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18 October 2012

Response

Consultation Document – “Undertakings for Collective Investment in Transferable Securities (UCITS) - Product Rules, Liquidity Management, Depositary, Money Market Funds, Long-term

Investments” BlackRock is one of the world’s pre-eminent investment management firms and a premier provider of global investment management, risk management and advisory services to institutional and retail clients around the world. As of 30 September 2012, BlackRock’s assets under management totalled $3.673 trillion (€2.88 trillion) across equity, fixed income, cash management, alternative investment and multi-investment and advisory strategies including the iShares® exchange traded funds (“ETFs”). Through BlackRock Solutions®, the firm also offers risk management, strategic advisory and enterprise investment system services to a broad base of clients, including governments and multi-lateral agencies, with portfolios totalling more than €9 trillion. In Europe specifically, BlackRock has a pan-European client base serviced from 20 offices across the continent. Public sector and multi-employer pension plans, insurance companies, third-party distributors and mutual funds, endowments, foundations, charities, corporations, official institutions, banks and individuals invest with BlackRock. BlackRock is a fervent supporter of UCITS as a vehicle for long terms investment by savers not only in Europe but around the world. As at 30 September 2012 BlackRock affiliates managed 396 individual UCITS funds located in 4 European jurisdictions with total assets under management of €256 billion. We therefore welcome the opportunity to comment on the European Commission’s Consultation Document. BlackRock is registered in the Interest Representative Register BlackRock with ID number 51436554494-18. Executive Summary General Comments BlackRock focuses on its clients’ interests and it is from this perspective that we approach the issues raised under this Consultation, like all other matters of public policy. BlackRock supports regulatory reform globally where it increases transparency, protects investors, facilitates responsible growth of capital markets and, based on thorough cost-benefit analysis, preserves consumer choice. BlackRock has written extensively on the activities that the European Commission includes in its consultation documents on UCITS. We would encourage the Commission to cross-reference the remarks in this response with those in the related BlackRock comment letters and ViewPoints

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September 2012: ViewPoint- Money Market Funds: A Path Forward

August 2012: Response to the IOSCO Consultation Report on Principles of Liquidity Risk Management for Collective Investment Schemes

June 2012: Response to the European Commission Green Paper on “Shadow Banking”

May 2012: ViewPoint - Securities Lending: Balancing Risks and Rewards.

May 2012: Response to the IOSCO Consultation Report Money Market Fund Systemic Risk Analysis and Reform Options.

1 Available at http://www2.blackrock.com/global/home/PublicPolicy/PublicPolicyhome/index.htm

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April 2012: ViewPoint - Reform of Credit Rating Agency Regulation in Europe: An End-investor Perspective.

March 2012: ViewPoint - Money Market Funds: The Debate Continues.

October 2011: ViewPoint - ETFs: A Call for Greater Transparency and Consistent Regulation Specific Comments 1. Eligible Assets We believe the current UCITS framework provides investors with the protection of a rigorous regulatory framework. This provides for high levels of protection for retail investors by focusing on liquidity, risk management, governance and transparency. Many of the Commission’s questions focus on the continued use of derivatives to achieve UCITS objectives. We would emphasise that the increased use of financial derivative instruments within the UCITS III framework allows a wider range of strategies to be carried out within a rigorous risk management framework. By providing more consistent and less volatile returns to investors, these strategies allow investors to manage their exposure to risk more effectively. We would also emphasise that it is important that investors continue to benefit from innovation in portfolio management techniques which permit investors to mitigate the effects of atypical or volatile market conditions. We also support the continued use of VaR as an effective tool for assisting managers in assessing portfolio risk alongside other measures. We note also that there may be differences amongst national regulators in the interpretation of existing rules and guidelines applicable to eligible assets which in practice may have resulted in certain strategies being readily authorised in some member states but not in others. We believe it is for ESMA to ensure consistency in the interpretation of these rules. 2. Efficient portfolio management (EPM) We agree that the activities covered under EPM techniques, such as securities lending, repo and reverse repo, share similarities (e.g. usage of collateral), but we believe it is important to stress that securities lending is a value added service which is performed by specialised providers charging separate fees from the usual annual management charge. EPM techniques benefit investors by reducing costs, contributing to performance and represent long-established techniques conducted in a risk-controlled environment.

Securities lending generates income for investors whose securities are lent. In addition, the availability of securities through lending arrangements translates into liquidity for the financial markets.

Repurchase agreements (“repo”) provide a source of short-term capital, facilitating liquidity and therefore contributing to the efficiency and stability of the financial markets.

EPM techniques are designed to operate in a low-risk environment and therefore rely on both rigorous counterparty risk management and definition of an appropriate collateral framework. We note these risk management tools are of wider importance, for example in the use of over-the-counter (“OTC”) derivatives. The risk mitigation tools which may be employed include over-collateralisation and, , in the case of securities lending, contractual indemnifications against losses as a result of borrower default are used in many cases to help minimise the risk that UCITS and their investors bear. The aim of collateral is to allow UCITS to replace lent assets quickly from a source of easily accessible liquid assets in the event of counterparty default. We firmly believe that liquidity and good credit quality of collateral are considerably more important than diversification in achieving the objective that collateral ultimately serves. The EPM counterparty is generally allowed to re-use collateral. In BlackRock’s lending programme however, the collateral received by the UCITS is not re-used, and we understand this is market practice across the securities lending industry. A full transfer of title takes place and the collateral is typically held in a ring-fenced tri-party account in the name of the UCITS.

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We remain concerned that mandatory haircuts applied to the securities lending market are likely to increase rather than reduce pro-cyclicality. If managers are not able to protect their investors by increasing haircuts (and a mandatory minimum haircut may in effect become a maximum), they may stop lending altogether to certain counterparties. We support efforts to provide a greater and consistent level of transparency on securities lending activities carried out on behalf of UCITS not only from the perspective of regulators, but also for investors to give them a clear view of the returns and the benefits received from securities lending. We also support clarity as to the costs taken out of the gross revenue to meet the costs of operating a securities lending programme. Generally, we would be concerned about additional limitations being imposed on the repo markets through further revisions of the UCITS Directive. Restricting the ability of a UCITS to enter into non-recallable repo transactions would ultimately increase frictional cost, reduce the number of counterparties willing to take on the additional risk of fully recallable repo transactions and suppress activity in the repo markets. End-investors benefit most when the capital transfer mechanism is as efficient as possible; efficient capital transfer mechanisms create liquidity and liquidity ultimately reduces costs for end-investors. In other words, specific restrictions on repo transactions would ultimately translate into a performance drag for end-investors whilst concentrating risk in a smaller number of counterparties. 3. Derivatives Counterparty assessment and collateral management are essential tools in the use of derivatives, particularly OTC derivatives. Collateral management exists as a risk management mechanism to protect the UCITS in the event of a counterparty defaulting on its obligations to the UCITS. The collateral provided does not need to, and in many cases, should not match the liquidity profile of the UCITS in question but rather be able to be liquidated as quickly as possible to allow the UCITS to recoup any loss it has suffered. Accordingly, collateral management should be encompassed within counterparty assessment and management. As for the use of collateral for efficient portfolio management techniques, we are concerned by efforts to impose mandatory haircuts which would diminish the ability of a manager to take decisions based on its own credit assessment and analysis. In particular, we believe it is key to clarify the treatment of centrally cleared OTC derivatives within the UCITS Directive. In particular, we welcome recent Commission statements regarding the exposure UCITS that may take to CCPs and the identity of the counterparty for the purposes of determining the 5% and 10% limits in UCITS. 4. Extraordinary Liquidity management tools Liquidity management is fundamental to the role of a UCITS manager. As with all risk management, the appropriate data, systems, tools and reporting should be in place and the process needs to be understood as a qualitative process. The Commission’s questions focus on extraordinary liquidity measures. As the employment of suspensions or, indeed, the potential use of side pockets is relatively rare, we believe that managers, depositary and national regulators should retain sufficient flexibility to implement these measures. Given the diversity of reasons giving rise to the use of such measures, fixed time lines for implementing these measures could well be counterproductive. We also believe normal liquidity measures (such as effective deferred redemption) can be used in a way which complements the diversity of ownership base and distribution models in widely held UCITS. 5. Depositary passport We do not believe there will be overriding benefits in developing a depositary passport at this stage in the development of the UCITS framework. While we acknowledge there are potential opportunities to develop the single market by promoting a depositary passport we believe there are overriding operational or commercial requirements which negate this. In our view, the need to avoid compromising consistency of investor protection and regulatory oversight is stronger than the arguments in favour of introducing a depositary passport.

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6. Money market funds To address the concerns of those who believe that MMF are a systemic risk, BlackRock believes that further enhancements to MMF regulation in Europe must meet a two part test, namely

(i) provide a mechanism for managing mass client redemptions, and

(ii) preserve the benefits of the product for investors and the functioning of the short term funding market.

We do not believe that redemption hold-backs, conversion from CNAV to VNAV or capital requirements meet these two requirements. Solutions that regulate MMFs as a bank but do not allow MMFs the same access to the central bank discount window seem to us to be inconsistent and unworkable. Furthermore, given the paucity of mark-to-market pricing in short maturity money market instruments (such as CP and CD under 1 year) pure mark–to-market funds will be impractical to manage. We note in this context that banks holding instruments to maturity typically use amortised cost accounting. We therefore propose that UCITS introduce a definition of MMF; ESMA enhance standards around asset quality, liquidity, disclosure and client concentration; and finally that a circuit breaker in the form of Standby Liquidity Fees (SLF) be introduced. Triggered by objective standards these fees would benefit the remaining investors, thereby discouraging redemptions and reversing the negative spiral of mass client redemptions. 7. Long-term assets BlackRock supports the agenda for long-term growth and encourages efforts to stimulate investment into those long-term assets defined by the Commission. We are devoting considerable resources to convince investors to increase savings for the long term. Many of the investment opportunities identified by the European Commission are specialist in nature, require detailed assessment by both manager and investor and in terms of direct investment opportunities are not suited for investment by retail investors. We believe a focus on relevant structural issues which inhibit greater investment in these assets by long-term institutional investors such as pension funds and insurance companies would result in far greater investment in these long term assets. In particular, expanding the classes of assets such as investment into small and medium enterprises (“SMEs”) requires levels of scalability and transparency on reporting which are not typically available in the market. Providing financing from the non-bank market finance sector into long terms assets is also likely to require a degree of standardised packaging and securitisation to give the levels of transparency and disclosure necessary to reach a wider range of investors. We also support consideration of the wider marketing of retails funds which do not qualify under UCITS, either because they invest in a wider range of assets types than permissible under the UCITS framework or because they offer limited or no redemption rights. We believe much could be achieved by focussing on the barriers to cross-border distribution of national vehicles, particularly the interplay between the Prospectus Directive and AIFMD for closed-ended vehicles. Finally, we wish to emphasise that existing UCITS play a key role in financing long-term growth by channelling investment into equities and bonds issued by a wider variety of companies. Index funds, for example, are particularly focussed on long-term investment objectives, as they remain invested in securities which fall within the relevant index. 8. UCITS IV Improvement We strongly support the analysis carried out by a number of trade associations including the European Fund and Asset Management Association (“EFAMA”) and the Investment Management Association (“IMA”) on measures to enhance the regulation of master-feeder structures, self-managed investment companies, the operation of master-feeder structures, fund mergers and cross-border notifications.

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We also support the recommendations made by EFAMA and the IMA that there should only be an obligation to provide KIIDs to retail investors (not professional investors). Furthermore, we strongly believe that no specific merit exists in further aligning UCITS with AIFMD given the detailed product and conduct of business rules already in place for UCITS which, in our view, cover the potential areas for alignment mentioned in the Commission consultation.

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2. Eligible assets and use of derivatives: evaluation of the current practices in UCITS portfolio management and assessment of certain fund investment policies

(1) Do you consider there is a need to review the scope of assets and exposures that are deemed eligible for a UCITS fund? In general, we believe that the UCITS eligible assets regime is appropriately calibrated and provides managers with the right balance of strategies and asset classes needed to meet the vast majority of investors’ long-term investment needs. The use of eligible assets and strategies is conducted within a robust management framework that focuses on liquidity, risk management and diversification. . We note also that there may be differences amongst national regulators in the interpretation of existing rules and guidelines applicable to eligible assets which in practice may have resulted in certain strategies being readily authorised in some member states but not in others. We believe it is for ESMA to ensure consistency in the interpretation of these rules though we believe there are no significant departures from the core requirements of UCITS. We also note that there are a number of asset classes and strategies which are not permitted within the UCITS framework because they do not currently meet UCITS requirements for diversification, liquidity or restrictions on borrowing. These strategies and asset classes may nevertheless be of benefit to certain types of retail investor in a less liquid structure than UCITS and we, therefore, consider them in further detail in our response to the Commission’s questions on other long-term retail investment vehicles. Finally, we note that, in the current environment, where ASEAN (Association of South East Asian Nations) is considering its own UCITS-equivalent brand, it would be more appropriate to focus on strengthening existing controls over the range of eligible assets rather than reducing product choice by restricting access to existing UCITS strategies. (2) Do you consider that all investment strategies current observed in the marketplace are in line with what investors expect of a product regulated by UCITS? Investors in UCITS, both institutional and retail, have diverse investment needs and risk appetites (indeed, such varies between retail investors). A requirement in common for all investors, however, is the fact that UCITS offers a diversified product, with high levels of disclosure, regular pricing, liquidity and robust governance and risk management processes. We believe that, within the UCITS framework, it is the duty of managers to focus on the products that meet the needs of specific client segments allowing investors to make an informed choice as to which UCITS meet their specific needs. Clear disclosure, in particular as mandated by the Key Investor Information Document (KIID) should then be given to investors as to the objectives of the UCITS, its outcomes and how the investments made by the UCITS contribute to achieving its objectives. There are a number of UCITS products that are designed for sophisticated or professional investors, subject to particular restrictions, which form an important part of the asset allocation strategy of certain institutions such as pension funds. These institutional clients frequently ask for bespoke products which are UCITS-compliant in order to benefit from the diversification, liquidity and transparency which the UCITS framework brings. These UCITS are often managed against specialist benchmarks used in the pensions or institutional market rather than the retail market, representing different asset allocation models. We support the use of strategies that strive to protect investor capital in atypical or volatile market conditions which may involve more complex portfolio management techniques or employ extensively the use of derivative instruments to mitigate risk. Despite the relative complexity of the underlying strategies, these products are designed to answer a clear demand from investors for smoother returns that long-only or index products cannot fulfil.

