquidity fees or utilise any other liquidity management tools affecting investors’ ability to redeem. Moreover, we note that no constant net asset value (CNAV) or low volatility net asset value (LVNAV) MMF breached their 20bps NAV collar.
• Central bank interventions assisted markets as a whole and EU MMFs did not receive direct assistance. Indeed, the European Central Bank’s (ECB) Pandemic Emergency Purchase Programme (PEPP) explicitly omitted financial commercial paper (CP) – an important asset class for e.g., LVNAV MMFs – from the scope of its purchases. Central bank interventions did, however, calm the short-term money markets more broadly and thus assisted, indirectly, MMFs in managing liquidity during the period in which the central bank initiatives operated. This point is made clear by IOSCO [4], which stated that “it seems reasonable to assume that these interventions were initiated to provide support to short-term money markets generally and not just the MMF portion of that market”.
• ESMA [5] acknowledges that MMFs, like other market participants and investors, faced difficulties in accessing liquidity in the underlying short-term money market during the Covid-19-related March/April 2020 liquidity event. ESMA also opined that these underlying market liquidity issues were, in part, linked to the “reluctance or inability by certain banks to act as dealer” during the period and that “it would be worth exploring options to improve the functioning of the secondary market and increase the attractiveness of money market instruments in order to incentivize dealers to provide liquidity”. It is certainly important to note that the Covid-19-related March/April 2020 liquidity event was a market-wide event and not specific to or as a result of perceived vulnerabilities in MMFs.
Given the above, and in addition to the points we make in response to Q5 in terms of the regulatory and supervisory framework governing MMFs, we believe that the EBA should reconsider its justification, as set out in Recital 5 [6] of the draft RTS, to include MMFs within the scope of the definition of shadow banking entities. Indeed, MMFs should be made exempt from such a designation through the removal of the provisions set out in Article 1(4) and (5)(a) and the inclusion of Regulation (EU) 2017/1131 in Annex I of the draft RTS.