## 1chlea2022002 - Preface

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---

### Mission context and scope
- At the request of the Comisión Para El Mercado Financiero (CMF), an IMF Monetary and Capital Markets (MCM) Department work-at-home mission assisted the CMF from September 2020 to June 2021 in respect of a review of the regulatory framework for money market mutual funds in Chile.
- Mission team: Mr. Martin Moloney, supported by Mr. David Porter (technical advisor), and Mr. Richard Stobo (IMF).
- The mission met with senior officials and representatives of the CMF, the Chilean Central Bank (CCB), the Chilean Association of Mutual Funds (CAMF), and other participants in the Chilean MMF sector.
- Assessment basis:
  - Relies on information submitted by the CMF and other interviewed parties; did not include review of supervisory case files.
  - Descriptions provided by regulator, central bank and industry are mutually consistent.
- Purpose:
  - Assess proportionality and appropriateness of Chile’s regulatory regime for MMFs against mission’s assessment of particular risks and global practices (IOSCO, FSB).
  - Not a formal assessment against these international standards.

### Key descriptive findings and overall judgements
- Chilean MMF sector features contributing to relative stability:
  - Substantial exposure to central bank securities.
  - Predominantly retail investor base with many small companies.
  - Active secondary markets for short-term deposits.
  - Daily oversight of valuation and strong supervisory practices.
- Main judgements:
  - Regulatory regime is robust in many features: comprehensive framework (though much not MMF-specific) and strong supervisory practices with regular day-to-day oversight.
  - Supervisory practices likely to identify and promptly tackle significant deviations by individual MMFs, supporting investor protection.
  - Scope for improvements to strengthen financial stability resilience and reduce risk of shock amplification via MMFs.
  - Recommended changes (including mark-to-market pricing and other measures) should be introduced progressively to avoid investor concerns.
  - No urgent implementation required in current conjuncture; changes important for unexpected, extreme stress.

### MMF sector key statistics (as of mission data)
- Number of MMFs: 56.
- Combined assets under management as of March 3, 2021: USD 30.8 billion.
- Representing circa 43 percent of the mutual fund (MF) market in Chile.
- Reporting currencies: CLP and more recently USD.
- Proportion of foreign assets: 17 percent.
- Asset denomination breakdown: 81 percent CLP, 17 percent USD, 1.5 percent UF.
- Predominant asset types: 98 percent Chilean short-term bank deposits or CCB Notes.
- Of 56 MMFs, only two hold foreign currency bonds; 14 hold USD-denominated short-term deposits.
- Asset manager concentration: 15 asset managers for 56 MMFs; six managers service over 80 percent of all MMFs and only those six manage more than five percent of total MMF assets in Chile.
- Importance to banking sector: MFs (in particular MMFs) represent some 10 percent of the liabilities of Chilean banks (as understood from the CCB).

### Mission timeline
- CMF requested TA in September 2020.
- Organizational and preparatory work between October 2020 and February 2021.
- Initial questionnaire completed by CMF with supporting material (March 2021).
- Virtual meetings between March and May 2021.
- Drafting, due diligence and IMF approval for publication between June and November, 2021.

### Final mission note
- The mission thanks senior officials and representatives for their cooperation and productive discussions.

*Source: 1chlea2022002 - Preface.*

### Executive summary — Key recommendations (summary with priorities and timeframes)
- Near term defined as < 12 months; Medium term defined as 12 to 24 months.
- Recommendation 1: Swing Pricing
  - MMFs (i.e., Type 1 funds) should have a tested operational capacity to move promptly to swing pricing in times of financial stress (CMF).
  - Priority: 3
  - Timeframe: Medium term
- Recommendation 2: Supervision of Swing Pricing
  - The CMF should have the capacity to require the whole sector to move in an orderly and coordinated way to the adoption of swing pricing and should factor into its inspections program the achievement of reassurance that each MMF has operable plans to move immediately to swing pricing overnight, if so required (CMF).
  - Priority: 3
  - Timeframe: Medium term
- Recommendation 3: Mark-to-market Pricing
  - Over a period of time consistent with the stable operation of the sector, the sector should move to mark-to-market pricing as a default; the plan should be worked out in cooperation with industry and the CCB and should probably involve an extended period of dual values where both market values and cost price are consistently displayed together for all investors (CMF, CCB).
  - Priority: 2
  - Timeframe: Medium term
- Recommendation 4: Duration limit cost-benefit analysis
  - Conduct a cost-benefit analysis on introducing a specific regulatory requirement that Type 1 funds be confined to fixed income instruments with a duration of no more than 90 days. The study should also assess costs and benefits of alternative ways to manage the risk that holding longer duration assets constitutes for MMFs (CMF, CCB).
  - Priority: 1
  - Timeframe: Near term
- Recommendation 5: Operational mandate for Type 2 funds oversight
  - There should be an explicit operational mandate within the CMF for the relevant supervisors to assess the extent to which Type 2 funds are also operating in ways which might justify the extension of similar requirements to them (CMF).
  - Priority: 3
  - Timeframe: Near term
- Recommendation 6: Stress test guidance and reporting
  - The CMF should publish guidelines which set out common reference parameters for stress test scenarios to be applied by MMFs and which provide a reporting template to be used by MMFs. MMFs should report results of the stress tests to the CMF semi-annually (CMF).
  - Priority: 2
  - Timeframe: Near term
- Recommendation 7: Operational and legal scenario exercises on redemption limits
  - Managers should be asked by the CMF to conduct scenario exercises to test their operational capacity and legal powers to suspend and/or gate redemptions (CMF).
  - Priority: 2
  - Timeframe: Near term
- Recommendation 8: Valuation robustness checks in inspections
  - The CMF should include in its inspection work, regular reviews of whether managers of MMFs periodically check the robustness and timeliness of the valuations provided by valuers (CMF).
  - Priority: 1
  - Timeframe: Near term

