Circular Letter ST.11-1967 — Modification of the Definition of Money Market Funds

Ref.: ST.11-1967 | Luxembourg, December 16, 2011

To all UCITS

Subject: Modification of the definition of Money Market Funds

Dear Sirs,

We have the honor to refer to Regulation (EU) No 883/2011 of the European Central Bank of August 25, 2011 amending Regulation (EC) No 25/2009 concerning the balance sheet of the monetary financial institutions sector (ECB/2008/32).

This regulation modifies the definition of money market funds (MMFs) to align with the guidelines concerning a common definition of money market funds published on May 19, 2010, by the European Committee of Securities Regulators (CESR), the predecessor of the European Securities and Markets Authority.

In this context, money market funds are considered to be collective investment undertakings that meet all of the following criteria:

a) they pursue the investment objective of preserving the fund's capital and offering a return consistent with money market instrument interest rates;

b) they invest in money market instruments satisfying the criteria for money market instruments set out in Directive 2009/65/EC of the European Parliament and of the Council of July 13, 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (*), or in deposits with credit institutions, or guarantee that the liquidity and valuation of the portfolio in which they invest are determined on an equivalent basis;

c) they guarantee that the money market instruments in which they invest are of high quality, as determined by the management company. The quality of a money market instrument is determined, inter alia, based on the following factors:

• the credit quality of the money market instrument,
• the nature of the asset class represented by the money market instrument,
• for structured financial instruments, the operational risk and counterparty risk inherent in the structured financial transaction,
• the liquidity profile;

d) they guarantee that their portfolio has a weighted average maturity (WAM) of less than or equal to six months and a weighted average life (WAL) of less than or equal to twelve months;

e) they provide the net asset value (NAV) and the calculation of the price of their shares daily, and allow for the daily subscription and redemption of such shares;

f) they limit their investments in shares to those with a residual maturity until the legal redemption date of less than or equal to two years, provided that the time remaining until the next interest rate revision date is less than or equal to 397 days, with variable rate shares being revised based on a money market rate or index;

g) they limit their investments in other collective investment undertakings to those that meet the definition of money market funds;

h) they do not take any risk, directly or indirectly, with respect to equities or commodities, including through derivative products, and use derivative products only in compliance with the fund's investment strategy in the money market. Derivative products creating exchange rate risk may only be used for hedging purposes. Investment in shares denominated in a currency other than the base currency is authorized provided that the exchange rate risk is fully covered;

i) they have a constant or fluctuating net asset value.

For the purposes of applying this new definition, it is specified that:

a) a money market instrument is considered to have high credit quality if each recognized rating agency that has rated the instrument has assigned it one of the two highest existing short-term credit ratings, or, if the instrument is unrated, if it presents equivalent quality, as determined by the management company's internal rating process. When a recognized rating agency splits its highest short-term rating into two categories, these two ratings are considered to form a single category and, therefore, to constitute the existing highest rating;

b) the money market fund may, by way of exception to the condition stated in point a), hold sovereign issuances that have obtained at least an "investment grade" rating, provided that "sovereign issuances" are money market instruments issued or guaranteed by a central, regional, or local authority or by the central bank of a Member State, the ECB, the European Union, or the European Investment Bank;

c) when calculating the WAL of shares, including structured financial instruments, the maturity calculation is based on the residual maturity until the legal redemption of the instruments. However, when a financial instrument contains a put option, it is possible to use the exercise date of this option instead of the residual legal maturity only if the following conditions are met at all times:

• the management company can freely exercise the put option on its exercise date,
• the exercise price of the put option remains close to the expected value of the instrument on the next exercise date,
• the investment strategy of the money market fund makes the exercise of the option on the next exercise date very likely;

d) when calculating the WAL as well as the WAM, the repercussions of financial derivative instruments, deposits, and efficient portfolio management techniques are taken into account;

e) "weighted average maturity" (WAM) is defined as: a measure of the average duration until the maturity of all underlying shares held in the fund, weighted to reflect relative holdings in each instrument, on the assumption that the maturity of a variable rate instrument is the time remaining until the next interest rate revision relative to the money market rate, and not the time remaining until the date on which the nominal value of the share must be repaid. In practice, WAM is used to measure the sensitivity of a money market fund to changes in money market interest rates;

f) "weighted average life" (WAL) is defined as: the weighted average of the residual maturity of each share held in a fund, namely the time remaining until the full repayment of the principal, without taking interest and discounts into account. Unlike the WAM calculation, the WAL calculation performed for variable rate shares and structured financial instruments does not allow the use of interest rate revision dates and uses, instead, the final maturity date indicated for the share. WAL is used to measure credit risk, given that the longer the repayment of the principal is delayed, the higher the credit risk. It is also used to limit liquidity risk;

g) "money market instruments" are defined as: instruments normally traded on the money market, which are liquid and whose value can be determined at any time in an exact manner;

h) "management company" is defined as: a company whose usual activity consists of managing the portfolio of a money market fund.

This new definition will enter into force on January 31, 2011, for S1.3 reports from January 2012 to be transmitted before February 14, 2012.

Please accept, Sirs, the assurance of our perfect consideration.

CENTRAL BANK OF LUXEMBOURG

Philippe Arondel
Roland Nockels

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