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As market demand demonstrates, there is a clear need for a variety of innovative investment strategies observed across different markets with the value add of the investor protection framework offered under the UCITS brand. (3) Do you consider there is a need to further develop rules on the liquidity of eligible assets? What kind of rules could be envisaged? Please evaluate possible consequences for all stakeholders involved. We believe that the UCITS investments rules which require managers to develop liquidity risk management processes to meet on-going redemption requirements are robust. In this context, we believe that it is key to look at the overall liquidity of a UCITS’ portfolio – not just the individual liquidity of specific assets. Liquidity management is not just a series of quantitative measures, but also a qualitative process. We comment further on the range of liquidity tools and how they can be used in the section on extraordinary liquidity management below. (4) What is the current market practice regarding the exposure to non-eligible assets? What is the estimated percentage of UCITS exposed to non-eligible assets and what is the average proportion of these assets in such a UCITS' portfolio? Please describe the strategies used to gain exposure to non-eligible assets and the non-eligible assets involved. If you are an asset manager, please provide also information specific to your business. The UCITS framework requires a robust risk management and liquidity framework to be in place covering all instruments in which a UCITS may invest. Financial instruments which give access to non-eligible assets within this framework include:

Other AIFs as referred to in the Eligible Assets Directive and which offer equivalent levels of protections and supervision to those found in UCITS.

Closed-ended AIFs, such as listed investment trusts and other securities such as exchange traded certificates, provided they meet the requirements to qualify as a transferable security, and their underlying instruments meet UCITS eligibility requirements. Closed-ended AIFs represent an asset class which is not explicitly referred to as an eligible asset for a UCITS under the UCITS Directive. The "dual nature" of closed-ended funds has, in particular, given rise to uncertainties as regards their categorisation. On the one hand, closed-ended funds are collective investment undertakings with occasional redemption rights. On the other hand, their units are often treated similarly to any other transferable security.

Investor protections and public offering requirements are common to both the Prospectus Directive (“PD”) and UCITS Directive. This implies that closed-ended AIFs may be held as eligible assets in UCITS funds when additional requirements are met and why they can be classified as securities. Outside the EU, the PD does not apply. However, the principles in the PD should be used for the purpose of classifying funds. The practical implications of the PD for non-EU AIFs are the following:

– In the EU, AIFs will be closed-ended when they publish a prospectus (under the PD or EU equivalent) to be offered to the public or admitted to trading on a regulated market.

– EU non-UCITS open-ended AIFs will need to meet the eligibility requirements for other undertakings for collective investment.

– Outside the EU, AIFs declaring themselves as close-ended or open-ended fund should be respectively classified as their EU equivalents. If not explicitly defined as closed-ended or open-ended, AIFs could be treated as a closed-ended fund when the subscription of the capital follows the principles and mechanisms of an offer to the public and an admission to trading takes place on a local regulated market equivalent to the PD requirements.

Transferable securities which neither embed nor are constituted as a financial derivative instrument.

Financial derivative instruments which give access to financial indices. We believe that there is no need to apply a full look through to the index provided the index is appropriately constructed and provides appropriate diversification. We do not think that this should exclude indices on non-eligible assets such as precious metals.

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– Where derivatives on an index comprising non-eligible assets are used to track or gain high exposure to the index, in order to avoid undue concentration, the index should be at least as diversified as set out under the diversification ratios.

– Where derivatives on an index comprising non-eligible assets are used for risk diversification, it is assumed that the 5/10/40% rules currently apply. The recent ESMA guidelines are not explicit on the matter. However these may not be the most appropriate limits in line with UCITS diversification principles. The Directive 2001/108/EC of the European Parliament and of the Council of 21 January 2002 amending Council Directive 85/611/EEC stated in its introduction that “10) For prudential reasons it is necessary to avoid excessive concentration by a UCITS in investments which expose them to counterparty risk to the same entity or to entities belonging to the same group” with a view to avoiding issuer counterparty risk. Commodities such as precious metals do not, in general, have an issuer counterparty risk. Accordingly, as an alternative, the principle of risk diversification in a UCITS could be met by reference to the 20% limit at group level for a single type of commodity.

(5) Do you consider there is a need to further refine rules on exposure to non-eligible assets? What would be the consequences of the following measures for all stakeholders involved: - Preventing exposure to certain non-eligible assets (e.g. by adopting a "look through"

approach for transferable securities, investments in financial indices, or closed ended funds).

- Defining specific exposure limits and risk spreading rules (e.g. diversification) at the level of the underlying assets.

We believe an absolute restriction on exposure to eligible assets is unnecessary. There is investor demand for some indirect exposure to assets such as precious metals. Looking at other jurisdictions with comparable regimes, we note that the regulatory regimes applicable to collective investment schemes in both Hong Kong and Singapore allow exposure to commodities through cash settled financial derivative instruments. (6) Do you see merit in distinguishing or limiting the scope of eligible derivatives based on the payoff of the derivative (e.g. plain vanilla vs. exotic derivatives)? If yes, what would be the consequences of introducing such a distinction? Do you see a need for other distinctions? The use of derivatives as an asset class has previously been authorised to give managers greater liquidity, cost-effectiveness and flexibility than is always possible through investment in physical holdings. Derivatives allow investors’ access to investment opportunities which would not otherwise be available. Examples of this include investments in emerging markets where local settlement and custody rules lead to unnecessarily high levels of operational and custody risk. The use of derivatives must, of course, continue to be subject to a robust risk management process. The Consultation enquires whether there should be a difference between vanilla and exotic derivatives but without clear guidance as how to differentiate between the two. For example, it remains unclear whether this would imply a difference between OTC and exchange traded derivatives. In particular, we would not support the classification of all OTC derivatives as “exotic” simply because they are traded over-the-counter. Many core strategies within UCITS rely on the use of OTC instruments. For example, bond funds are exposed to market, credit, and interest rate and inflation rate risks and, therefore, rely on a variety of OTC derivative strategies to reduce risk. Reducing access to these instruments could lead to increased portfolio risk. (7) Do you consider that market risk is a consistent indicator of global exposure relating to derivative instruments? Which type of strategy employs VaR as a measure for global exposure? What is the proportion of funds using VaR to measure global exposure? What would be the consequence for different stakeholders of using only leverage (commitment method) as a measure of global exposure? If you are an asset manager, please provide also information specific to your business.

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We believe that both VaR and the commitment approach have their role to play in different types of UCITS. We would stress that VaR is not a measure of leverage and acts as a useful statistical measure of the probability of maximum loss on a portfolio based on historical price trends and volatilities. VaR is used in a UCITS’ risk management process not to manage leverage but as a measure for assessing risk and exposure in a portfolio, particularly where individual exposures are offset rather than netted off under the narrow definition allowed in the commitment approach. Leverage, in itself, does not lead to increased risk in a UCITS portfolio. Leverage in UCITS can occur in a number of ways, primarily through the use of derivative positions and borrowing. Leverage creates investment exposure by a UCITS greater than the NAV of the fund. Higher leverage levels are often equated in investors’ minds with higher levels of overall risk. While this may be the case where a UCITS uses leverage to magnify a directional trade, this is frequently not the case as, in other contexts, UCITS commonly use derivatives to gain exposure to specific assets classes, offset other exposures, thereby reducing risk. Building upon this theme, in certain cases, derivatives may actually be used to mitigate the effects of atypical volatile market conditions, liquidity risk, counterparty risks and drawdowns. For instance, derivatives may be used to hedge or net an exposure. Derivatives may also be used to generate profits from unusual market conditions, such as unusually low market volatility. Examples include “relative value” trades (especially synthetic long/short embedded in financial derivatives instruments), which should generate little directional market risk. The leverage resulting from the use of derivatives in long-only fixed income management is often essential to portfolio construction in order to reduce currency, duration and interest rate risks. We set out below some of the reasons for this in the context of the management of a portfolio of global bonds:

The UCITS hedges the different currencies of the bonds in the portfolio back to the base currency of the funds:

– Impact – leverage up, currency risk down

The UCITS anticipates that the duration of the portfolio will differ from that of the benchmark and hedges the duration of the portfolio back to the duration of the benchmark:

– Impact – leverage up, duration risk down

The UCITS has a negative view of some of the bonds in a portfolio and decided to hedge the credit risk of these bonds:

– Impact – leverage up, credit risk down The hedging strategies described in the above will not necessarily fall within the narrow definition of hedging or netting allowed under the commitment approach such as, for example, offsetting the currency risk of one geographical market by taking a position in another market. In this respect, we believe it is essential that the use of VaR continue to be allowed so as to allow UCITS to explain to regulators and investors the purposes for which they are using leverage and to show clearly the difference in effect between directional and non-directional uses of leverage. Otherwise, the reporting of leverage under the commitment approach will not, in itself, allow regulators to determine whether the use of derivatives increases or reduces risk in the portfolio. (8) Do you consider that the use of derivatives should be limited to instruments that are traded or would be required to be traded on multilateral platforms in accordance with the legislative proposal on MiFIR? What would be the consequences for different stakeholders of introducing such an obligation? As mentioned above, we do not agree with limiting derivatives on this basis given that only a limited range of derivatives are currently available on multilateral platforms. For example foreign exchange forwards which are key to managing currency exposure are not currently exchange-traded. We note there are already a number of major initiatives to reduce counterparty risk such as the move to central clearing under EMIR.

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3. Efficient portfolio management techniques: assessment of current rules regarding certain types of transactions and management of collateral

In this section, we refer to efficient portfolio management techniques as defined in the Eligible Assets Directive. However, our comments on the use of collateral are generally of wider application when discussing the use of collateral to cover counterparty exposure on derivative transactions. We cover this in more detail in section 4 below. (1) Please describe the type of transaction and instruments that are currently considered as EPM techniques. Please describe the type of transactions and instruments that, in your view, should be considered as EPM techniques. Previous UCITS iterations provide a comprehensive list of EPM techniques (notably the enhanced regime under UCITS III focusing on securities lending and repurchase transactions). Of the EPM techniques available under UCITS, we think it is worth highlighting that securities lending is a value added service that is performed by specialised providers. Therefore, compensation arrangements for securities lending services are validly categorised as being separate from investment management fees. (2) Do you consider there is a specific need to further address issues or risks related to the use of EPM techniques? If yes, please describe the issues you consider merit attention and the appropriate way of addressing such issues. In our view, the existing UCITS framework provides the appropriate level of regulation for EPM techniques. (3) What is the current market practice regarding the use of EPM techniques: counterparties involved, volumes, liquidity constraints, revenues and revenue sharing arrangements? Securities lending is a well-established and comprehensively regulated activity in Europe. Investment vehicles such as mutual funds, ETFs, pension funds and insurance companies make short-term loans of their securities to banks and broker dealers in order to generate incremental returns for their portfolios. This additional income that is returned to the fund lowers the cost of investing for end-investors. Securities lending has evolved into a vital component of the financial markets and an important revenue stream for many investment portfolios. It has, for decades, produced benefits for UCITS investors. The counterparty risk that arises from this activity is mitigated by regulation in combination with firms’ own risk management. In the case of asset management firms, risk management is focussed on protecting client’s assets, taking into account the fiduciary role that an independent investment manager has assumed with respect to such assets. Beyond benefitting the end-investor directly, securities lending benefits investors more broadly by providing market liquidity through facilitating settlement and price formation. End-investors ultimately benefit from efficient and stable markets. We provide some information in respect of BlackRock’s own securities lending programme below. Counterparties: The UCITS minimum rating requirement defines the threshold for eligible counterparties. In addition, a lending agent’s credit department should review counterparties on an on-going basis and assign credit limits. In BlackRock’s case, this is done by our Risk & Quantitative Analysis Group (“RQA”), which is independent from both our portfolio management and our securities lending functions. We provide more detail on BlackRock’s counterparty selection process in section 4 below. Since the securities lending transactions are overnight, credit limits can be adjusted on a daily basis.

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Volumes: On average, our European UCITS fund ranges have less than 20% of their assets lent out on a daily basis to a set of more than 10 eligible borrower counterparties. Liquidity constraints: An important part of the service BlackRock provides as a lending agent is defining appropriate collateral parameters. This includes issuer limits for fixed income collateral and average daily trading (ADV) limits for equity collateral. Revenues and revenue sharing arrangements: Securities lending is a resource-intensive activity. A high proportion of securities lending trades are executed automatically, which requires significant investment in systems and technology. A smaller number of trades are negotiated manually, where pricing can be influenced by many variables, and the outcome for end investors can be significantly improved through the application of quantitative and fundamental research and analytics. In addition, investment in risk management capabilities is required to continuously review counterparties and collateral parameters. Significant resources are also required to monitor settlement, collateralisation and corporate actions activity. These investments permit the lending agent to provide their trading expertise, scalability and risk controls across all lending clients. It is difficult to assign these costs to specific lending clients. As a result, beneficial owners and the securities lending industry have established a model whereby the lending agent receives a percentage of gross revenues to cover the costs of providing securities lending services. This model ensures that the lending agent is compensated only if the lending client generates revenue for the fund. In our view, paying the lending agent a percentage of the gross revenue generated is the most appropriate way of ensuring alignment between the interests of the UCITS fund and the lending agent. Charging a flat (basis point) fee to a fund would reduce the alignment of interest between lending agent and fund. It may also mean that funds which hold few assets with high borrowing demand (and, as a result, benefit only marginally from an investment-intensive securities lending programme), generate less revenues than the flat fee. An example of this would be if a fund earns 1 basis point of revenue from securities lending, but the flat fee is 2 basis points, the fund would be net negative as a result of participating in the programme. As a result, many funds may decide not to engage in securities lending as forecasting revenues from securities lending and weighing up the flat fee against a fee-sharing structure entails significant uncertainty. From recent public commentary, there appears to be a misconception that securities lending agents take no risk in facilitating these services. This, however, is not the case. Conversely, they assume significant reputational risk in acting as a lending agent. Furthermore, in many cases the agent also provides the UCITS fund or its clients with explicit indemnification coverage against losses arising from the default of a counterparty. In the European market specifically, counterparty default risk is generally considered to be the most significant risk to a lending programme. As such, where indemnification is offered, the agent lender bears the bulk of the risk in securities lending (both reputational and pursuant to its indemnification obligations) and it is appropriate for the lending agent to be compensated on that basis.

There are at least three active compensation models being used for securities lending in the European markets today:

1) Affiliated Model: In-house lending programmes, where the asset manager or an affiliate performs securities lending services as the lending agent. The agent receives a proportion of the gross securities lending revenue generated.

2) Outsourced Model: All securities lending services are outsourced to a lending agent, which could be a custodian, another asset manager or a specialised third-party lending provider. As before, the agent receives a proportion of the gross securities lending revenue generated.

3) Three-Way Split Model: Securities lending is outsourced as in the second model, but the investment manager also receives part of the securities lending revenues. Fees are split between lending agent, fund and asset manager.

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Regardless of whether the fee split is applied through an outsourced model or through an affiliated model, the service fee (i.e. fee split) should comprise part of the ‘direct and indirect costs’ contemplated by ESMA’s Guidelines on ETFs and other UCITS issues (the “ESMA Guidelines”).

The compensation arrangements for the provision of securities lending services should be disclosed to end-investors (which could be in the KIID, annual report and/or website – although, as additional revenue, should not be aggregated with the management fee and other charges as part of the on-going costs). Where the lending agent or asset manager deducts any other costs from the gross securities lending revenues, this should also be disclosed and made clear to end-investors.

