By Todd Zerega and Tom Watterson

On December 20, 2013, the European Securities and Markets Authority (“ESMA”) proposed a revision (the “Proposed Revision”) to the collateral diversification requirements in the Guidelines on ETFs and other UCITS issues (the “Guidelines”).

The Guidelines included a requirement that UCITS diversify the collateral held under “financial derivative transactions,” including repos, by issuer, market and country. Under Section 43 e) of the Guidelines, the maximum exposure to an issuer of collateral a UCIT received from its repo counterparties (on an aggregate basis across counterparties) could not exceed 20% of the UCITS’ NAV. However, the Guidelines did not include an exclusion from the collateral diversification requirement for governmental or sovereign issuers. In our November 4, 2013 post, “ESMA Collateral Diversification Rules with Respect to Repo May Hamper Operation of Government MMFs in Europe“, we noted that Section 43 e) could impair the ability of some MMFs to operate and actually cause some MMFs to increase their direct credit exposure to issuers.

The Proposed Revision permits Money Market Funds and Short-Term Money Market Funds (as defined in the Guidelines on a common definition of European money market funds (Ref. 10-049) available here) to receive collateral up to 100% of their net asset value in different transferable securities issued by a “Member State, one or more of its local authorities, a third country, or a public international body to which one or more Member States belong.” However, such UCITS need to receive securities from at least 6 different issues and any single issue cannot account for more than 30% of the collateral received.

The Proposed Revisions have a comment period ending on January 31, 2013 and included the following three questions for comments:

  1. Do you believe that ESMA should revise the rules for the diversification of collateral received by UCITS that take the form of money market funds in the context of efficient portfolio management techniques and OTC transactions? If yes, do you agree with ESMA’s proposal?
  2. Do you think that ESMA should introduce additional safeguards for government bonds received as collateral (such as a specific issuer limit) in order to ensure a certain level of diversification? Please give reasons for your answer.
  3. Do you agree with the proposed requirement to diversify the government securities across at least six different issues?

In addition, the Proposed Revision considered, but rejected, applying the same exemption for all UCITS, not just Money Market Funds and Short-Term Money Market Funds, providing an additional topic for any comment letter.

Good day. Good commenting. TSR