### Chile’s regulatory framework and supervisory practices
- Fund categorization:
  - Mutual funds categorized in one of eight types; Type 1 in practice applicable to MMFs.
  - The eight types include:
    1. Short-term debt = < 90 days
    2. Short-term debt = < 365 days
    3. Medium and long-term debt
    4. Mixed mutual fund (range of short, medium, and long)
    5. Mutual fund for investment in capitalization instruments
    6. Free investment mutual fund (not 1 to 5 above)
    7. Structured mutual fund (seeks pre-determined yield)
    8. Mutual fund aimed at qualified investors (any of 1 to 7 above)
- Maturity constraints and practice:
  - Short-term debt of a MMF is not to be greater than 90 days but this applies to only 50 percent of the assets of the MMF.
  - Data shows assets are predominantly under 90 days in maturity, but over 25 percent of MMF assets have maturities of longer than 90 days; in practice Type 1 funds hold substantial portions with initial maturity > 90 days.
- Valuation and reporting regime:
  - Circular 592 exempts Type 1 MFs from applying IFRS valuation criteria, permitting use of acquisition/purchase internal rate of return (IRR) but only within deviation tolerance thresholds of 0.1 percent, 0.6 percent, and 0.8 percent depending on asset type.
  - Daily reporting of valuations to the regulator; CAMF involved in reporting process.
- Supervision and inspection:
  - Inspections and supervision by the Patrimonial Funds Control Division (DCFP) of the CMF based on a risk management control system and internal control assessments.
  - CMF has broad powers under Article 5 of Law 3538 including determining standards, interpreting laws, reviewing complaints, examining files, and inspecting supervised entities.
- Institutional arrangements:
  - CMF operates a separate Regulatory Impact Analysis (RIA) division providing cross-industry risk analysis and financial stability views.
  - CCB monitors general trends and directly sells short-term securities to the sector.
  - CMF and CCB sit together on the Financial Stability Council (FSC), meeting monthly, which includes the Ministry of Finance and the Chair of the Pensions Supervisor.

### Market structure, liquidity, and valuation practice
- Market liquidity and valuation:
  - MMF assets generally trade on one secondary market or off-market.
  - Short-term deposits are actively traded; stock exchange provides effective market structure.
  - Valuation process relies on a small number of independent valuers using models extrapolating from secondary market prices.
  - Where models are used, valuation quality depends on depth of secondary market trading.
- Circular No. 1,990 liquidity policies:
  - Managers must establish liquidity policies; minimum content includes management of liquidity mismatches, monitoring maturities, and review of proportion of assets held as available or easily liquidated funds.
  - CMF requires daily information including NAV information (Circular 1,850).
- Valuation triggers that move to mark-to-market:
  - At portfolio level, total deviation cannot be greater than 0.1 percent of the portfolio value.
  - At instrument level, no nominal instrument may have a deviation greater than 0.6 and 0.8 percent of the present value in the case of an instrument denominated in currencies other than the CLP.
- Operational arrangements:
  - Management companies maintain daily valuation service contracts with external providers; high degree of transparency of valuation changes and reasons to the CMF.
  - Audit and external opinion: Article 21 of the 20712 LUF law requires external audit firms to opine on internal control mechanisms and compliance with MMF policies.

### Stress testing, disclosure, and investor profile
- Stress testing practice and supervision:
  - Circular 1,990 requires periodic stress testing; some managers perform stress tests every six months, generally monthly, increasing frequency in adverse conditions.
  - Supervision gaps: coordination and centralized quality assurance of stress testing is relatively weak; centralized analysis of common scenarios is not achieved to an appropriate degree.
  - Recommendation: CMF should publish guidelines with common reference parameters and a reporting template; MMFs should report results semi-annually.
  - Parameters should at least cover: redemption levels; asset liquidity; interest rates; exchange rates.
- Investor base and disclosure:
  - NCG 365 requires disclosure in internal regulations and informative brochure on fund characteristics and investor profile.
  - Portfolio data: almost all investors in MMFs are retail investors; no MMFs have more than two percent of investors as institutional investors; only two MMFs have over one percent institutional investors.
  - Supervisory implication: if investor profile shifts significantly, supervisory approach may need rethinking.

### Redemption management tools, swing pricing, and operational preparedness
- Current legal tools:
  - NCG 365 permits internal regulations to provide limits on daily redemptions (maximum daily amount or percentage of NAV).
  - Managers can apply to CMF to approve suspension of redemptions; Article 40 of Law 3538 allows CMF to suspend redemption operations, cash distributions, and consideration of new contribution requests for up to 60 days at the manager’s request in exceptional circumstances.
- Swing pricing:
  - Purpose: allocate cost of redemption to redeeming investor.
  - Risks: in many stress situations costs of redemption are small and may not deter exiting investors; fear of implementation can accelerate redemptions.
  - Recommendation: CMF should have practical capacity to require sector-wide coordinated adoption of swing pricing and include in inspections program assurance that each MMF can move immediately to swing pricing overnight if required.
  - Preparatory work: determine appropriate swing factor in consultation with industry; plan for coordinated triggering without defining trigger thresholds now.
  - Emphasis: preparatory capacity building, not a present recommendation to introduce swing pricing.