The performance contribution to the UCITS from securities lending should also be disclosed to end investors. Securities lending agents deliver different levels of incremental return to clients for a given level of risk. To the extent commercial terms for securities lending services were specifically mandated or restricted by regulation, there would be limited incentive for lending agents to provide lending services or, at least, limited incentive for those currently providing such services to invest significantly in improving returns and further enhancing risk management over time. The boards of the BlackRock funds conduct due diligence on potential agents before choosing a specific securities lending agent and thereafter regularly perform benchmarking of the securities lending agent’s performance in order to demonstrate the value generated for investors. Importantly, investors receive transparency into the compensation arrangements and the value these have delivered back to the relevant fund. The appointment of the lending agent and the specific commercial terms are the responsibility of the fund board, which has a fiduciary duty to the end-investors. In our

Gross SL Return

X %

Affiliated Model (BlackRock)

Fund receives X% of

gross SL revenues

Lending Agent

(BLACKROCK) retains

Y% + covers all costs

Y%

Gross SL Return

X %

Outsourced Model

Fund receives X% of

gross SL revenues

SL Agent (custodian /

third-party) retains Y%

+ may cover costs

Y %

Gross SL Return

X %

3-way Split Model

Fund

receives X%

of revenues

SL Agent

retains Z% of

revenues

Z %

Y %

Asset Manager

retails Y% of

revenues

Agent receives % of gross SL revenues as fee for providing SL services (negotiated between fund board and SL Agent)

The percentage fee is disclosed to end-investors (e.g. KIID) Fund receives majority of SL revenues No additional cost are incurred by the UCITS – agent pays the costs out

of their revenue share Affiliated agent makes significant investment in research and risk

management technology to support services and bears risk Periodic reporting to fund board on risk and returns

Benchmarking of securities lending performance

Agent receives % of gross SL revenues as fee for providing SL services (negotiated between fund board and SL Agent)

The percentage fee is disclosed to end-investors (e.g. KIID) Fund receives a portion of SL revenues No additional costs beyond the split are incurred by the UCITS – agent

pays the costs out of their split Agent makes significant investment in risk management technology to

support services and bears risk Periodic reporting to fund board on risk and returns Asset managers that claim the “funds receive 100% of SL revenues” may have expressed returns following the application of the lending agent’s fees.

Fee sharing arrangement between asset manager, lending agent and fund

Lending agent would provide services very similar to the other models Asset manager may provide services such as risk oversight or client

service In our view 3-way fee splits may be appropriate, if all parties involved can document the value they add to the process.

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view, affiliated lending agents have an even stronger incentive to protect clients as, for them, the entire asset management relationship is at stake, not only securities lending. BlackRock also provides borrower default indemnification to its UCITS funds thereby insulating those clients from the vast majority of risks associated with securities lending in the European market. We understand that the focus of regulatory policy in this context is on investor protection and financial stability, which we share. It is in the end-investors’ best interests to have their incentives aligned with lending agents, which we believe can be best accomplished through transparent disclosure of the portion of gross revenue compensation model. This provides lending agents with a strong incentive to invest in the infrastructure, research and technology to deliver attractive returns to end-investors while at the same time investing in risk management to protect both end-investors, the agent and in turn the financial system. (4) Please describe the type of policies generally in place for the use of EPM techniques. Are any limits applied to the amount of portfolio assets that may, at any given point in time, be the object of EPM techniques? Do you see any merit in prescribing limits to the amount of fund assets that may be subject to EPM? If yes, what would be the appropriate limit and what consequences would such limits have on all the stakeholders affected by such limits? If you are an asset manager, please provide also information specific to your business. We do not believe that imposing a lending limit per fund would be appropriate. Within appropriate collateral parameters, a robust counterparty approval process and potentially indemnification against losses resulting from borrower default, securities lending can be performed in a low-risk manner that does not require it being limited at either the fund or counterparty level. Based on client preferences, a UCITS may decide to limit lending activities at a fund level - BlackRock operates an internal limit - but we do not believe this should be a regulatory requirement as any limit would be fairly arbitrary. In the future, demands for collateral may grow and securities lending programmes may in part be able to meet demands for certain types of collateral in the future. We recommend, instead, focussing on the risk management processes used to reduce risk in the operation of securities lending programmes. (5) What is the current market practice regarding the collateral received in EPM? More specifically: - are EPM transactions as a rule fully collateralized? Are EPM and collateral positions

marked-to-market on a daily basis? How often are margin calls made and what are the usual minimum thresholds?

- does the collateral include assets that would be considered as non-eligible under the UCITS Directive? Does the collateral include assets that are not included in a UCITS fund's investment policy? If so, to what extent?

- to what extent do UCITS engage in collateral swap (collateral upgrade/downgrade) trades on a fix-term basis?

Market practice is to over-collateralise securities lending transactions. Both lent securities and collateral are marked to market on a daily basis. The recently published ESMA Guidelines require “collateral to be held by the depositary of the UCITS”. Due to the efficiency gains from tri-party collateralisation for non-cash securities lending programmes, it is important that this requirement be acknowledged as being satisfied when collateral is held by tri-party collateral agent acting on a sub-custodial basis on behalf of the UCITS’s custodian. Using a tri-party model reduces administrative and infrastructure costs for the UCITS, while enabling a broader range of collateralised transactions. The alternative to the tri-party framework involves the borrower and lender managing collateral on a trade-by-trade basis, which is operationally inefficient and may result in a considerably less diversified pool of collateral.

We do not believe that collateral should be limited to the assets in a fund’s investment policy and a high level of correlation between lent security and collateral does not necessarily benefit end-investors. So, whilst we do believe that correlation is an important factor when determining the appropriate level of over-collateralisation, liquidity and volatility of the collateral should also be considered. For example, high quality government debt collateral will have a lower level of price correlation with equities, but this should not mean that high quality government debt is an inferior form of collateral. In our view, the fundamental issue is the liquidity of collateral taken by the UCITS.

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Based on UCITS requirements

2, our policy is that securities lending transactions can be terminated at

any time if required. Only focussing on the collateral type when describing a trade as ‘collateral upgrade or downgrade’ is not sufficient as the level of over-collateralisation and concentration limits also need to be considered. Liquidity, volatility and correlation should be the key considerations when determining levels of over-collateralisation. Within the right collateral framework, different asset types can be lent / taken as collateral. (6) Do you think that there is a need to define criteria on the eligibility, liquidity, diversification and re-use of received collateral? If yes, what should such criteria be? We have a strong preference for qualitative criteria. These criteria could be supplemented with an indicative list of collateral types and permissible cash reinvestment parameters (offering non-exhaustive examples). So, while an indicative list can provide guidance, the UCITS has to consider liquidity, volatility and correlation for different loan /collateral combinations in order to assign appropriate levels of over-collateralisation and issuer limits. For our view on the re-use of received collateral please see our answer to (10). (7) What is the market practice regarding haircuts on received collateral? Do you see any merit in prescribing mandatory haircuts on received collateral by a UCITS in EPM? If you are an asset manager, please provide also information specific to your business. The level of over-collateralisation depends on liquidity, volatility and correlation of the loan / collateral combination. Below is a sample collateral matrix for equity and government debt collateral:

Loan Type Collateral Types

Equities Government Bonds

Equities 110% - 112% 108%

Government Bonds 110% - 112% 102.5% - 104%

Corporate Bonds 110% - 112% 104%

If the underlying concern is the use of securities lending by banks and brokers as a source of short-term financing, regulators should address that issue directly by imposing liquidity requirements on those banks and brokers, rather than indirectly by regulating the securities lending markets and thereby risking harm to markets and investors. Regulators should beware of the unintended consequences of certain measures to limit “pro-cyclicality”. For example, limits on changing collateral margins will have the opposite effect. If lenders cannot adjust margins on loans to a counterparty with declining creditworthiness, they will simply use a more straightforward option – recalling loans to reduce overall counterparty exposures. This, in turn, may be more pro-cyclical than allowing margin adjustments. As acknowledged in the Interim Report of the FSB Working Group on Securities Lending and Repo issued April 27 2012, significant adjustments to margins did not occur in the securities lending markets but rather in the markets for repurchase agreements (“repo”). When seeking to apply regulation in this context, regulators should bear in mind the significant commercial differences between securities lending and repo transactions. These include differences in the tax and legal treatment of the transaction, the mechanics of the transaction, the main counterparties to the transaction and the uses of the transaction. To avoid inadvertently harming securities lending markets in the process of seeking to regulate the repo markets, we encourage regulators to factor in these considerations as part of their overall analysis.

2 E.g. in Ireland http://www.centralbank.ie/regulation/industry-sectors/funds/Documents/UCITS%20Notices.pdf ,

P.119 Nr. 14

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In a financial crisis, lenders will rationally seek to reduce their exposures to certain counterparties. Given the conservative nature of the underlying lenders: pensions, insurance companies, funds, etc., this is a prudent reaction, and should not be limited or restricted. A key lesson from the financial crisis is that regulators should have access to and value market signals such as this, and the response should not be to eliminate that signal when lenders are acting rationally to protect their interests. To avoid the moral hazard associated with, and the chilling effect mandated minimum haircuts would likely have on the securities lending market, we recommend either:

that regulators require securities lending participants to have robust risk management with over-collateralisation policies in place; or

that the lender discloses the level of margins it applies to specific counterparties on a periodic basis so that regulators can effectively monitor market sentiment and subsequent client asset protection measures.

(8) Do you see a need to apply liquidity considerations when deciding the term or duration of EPM transactions? What would the consequences be for the fund if the EPM transactions were not "recallable" at any time? What would be the consequences of making all EPM transactions "recallable" at any time? BlackRock currently only engages in reverse repo transactions in UCITS, taking in government debt as collateral for investment in financial instruments. EMIR, however, may lead us to use repo more broadly to raise cash to post as variation margin with CCPs. Generally, we would be concerned about additional limitations being imposed on the repo markets through further revisions of the UCITS Directive. Restricting the ability of a UCITS to enter into non-recallable repo transactions would ultimately increase frictional cost, reduce the number of counterparties willing to take on the additional risk of fully recallable repo transactions and suppress activity in the repo markets. End-investors benefit most when the capital transfer mechanism is as efficient as possible; efficient capital transfer mechanisms create liquidity and liquidity ultimately reduces costs for end-investors. In other words, absolute restrictions on repo transactions would ultimately translate into a performance drag for end-investors whilst concentrating risk in a smaller number of counterparties. Specifically, an absolute restriction on the ability of a UCITS to enter into non-recallable repo transactions would, we believe, transform the behaviour of UCITS counterparties. UCITS counterparties would demand a reciprocal right to recall assets, potentially giving rise to detrimental consequences for a UCITS and its investors. In particular, it would result in a greater tendency towards overnight repo financing, thus weakening the stability of UCITS funding arrangements. This means that a UCITS would be more susceptible to re-rates/punitive haircuts and circumstances where, to satisfy redemption requests, it is obliged to sell positions into a precipitously declining market. We therefore believe that UCITS funds should be permitted to enter into term transactions as long as the necessary risk parameters are in place to ensure that only a suitable proportion of the UCITS is lent on a term basis. For securities lending, the same rationale for term transactions applies. When determining the appropriate amount of term transactions, a UCITS should always consider its own redemption and liquidity requirements. As most term activity is undertaken with the right to substitute individual securities, this activity does not impede on the UCITS ability to sell individual investments.

(9) Do think that EPM transactions should be treated according to their economic substance for the purpose of assessment of risks arising from such transactions? In our view this is already the case. (10) What is the current market practice regarding collateral provided by UCITS through EPM transactions? More specifically, is the EPM counterparty allowed to re-use the assets provided by a UCITS as collateral? If so, to what extent?

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The EPM counterparty is generally allowed to re-use collateral. In BlackRock’s lending programme however, the collateral received by the UCITS is not re-used, and we understand this is market practice across the securities lending industry. A full transfer of title takes place and the collateral is typically held in a ring-fenced tri-party account in the name of the UCITS. (11) Do you think that there is a need to define criteria regarding the collateral provided by a UCITS? If yes, what would be such criteria? We do not see the need for any additional requirements. (12) What is the market practice in terms of information provided to investors as regards EPM? Do you think that there should be greater transparency related to the risks inherent in EPM techniques, collateral received in the context of such techniques or earnings achieved thereby as well as their distribution?

We believe the following information should be provided to end-investors:

Educational materials Risk factors Collateral / counterparty policy Compensation arrangements for provision of securities lending services Benefit earned by the UCITS through securities lending

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4. Over the counter (OTC) derivatives: treatment of OTC derivatives cleared through central counterparties, assessment of the current framework regarding operational risk and conflicts of interest, frequency of calculation of counterparty risk exposure

General comments As a general introduction to our answers on counterparty exposure, we set out below some general comments on how BlackRock manages counterparty risk. To this end, BlackRock established in 2005 a dedicated Counterparty & Concentration Risk Group (part of its RQA Group), which leads the firm’s global process for managing counterparty risk. The Group is responsible for managing credit risk in all trading relationships with counterparties and to that end coordinates with Credit Research, Portfolio Management, Operations, and data integrity functions across the organisation. The Group monitors and assesses counterparty exposures arising from a wide range of instruments that include derivatives, mortgage TBAs, foreign exchange, financing trades (repo and securities lending), equities, and other forward-settling transactions. Reporting is generated to show aggregate risk exposures by counterparty and by portfolio. The Counterparty & Concentration Risk Group has developed firm-wide “Counterparty Credit Policy and Procedures”, and is responsible for implementing, updating and enforcing it, as follows:

1. Assess prospective counterparty creditworthiness and approve counterparties;

2. Measure and monitor credit exposure to each counterparty, broken out by asset classes;

3. Monitor financial performance of counterparties in order to establish, confirm, or adjust exposures as needed;

4. Monitor levels of exposure by product, by tenor, and by counterparty, and provide feedback to

portfolio management when aggregate exposures warrant; and

5. Provide guidance and supervision of credit issues for ISDA and other derivatives documentation.

The firm has so-called “Credit Alert Procedures” which serve as a guideline for the action and interaction of key BlackRock constituencies in the case of a counterparty-related “credit event.” These procedures specifically contemplate the coordination among the Counterparty & Concentration Risk, Portfolio Management, Legal, and Operations groups in order to facilitate BlackRock’s ability to make timely and informed decisions following the recognition of credit concerns. The major aspects addressed include fact-finding, communication, liquidation and close-out, and key roles and responsibilities. BlackRock's Counterparty Approval Process BlackRock focuses primarily on counterparty credit risk and counterparty reputation risk. Counterparty credit risk is the potential loss that BlackRock or our clients' accounts could incur if a counterparty is unable to perform on its trading commitments. Reputation risk is defined as the risk to earnings or capital arising from negative public opinion. The process by which we select broker/dealer counterparties for transaction purposes is outlined below:

Determine the nature of the proposed transaction activity:

What are the securities to be traded? What is the expected volume by security?

