These funds form part of the 'shadow banking' sector that the G20 and the Financial Stability Board have been keen to regulate, the Council of Ministers said.
The term 'shadow banking' generally refers to the provision of credit either fully or partially outside of the regular banking system. Shadow banking activities are typically subject to less stringent regulatory oversight than traditional banking activities, or none at all. However, these activities and the entities that carry them out can also run into financial difficulties.
MMFs are open-ended mutual funds that invest in short-term debt securities such as commercial paper and government debt, and are attractive due to their relative safety and high yields. In Europe, MMFs hold around 22% of short-term debt securities issued by companies and governments, and 38% of short-term debt issued by the banking sector.
"With assets under management of around €1 trillion, MMFs are mainly used to invest excess cash within short timeframes. They represent an important tool for investors because they offer the possibility to diversify their excess cash holdings, while maintaining a high level of liquidity," the Council said.
However, the financial crisis of 2008 showed that MMFs can be vulnerable to shocks and can spread risks throughout the financial system, it said.
"Investors are likely to redeem investments as soon as they perceive a risk, which can force funds to sell assets rapidly in order to meet redemption requests. This can fuel an investor 'run' and liquidity crisis for an MMF, potentially triggering further negative effects on other parts of the financial system," the Council said.
The draft regulation lays down rules on the composition of MMF portfolios and the valuation of their assets, to ensure the stability of their structure and to guarantee that they invest in well-diversified assets of high credit quality. It also introduces standards to increase the liquidity of MMFs to ensure they can meet sudden redemption requests, the Council said.
Banking expert Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com said: "These measures, along with the structural reforms introduced by the Securities and Exchange Commission, are having a significant impact not only on MMFs but also on the liquidity and cash management propositions of corporate banks. Banks and MMFs are having to rethink what they take to market and in turn, this is making corporate treasurers and financial directors re-think what they do with their group cash on a daily basis."