### Operational capacity and war gaming
- Observed limitation:
  - MMF markets historically stable are likely to have limited operational capacity to introduce redemption management tools at short notice.
  - Managers may lack experience and be reluctant to trigger tools due to logistical, legal, delegated authority uncertainties or brand damage concerns.
- Recommendation:
  - Managers be asked by the CMF to conduct scenario exercises to test operational capacity and legal powers to suspend and/or gate redemptions.
  - Rationale: well-designed “war gaming” can provide resilience and enable orderly, prompt stress management interventions.

### Conflicts of interest and governance
- Regulatory requirements:
  - Circular 1869 requires fund managers to define policies and procedures to identify, manage and monitor all potential conflicts of interest inherent to the management of third-party funds and to identify persons assigned to monitor and control these conflicts.
  - NCG 270 establishes rules for publicity of policies and procedures related to acquisition/disposal of securities and handling/disclosure of market information.
  - NCG 365 requires internal regulations to specify dispute resolution mechanisms for conflicts.
- Market observation:
  - Significant degree of concentration in valuer services, with two valuers dominating the market.
- Assessment:
  - Regulatory framework for conflicts appears appropriate; effectiveness depends on market culture as well as formal rules.
  - Mission found no evidence to doubt conflicts are well managed; recommendation is vigilance by the regulator rather than new rules.

### Tail-risk scenarios and transmission to banking sector
- Primary tail risk: loss of confidence in local currency assets
  - Key risk: real-economy developments reducing cash and near-cash holdings in the Chilean economy, i.e., a run out of the local currency impacting MMFs.
  - Currently deemed small but highest-priority tail-risk scenario for regulatory planning.
- Secondary tail risk: generalized concern about the Chilean banking sector
  - Investors could exit entire MMF sector if they view bank exposure as unattractive; similar impact to currency-run scenario.
- Transmission channels:
  - Redemption stress in the MMF sector would almost certainly drive immediate knock-on effects in the banking sector.
  - MMFs provide short-term financing to banks often through commercial paper markets and by taking short-term deposits.
  - Impacts on short-term bank funding will ripple through to lending markets quickly and can rapidly affect economic activity.
- Additional note:
  - Investors could remain in Chilean MMFs but shift to a greater weighting of USD$-denominated assets; modelling required to assess impacts on Chilean banking sector (Chilean banks issue USD$-denominated short term deposits).

### Regulatory risk mitigants — assessment and specific recommendations
- Mitigant 1: Clarity of MMF definition and naming
  - MMFs defined as “Type 1” MFs. Law 20,712 requires all MFs to have “Mutual Fund” in their name but not “Money Market Fund”.
  - Mission decision: do not recommend change to law concerning naming of funds; recommend active attention to behaviors of investors in Type 2 funds to avoid perimeter/clarity issues.
- Mitigant 2: Appropriate restrictions on asset maturities / liquidity
  - Current rule: short-term debt of a Type 1 MF is not to be greater than 90 days but applies to only 50 percent of assets under NCG 376.
  - Mission view: supervision alone is unlikely to assure requisite residual maturity liquidity.
  - Recommendation (repeated): CMF and the Central Bank should conduct a study to assess costs and benefits of introducing a specific regulatory requirement that Type 1 funds are confined to fixed income instruments with a duration of no more than 90 day and the costs and benefits of alternative ways to manage the risk that holding longer duration assets constitutes for MMFs.
- Mitigant on valuation approach
  - Current approach permits valuation at purchase IRR with deviation tolerances (Circular 592).
  - Mission assessment: current approach is working but prudence is not optimal; publishing NAV based on amortized cost can attract investors with no appetite for NAV fluctuation, increasing "flight to quality" risk.
  - Recommendation: move to mark-to-market pricing by eliminating the current exemption, implemented gradually and probably involving an extended period of dual value display where both market values and cost price are consistently displayed together for all investors.
- Mitigant on stress testing and reporting
  - Recommendation: CMF to publish guidelines with common reference parameters and reporting template; MMFs to report results semi-annually. Parameters to include redemption levels, asset liquidity, interest rates, exchange rates; managers should consider adverse scenarios from the CCB to supplement CMF parameters.
- Mitigant on valuation governance and inspections
  - Recommendation: CMF inspections should regularly review whether managers periodically check robustness and timeliness of valuations provided by valuers; review of CMF inspection practices desirable to ensure documented evidence of review and challenge of valuations.
- Mitigant on redemption tools and operational preparedness
  - Recommendation: CMF to require scenario exercises by managers to test operational capacity and legal powers to suspend and/or gate redemptions; CMF should ensure practical capacity for coordinated swing pricing adoption if required.
- Mitigant on conflicts of interest
  - Regulatory framework (Circular 1869, NCG 270, NCG 365) is appropriate; mission recommends continued regulatory vigilance rather than new rules.

### Conclusion — principal message
- Mission acknowledges stability and maturity of the Chilean MMF sector and the fundamental soundness of the current regulatory regime and the quality of the CMF’s regulatory arrangements.
- Most significant recommendation:
  - Observation: Not using mark-to-market pricing for MMFs as a default is not justified by the objective market structure or commercial activities in Chile.
  - Rationale: Inappropriate not to use market pricing when the term deposits in which MMFs predominantly invest are actively traded; lack of inter-market congruity between short-term deposit market and MMF market is a fault-line that should be eliminated.
  - Implementation advice: Market practice becomes entrenched; a cautious transition is recommended with careful market consultation and a period of dual value display.