Determine the settlement and delivery procedure: How are we going to receive monetary compensation in exchange for delivering the particular security in question? If we are going to receive securities, how is the counterparty going to deliver

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those securities? Is settlement through an established clearing platform or is there also a physical settlement? From a delivery risk perspective, we view DTC and Fed settlement along with settlement through several other established trading and clearing platforms to be of limited risk.

We view settlement via other methodologies as bearing potentially significant risk, and generally limit it to only those counterparties who have had investment grade debt ratings (for senior unsecured debt) for an extended period of time. Please see our further comments on using CCPs below.

Determine if the proposed counterparty settles "directly" or uses a correspondent:

Most "agency" counterparties utilise correspondents to clear securities for them. If they do so, who are they using? On what basis are they clearing (fully disclosed or otherwise)? BlackRock will only accept clearing correspondents that are well-capitalised, well-established, and possess a favourable reputation in the marketplace.

Settlement risk tolerance levels:

BlackRock has established tolerance levels for our exposure to settlement risk (defined as a credit balance on all trades outstanding but not settled). The level reflects our settlement risk tolerance per counterparty and is monitored by BlackRock's Counterparty & Concentration Risk Group, Operations, and Compliance personnel on a daily basis. If the limit is exceeded, the trade details are reviewed in concert with the counterparty's financial strength in order to determine if any intervention is required.

Financial review:

Our view is that the level and trend of excess regulatory capital, as shown in a counterparty’s financial information, is the principal barometer of the financial strength of that counterparty. Most brokerage firms are required to calculate and report this figure to regulatory authorities on a periodic basis. We are directly interested in ensuring that the process is maintained. Therefore, investment grade counterparties are monitored as part of our on-going credit research process, which includes daily corporate bond morning meetings and monthly watch list meetings. Our credit research analysts review financial statements on a quarterly basis. As previously stated, non-investment grade counterparties are required to clear through well -established clearing correspondents and are limited to short settlement trades. Current regulatory financial filings are reviewed on an on-going basis.

Counterparty Monitoring BlackRock prefers to have multiple counterparties for liquidity, risk management, and best execution purposes. The counterparties with which we trade must have broad market coverage. With respect to OTC derivatives, exposure to each counterparty is monitored, and agreements are diversified to minimise exposure to individual counterparties. Positions are marked-to-market on a regular basis. BlackRock’s standard approach is to negotiate threshold limits in each agreement at zero, minimum transfer amounts to $500,000, and independent amounts (or initial margin) are set to zero. Margin calls are made on a dealer-by-dealer basis for each portfolio in line with respective master agreement terms. To monitor post-trade counterparty risk, BlackRock has a strong technological infrastructure and proprietary internal review processes in place, including a proprietary derivatives collateral management system. This system automates daily monitoring of collateral requirements for OTC derivative instruments (including forward FX trades as applicable) governed by master agreements. BlackRock also has a number of reporting tools that allow us to manage counterparty exposure, balancing net exposures to our different counterparty. Where necessary, credit risk exposure to counterparties can be adjusted, both at the individual portfolio level and at the aggregate firm-wide level. (1) When assessing counterparty risk, do you see merit in clarifying the treatment of OTC derivatives cleared through central counterparties? If so, what would be the appropriate approach?

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The nature of counterparty exposures for cleared derivatives (vs. bilateral uncleared trades) will be different given the construct of executing broker, clearing member (DCM) and the central counterparty (CCP). Once a trade is accepted for clearing, counterparty risk transfers away from the executing broker and to the CCP itself (and to some extent the clearing member if accessing the CCP indirectly). This occurs irrespective of the use of an exchange platform.

Commission Recommendation 2004/383/EC (27

th April 2004) Para 5.1 states the following with

regards to limitations of counterparty risk exposure of OTC derivatives: “Member States are recommended to ensure that all the derivatives transactions which are deemed to be free of counterparty risk are performed on an exchange where the clearing house meets the following conditions: it is backed by an appropriate performance guarantee, and is characterized by daily mark – to market valuation of the derivative positions and an at least daily margining.” Centrally cleared contracts meet these criteria (regardless of being performed on an exchange). The G20 commitment to clear all eligible products recognises the reduction in systemic risk brought about through the use of a central counterparty and seeks to mandate and incentivise clearing wherever possible. UCITS funds then should not face any limits on exposures to authorised CCPs or be required to diversify this risk to multiple CCPs provided that collateral and positions are individually segregated and not at risk of a default by another market participant or their elected clearing member. To this end, we support the view expressed recently by Commission officials that centrally cleared swaps are not the type of derivatives which UCITS rules on counterparty exposure intend to capture. (2) For OTC derivatives not cleared through central counterparties, do you think that collateral requirements should be consistent between the requirements for OTC and EPM transactions? We do not believe it is appropriate to dictate that collateral requirements for OTC derivatives transactions and EPM (securities financing) transactions be consistent. The nature (purpose, usual duration, legal entity counterparty, legal agreement terms, market operational practices) are different, thus flexibility should be maintained to allow for the most appropriate risk management practices given the particular transaction/structure/counterparty combination. (3) Do you agree that there are specific operational or other risks resulting from UCITS contracting with a single counterparty? What measures could be envisaged to mitigate those risks? The level of risk resulting from a UCITS trading uncleared transactions with a single counterparty will depend upon the nature and amount of current and/or potential counterparty exposure the UCITS actually has at a given point in time. It is prudent for a UCITS to have available to it several quality counterparties from a credit worthiness, as well as market and operational capability standpoint. However, at any particular point in time, it is conceivable that a UCITS may only have a modest amount of counterparty exposure and it may in fact be to a single counterparty. The existing counterparty risk exposure limits under the UCITS Directive already restrict the potential for excessive concentration since the limit is set as a percentage of the UCITS assets and eligible collateral is prescribed.

We do not believe that a UCITS clearing through a prudentially managed CCP represents material risk to that UCITS even where the UCITS clears through a limited number of CCPs or a single entity we will only clear through a CCP for certain trades. In some cases, it may be prudent to use multiple CCPs to reduce reliance on a single entity but this may not always be an option for any given asset class and jurisdiction. Currently for instance, there is only one CCP (LCH Swap Clear) capable of clearing IRS for indirect clients. Operational and collateral efficiency require the utilisation of a limited (or single) CCP in each asset class and requiring excessive diversification would increase exposure through the loss of netting benefits as well as impacting returns. Prudential management of clearing arrangements would entail the appointment of a ‘back up’ clearing member for end users accessing the CCP indirectly (in case of the default of the primary clearing member) and regulators should consider making this a requirement of a UCITS along with an appropriate level of segregation over and above an omnibus account structure.

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(4) What is the current market practice in terms of frequency of calculation of counterparty risk and issuer concentration and valuation of UCITS assets? If you are an asset manager, please also provide information specific to your business. Market best practice is to calculate counterparty exposure on a daily basis. BlackRock’s practice is to calculate current (mark-to-market) net counterparty exposure on a daily basis for all UCITS. Specifically, exposure is calculated net of the market value of collateral received from (or posted to) a legal entity counterparty and netting is applied as contractually allowed per governing legal agreements. We believe it is best practice for OTC transactions to have these calculations and valuation made on a daily basis for all pooled funds (not just UCITS) due to the potential complexities, valuation uncertainties and effects of leverage. (5) What would be the benefits and costs for all stakeholders involved of requiring calculation of counterparty risk and issuer concentration of the UCITS on an at least daily basis?

As is the case for daily asset/contract valuation, daily counterparty exposure calculation provides for a significant degree of transparency and active management of counterparty risk, allowing for the most appropriate risk mitigation/reduction actions (e.g. diversification, hedging and margining) to be taken as deemed appropriate. As for costs, for firms which do not have a fully integrated collateral management team, there would presumably be increased costs to introduce or upgrade this function either internally or through an outsourced solution. However, most of the market data and models involved in these calculations for OTCs are set up for daily updates, so the costs for other institutions to run these more regularly should not be drastically different to running weekly or monthly. (6) How could such a calculation be implemented for assets with less frequent valuations?

For the transparency and risk management requirements for OTCs under UCITS, our interpretation is that there should not be material exposure in OTCs which cannot be valued on a daily basis, except for funds which limit open trading days. If for some reason certain OTCs can only be valued monthly, then you could attempt to approximate pricing and risk measures daily with reference to some kind of proxy data which updates daily. BlackRock does this for certain holdings of externally managed funds which only price monthly (usually for segregated portfolios, or limited exposures in non UCITS funds), by applying “drifted” prices according to mid-month moves of an appropriate benchmark index or proxy. This can allow for more up-to date risk measures to be calculated, which can then be calibrated against the actual measures when these valuations are reconciled at the end of the month.

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5. Extraordinary liquidity management rules: assessment of the potential need for uniform guidance in dealing with liquidity issues

General: By way of background, we support the principles set out in the recently published principles outlined in the IOSCO Consultation Report on Principles of Liquidity Risk Management for Collective Investment Schemes. BlackRock welcomes the focus given by those principles and believes that they reflect best practice in many regulated structures like those falling within the scope of EU Directives such as UCITS. We do propose a number of specific actions in connection with the following themes:

Focus not only on redemption restrictions but also on the life cycle of a UCITS and the wider management context.

Focus on liquidity issues raised by less liquid assets.

Acknowledge the role of liquidity risk management.

Distinguish between liquidity management for collateral as opposed to the UCITS investment portfolio.

We believe that UCITS provides an appropriate framework for identifying, managing and monitoring conflicts of interest arising between investors wishing to redeem their investment(s) and those investors wishing to maintain their investment(s) in the portfolio. As a general principle, we believe that duties of the fund boards to investors mean liquidity policies should be applied in a manner which is consistent with the fair treatment of investors taking into account the impact on underlying prices and/or spreads of the individual assets of the UCITS, as well as its investor base. We recommend focussing on the overall portfolio liquidity using qualitative measures and not just measuring liquidity in terms of individual positions. It is important that liquidity measures be aligned with pricing policies and committees, taking into consideration the provision for ad hoc reviews particularly in times of market stress. (1) What type of internal policies does a UCITS use in order to face liquidity constraints? If you are an asset manager, please provide also information specific to your business. Discussions relating to liquidity measures typically focus on the challenges of meeting redemption requests. It is also important, in the case of open-ended funds (such as UCITS), for management companies to focus on liquidity issues throughout the life-cycle of a fund. Liquidity issues vary depending on whether the UCITS is in start-up mode, taking in large numbers of subscriptions as well receiving high levels of redemptions. It is also important to situate the UCITS in the wider context of the manager’s book of business. In specialised or growth markets, a key issue governing liquidity is the size of the underlying markets. If a fund grows too quickly or too large it may not be able to invest in available assets without damaging its liquidity profile. In this case, the manager will need to prepare for and consider a variety of options, such as temporary closure to new subscriptions, offering limited issue shares and/or providing suitable warnings to investors of market constraints. The investment manager may also be managing a number of separate funds (e.g. UCITS, AIF, US RIC) as well as segregated accounts, all investing in the same market. In this case, to ensure a fair allocation of liquidity across all of its end investors, the manager will also need to consider liquidity issues across its entire book of business. The liquidity challenges faced by a UCITS can change significantly depending on whether the UCITS is in its launch phase or whether it is well established. We would stress the need for continuous engagement by the management company with its portfolio and risk managers to assess whether specific measures need to be taken to manage liquidity. Powers to protect shareholders’ interests on redemptions Typically the following actions can be used to remedy the potential dilutive effect of a large redemption:

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1. Prior agreement In practice, when requests for redemptions on a specific day are likely to exceed the relevant threshold stated in the prospectus, BlackRock’s relationship managers will attempt to contact the shareholder(s) making the largest requests by value and work to negotiate a phased approach to redemption so as not to have to defer redemptions. Our normal process would be to agree to stagger the redemption request over an additional dealing day. It is not always possible to contact such large clients in time to agree a staggered investment approach to redemption, especially where they are based in a different time zone. In such scenarios, we may consider forcing a limited deferral if other tools are not available. 2. Prior notice In some cases, it is possible to set up the UCITS with prior notice provisions on redemptions so that managers have more time to seek liquidity in the market to meet redemption requests. 3. In specie redemptions Some types of investors may be prepared to take redemptions in specie rather than have the assets sold for them at times of market illiquidity, especially if they are seeking reallocation of existing portfolios rather than necessarily seeking cash proceeds. In these instances, there need to be appropriate safeguards on valuation, typically overseen by the depositary or the UCITS’ auditor. 4. Deferred redemptions

Liquidity can be a distinctly variable factor, and there will be times when particular markets become relatively "thin". Very occasionally, the size of a particular trade can give rise to concern regarding the impact on asset prices or may, in our view, not realistically be able to be executed in markets in one day owing to constrained liquidity. Such concerns would give rise to the risk that prices realised for assets are likely to be below those used to value the fund on that day. Most commonly the key concern is in respect of markets which are closed at the UCITS’s valuation point (i.e. typically Asian markets). These circumstances open the fund to market risk i.e. the risk that the prices used to value the fund on the day of the redemption will be above those available when the relevant markets re-open the next day. If this is the case, our preference would be to seek to defer an element of the trade and so act always in the best interests of remaining shareholders. In some, but not all EU jurisdictions, a UCITS may defer redemptions received on the same dealing day which exceed a certain level, typically 10%. In practice, we are commonly able and do facilitate redemptions from our funds well in excess of 10% of portfolio assets because there is sufficient liquidity in the underlying markets and the markets in question are open at the time of the UCITS’ valuation point. We only consider deferral when at least one of these factors is not present. We see deferral as an exceptional process which ideally would be applied to a limited number of trades on a specific day. Typically, national rules require deferred redemptions to apply pro rata across all redemptions on a specific day. Where the power is available, typically a request so deferred must be treated as if the request had been made for the following dealing day or days until full settlement of the original request. An alternative view is that it is in the best interest of all these shareholders and other shareholders of the fund to allow redemptions of the vast majority of investors and apply deferred redemption only to the largest redemption requests. Operationally, it is a complex process to reverse all redemption instructions across the board, especially when many of those are received using straight-through processing systems. As such, deferred redemptions are rarely in practice. (2) Do you see a need to further develop a common framework, as part of the UCITS Directive, for dealing with liquidity bottlenecks in exceptional cases? We believe that it is important to have a range of tools at the fund’s disposal to manage the different causes which may give rise to liquidity bottlenecks both on an on-going basis (e.g. in specie redemptions and deferred redemptions) and on exceptional basis (such as suspensions). Given the

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various and often unpredictable reasons which may give rise to liquidity issues, we recommend that any legislation sets out key principles which then have to be applied by the UCITS in consultation with its competent authorities. (3) What would be the criteria needed to define the "exceptional case" referred to in Article 84(2)? Should the decision be based on quantitative and/or qualitative criteria? Should the occurrence of "exceptional cases" be left to the manager's self-assessment and/or should this be assessed by the competent authorities? Please give an indicative list of criteria. We consider that, in the context of a UCITS, the fund boards’ overriding duty to investors as a whole should be to ensure that redemption requests from individual investors can be met to the extent possible without damaging the interests of remaining investors. This is of course closely linked into UCITS requirements to maintain investment in sufficiently liquid assets to meet on-going redemption requests. There are a number of different causes for liquidity constraints which mean that managers require a variety of tools to deal with the differing causes of liquidity constraints. In these circumstances, the potential for a conflict of interest between the interests of different investors typically arises when one or more investors with significant holdings present redemption requests that, when aggregated with redemption requests from all other investors on that day, in total represent more than the relevant thresholds. In terms of redemptions, issues in meeting redemption requests may arise when requests for redemption in aggregate exceed 10% of the NAV of a UCITS. Forced redemption above these limits may lead to the UCITS concerned having to dispose of a significant level of assets at times where market liquidity is relatively thin, thus causing repricing of assets and artificially depressing the net asset value of the UCITS while incurring dealing costs to the detriment of remaining holders in that UCITS. This, of course, is not always the case and in many cases there are no material liquidity issues and redemptions in aggregate above the relevant thresholds can be met without adversely affecting remaining investors, meaning liquidity management tools would not need to be exercised. (4) Regarding the temporary suspension of redemptions, should time limits be introduced that would require the fund to be liquidated once they are breached? If yes, what would such limits be? Please evaluate benefits and costs for all stakeholders involved. This should be a matter for consultation between the UCITS and its regulators; otherwise the UCITS runs the risk of locking in losses at the worst part of a market cycle. We would prefer regular reporting between the UCITS and its competent authority justifying the continued suspension of the UCITS. (5) Regarding deferred redemption, would quantitative thresholds and time limits better ensure fairness between different investors? How would such a mechanism work and what would be the appropriate limits? Please evaluate benefits and costs for all the stakeholders involved.

