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Written evidence submitted by Federated Hermes

Federated Hermes, Inc. (Federated Hermes) is a global leader in active, responsible investing and is submitting this letter today in response to the Treasury Select Committee’s Call for Evidence on the Future of Financial Services.  Federated Hermes is a leading global investment manager with over £450 billion in assets under management as of Sept. 30, 2020.  Federated Hermes is committed to the continued growth and development of financial services in the United Kingdom post-Brexit, where we have nearly 500 employees in our London offices.

Now that the United Kingdom is independent from the European Union there are a few straight forward changes in the area of financial services which, post-Brexit, would contribute to (i) increased and lower cost funding for UK domiciled institutions, (ii) an increase in UK domiciled funds, (iii) the retention and creation of high level financial service jobs in the United Kingdom, and (iv) increase resilience of MMFs domiciled in the UK.

Currently, the global market for high-quality short-term investment vehicles denominated in Sterling is approximately £270 billion (invested in Sterling denominated money market funds “MMFs”).  Of that £270 billion, approximately £170 billion is UK investor money.  UK investors have also invested an additional £130 billion in non-Sterling MMFs domiciled outside of the UK.   In total, out of the approximately £300 billion of UK investor money invested in MMFs, only £10 billion is invested in MMFs domiciled in the United Kingdom. 

Application of the European Money Market Fund Regulation (EU MMFR) now prohibits all MMFs domiciled in the EU from investing in UK Banks and utilising UK Banks as counterparties in the same way that they are able to invest and transact with European Banks.  This is because the EU MMFR specifically states that MMFs domiciled in the EU may only place deposits with EEA credit institutions or non-EEA credit institutions subject to equivalent prudential rules.  In addition, if an EU domiciled MMF engages in certain transactions, additional requirements are required which places UK institutions at a severe disadvantage. In particular, for reverse repurchase agreements haircuts would be required on the assets received where the counterparty is a UK bank unless the prudential supervisory and regulatory requirements are equivalent.  This disparate treatment towards UK Banks is especially egregious when one considers that UK investor assets are unfairly benefiting EU institutions to the detriment of UK institutions.

To correct this inequity and to ensure that a robust domestic UK investment fund market exists, the Treasury Select Committee should consider recommending a small number of changes to the existing UK MMF regulations which would incentivise firms to establish, strengthen and grow UK domiciled money market funds, which could lead to the potential onshoring of a significant portion of the £300 billion in UK investor money currently invested outside of the UK, with the knock-on effect of not only retaining but increasing financial services jobs in the UK and the ability for UK domiciled MMFs to provide increased low cost financing to UK institutions.  These changes include:

1. UK domiciled MMFs should be able to consider all High-Quality Government Securities liquid.  The EU MMFR rightly mandates that MMFs hold certain levels of required daily and weekly liquidity.  However, the EU MMFR then provides that the most liquid investment in the market, a High-Quality Government Security, such as UK Government Debt, should not always count as liquid.  Experience in both the Financial Crisis and the Global Pandemic has proven that in times of severe market stress, High Quality Government Securities are the most liquid assets a fund can hold.  For UK domiciled and UK distributed MMFs, all holdings in High-Quality Government Securities should be considered liquid.

2. UK domiciled MMFs should be permitted to utilize Repo Agreements on both an overnight and 5-day basis.  Under the EU MMFR, liquidity requirements for MMFs are set on a daily and weekly basis.  Global repo markets operate on an overnight and 5-day (1 week) basis.  Arbitrarily, the EU MMFR does not permit MMFs to participate in 5-day repos. This prohibition has placed UK MMFs at a disadvantage to funds organized outside of the EU as they are able to invest in 5-day Repo to satisfy weekly liquidity requirements.

3. UK domiciled MMFs should be able to utilize amortised cost for securities up to 180 days.  For over twenty-five years MMFs in Europe utilized amortised cost accounting for securities with maturities up to 365 days.  Under the “compromise” agreed in Brussels, amortised cost accounting was permitted to be used only for securities with maturities up to 75 days.  A reasonable compromise would have been permitting amortised cost accounting for use on securities with maturities of up to 180 days (or one half the length of the pre-EU MMFR requirements), however post-Brexit there was simply no leverage to negotiate a fair result.  This was done not for the good of the investors or markets, as this change simply means these funds will not be able to purchase longer issued high quality securities, a result which is only negative for investors in the UK and financing the real economy. 

The changes referenced above will not only enhance the safety and stability of UK domiciled money market funds, by increasing access to high quality liquid assets, but also ensure that UK domiciled money market funds are able to invest in UK banks on equal footing to EU institutions and will be able to do both while providing UK investors with a UK domiciled investment options that focuses on high-quality liquid assets.  Additionally, it is important to note that the recommendations made herein were supported by HMT during the debate in Brussels, and only after the UK lost its negotiating leverage post-Brexit vote was the EU MMFR finalised. 

These changes can be incorporated into a more comprehensive financial services bill or included in a stand-alone new regulation which amends the existing UK MMF rules.   Additionally, any domestic UK MMF operating under these enhanced regulations would not be permitted to be sold within the EU and therefore there should be no issue with respect to EU equivalence.

The Treasury Select Committee has asked what are the strengths and weaknesses of the model used in the European Union to scrutinise legislation.  The adoption and implementation of the EU MMFR is a perfect example of one of the weaknesses of the EU model, as many of the key elements of the EU MMFR were driven by a single large Member State motivated not by investor protection, but rather self-promotion of its own domestic market. 

MMFs are very important short-term liquidity products used by UK local authorities, universities, corporates and insurance companies.  These UK investors utilise MMFs to diversify their short-term investments amongst high quality liquid assets in a manner that provides greater protection than investing in a single bank for cash management purposes (note: Icelandic Bank issues). 

The EU MMFR was fiercely debated in Brussels, and unfortunately, after the Brexit vote, reasonable compromises were sacrificed as a result of political gamesmanship and the final text of the EU MMFR includes several compromises which do not reflect how global markets operate and which have had a negative impact on how MMF portfolios are managed. 

Federated Hermes believes that by taking decisive action to enhance the safety and stability of UK domiciled MMFs, in a manner that ensures the equal treatment of financial institutions across the UK and the EU, and in doing so serves to ensure the retention and growth of the UK’s domestic fund industry, will only strengthen the British government’s position in future financial services discussions with the European Union.

Federated Hermes appreciates the opportunity to respond to the Committee’s Call for Evidence on the Future of Financial Services in the UK post-Brexit and we very much appreciate the Committee’s consideration of our comments.  We would be very happy to respond to any questions or comments you may have on our submission and would also be happy to provide further evidence or participate in any Committee Meetings on the benefits of our proposal to enhance UK financial services.

January 2021