*Source: IMF staff mission chapter text provided in the source content.*

### Preface ................................................................................................................

### 1chlea2022002 - Preface

### Preface
- At the request of the Comisión Para El Mercado Financiero (CMF), an IMF Monetary and Capital Markets (MCM) Department work-at-home mission assisted the CMF from September 2020 to June 2021 in respect of a review of the regulatory framework for money market mutual funds in Chile.
- Mission team: Mr. Martin Moloney, supported by Mr. David Porter (technical advisor), and Mr. Richard Stobo (IMF).
- The mission met with senior officials and representatives of the CMF, the Chilean Central Bank (CCB), the Chilean Association of Mutual Funds (CAMF), and other participants in the Chilean MMF sector.
- The mission thanks senior officials and representatives for their cooperation and productive discussions.

### Executive Summary — scope and overall findings
- Timeline:
  - CMF requested TA in September 2020.
  - Organizational and preparatory work between October 2020 and February 2021.
- Assessment basis:
  - Relies on information submitted by the CMF and other interviewed parties.
  - Did not include review of supervisory case files.
  - Descriptions provided by regulator, central bank and industry are mutually consistent.
- Purpose:
  - Assess proportionality and appropriateness of Chile’s regulatory regime for MMFs against mission’s assessment of particular risks and global practices (IOSCO, FSB).
  - Not a formal assessment against these international standards.
- Key descriptive findings:
  - Chilean MMF sector has specific characteristics contributing to relative stability in investment levels and impact on banking sector.
  - Some risks identified; report evaluates whether regulatory mitigants are proportionate.
- Main judgements:
  - Chilean regulatory regime is robust in many features: comprehensive framework (though much not MMF-specific) and strong supervisory practices with regular day-to-day oversight.
  - Supervisory practices likely to identify and promptly tackle significant deviations by individual MMFs — supporting investor protection.
  - There is scope for improvements to strengthen financial stability resilience and reduce risk of shock amplification via MMFs.
  - Recommended changes include mark-to-market pricing and other measures; these should be introduced progressively to avoid investor concerns.
  - Underlying resilience is reinforced by substantial exposure to central bank securities.
  - No urgent implementation required in current conjuncture; changes important for unexpected, extreme stress.

### Key Recommendations (summary with priorities and timeframes)
- Near term defined as < 12 months; Medium term defined as 12 to 24 months.

- Recommendation 1: Swing Pricing
  - MMFs (i.e., Type 1 funds) should have a tested operational capacity to move promptly to swing pricing in times of financial stress (CMF).
  - Priority: 3
  - Timeframe: Medium term

- Recommendation 2: Supervision of Swing Pricing
  - The CMF should have the capacity to require the whole sector to move in an orderly and coordinated way to the adoption of swing pricing and should factor into its inspections program the achievement of reassurance that each MMF has operable plans to move immediately to swing pricing overnight, if so required (CMF).
  - Priority: 3
  - Timeframe: Medium term

- Recommendation 3: Mark-to-market Pricing
  - Over a period of time consistent with the stable operation of the sector, the sector should move to mark-to-market pricing as a default; the plan should be worked out in cooperation with industry and the CCB and should probably involve an extended period of dual values where both market values and cost price are consistently displayed together for all investors (CMF, CCB).
  - Priority: 2
  - Timeframe: Medium term

- Recommendation 4: Duration limit cost-benefit analysis
  - Conduct a cost-benefit analysis on introducing a specific regulatory requirement that Type 1 funds be confined to fixed income instruments with a duration of no more than 90 days. The study should also assess costs and benefits of alternative ways to manage the risk that holding longer duration assets constitutes for MMFs (CMF, CCB).
  - Priority: 1
  - Timeframe: Near term

- Recommendation 5: Operational mandate for Type 2 funds oversight
  - There should be an explicit operational mandate within the CMF for the relevant supervisors to assess the extent to which Type 2 funds are also operating in ways which might justify the extension of similar requirements to them (CMF).
  - Priority: 3
  - Timeframe: Near term

- Recommendation 6: Stress test guidance and reporting
  - The CMF should publish guidelines which set out common reference parameters for stress test scenarios to be applied by MMFs and which provide a reporting template to be used by MMFs. MMFs should report results of the stress tests to the CMF semi-annually (CMF).
  - Priority: 2
  - Timeframe: Near term

- Recommendation 7: Operational and legal scenario exercises on redemption limits
  - Managers should be asked by the CMF to conduct scenario exercises to test their operational capacity and legal powers to suspend and/or gate redemptions (CMF).
  - Priority: 2
  - Timeframe: Near term

- Recommendation 8: Valuation robustness checks in inspections
  - The CMF should include in its inspection work, regular reviews of whether managers of MMFs periodically check the robustness and timeliness of the valuations provided by valuers (CMF).
  - Priority: 1
  - Timeframe: Near term