If a common European framework is sought, we would recommend allowing as many redemptions as possible to be executed on a day (hence maintaining daily liquidity for as many investors as possible) whilst focussing on, and if necessary deferring, the redemptions of certain large professional investors whose proposed activity has resulted in the issue of potential deferral arising in the first place. This avoids small retail investors being caught up in a process which is really designed to protect on-going investors from the costs of executing redemptions for large professional investors. We have considered a minimum threshold such as a percentage of net asset value represented by the redemption but consider this would be too blunt a test given its overriding aim to allow as much of the redemption(s) to take place without compromising the interests of remaining investors. In addition, such a policy would not allow us to take into account the different assets under management of the sub-funds within our range and varying liquidity profiles of the various sub-funds. An investor able to make a significant redemption is almost invariably going to be a professional investor such as a discretionary asset manager, fund of fund, structured provider or insurance company, whereas the smaller shareholders are typically directly invested retail holders. In most

24

cases, waiting or splitting large redemption requests over a day to meet large redemption requests would be sufficient to satisfactorily resolve these competing demands. (6) What is the current market practice when using side pockets? What options might be considered for side pockets in the UCITS Directive? What measures should be developed to ensure that all investors' interests are protected? Please evaluate benefits and costs for all the stakeholders involved. We do not currently use side pockets in any of the UCITS we manage, though we do have provision for side pockets in a number of AIFs. If side pockets are considered for retail funds, then as noted in the ESMA AIFMD advice, this should include disclosure of notice periods in relation to redemptions, details of lock-up periods, an indication of circumstances in which normal redemption mechanics might not apply or may be suspended, together with details of any measures which may be considered by the responsible entity, such as gates, side pockets, lock ups, closure to new subscriptions or penalties. Given the retail focus of many UCITS, we recommend focussing on the clarity of the description of the relevant measures in the CIS’s offering documents and associated marketing documents. (7) Do you see a need for liquidity safeguards in ETF secondary markets? ETFs are intended to be traded on the secondary market on regulated stock exchanges. These venues have existing rules on the provision of liquidity providers for secondary market trading of ETFs, as well as other equities. The exchanges also have detailed rules covering market disruptions and volatility events for all traded securities. Both sets of rules are approved and regulated by the relevant supervisory body of the exchange domicile. We feel that these rules are sufficient to ensure the efficient functioning of the secondary markets. In addition, we would advocate that the benefits of an independent multi-dealer model, with many approved market makers and authorised participants, ensures the best possible provision of liquidity for investors without compromising long-term fund holders. Should the ETF provider be directly involved in providing liquidity to secondary market investors? We feel that the liquidity needs of clients on the secondary markets are best served by competition amongst many different liquidity providers, and that, in fact, it is this competition among trading firms that serves to tighten spreads and deepen the order book on secondary markets. Where ETF issuing entities choose to engage in the market making of their own funds, this activity can discourage the participation of non-affiliated firms in the quoting of that issuer’s product. This may then lead to less competition and the benefits aforementioned. This could be detrimental to both the existing fund holders and the new investors. We would be supportive of multi-dealer models with multiple liquidity providers and authorised participants. What would be the consequences for all the stakeholders involved? Should an ETF provider trade directly with any investor in the secondary market, there would be a number of potential issues:

Loss of independence in price formation. ETF issuing entities are not best placed to form pricing of the product in secondary markets. This is best done by multiple expert market makers who ensure best execution for clients in a competitive environment.

Trading directly in the secondary markets could expose existing fund holders to any potential risks associated with such trading. In the primary market environment, the fund only transacts with authorised participants. The selection criteria of authorised participants in the primary market helps to protect existing fund holders from any transaction risk. This would not be the case if a fund were to transact with any market participant on the secondary market.

Secondary trading could also create potential conflicts of interest for the issuing entity. If the liquidity provision entity is the same as the issuing entity, they could potentially have

25

preferential access to price sensitive data including for example, rebalancing activity, dividend data, and fund composition.

Do you see any other alternative? We would suggest that our current multi-dealer model is the most robust setup to ensure continuous secondary market liquidity whilst also minimising existing investors risks from trading activity (as a guide iShares has around 40 authorised participants and market makers). In the event of multiple market maker and authorised participant absence or failure (which we consider would be a near doomsday scenario), we would suggest that the most appropriate action would be for the fund(s) to close by selling the assets in the funds, assuming this could be done in the absence of any brokers, and returning cash to investors via the dividend payment methodology. (8) Do you see a need for common rules (including time limits) for execution of redemption orders in normal circumstances, i.e. in other than exceptional cases? If so, what would such rules be? A number of national rules and practices have developed over time and are generally strictly enforced. Provided the UCITS clearly discloses the time limits for executions, we do not see the need for additional rules.

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6. Depositary passport: assessment of whether or not to introduce a cross border passport for the performance of the depositary functions set out in the UCITS Directive.

(1) What advantages and drawbacks would a depositary passport create, in your view, from the perspective of: the depositary (turnover, jobs, organisation, operational complexities, and economies of scale …), the fund (costs, cross border activity, enforcement of its rights …), and the competent authorities (supervisory effectiveness and complexity …), and the investor (level of investor protection)?

We do not believe there will be overriding benefits in developing a depositary passport at this stage in the development of the UCITS framework. As a general comment, while we acknowledge there are potential opportunities to develop the single market by promoting a depositary passport, we do not see that there are pressing operational or commercial requirements to do so.. The arguments in favour of such an initiative need to be carefully balanced to avoid compromising the on-going consistency of investor protection and regulatory oversight. We also note that under the UCITS V proposals, the eligibility of entities able to act as depositaries is being reduced which, if applied on a cross-border basis, is likely to lead to a concentration of providers which would negate possible competition benefits. Potential benefits Benefits of the depositary passport might include:

The developments of cross-border services by potentially reducing the organisational costs of due diligence for managers when setting up fund operations in a new jurisdiction by allowing them to rely on existing relationships in their home country.

Providing for greater operational certainty and oversight if the management company and depositary are located in the same jurisdiction. We believe there are relatively few examples of the use of the management company passport to date. Before introducing a depositary passport, we recommend first analysing feedback from regulators as to the success or otherwise of supervision of UCITS with a cross-border management company.

Operational simplicity and greater operational resilience if the depositary of master and feeder funds were the same legal entity.

Providing greater competition in markets where there are few players. However, in BlackRock’s key UCITS domiciles, we consider that there is already a competitive landscape, which encourages active competition not only on price but also on quality of service.

Challenges of applying a depositary passport Set against the potential benefits are a number of serious concerns relating to investor protection and regulatory oversight.

The challenges associated with having a fund in jurisdiction A, having a depositary in jurisdiction B, and a manager in jurisdiction C. We believe this scenario presents significant issues in respect of the coordination of regulatory oversight between the competent authorities of the UCITS and its functionaries. A clear hierarchy of controls and supervision would need to be established so that it is clear to regulators, managers, depositaries and investors which regulatory authority takes overall control in a crisis situation. This would require a complex web of cross-border regulatory cooperation and joint supervision. While aspirational. this will be difficult to implement given other existing regulatory priorities, as well as running the risk of investors being subject to a game of regulatory pass the parcel.

We also believe that a prerequisite for an effective provision of depositary services is the cross border coordination of custody, insolvency and securities law. Until initiatives such as UCITS V and the Securities Law Directive have been finalised, we think it is premature to push forward a depositary passport. Otherwise, investors in different UCITS in the same jurisdiction run the risk of

27

being subject to different regulatory outcomes dependent on the location of the depositary of the fund.

Tax considerations also need to be taken into account especially for non-corporate funds as locating the depositary outside the jurisdiction of the fund could change national tax authorities’ treatment of a fund.

ESMA’s role in coordinating the supervision of any cross-border provision of services is essential in avoiding investors being confused as to which regulator is in charge in the event of a depositary being in breach of its duties. Given ESMA’s current and projected future workload, any extension of oversight will need to be matched by appropriate resources within ESMA and/or at individual national regulators.

(2) If you are a fund manager or a depositary, do you encounter problems stemming from the regulatory requirement that the depositary and the fund need to be located in the same Member State? If you are a competent authority, would you encounter problems linked to the dispersion of supervisory functions and responsibilities? If yes, please give details and describe the costs (financial and non-financial) associated with these burdens as well as possible issues that a separation of fund and depositary might create in terms of regulatory oversight and supervisory cooperation. We do not encounter problems with the requirement for the fund and depositary to be located in the same member state. We believe it contributes to the effective control and supervision of the UCITS and provides valuable focus by the local depositary on developments in regulatory and operational best practice which is of great benefit to the UCITS. Any change would need to ensure a similar level of coordination and control with, say, joint monitoring teams. (3) In case a depositary passport were to be introduced, what areas do you think might require further harmonisation (e.g. calculation of NAV, definition of a depositary's tasks and permitted activities, conduct of business rules, supervision, harmonisation or approximation of capital requirements for depositaries…)? Given that there are different national regimes which currently apply to depositaries, we believe it would be important for depositaries relying on a passport to be subject to a clear regulatory regime as is the case for management companies under UCITS IV. (4) Should the depositary be subject to a fully-fledged authorisation regime specific to

depositaries or is reliance on other EU regulatory frameworks (e.g., credit institutions or investment firms) sufficient in case a passport for depositary functions were to be introduced?

We believe that such a specific authorisation is appropriate. This will ensure that appropriate focus is placed on the specific fiduciary duties and liabilities of depositaries, rather than being subsumed within

wider regulation of banks and credit institutions. (5) Are there specific issues to address for the supervision of a UCITS where the depositary is

not located in the same jurisdiction?

As mentioned above, it is essential to ensure that a rigorous supervisory framework can be established with a clear hierarchy of regulatory responsibilities between the relevant competent authorities overseen by ESMA.

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7. Money Market Funds (MMF): assessment of the potential need to strengthen the resilience of the MMF market in order to prevent investor runs and systemic risks

(1) What role do MMFs play in the management of liquidity for investors and in the financial markets generally? What are close alternatives for MMFs? Please give indicative figures and/or estimates of cross-elasticity of demand between MMFs and alternatives.

Money market funds (MMFs) play a critical role in the financial markets and broader economy, bringing together issuers of and investors in short-term financial instruments. MMFs produce important benefits to borrowers in the capital markets, that is, issuers of commercial paper, certificates of deposit and sovereign and supranational securities such as sovereigns, their agencies, corporations and financial institutions. Issuance in the market is driven by institutional entities’ collective and individual need for short-term funding. In times of market stress, banks are quick to reduce lending, especially inter-bank lending, and outside of national borders. MMFs often provide a cheaper, more stable, cross-border source of funding that is able to respond rapidly and in a market-based manner to the needs of borrowers, for example through reverse enquiries for financing. A significant reduction in the size of the MMF market would raise funding costs for issuers and make banks more reliant on the inter-bank lending market for their funding. The investor side is equally diverse and includes corporations, sovereigns and their agencies, public sector entities, pension plans, mutual funds, venture capital trusts, foundations, charities, universities and individuals. Investors are attracted to MMFs because they offer capital preservation, liquidity, ease of operation and accounting and (depending on the interest rate environment) competitive money market returns relative to bank deposits and other forms of direct investments. Equally importantly, money market funds are diversified pools of high quality short term debt instruments which many investors represent a favorable alternative to single-counterparty risk exposure through bank deposits or direct instruments.

3 Many investors value, in particular, the fact that the MMF portfolio holdings are ring-

fenced from the balance sheet of the MMF provider and distributor by being held in third party custodial accounts. Institutional investors use MMFs for a wide range of liquidity-related purposes including as working capital investments, asset allocation vehicles, to avoid single counterparty risk exposure on the cash held within investment portfolios, as collateral vehicles and for holding cash reserves. Individual investors often use MMFs as savings vehicles or to hold cash balances within their retirement or investment portfolios. MMFs invest in short term debt instruments which are also often their closest substitutes and alternatives for cash investors buying instruments directly. These instruments include commercial paper issued by financial and non-financial institutions, asset-backed commercial paper, repurchase agreements, time deposits, certificates of deposit and sovereign or sovereign agency-issued bills, notes and bonds. However, it is important to recognize that MMF investors are drawn to the diversification inherent in the mutual fund structure and the additional constraints around counterparty concentration risk imposed through regulation (i.e. EC UCITS parameters around diversification) or credit rating agencies requirements. As a result, the utility that many MMF investors derive from their diversification cannot easily be replicated by either retail or many institutional investors. Institutional investors are driven primarily by their desire for capital preservation, diversification and liquidity rather than yield, particularly in the current low rate environment. As a result there is less cross-elasticity or volatility in MMF balances relative to overnight bank deposits or other direct instruments than might be assumed.

