High-quality fixed income funds are set to become more attractive investments for banks and securiti...
High-quality fixed income funds are set to become more attractive investments for banks and securities firms under new EU regulations, according to Standard & Poor's Ratings Services.
The EU has treated fixed income and equity funds as the same in rules about their potential risks and how much capital financial institutions need to hold against those risks, even though funds investing in cash and bonds are generally safer.
But, for the first time, the EU is now treating money market and fixed income funds more favourably, as laid out in the new Capital Requirements Directive (CRD) - Europe's answer to Basel II.
Financial institutions have been free to adopt the rules since the beginning of the year. Significantly, they can now calculate regulatory capital based on their analysis of a fund's underlying investments or on agency ratings.
Françoise Nichols, a credit analyst at S&P, said: "As the analytical approach can be complex, banks may be keen to lean toward investment funds that are rated."
Most rated funds, which generally are money market and enhanced cash funds of the highest quality, will be put on equal footing with bank deposits with just a 20% risk weighting under the CRD's standardised approach.
"With such a low-risk weigh-ting, these high-quality fixed income funds could attract sizable investment inflows," said Nichols.
In contrast, equity funds under the CRD may attract much higher risk weights (up to 370%) than under the current framework (100%). Highly-rated funds may also be attractive to financial institutions using the look-through method under the internal ratings-based approach, because these would likely merit a relatively low-risk weighting.
European money market and enhanced cash funds are the most common types of funds rated by S&P, representing €214bn under management.key points
Capital Requirements Directive is the EU answer to Basel II
It allows banks to balance their regulatory risk exposure using agency ratings
New rules could encourage inflows into fixed-income funds
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