2a7 Regulatory Reporting for Money Market Funds – Challenges Faced by The Research Desk
A money market fund is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper (CP). Money market funds seek to limit exposure to losses from credit, market, and liquidity risks. They are intended to maintain a highly stable asset value through liquid investments while paying income to investors in the form of dividends.
Introduction of Rule 2a7 for money market regulatory reporting
Money market funds were considered safe investments since their inception in the 1970s till the systemic collapse of 2008. Historically, they maintained a net asset value (NAV) of $1 per share and offered a higher rate of interest than checking accounts, making it a safe investment with reliable returns. Money market funds were advantageous venues to keep capital because of their stable share price and competitive interest rates. However, this definition of Money market funds being ‘safe’ was considered void in 2008 when the ‘Reserve Fund’ broke the buck as their NAVs fell below $1 per share. So, the investors, who initially considered their money market investments as ‘Cash Equivalent’ were now in a fix. As a result, Rule 2a-7 was introduced as the principal rule governing money market funds in the US under the purview of the SEC (The Money Market Fund industry is nearly $6 Tn in the US). The quality, maturity, and diversity of investments made by money market funds in the US are constrained under Rule 2a-7 of the Investment Company Act of 1940.
In Europe, Money market funds are governed by the EU Money Market Fund Regulation (EUMMF). However, MMFs in Europe have always had much lower levels of investment capital than in the United States or Japan. Regulations in the EU have always encouraged investors to use banks rather than money market funds for short-term deposits. Based on Money Market Funds Regulation (MMFR) data, EU MMFs had EUR1.44 Tn in assets at the end of 2021.
Rule 2a-7 has had several amendments since its inception. As per the current requirement, money market funds are required to do a thorough credit risk analysis, detailing the investment case.
Synopsis of current 2a-7 money market requirements under appropriate domains:
As noted above in the research section, money market funds are required to do a thorough credit risk analysis, detailing the investment case along with sector and peer analysis. Thus, a lot of time between the fund manager and the analysts is taken up in maintaining and updating these records.
Challenges faced by Money Market Funds due to increased regulatory requirements
- Increased regulatory requirements consume a significant amount of analyst’s time in record-keeping and maintaining activities
- Annual review requirement for money market names leading to broad volume coverage
- Criticality of time to market as MMFs are short-term investments
- Temporary delay of coverage in case of analyst transitions or internal resource constraints
- Fund is required to maintain analytical quality, sometimes operating within strict timelines
- Ability to deal with changes in requirements and manage ad hoc requests
- Difficulty in managing workload fluctuations due to increasing coverage during periods of high interest rates when MMFs become lucrative investments
Outsourcing the research component of 2a7 money market regulatory requirements can optimize the research desk process, with benefits including:
- Process efficiency: Outsourcing record-keeping and maintenance work can help the research desk of Money market funds to focus more on value-added work.
- Access to expertise: Outsourcing firms have people with strong domain expertise across sectors.
- Scalability: Outsourcing firms can scale their research services up or down to meet the changing needs of their clients, without the need for clients to manage attritions and hiring.
- Flexibility: Outsourcing firms can provide backup support for any kind of analyst transitions and help manage volatility in workload throughout the year.
We, at Evalueserve, aim to assist the asset management unit of a multinational bank in meeting compliance requirements of their money market funds and enhance credit research capabilities across multiple geographies and product sectors. We have domain expertise in credit research across multiple sectors and issuer types - corporates, financial institutions, and sovereigns. We support 2a7 credit analysis reports with in-depth analysis of credits, including investment recommendations, in line with the client's requirements. We add value by functioning as an extended arm of asset management’s money market teams, offering flexibility simultaneously.
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