3 Source: BlackRock Viewpoint: Money Market Funds: Potential Capital Solutions

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The Institutional Money Market Funds Association (IMMFA) is a European trade association whose members are promoters of triple-A rated money market funds (the funds). In this response we refer to the IMMFA Code and data provided by IMMFA. This can be evidenced through the relative stability of U.S. and IMMFA MMF balances over the past two years. MMFs provide an important and unique role in the cash investment landscape through their ability to provide investors with liquidity and capital preservation combined with diversification. (2) What type of investors are MMFs mostly targeting? Please give indicative figures. European investors in MMFs are largely institutional. The percentage of distributor/private clients investing in IMMFA MMFs, for example, varies between roughly 10% and 20%. We do not have similar data for the overall MMF industry but understand that French MMFs have a similar profile with approximately 30% of AUM represented by distributor / private clients. The largest institutional client types investing in IMMFA MMFs are corporates, asset managers and pension funds, insurance companies and finally other segments such as local authorities and venture capital trusts

4. The client weightings differ according to the currency of denomination of the MMF.

Corporates and distributor/retail clients represent a higher percentage of Euro MMFs, for example, while pension funds and asset managers represent a higher percentage of sterling denominated MMFs than for other currencies. (3) What types of assets are MMFs mostly invested in? From what type of issuers? Please give indicative figures.

Money market instruments are typically issued by sovereigns, supra-national entities and financial institutions. Prime MMFs (credit MMFs) invest primarily in time deposits, certificates of deposit and commercial paper. Government MMFs invest primarily in treasuries, government bonds and repos. IMoneynet collects data for IMMFA on the asset allocation of member’s MMF. According to the IMMFA Money Fund Report as end September 2012

5, the average asset allocation for IMMFA Prime

MMFs in percentage terms was as follows:

30/09/2012 Treasury (wk/mo-

%)

Govt Other

(wk/mo-%)

Repos (wk/mo

-%)

TDs (wk/mo-%)

CDs (wk/mo-

%)

CP (wk/mo-

%)

FRNs (wk/mo-

%)

Other (wk/mo-%)

ABCP (wk/mo-

%)

Euro Prime 4 2 12 22 18 32 4 1 5

Sterling Prime 1 1 7 22 28 32 5 - 3

USD Prime 3 1 15 14 20 34 7 1 5

The equivalent figures for IMMA Government MMFs in percentage terms were as follows:

30/09/2012 Treasury (wk/mo-

%)

Govt Other

(wk/mo-%)

Repos (wk/mo-

%)

TDs (wk/mo-

%)

CDs (wk/mo-

%)

CP (wk/mo-

%)

FRNs (wk/mo-

%)

Other (wk/mo-

%)

ABCP (wk/mo-

%)

Euro Govt 33 16 41 - - 10 - - -

Sterling Govt

30 2 68 - - - - - -

USD Govt 30 4 64 - - - 2 - -

4 Source: IMMFA

5 Source: IMMFA and iMoneyNet

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(4) To what extent do MMFs engage in transactions such as repo and securities lending? What proportion of these transactions is open-ended and can be recalled at any time, and what proportion is fixed-term? What assets do MMFs accept as collateral in these transactions? Is the collateral marked-to-market daily and how often are margin calls made? Do MMFs engage in collateral swap (collateral upgrade/downgrade) trades on a fixed-term basis? MMFs, primarily Government MMFs, frequently engage in repo transactions but almost invariably do not engage in securities lending. The repurchase agreement market is one of the largest and most actively traded sectors in the short term credit markets and an important source of liquidity for both MMFs and institutional investors. Repurchase agreements are used by MMFs to invest surplus cash on a short term basis and by dealers as a key source of secured funding. Securities dealers use these deals to manage their liquidity and finance their inventories. There are three types of repurchase agreements used in the markets: deliverable, tri-party and held in custody. Tri-party agreements are most commonly utilized by money market funds. Repurchase agreements are typically done on an overnight basis, while a small percentage of deals are set to mature longer and are referred to as “Term Repo.” Additionally, some deals are referred to as “Open,” and have no end maturity date, but allow the lender or borrower to mature the repo at any time. In a deliverable repurchase agreement, a direct exchange of cash and securities takes place between the borrower and lender. As mentioned, the most widely used form of repurchase agreements by money market funds is referred to as the tri-party repo market. These agreements use a third party — a custodian bank or clearing organization known as the “collateral agent” — to act as an intermediary between the counterparties to a deal. The role of the collateral agent is critical: it acts on behalf of both the borrower and lender minimizing the operational burden and receiving and delivering out securities and cash for the counterparties. The collateral agent also serves to protect investors in the event of a dealer’s bankruptcy, by ensuring the securities held as collateral are held separate from the dealer’s assets. While there are several factors that impact market rates, two of the most important are the type of collateral behind a contract and the terms of a deal. Traditional, or general collateral (often referred to as GC), is comprised of government securities including treasuries, agencies and agency mortgage securities. U.S. and IMMFA MMFs are frequent investors in tripartite repurchase agreements (repo) which are generally held as overnight investments and a key component of a fund’s most liquid component. U.S. and IMMFA money market funds typically invest in GC repo backed by sovereign or sovereign-agency debt. Repo collateral is marked-to-market daily by the collateral agent, typically a custodian bank. The agent is responsible for ensuring that only collateral listed as eligible within an agreement’s collateral schedule is provided by the borrower. It is highly unusual, almost unheard of for margin calls to be made. MMFs do not typically engage in collateral swap trades on a fixed-term basis. (5) Do you agree that MMFs, individually or collectively, may represent a source of systemic risk ('runs' by investors, contagion, etc…) due to their central role in the short term funding market? Please explain. We agree that MMFs may be impacted by systemic risk as clearly highlighted by the demise of the Reserve Primary Fund in the U.S. following the bankruptcy of Lehman Brothers in September 2008. However, observers have noted that there was not so much a “run on MMFs" during the 2008 crisis; rather, there was a run on the bank credit held in MMF portfolios. Had the same end-investors invested directly with banks, they would have still redeemed or withdrawn their investments.

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The investor behaviour was rational as many thought that large parts of the banking industry were effectively insolvent during the second half of 2008 and institutional investors do not generally benefit from bank deposit guarantee schemes. The redemptions from prime MMFs did not represent fears or concerns by investors regarding the pricing structure of one type of MMF but rather their concern regarding the creditworthiness (that it, solvency) of banks. Consequently, a large part of the money redeemed from so-called prime CNAV MMFs (which had bank credit exposure) was reinvested in other MMFs that were limited to Government and Treasury-backed investments. BlackRock would urge the European Commission when reviewing this period to examine the experience of MMFs by currency of denomination as the profiles are significantly different. We believe that this reflects investors differing perceptions of the credit risk of the banking industry in the USA, continental Europe and the UK which in turn depended in part on the actions taken (or not taken) by regulators in the different areas. For example, sterling denominated MMF saw few outflows in the weeks following the Lehman’s bankruptcy; part of the reason for this is that the British Government quickly nationalized RBS and Lloyds. In contrast, investors switched more challenging levels of assets from US Dollar Prime MMFs into Treasury MMFs as large part of the US banking industry was considered insolvent. Euro denominated MMFs experienced more modest levels of redemptions as the ECB very quickly put in place more liquidity lines. Since the 2007/2008 financial crisis, two important steps have been taken to improve the resilience of MMFs in both the European and U.S. markets. The first was the tightening of Rule 2a-7 in the U.S and the introduction by the European Securities Market Authority (ESMA) of MMF guidelines in the European Union. These changes were not cosmetic but had real substance (most notably weighted average maturity and liquidity requirements, including daily and weekly liquid asset minimums in the U.S. which have been paralleled by IMMFA MMFs). The second change is not often noted but may be even more important in terms of decoupling MMFs from systemic events. Bank regulators successfully reduced the reliance of banks on the short term funding markets. Between end December 2007 and end September 2011, the Euro financial commercial paper outstanding from bank, finance company & ABCP fell by more than half, from USD $533B to $239B (source: Morgan Stanley Short Term Credit Weekly Update) ABCP outstandings now represent just $33B in Europe, the major part of which are ABCP multiseller programs and bank lending to SMEs and trade receivables. With this change, MMFs by definition became much less systemically important. Finally, we note that a recent ECB report on financial stability states that MMF balance sheets represent only 4% of the balance sheet of the monetary financial institutions in the euro area and that, accordingly, MMFs do not seem to play a sizeable role at an aggregate level in the euro area. Similarly, Fitch commented in a recent publication that no European bank had a funding exposure of more than 5% to MMFs. These facts taken together would seem to indicate that MMFs provide an important source of diversification for European corporates and institutions, provide European banks with an alternative source of funding to the interbank market (which is particularly important when banks are deleveraging) but play a limited systemic role. (6) Do you see a need for more detailed and harmonised regulation on MMFs at the EU level? If yes, should it be part of the UCITS Directive, of the AIFM Directive, of both Directives or a separate and self-standing instrument? Do you believe that EU rules on MMF should apply to all funds that are marketed as MMF or fall within the European Central Bank's definition? We believe that the adoption by the SEC of harmonized regulations for U.S. registered MMFs within Rule 2a-7 of the Investment Company Act has contributed to the growth and relevance of the MMF industry over several decades in the U.S. market. In particular, the detailed and structured framework provided by Rule 2a-7 gives investors a high degree of confidence in MMFs as an efficient means of providing diversification, principal stability and liquidity.

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BlackRock supports the introduction of detailed and harmonized regulations that allow for both CNAV and VNAV MMFs within Europe. Consequently, we recommend that UCITS should be enlarged to include a new section which would set out a common definition of European MMFs. ESMA should then develop detailed technical standards which allow for differing valuation practices (amortized cost versus mark-to-market) but that ensure stringent risk criteria is applied consistently to key measures such as credit quality, diversification (beyond the UCITS standard guidelines), interest rate risk, liquidity, governance and transparency. Institutional clients often operate across national borders and would therefore prefer a standard approach to MMF regulation. We do not discount that certain types of “unusual” or “sophisticated” cash investment vehicle may fit better within the AIFM directive and there should be specific accommodation for “unconventional” product structures that might appeal to sophisticated investors. It may, however, be prudent in order to ensure consistency and investor confidence to limit the usage of the term “MMF” to certain types of publicly available UCITS products only, rather than allowing the term to be used for privately offered investments such as those offered as Irish Qualified Investor Funds (QIFs) to accredited investors. (7) Should a new framework distinguish between different types of MMFs, e.g.: maturity (short term MMF vs. MMF as in CESR guidelines) or asset type? Should other definitions and distinctions be included? BlackRock believes that the MMF industry in Europe was strengthened by the introduction of ESMA Guidelines and that it was appropriate for the framework to differentiate between different types of MMF. From an investor perspective, the current STMMF category appeals to clients who prioritise capital preservation and liquidity over yield and the MMF category to clients who prioritise capital preservation and yield over liquidity. However, while key measures were introduced within ESMA’s guidelines for credit quality, maturity, risk management and disclosure we believe that standards governing MMFs in Europe could be further strengthened in a number of ways:

Liquidity o Mandate minimum levels of portfolio liquidity (through daily and weekly liquid asset

minimum liquidity ladders) for ST MMFs.

Disclosure o Require all MMFs to be very clear about the accounting treatment they deploy, whether

amortization, mark to market or a hybrid approach (see question (4) under Box 7). o Create rules for publication of portfolio holdings data, including standardizing data-points

with holdings reports. o Create rules that ensure information must be available publicly to investors shortly after

month-end. o Require asset managers to submit to regulators on a monthly basis a report mandating

that mark-to-market prices are reported for all MMF securities and made publicly available via the asset manager’s web-site. In the USA this has particularly assisted investor understanding of the price volatility of a MMF’s underlying investments.

o Require the MMF Board or Management Company to determine an appropriate Policy towards client concentration and to require portals to provide MMF sponsors with disclosure on the underlying clients.

7.1. Valuation and capital

Box 7

(1) What factors do investors consider when they make a choice between CNAV and VNAV? Do some specific investment criteria or restrictions exist regarding both versions? Please develop.

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An investor’s fundamental focus is on their investment objective, that is, capital preservation / diversification, liquidity and yield and their choice of MMF provider rather than on making an explicit choice between CNAV and VNAV MMFs.

In the two largest MMF markets, the USA and France, there is in effect little investor choice between CNAV and VNAV MMFs on an ongoing basis. CNAV MMFs have become engrained in the USA and VNAV MMFs in France driven by a mixture of regulation, tax and accounting regulations and product familiarity. In the US market, US investors campaigned vigorously against a move to VNAV MMFs, citing primarily tax and operational constraints. It is worth noting that fund sponsors can create a VNAV Rule 2a-7 funds but have never done so, presumably because the tax and operational constraints dampen investor demand for such products. In France, CNAV MMFs are prohibited and investors have developed a strong preference for VNAV MMFs although their investments in CNAV MMFs did increase during the Eurozone crisis. More broadly, many investor types have gravitated towards CNAV MMFs in a large number of other countries. BlackRock’s experience is that the original decision was rarely taken on the basis of the accounting treatment of one fund or another but because CNAV MMFs were rated by CRAs and that this rating (and the credit, maturity and liquidity standards required by the rating) was required by the investing entity in the absence of MMF regulation or guidelines. Since the initial decision, however, investment and operational processes and systems have developed, anchoring the investor’s preference to one type of fund or another: the investment policy of many institutions allow only investments in rated MMFs; and their systems and operational processes are designed around a price of 1.00. This is especially true of corporates and many financial institutions. They find CNAV MMFs attractive for transactional reasons in that it eliminates taxable gains and losses on each trade (for those clients subject to such treatment) and facilitates sweep and other transactions. Those posting collateral, for example, have to do so well before the fund NAV is struck and so are forced to rely on CNAV MMFs. At this point, we would like to stress that the CNAV/VNAV debate is sometimes be confused by the fact that the terms are used in an imprecise manner. Three types of MMFs exist (and BlackRock offers all three types):

CNAV MMFs maintain a constant NAV by distributing earnings on a daily basis and rounding the value of fund holdings to the closest full value, i.e., (in the case of US funds) to $1. The validity of rounding is tested regularly by marking all the assets to market. Clients in a number of jurisdictions, including Belgium, Germany, Luxembourg, the Netherlands, Japan, South Africa, Switzerland, the UK and the USA, find this extremely attractive.

True VNAV MMFs or Floating NAV MMFs sell and redeem their shares at the true mark-to-market value every day. These funds would inconvenience those clients who are subject to tax-lot accounting.

A third type of hybrid fund is used in a number of European countries and is the prevalent form of MMF in France. These Hybrid VNAV MMFs use a combination of mark-to-market accounting, model-based accounting and/or amortized cost accounting to determine the value of assets. Such Hybrid VNAV MMFs reflect in part the paucity of market pricing in short maturity Euro instruments, such as CP and CD under 1 year, making true Floating VNAV MMFs impossible to manage. Hybrid VNAV MMFs also have accumulating shares. Interest earned is added to the value of shares as this is the most tax efficient approach in some countries, although retention of earnings is not permitted in many other markets. The result is shares that are indeed variable, but they are almost always rising.