### Introduction — mission outline and Chile’s MMF sector key statistics
- Mission phases:
  - (i) initial questionnaire prepared by mission and completed by CMF with supporting material (March 2021);
  - (ii) virtual meetings between March and May 2021 with CMF, CCB, CAMF, and an independent valuer;
  - (iii) information assessment phase;
  - (iv) drafting of report;
  - (v) due diligence and IMF approval for publication between June and November, 2021.
- MMF scale and composition:
  - Number of MMFs: 56.
  - Combined assets under management as of March 3, 2021: USD 30.8 billion.
  - Representing circa 43 percent of the mutual fund (MF) market in Chile.
  - Reporting currencies: CLP and more recently USD.
  - Proportion of foreign assets: 17 percent.
  - Asset denomination breakdown: 81 percent CLP, 17 percent USD, 1.5 percent UF.
  - Predominant asset types: 98 percent Chilean short-term bank deposits or CCB Notes.
  - Of 56 MMFs, only two hold foreign currency bonds; 14 hold USD-denominated short-term deposits.
  - MMFs are a key investment product for retail investors; held predominantly by retail investors including many small companies.
  - Switching between MMFs has few costs or frictions; tax liabilities realized only when cashing out.
- Importance to banking sector:
  - MFs (in particular MMFs) represent some 10 percent of the liabilities of Chilean banks (as understood from the CCB).
  - A dysfunction in the MMF sector would have an immediate marginal impact on bank short-term funding, varying by bank.
- Asset manager concentration:
  - 15 asset managers for 56 MMFs.
  - Six managers service over 80 percent of all MMFs and only those six manage more than five percent of total MMF assets in Chile.
- Market liquidity and valuation:
  - MMF assets generally trade on one secondary market or off-market.
  - Short-term deposits are actively traded; stock exchange provides effective market structure.
  - Valuation process relies on a small number of independent valuers using models extrapolating from secondary market prices.
  - Where models are used, valuation quality depends on depth of secondary market trading.

### Chile’s approach to regulation and supervision of MMFs
- Fund categorization:
  - Mutual funds in Chile are categorized in one of eight types; Type 1 in practice applicable to MMFs.
  - The eight types include:
    1. Short-term debt = < 90 days
    2. Short-term debt = < 365 days
    3. Medium and long-term debt
    4. Mixed mutual fund (range of short, medium, and long)
    5. Mutual fund for investment in capitalization instruments
    6. Free investment mutual fund (not 1 to 5 above)
    7. Structured mutual fund (seeks pre-determined yield)
    8. Mutual fund aimed at qualified investors (any of 1 to 7 above)
- Maturity constraints and practice:
  - Short-term debt of a MMF is not to be greater than 90 days but this applies to only 50 percent of the assets of the MMF.
  - Data shows assets are predominantly under 90 days in maturity.
- Valuation and reporting regime:
  - Circular 592 exempts Type 1 MFs from applying IFRS valuation criteria, permitting use of acquisition/purchase internal rate of return (IRR) but only within deviation tolerance thresholds of 0.1 percent, 0.6 percent, and 0.8 percent depending on asset type.
  - Regulatory framework supplemented by daily reporting of valuations to the regulator.
  - CAMF is involved in the reporting process.
- Supervision and inspection:
  - Inspections and supervision are undertaken by the Patrimonial Funds Control Division (DCFP) of the CMF based on a risk management control system and internal control assessments.
  - Daily reporting regime plus inspections are critical to supervisory robustness.
  - CMF has broad powers under Article 5 of Law 3538 including: determining standards, administratively interpreting laws and regulations, reviewing complaints, examining files and documents without restriction, and inspecting supervised entities.
- Institutional arrangements and monitoring:
  - CMF operates a separate Regulatory Impact Analysis (RIA) division undertaking cross-industry risk analysis and providing financial stability and systemic views to commissioners and supporting discussions with the CCB.
  - CCB monitors general trends in the sector and directly sells short-term securities to the sector, providing market information and challenge.
  - CMF and CCB sit together on the Financial Stability Council (FSC), meeting monthly, which includes the Ministry of Finance and the Chair of the Pensions Supervisor.

### Start of Summary Regulatory Risk Analysis
- The report proceeds to summarize regulatory risks (Section II) and mitigants (Section II.B) following the contextual findings above.

*Source: 1chlea2022002 - Preface.*

### 20. While the risk to investors from a badly run MMF  is real at a global level, the

### 20. While the risk to investors from a badly run MMF  is real at a global level, the

### Investor risks and Chilean market features
- Investor risks from a badly run MMF summarized as: bad marketing, bad valuation, or bad administration.
- The mission team discounts investor-level risk in Chile for this report and focuses on financial stability risk association with MMFs.
- Chilean factors reinforcing low investor-level risk:
  - reasonably strong market with clear pricing;
  - multiple MMF suppliers and comparable alternatives that investors can switch between;
  - quite active secondary markets for the deposits in which MMFs traditionally invest;
  - daily oversight of valuation at both industry association and regulatory level;
  - low levels of conflicts of interest on the part of professional asset valuers.
- These features allow focus on the risk that a run on MMFs will amplify market stress in the short-term funding market (primarily a secondary market in short-term deposits in Chile) or in the MMF sector itself.

### Global MMF context and scale
- Estimated global MMF investment: circa $8 trillion (up from just under $5 trillion about a decade ago).
- MMFs vary by:
  - retail vs institutional investor base;
  - lending primarily into banks or into the state;
  - inter-jurisdictional vs intra-jurisdictional intermediation;
  - valuation basis: cost of assets purchased vs current market values;
  - dividend/interest treatment: accumulate vs distribute as received;
  - asset maturity limits: less than 90 days up to 365 days.

### Drivers of MMF behavior in periods of extreme market stress
- Three critical drivers:
  - first mover advantage: investors move quickly to seek advantage over other investors who might redeem soon; imminent possibility of suspended redemptions or unclear valuation increases propensity to redeem.
  - flight to quality: shift from MMFs with banking assets to MMFs with sovereign assets when asset quality deteriorates.
  - flight to cash: sudden increase in working capital needs of MMF investors (e.g., due to leverage or margin calls) leading investors to prefer cash for lowest issuer risk.