(2) Should CNAV MMFs be subject to additional regulation, their activities reduced or even phased out? What would the consequences of such a measure be for all stakeholders involved and how could a phase-out be implemented while avoiding disruptions in the supply of MMF?

The question asks whether CNAV MMFs should be subject to additional regulation or phased out/ prohibited. This pre-supposes that CNAV MMFs are somehow more susceptible to mass

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redemptions. We do not support this view. The NAV of VNAV MMFs generally oscillates within a tight range of +/- 10bps around par for 99.9% of the time. When a market crisis that tests the solvency of banks hits, the fund’s NAV can fall out of this “normal” range, leading to significant client redemptions. Clients will redeem from floating NAV MMFs whenever they believe that the NAV is declining in an unusual manner and will likely worsen substantially (perhaps irreparably) in the future. BlackRock is not opposed to additional risk mitigants, some of which could apply to both CNAV and VNAV MMFs. We have considered a number of risk mitigants and made a number of recommendations over the past few years. We continue to support the idea that sponsors should be able to set aside some reserves in a tax-efficient manner for a “rainy day” to be used in support of their fund and also support liquidity enhancements, including liquidity ladders and a standby liquidity facility which we outline in the next section. However, we do not support a conversion from CNAV MMF to VNAV MMF. This is not because we believe that it would destroy the MMF industry. The industry would contract significantly but survive in reduced form. We oppose a conversion because it will not solve the issue of mass redemptions from MMF in times of widespread market crisis. A conversion of CNAV MMFs to VNAV MMFs would be particularly questionable in Europe as MMFs play a smaller role in the short term funding markets in Europe but a conversion would nevertheless mean that investors and banks would lose valuable benefits: European investors would be forced to increase their exposure to “too big to fail banks”; and European banks would lose an alternative source of funding, all the more important when they are deleveraging and inter-bank lending is challenged.

(3) Would you consider imposing capital buffers on CNAV funds as appropriate? What are the relevant types of buffers: shareholder funded. The European Central Bank defines a MMF as a collective investment undertaking whose units are close substitutes for deposits and that primarily invest in money market instruments, shares or units in money market funds, and/or other transferable debt instruments with a residual maturity of up to and including one year; and/or bank deposit, cf. Council Regulation (EC) 2423/2001 of 20/11/2001, Annex 1, Part 1, Section 1, paragraphs 6 and 7 sponsor funded or other types? What would be the appropriate size of such buffers in order to absorb first losses? For each type of the buffer, what would be the benefits and costs of such a measure for all stakeholders involved? BlackRock was one of the first firms to seriously consider the value of adding a capital requirement to MMFs. In a ViewPoint issued in January 2011, we proposed treating MMFs as special purpose banks that would hold capital and have access to the Fed’s discount window. Regulators in the USA rejected the idea that MMFs should have access to the discount window. Solutions that regulate MMFs as a bank but do not allow MMFs the same access to the Fed window seem to us to be inconsistent and unworkable. While we believe that capital might make MMFs marginally safer, we believe it will not solve the core issue regulators are trying to address; increased resilience to mass client redemptions. One of the problems with capital in MMFs is that in almost all conceivable scenarios, it will either be unnecessary or insufficient. For idiosyncratic events, most sponsors have historically had sufficient access to capital to protect their funds. For true systemic market failures, the amount of capital necessary to protect the funds fully would be so large as to destroy the commercial viability of the product. In addition, the presence of explicit capital could lead investors in MMFs to assume that they are guaranteed. This may cause them to chase yield more aggressively, further destabilizing the industry. We summarise below the key issues with the main capital buffer proposals:

Shareholder capital -- builds up slowly, tax inefficient and provides no “skin in the game”.

Sponsor capital -- a quicker solution but one which will cause a major contraction in the industry and will trigger consolidation of the funds onto sponsor balance sheets for accounting purposes.

A combination of shareholder and sponsor capital -- a complex outcome that may be confusing for clients.

Subordinated capital in MMFs – intellectually interesting but too complicated and impractical

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Many of the issues around such arrangements are described in detail in a publication entitled “Money Market Funds: Potential Capital Solutions” from August 2011. Despite these issues, we continue to support the idea that sponsors should be able to set aside some reserves in a tax-efficient manner for a “rainy day” to be used in support of their funds.

(4) Should valuation methodologies other than mark-to-market be allowed in stressed market conditions? What are the relevant criteria to define "stressed market conditions"? What are your current policies to deal with such situations? Valuation methodologies other than mark-to-market should be allowed in both normal and in stressed conditions. Indeed, they are required given the lack of mark to market pricing in short maturity Euro and (to a lesser extent) Sterling instruments (such as CP and CD under 1 year) making pure mark–to-market funds impossible to manage. Such valuation methodologies should include amortized cost accounting and / or model based valuations. . Stress market conditions could include a market-wide event, significant news on an issuer, political, economic or governmental developments, or securities do not have a price source due to complete lack of trading. In the event of such situation, an asset manager may seek to determine the price that a Fund/Account might reasonable expect to receive from the current sale of that asset or the cost to extinguish that liability in an arm's-length transaction on the measurement date. The price generally may not be determined based on what a Fund/Account might reasonably expect to receive for selling an asset or the cost of extinguishing a liability at a later time or if it holds the asset or liability to maturity. Asset managers may use one or more of the following methods or such other methods as it deems appropriate, to fair value securities or other assets and/or liabilities depending on the relevant facts and circumstances: Costs Methods, Analytic Methods, Private Market Method, Appraisal, Systematic Fair Value Pricing and/or Parametric Pricing.

7.2. Liquidity and redemptions

Box 8

(1) Do you think that the current regulatory framework for UCITS investing in money market instruments is sufficient to prevent liquidity bottlenecks such as those that have arisen during the recent financial crisis? If not, what solutions would you propose?

BlackRock believes that UCITs and ESMA standards could, in combination, be enhanced to improve the resilience of MMFs during times of market stress. We would recommend that that the technical standards should include weighted average maturity (WAM) and weighted average life (WAL) restrictions, minimum levels of MMF portfolio liquidity (daily or weekly ‘liquidity ladders’), and a Standby Liquidity Fee (SLF). We are broadly supportive of the WAM and WAL limits set out in the ESMA guidelines. We set out our views on liquidity ladders and SLF in our responses to question 4 and 2 respectively. (2) Do you think that imposing a liquidity fee on those investors that redeem first would be an effective solution? How should such a mechanism work? What, if any, would be the consequences, including in terms of investors' confidence?

BlackRock has recently published a paper entitled “Money Market Funds: A Path Forward” (September 2012) in which we recommend the use of Standby Liquidity Fees (SLFs) combined with uniform requirements around asset standards and disclosure to strengthen the MMF framework globally. We believe that the SLF will create an effective brake (act as a ‘circuit breaker’) on client redemptions by introducing a mechanism that requires runners to pay for the cost of their liquidity plus an increment to protect clients that do not redeem.

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We believe that SLFs, triggered by an objective measure (such as a fall in available liquidity or a fall in the mark-to-market NAV), could be a useful tool in mitigating the effects of a run. We believe such a mechanism should have the following characteristics:

Objective triggers. The SLFs would not be active during times of normal market functioning. They would be triggered when a fund has fallen to half the requirement for NAV rounding or to half the required liquidity levels based on the standards set above. In the case of US Rule 2a-7 MMFs, this means that the SLFs would be triggered when the fund fell below a mark-to-market NAV of 99.75 or when its overnight liquidity fell below 5% or its 1-week liquidity fell below 15%.

The amount of the fee is a simple calculation. We recommend the amount of the fee charged when the SLFs are in force to be twice (2x) the difference between the mark-to-market NAV and $1. As an example, if the mark-to-market NAV fell to 99.70%, the fee would be 60 basis points (30x2). The reason for using 2-times the deficit is to create a positive cycle as clients redeem in place of a negative cycle. As each client redeems and leaves behind twice the deficit, the NAV for the remaining shareholders is strengthened. In a run today, redeeming shareholders weaken the fund as they leave (i.e. the NAV begins to spiral downward further accelerating the run). In this case, the NAV will be improved as people leave create a natural brake on a run and investors remaining in the fund are protected from the behavior of those who redeem. In the event the SLF is triggered by reduced liquidity but NAV is still at $1 (an unlikely event but a possibility), the SLF would be a fixed amount of [0.5%] in order to disincentivise investors from leaving and to protect and bolster those who remain.

Let clients choose. The SLF model gives clients a choice in a crisis. Clients that truly need liquidity (e.g. to meet the payment of salaries and pensions) can get it, but they must pay a market price for it. If a client can wait for their liquidity, then they can preserve the value of their shares by staying put and redeeming once the SLFs are lifted.

Closure to redemptions once it breaks the buck. Finally, in the event a fund fell below 99.50%, it would close to redemptions and move into orderly liquidation.

Payment to clients that stayed. Any amount of liquidity fees gathered by the fund would be retained in the fund for the benefit of remaining shareholders. If there were an excess liquidity fee in the fund, it would be paid to all shareholders of record on the last day in which the SLFs were in force. This way, those shareholders that stayed with the fund in the difficult time, as well as those who invested or reinvested and thereby helped “boost” the fund, would receive a benefit for the risk they took.

While many clients may initially object to the idea of SLFs, and the industry will initially contract, we believe that clients will adjust. Those that simply cannot tolerate any form of liquidity limits will favour government MMFs. Others may choose to use a combination of government MMFs and Prime MMFs. The SLFs will also encourage fund managers to deal with potential problems sooner, to avoid tripping a SLF trigger.

(3) Different redemption restrictions may be envisaged: limits on share repurchases, redemption in kind, retention scenarios etc. Do you think that they represent viable solutions? How should they work concretely (length and proportion of assets concerned) and what would be the consequences, including in terms of investors' confidence? Blackrock has looked in some detail at proposals for continuous redemption holdbacks and oppose them as we believe that they would cause a major contraction in short-term funding without solving the core issue of mass redemptions. The proposals we considered stated that redeemers from MMFs would leave behind a fixed percentage of their deposit which would only be returned after a day. This would be in force even during times of normal functioning in the markets. Clients told us that the permanent and punitive nature of the holdback, which would absorb first losses, would totally undermine the utility of MMFs for them. In addition, they said that the holdback would make them more likely to redeem, if they invested at all, and they would do so sooner in order to secure their investment before market stresses took hold.

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(4) Do you consider that adding liquidity constraints (overnight and weekly maturing securities) would be useful? How should such a mechanism work and what would be the proposed proportion of the assets that would have to comply with these constraints? What would be the consequences, including in terms of investors' confidence?

BlackRock believes that such liquidity provisions are the first line of defense in being able to satisfy investor redemption orders, especially in times of market stress, and far more effective than a ‘prudent man’ approach. We believe that a minimum liquidity requirement for MMF is an important factor in reducing their susceptibility to runs and improving their usefulness to investors as sources of liquidity and principal preservation. We recommend that MMFs be required to maintain minimum amounts of ‘natural’ liquidity, since crucially this will better enable them to meet redemptions without relying on secondary market liquidity. Liquidity ladders give MMF providers greater ability to meet redemption requests out of overnight deposits, thus avoiding / minimizing the sale of longer maturity assets into an illiquid market with difficult consequences for MMFs (whether CNAV or VNAV).

The value of liquidity ladders was highlighted during the summer of 2011 in the U.S. MMF industry when concerns related to the Eurozone debt crisis led to investor concerns around MMFs holding debt issuance from European-based counterparties. Significant outflows took place in U.S. prime MMFs over several months. MMFs were able to handle these redemptions without significant stress on their valuations due to their high levels of portfolio liquidity. In the U.S., money market funds are required to comply with Rule 2a-7 of the 1940 Act which includes restrictions around credit quality, maturity and liquidity as well as rules around ongoing operations and transparency to investors. Liquidity standards include holding daily portfolio liquidity of 10%, that can include cash, US Treasuries and securities that can be sold in one day (municipal funds are not subject to the daily limit,) and weekly liquidity of 30%, that includes weekly assets and agency discount notes of 60 days maturity or less. The IMMFA code of practice dictates that funds hold a minimum 10% of the portfolio must be invested in securities which mature the following business day and 20% in securities maturing within five business days. In addition, credit ratings agencies require additional limits on portfolio liquidity in order for MMFs to hold a triple-A rating.

(5) Do you think that the 3 options (liquidity fees, redemption restrictions and liquidity constraints) are mutually exclusive or could be adopted together?

We believe that liquidity ladders and standby liquidity fees are mutually reinforcing and should be adopted together. We are opposed to other forms of redemption restrictions.

(6) If you are a MMF manager, what is the weighted average maturity (WAM) and weighted average life (WAL) of the MMF you manage? What should be the appropriate limits on WAM and WAL?

In the international market ESMA introduced the requirement that ST-MMFs must operate with very short WAMs (less than 60 days) and WALs (less than 120 days). IMMFA also includes maturity guidelines in the IMMFA Code of Practice. They note that IMMFA MMFs must have weighted average maturity (WAM) equal or less than 60 days, and a weighted average final maturity (WAFM) equal to or less than 120 days. Credit ratings agencies also require similar WAM and WAL limits for triple-A rated CNAV MMFs. We believe that these WAM and WAL limits are appropriate and provide a strong framework to manage interest rate and credit risk for CNAV MMFs.

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In addition to CNAV MMFs, we also manage VNAV MMFs and ultra-short bond funds which fall within the definition of the ESMA MMF guidelines. The VNAV MMFs have a WAM of 90 days and a WAL of 180 days and the ultra-short bond funds have WAMs of 180 days and WALs of 1 year.

7.3. Investment criteria and rating

Box 9

(1) Do you think that the definition of money market instruments (Article 2(1)(o) of the UCITS Directive and its clarification in Commission Directive 2007/16/EC) should be reviewed? What changes would you consider?

In general, BlackRock thinks that the current definition of money market instruments within the

Directive and subsequent clarification is satisfactory. However, we do think that the language could

be improved by providing clarity around the fact that money market instruments do not typically trade

on exchanges but are bought and sold by regulated entities to each other through regulated markets.

(2) Should it be still possible for MMFs to be rated? What would be the consequences of a ban for all stakeholders involved?

BlackRock believes that it should be possible for MMFs to continue to be rated. Ratings on MMFs are specified in the Investment Policies of a very significant proportion of corporate and financial services investors in MMFs. In our experience, most Investment Policies require a MMF to be rated by two CRAs and a minority by three CRAs. In general, ratings agency standards are seen as holding an MMF to consistent and somewhat higher standards than applicable regulation, and investors understand and appreciate the level of oversight and continuous review performed by the ratings agencies which is greater than what any regulatory agency could or does provide. Were a particular MMF downgraded or otherwise were no longer rated at a particular level, clients would likely to redeem from that MMF. This should not, however, be a systemic issue as those investors would simply invest in another MMF that met their criteria. This is what happened when the MMFs of prime rate were downgraded in December 2011. Were ratings at the MMF level to be prohibited, this would represent a significant administrative burden for investors as it would take considerable time to amend their Investment Policies and their Investment Management Agreements (private contract between the investment manager and investor).