### Chile-specific assessment of the three global risks
- Sensitivity to small valuation changes:
  - Investors in Chile appear relatively insensitive to prospective small changes in MMF value.
  - A substantial portion of MMF investment is under direct control of ultimate beneficiaries rather than institutional intermediaries, contributing to sector stability.
  - Lack of easily accessible alternatives for small investors to MMFs makes them less likely to withdraw funds except in periods of extreme market stress.
  - Retail investor behavior is sensitive to tax implications and precise mode of access for investment/withdrawal.
  - Conclusion: less instability in moderate market stress; if retail investors move, it is likely to be on a large scale and happen suddenly.
- Asset profile:
  - Chilean MMFs have a blended asset profile combining exposure to Chilean central bank assets with exposure to short-term bank deposits.
  - This blended profile reduces likelihood Chilean MMFs will perform like “prime” MMFs that move heavily into public-debt MMFs in stress.
- Institutional cash hoarding risk:
  - Post-2008 reforms mean market stress increases cash demands for institutional investors and treasury desks (margin calls, asset price moves).
  - Even low-risk MMFs can face redemption pressure if investor base includes institutional/treasury functions exposed to leveraged or repo-based positions.
- Overall position:
  - Chilean MMF sector appears at the lower end of the risk spectrum: mixed assets (public and bank) and an investor base not strongly exposed to leveraged wholesale positions.

### Tail-risk scenarios identified
- Primary tail risk: loss of confidence in local currency assets
  - Main risk does not fit neatly into first mover/flight to quality/cash categories.
  - Key risk: real-economy developments reducing cash and near-cash holdings in the Chilean economy, i.e., a run out of the local currency impacting MMFs.
  - While currently deemed small, this scenario is the best tail-risk scenario for regulatory planning.
- Secondary tail risk: generalized concern about the Chilean banking sector
  - Investors could exit the whole MMF sector if they view exposure to the banking sector as unattractive.
  - This would likely occur as part of stress in all short-term funding markets and is similar in impact to the currency-run scenario.
- Transmission to banking sector:
  - Redemption stress in the MMF sector would almost certainly drive immediate knock-on effects in the banking sector.
  - MMFs play an influential role in providing short-term financing to banks, often—but not solely—through commercial paper markets and by taking short-term deposits.
  - Impacts on short-term bank funding will ripple through to lending markets quickly and can rapidly affect economic activity.
- Additional note:
  - Investors could remain in Chilean MMFs but shift to a greater weighting of USD$-denominated assets; precise scenarios would require modelling of moving within the Chilean MMF sector into predominantly USD$ assets and the impact on the Chilean banking sector. A key point: Chilean banks issue USD$-denominated short term deposits.

### Regulatory risk mitigants — assessment and recommendations
- Purpose of regulatory framework: address market-sector tendencies that, if unregulated, do not meet reasonable expectations of the public interest.
- The mission prioritized mitigants proportionate to Chilean risks rather than strict conformity with other jurisdictions.
- Mitigant 1: clarity of the definition of MMFs in law
  - In Chile, MMFs are defined and formally named as “Type 1” MFs.
  - Chile Law 20,712 requires all MFs to have the words “Mutual Fund” in their name but does not require “Money Market Fund”.
  - Considered whether Type 1 MFs should be required to adopt the name “Money Market Fund” to make characteristics clear and distinguish from longer-term investment vehicles.
  - Key drawback: constraining naming to Type 1 funds risks perimeter issues; funds outside Type 1 (e.g., Type 2 with assets maturing up to 365 days) could display MMF characteristics.
  - Decision: do not recommend change to law concerning naming of funds; recommend active attention to behaviors of investors in Type 2 funds to ensure naming conventions do not facilitate future lack of clarity (see Mitigant 3 referenced).
- Mitigant 2: appropriate restrictions on MMF assets so that they are suitably liquid
  - Chile’s regulatory framework creates explicit requirement around maturity of assets but delegates liquidity judgment to the asset manager.
  - MMFs in Chile invest predominantly in very short maturities and in assets that can be actively traded on secondary markets, particularly term deposits.
  - Article 59 of Law 20712 establishes limits for investments of mutual funds not directed to qualified investors; supplemented by NCG 376. These are for all MFs, not MMFs specifically.
  - Short-term debt of a Type 1 MF is not to be greater than 90 days, however this applies in accordance with NCG 376 to only 50 percent of the assets of these MMFs.
  - Chart (described) shows over 25 percent of MMF assets have maturities of longer than 90 days.
  - In practice, Type 1 funds hold substantial portions of their portfolio in assets of greater than 90 days initial maturity.
  - Supervisory data: CMF and MMF managers have half-yearly portfolio data broken down into assets maturing in under one week, one week to one month, one month to three months, and over three months.
  - Mission view: supervision alone is unlikely to provide requisite assurance that MMFs are robustly liquid in terms of residual maturity.
  - Trade-off: degree of MMF stability versus blended yield offered to investors.
  - Recommendation: it would be prudent to reduce the risk arising from holdings of assets with maturities greater than 90 days even if that reduces yield. Specifically:
    - "It is recommended that the CMF and the Central Bank should conduct a study to assess the costs and benefits of the introduction of a specific regulatory requirement that Type 1 funds are confined to fixed income instruments with a duration of no more than 90 day and the costs and benefits of alternative ways in which to manage the risk that holding longer duration assets constitutes for MMFs."

*Italic: IMF staff mission chapter text provided in the source content.*

### 37. The second aspect of liquidity  is the health of secondary markets. Circular No. 1,990

### 37. The second aspect of liquidity is the health of secondary markets. Circular No. 1,990

### Liquidity policies required by Circular No. 1,990
- Circular No. 1,990 requires a manager to establish liquidity policies for each MMF; these policies must be reviewed and evaluated periodically by the MMF Manager.
- Minimum content of liquidity policies:
  - 12.01
  - 32.56
  - 29.52
  - 25.92
  - i) Management of liquidity mismatches in the funds and contingency plans in scenarios of illiquidity, considering, at least, statistics on the historical behavior of redemptions.
  - ii) Monitoring of the maturities of the instruments in the portfolio.
  - iii) Review of the proportion of assets held as available or easily liquidated funds.
- Figure 4. Residual Maturity: Under One Week; One Week to One Month; One Month to Three Months; Over Three Months.

### Stress testing: practice, supervision, and recommendations
- Current practice:
  - Circular 1,990 requires MMF managers to undertake stress testing on a periodic basis on the investment portfolio of MMFs.
  - Some fund managers perform stress tests every six months; generally stress tests are performed on a monthly basis and frequency increases during adverse market conditions.
  - CMF monitors stress testing practices and observes managers consider variables such as changes in market conditions, liquidity, portfolio valuation gaps, and levels of actual and potential redemptions; tests performed daily and/or monthly and reported/escalated accordingly.
- Supervision gaps:
  - Coordination and centralized quality assurance of stress testing is relatively weak.
  - Centralized analysis of a common set of scenarios is not achieved to an appropriate degree.
- Recommendations:
  - The CMF should publish guidelines which set out common reference parameters for the stress test scenarios to be applied by MMFs, including a reporting template.
  - MMFs should report results of the stress tests to the CMF semi-annually.
  - Parameters should at least cover:
    - redemption levels;
    - asset liquidity;
    - interest rates; and
    - exchange rates.
  - Footnote: More detailed adverse stress scenarios may be included. In addition, managers should be guided to have regard to any adverse scenarios from the CCB, where these are available, to supplement, but not to replace, the common CMF parameters.

### Monitoring market liquidity and valuation adjustments
- CMF on-going monitoring:
  - CMF monitors market liquidity of MMFs and analyzes portfolio impact, share value, nominal profitability, and participant effects when valuation adjustments occur.
- Valuation regime and triggers (Circular 1,990 and Circular 592 of 2010):
  - Type 1 MMFs are permitted to value instruments at purchase IRR (internal rate of return implicit in acquisition) rather than applying IFRS classification/valuation.
  - Triggers that move valuation to mark-to-market:
    - At portfolio level, the total deviation cannot be greater than 0.1 percent of the portfolio value.
    - At the instrument level, no nominal instrument may have a deviation greater than 0.6 and 0.8 percent of the present value in the case of an instrument denominated in currencies other than the CLP.
- Operational arrangements:
  - Management companies maintain daily valuation service contracts with external providers.
  - MMFs provide daily, weekly, and monthly data to the CMF; Circular 1,850 requires provision of daily information, including NAV information.
  - NAV of instruments in MMF portfolios are valued at purchase IRR even while instrument values fluctuate.
- Assessment and recommendation on valuation approach:
  - Mission concluded current approach is working but prudence is not optimal; publishing NAV based on amortized cost can attract investors with no appetite for NAV fluctuation, increasing "flight to quality" risk.
  - Recommendation: move to mark-to-market pricing by eliminating the current exemption, implemented gradually.
  - Implementation guidance: plan to be worked out with industry and the CCB; probably involve an extended period of dual value display where both market values and cost price are consistently displayed together for all investors.

### Independent review, inspection, and valuation governance
- Audit and external opinion:
  - Article 21 of the 20712 LUF law requires external audit firms to issue an opinion in the annual report on internal control mechanisms imposed by fund managers, including activities and assets of the MMF.
  - MMF’s external audit firm must express its opinion on MMF’s compliance with MMF policies and rules contained in internal regulations.
- Valuation providers:
  - Valuation carried out by managers based on market prices or advisory services from independent price vendors not related to managers.
  - High degree of transparency of valuation changes and reasons to the CMF.
- Supervisory recommendation:
  - CMF inspections should regularly review whether managers periodically check the robustness and timeliness of valuations provided by valuers.
  - A review of CMF inspection practices is desirable to ensure active and consistent checking for documented evidence of review and challenge of valuations.

### Investor base and disclosure
- Disclosure requirements:
  - NCG 365 requires fund managers to inform participants in internal regulations (section I.1) and informative brochure (section IV.2) about fund characteristics: asset types, term of payment of redemptions, and fund duration.
- Investor profile:
  - Circular 1869 requires MMF managers to implement a risk management and internal control program including investor suitability policies and procedures.
  - NCG 365 requires the MMF’s informative brochure to include an investor profile determined by the MMF’s manager; internal regulations must indicate investor types (qualified investors or general public).
  - Portfolio data shows almost all investors in MMFs are retail investors; no MMFs have more than two percent of investors as institutional investors; only two MMFs have over one percent institutional investors.
- Supervisory implication:
  - If investor profile shifts significantly, supervisory approach may need rethinking.
  - If stress testing recommendations are implemented, additional information on likely investor behavior should become available to the CMF and no further recommendations on this point are required.

### Redemption tools, swing pricing, and operational preparedness
- Current tools and legal powers:
  - NCG 365 permits internal regulations to provide for restrictions on redemptions of significant amounts; significant daily redemption amounts must be specified as a maximum daily amount or percentage of NAV based on portfolio characteristics.
  - Managers can apply to CMF to approve suspension of redemptions; Article 40 of Law 3538 allows CMF to suspend redemption operations, cash distributions, and consideration of new contribution requests for up to 60 days at the manager’s request in exceptional circumstances to protect participants.
- Issues identified:
  - Need further work on the application of swing pricing and testing how quickly and smoothly Chilean MMFs can implement redemption management tools.
- Swing pricing assessment and recommendations:
  - Swing pricing allocates cost of redemption to the redeeming investor; globally debated and may be helpful in limited circumstances.
  - Risks: costs of redemption in many stress situations are small and may not deter exiting investors; fear of implementation can accelerate redemptions.
  - Recommendation: CMF should have practical capacity to require sector-wide coordinated adoption of swing pricing and include in inspections program assurance that each MMF has operable plans to move immediately to swing pricing overnight if required.
  - Preparatory work: determine appropriate swing factor (consult industry); plan for coordinated triggering without defining trigger thresholds at present.
  - Emphasis: this is preparatory capacity building, not a recommendation to introduce swing pricing now.

*Source: IMF chapter/section 1chlea2022002 - content unit provided.*

### 60. MMF markets which  are historically stable are likely to have limited operational

### 60. MMF markets which  are historically stable are likely to have limited operational capacity to introduce redemption management tools at short notice

### Operational capacity and war gaming
- 60. MMF markets which are historically stable are likely to have limited operational capacity to introduce redemption management tools at short notice.
- Most funds will have little experience of the kinds of stress which lead to such tools being used.
- Managers will often be reluctant to trigger redemption tools when they are the appropriate next step because:
  - the manager is not quite sure how to do it—either logistically, legally or in terms of delegated authorities to decide;
  - managers can be concerned with potential brand damage which may lead them to delay until the regulator mandates the tool to be applied.
- Recommendation: managers be asked by the CMF to conduct scenario exercises to test their operational capacity and legal powers to suspend and/or gate redemptions.
- Rationale: Such “war gaming” — if well done — can provide substantial additional resilience and allow stress management interventions to be executed in an orderly and prompt fashion. That itself can help to calm markets in difficult times.
- Footnote observation: In some jurisdictions, there can be third party technology used to distribute and to redeem funds (platforms) which can also be a problem, because they are not well designed to administer gates or suspensions. The mission did not explore whether that is an issue in Chile.

### Mitigant 8: regulatory requirements to manage and mitigate conflicts of interests
- 61. Circular 1869 provides instructions on the implementation of measures related to risk management and internal control in fund managers.
- Circular 1869 requires that each fund manager must "define policies and procedures that specify the methods according to which all potential conflicts of interest inherent to the management of third-party funds will be identified, managed and monitored, such as those existing between the different funds managed by the company. Such policies and procedures shall identify the persons assigned to monitor and control these conflicts".
- 62. The CMF has issued several regulations that establish the need to comply with policies and/or disseminate information regarding the management of conflicts of interest and inappropriate incentives.
  - NCG 270 establishes rules for the publicity of policies and procedures related to the acquisition or disposal of securities of the entity and the handling and disclosure of information for the market and this is applicable to securities issuers and funds.
  - Circular 1,869 also requires that entities must define policies and procedures that specify the methods according to which all potential conflicts of interest inherent to the administration of third-party funds will be identified, managed, and monitored, such as, for example, those existing between the different funds managed by the company.
  - NCG 365 establishes that the internal regulations of the funds must specify the dispute resolution mechanism(s) to be used in the event of conflicts that may arise.
- Observation: There is a significant degree of concentration in the valuer services, with two valuers dominating the market.

### Assessment of conflict-management framework
- 63. The regulatory framework for the management of conflicts of interest seems appropriate.
- Conflicts of interest are a feature of securities markets and are part of the trade-off price that is paid for important synergies; this trade-off is particularly important in emerging and smaller markets.
- Effectiveness of conflict management depends importantly on market culture as well as formal rules.
- The mission's high-level engagement with the Chilean market revealed nothing to doubt that conflicts are well managed.
- Conclusion: Vigilance by the regulator is important in encouraging high standards. On that basis, no recommendations are made in this regard.

### Conclusion and key recommendations
- 64. The mission acknowledged the stability and maturity of the Chilean MMF sector and the fundamental soundness of the current regulatory regime and by the quality of the CMF’s regulatory arrangements.
- 65. The mission makes a number of recommendations focused on adding to the resilience of the Chilean regulatory regime to prepare for the relatively remote eventuality of a very powerful shock to the Chilean MMF sector, and the associated risk of that shock being further amplified by the MMF sector itself. There are eight recommendations made across a range of issues.
- 66. Most significant recommendation:
  - Observation: Not using mark-to-market pricing for MMFs as a default is not justified by anything in the objective market structure or the commercial activities in the Chilean economy.
  - Rationale: It is inappropriate not to use market pricing for MMFs when the term deposits in which they predominantly invest are so actively traded. The lack of inter-market congruity between the short-term deposit market and the MMF market is a fault-line in the Chilean financial market structure. It should be eliminated.
  - Implementation advice: Recognize that market practice often becomes entrenched over time, and changes to the format and conventions of pricing of any asset need to be done with care. A cautious approach to the transition is recommended, based on a careful market consultation and a period of dual value display.

*Source: IMF mission text (excerpts as provided).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1chlea2022002.pdf_