More significantly, a prohibition on MMF ratings at the fund level would reduce the ability of investors to compare MMFs across different providers on an on-going basis (in terms of portfolio construction, holdings and liquidity etc.). Unless European regulation requires similar standards to those demanded by the CRAs in terms of asset quality, liquidity and maturity, there will be much greater variability in the quality of the MMF with some providers ‘gold-plating’ and others just fulfilling the regulatory requirements). The value of ratings on MMFs to the investor is precisely that they give reassurance that certain (high) standards are met. BlackRock issued a Viewpoint in May 2011 titled “Money Market Funds: Importance of Both Credit Research and NRSRO Ratings” which summarizes our views regarding a specific proposal regarding the use of ratings for assets by MMFs.

(3) What would be the consequences of prohibiting investment criteria related to credit ratings? BlackRock considers that credit ratings on the instruments held by a MMF act as a useful preliminary screen in our own independent credit review. Ratings provide a benchmark or a reference point that investors use to evaluate a security or issuer’s potential eligibility for the inclusion of that investment in a portfolio, that is, we use the ratings as a ‘starting point’ in our assessment of an investment and formulate our own independent ‘credit opinion’ about an issuer or a specific investment instrument. Our assessment does not end when we purchase a security. Just as each CRA may upgrade or

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downgrade issues, our credit analysts apply an independent assessment of each security throughout the period that we hold the security in a portfolio which includes monitoring CRA ratings changes.

BlackRock believes that the elimination of references to ratings may inadvertently result in the creation

of new risks for MMF investors.

First, as lower quality securities may be deemed creditworthy by investment managers. Removal of the rating requirement could have the opposite of the intended effect, as it could permit a money market fund to purchase a security that would not meet the minimum threshold created by the current rating requirements. This would cause a divergence in the quality of securities held by different funds which could be difficult for investors to discern. In our view, the removal of references to ratings on these forms would harm money market fund investors. For example, many current and potential investors in money market funds have investment guidelines which limit their holdings to instruments which carry ratings from CRAs.

In addition, we believe the disclosure of ratings on portfolio holdings is helpful to the end investor and that a prohibition on investment criteria related to credit ratings would lead to less meaningful disclosure. End investors currently receive a monthly Statement of Investments which lists the portfolio holdings together with their ratings. References to ratings on disclosure forms help these investors evaluate money market fund portfolios and compare the relative ‘prudence’ of competing money market fund products. There is not comparable alternative data available to investors. (4) MMFs are deemed to invest in high quality assets. What would be the criteria needed for a proper internal assessment? Please give details as regards investment type, maturity, liquidity, type of issuers, yield etc.

BlackRock’s active investment philosophy emphasises a commitment to fundamental research and independent credit evaluation. Our research team follows a rigorous process when assessing the creditworthiness of a security. In order to develop a formal view, we conduct both quantitative analyses of corporate capital structures and qualitative assessments of management and industry positioning. We believe in fundamental analysis and a disciplined review process that focuses on the underlying issuer’s creditworthiness and valuations, along with the consideration of qualitative and quantitative factors. Within this process we focus on the importance of a team framework combining the expertise and experience of fund managers, credit analysts and risk and quantitative analysis professionals. In general terms, our approach and belief is that the investment manager is responsible for developing their individual risk management criteria; maturity limitations, issuer and liquidity restrictions, and the compliance framework to apply those parameters. The credit committee should work hand-in-hand with risk and quantitative analysts, credit analysts and fund managers to assess the relative value of each potential investment, and play an active role in the decision-making process. This team approach ensures that all credit positions benefit from the combined experience of the team of investment professionals. Finally, investment managers have to be able to demonstrate to their Fund Board or Management Company that they have a robust and independent credit review process that does not rely on credit ratings agencies input. BlackRock would be delighted to demonstrate our credit process for MMF to the EC if this would be helpful. We set out a summary below.

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BlackRock’s fundamental credit analysis framework

Qualitative Analysis

Industry AttractivenessMacro Economic ViewMarket Demand/GrowthPotentialRevenue/Cash FlowPredictabilityDegree of Commoditization

Competitive PositionRelative Market PositionOperating PerformanceRevenue/CF diversificationEvent Risk Potential

Management QualityExperienceBench strength Operating track record

Quantitative Analysis

LeverageAbility to repay obligationsDebt market accessResiliency/”shock” absorbency

LiquidityBack up liquidityRefinancing needsCovenant compliance

Equity Market PerspectiveEquity market accessInvestor confidenceEvent risk potential

• Leading business in its industry

• Strong management team

• Pricing power and ability to maintain /expand margins

• Free cash flow to reduce debt

• Strong covenants and prudent capital structure

• Catalyst to reduce credit risk and drive value higher

Key Positive Characteristics

• Highly volatile revenues/cash flows or minimal operating cash flows

• Seasonal, project-oriented or start-up companies

• Downside risks that cannot be clearly defined

• Litigation, environmental, regulatory, etc.

• Weak management teams

• Industries at a competitive disadvantage

Key Negative Characteristics

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8. Long term investments: assessment of the potential need for measures to promote long-term investments and of the possible form of such measures (including investments in social entrepreneurship)

General BlackRock supports the financing of long-term assets as part of an agenda to drive growth within the EU. We believe that policy focus should be how to attract investor capital to what are often illiquid bespoke investments where there is a limited pool of investors with the experience of analysing the risks of specific long-term asset classes. Investment in renewables or SME loan financing, for example, typically requires very specific skills and knowledge which only a few specialist teams outside the mainstream banking sector in non-banking market finance entities possess. 1. Asset manager’s primary activity is investing for the long term

We emphasise that the key focus of asset management activities should be on long-term investment. Most investors have a long-term horizon and wish to save for the future– and are forced increasingly to save for old age. Our core investment strategies of investing in equities and bonds are long term investments. By way of example, index management by definition is a long-term activity as investors in indices are permanent owners of securities in the relevant index. In active equity investment, there is a strong correlation between an individual company’s equity returns and its earnings over the medium to long term. However, currently volatility in markets means that client’s exposures are not aligned with their investment horizons and so we currently see a focus on investment in defensive positions such as cash, precious metals and property. We do not agree that only greater investment into “long-term assets” as defined by the European Commission will lead to long-term growth. Equally important is the re-alignment of investors’ asset allocations to increase their investments into mainstream equities and bonds. Daily liquidity within the investment vehicle is core to the bulk of retail investors putting their money away for the long-term and vehicles such as UCITS provide this.

2. The biggest uplift to growth of the European economy will be achieved by increasing

investment into equities and corporate debt

The questions posed by the Commission raise questions surrounding how investors can be encouraged to invest in asset classes which have previously been shunned otherwise than by a number of specialist or larger institutional investors with the knowledge to evaluate risk and controls. Increased investment in long-term assets requires asset managers to be able to perform their own due diligence of issuing entity and collateral which requires minimum levels of transparency. To gain significant traction among such investors, these long-term assets need to be included in standard industry benchmarks. A small percentage increase in allocation to long-term asset by institutional investors will make a big difference compared to a doubling of investment in ‘fringe’ investments by retail investors. We note that there are a number of factors inhibiting investment by investors in long-term assets. A recent

OECD study 6

set out a number of the key drivers inhibiting investment into long-term assets

especially by institutional investors. It did not identify retail investors as a source of future finance for these types of assets. 3. Potentially, significant demand exists from institutional clients for long term asset classes

as defined by EC

Long-term infrastructure projects are potentially very appealing to institutional investors such as pension funds seeking yield enhancement over government bonds with inflation protection and a lack

6 Kaminker, Ch., Stewart, F. (2012), “The Role of Institutional Investors in Financing Clean Energy”,

OECD Working Papers on Finance, Insurance and Private Pensions, No.23, OECD Publishing.

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of correlation with traditional investments. The product structure has to be appropriately structured before institutional investors will invest in scale. Much thought is being devoted on how to structure such a product (given Solvency II constraints) so that it can form a core part rather than an opportunistic allocation of a pension fund portfolio. Even then, the risk is still very high even for institutional clients, particularly in the development phase as pension funds will not accept the risks involved given the very high project failure rate (e.g. land rights not secured, power contract not secured, requisite permits not being obtained). Typical investors at this stage are venture capital funds and early stage private equity funds. Instead, the institutional focus is on the construction and operations phase. Even at this point, the fund structuring required is challenging as it often involves complex tax and regulatory structuring. We believe that investment managers have greater opportunity to invest in debt of SMEs than equity. We are seeing more “Mittelstand” companies issuing bonds and welcome this. Smaller SMEs, however, do not have the resources to establish debt financing through bond issuance and so typically rely on loan financing from banks. We are researching whether asset managers could establish loan funds to finance SMEs but this represents a number of hurdles (which we are currently considering) not least of which is that that asset managers need to raise money from clients and convince them of the merits of the investment opportunity. Direct investment into SME equity is, in our view, unrealistic as a mainstream investment opportunity given the rate of failure and the requirements for significant investor involvement (such as on-going board and management participation) which is not practicable outside of venture capital. (1) What options do retail investors currently have when wishing to invest in long-term assets? Do retail investors have an appetite for long-term investments? Do fund managers have an appetite for developing funds that enable retail investors to make long-term investments? Retail investment into long-term assets While many retail clients do invest for the long-term, we foresee little demand from retail clients for direct investment in the types of long-term assets contemplated by the Commission. This is due to a number of reasons:

The risk/reward profile of many of long -term assets is complex and is challenging to explain to retail clients in a PRIPS KID;

The cost of retail distribution is likely to undermine any investment case by managers;

Investment in long-term assets, as defined by the European Commission, will require specific tax breaks to incentivise clients. These are typically nationally –based rather than on a pan-European base and are unlikely to arise in today’s climate; and

Investment in long-term assets is probably only suitable for those clients who have the resources to analyse the opportunities and match the pay-off profile to their long-term obligations.

We do, however, see an opportunity to review the regulation of non-UCITS funds aimed at retail investors. These vehicles are all AIFs and under Article 43 of AIFMD, distribution to retail clients will be a national issue, rather than being coordinated on a pan-European basis. (2) Do you see a need to create a common framework dedicated to long-term investments for retail investors? Would targeted modifications of UCITS rules or a stand-alone initiative be more appropriate? There are many open-ended and closed-ended vehicles already in existence in the EU aimed at retail investors. For example, in the UK BlackRock runs open-ended Non-UCITS Retail Schemes, closed-ended investment trusts, Part II FCPs and Luxembourg and non-UCITS unit trusts in Ireland. We believe that, rather than create another new wrapper to compete along-side the existing ranges, any new initiative should rather focus on creating the conditions for a common pan-European distribution regime for these products.

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The ability to take advantage of existing distribution channels is key to the success of any regime. There are essentially two key limbs of retail fund distribution:

Firstly, the existing open-ended fund distribution platforms which, to develop economies of scale, require operational standardisation with predictable dealing cycles.

Secondly, the other key distribution channel will be exchange-traded funds. Exchange listing presupposes a minimum fund size in order to meet the listing costs. Listed funds typically do not pay commission and are often offered to a narrower set of the population and, unless offered through secondary market mechanisms such as a manager’s savings schemes, do require investors to open a dealing account with a broker. As financial advisers’ requirements to advise on a wider set of products increase following initiatives in MiFID, we can see the popularity of these vehicles growing over time.

In practical terms, we could foresee potential in this context for open-ended AIFs with reduced liquidity (e.g. monthly or quarterly), which would need to have a broader eligible asset base and more relaxed diversification and concentration requirements. For example, the scope of eligible assets could include wider access to precious metals, bank loans or real estate. We believe some of our retails clients may benefit from the creation of retail funds with specific lock up periods (i.e. monthly, quarterly) because this will allow retail funds to take more exposure to potentially less liquid assets, which have stronger risk/return characteristics. For instance, we would not operate a daily dealing retail fund that invests 100% NAV in leveraged loans (see response to question 3 below), but would consider such a product for a longer-term vehicle.

In general, the less liquidity there is in a product, the smaller the retail demand becomes i.e. the further you move away from a UCITS-type model, the smaller the demand from retail clients.

A further option would be to look at the prospectus directive (PD) and its interplay with AIFMD. Closed-ended funds (such as investment trusts or SICAFs) already attract significant assets in different countries. Closed-ended funds for retail investors typically:

invest a proportion of their assets in less liquid transferable securities, though typically not in long-term assets as defined in the Consultation;

will meet AIFMD requirements for the management company and depositary, but focus on a national market and capital – not all jurisdictions in the EU accept that an AIF issuing securities according to the PD can benefit from the PD passport.

Allowing listed closed ended funds to be sold systematically under the PD would go a long way to providing a pan-European regime using existing vehicles. In our experience of managing these vehicles, the key to the success of closed-ended vehicles is the ability to offer adequate secondary market liquidity. Taking the example of an investment trust in the UK, we note a number of key characteristics which we understand may be replicated in similar vehicles in other European jurisdictions. These include:

oversight by the listing authority;

a discount or premium between the NAV and the traded price;

a tender or buy-back mechanism to reduce the discount between the NAV and the traded price;

trading on the secondary market once the initial offer period is over. This means the fund is dependent on secondary market mechanisms to provide adequate liquidity, such as agreements with market makers. Most UK investment trusts go for premium listing in order to provide confidence to investors.

In a number of countries, closed-ended funds have minimum subscription levels e.g. €10,000 which means they are not aimed at the mass-market retail public. Secondary market liquidity requirements typically require clients to have brokerage accounts which many European investors do not have and which are not supported by traditional distribution platforms.

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(3) Do you agree with the above list of possible eligible assets? What other type of asset should be included? Please provide definitions and characteristics for each type of asset. We consider that, in addition to UCITS eligible assets, the following assets could be considered:

Loans: We see value for our clients in being able to invest in certain loans within retail funds. Although we can invest in some types of leveraged loans via total return swaps in our retail funds today, we believe clients would benefit from the flexibility to be able to invest in leveraged loans directly. These instruments, however, must be set up manually and are operationally complex to trade in volume. Risk management systems need to be designed to allow managers to monitor and manage underlying risks including liquidity. We would recommend applying diversification requirements (similar to the UCITS 5/10/40 rules) and other internal limits on exposure as required. We believe clients would benefit from the flexibility to be able to invest in leveraged loans directly.

AIFs which do not meet the UCITS requirements due to non-UCITS diversification or liquidity profiles.

A limited exposure, say 10 to 20% in precious metals or instruments representing such instruments.

The ability to borrow, within limits, on a permanent rather than on a temporary basis (as is the case under UCITS). This could potentially also allow direct covered shorting positions to be made rather than on a synthetic basis as is currently the case under UCITS.

(4) Should a secondary market for the assets be ensured? Should minimum liquidity constraints be introduced? Please give details. The secondary market for any non-UCITS assets is limited and it seems unlikely to create such a market. We note that the AIFMD has detailed liquidity management criteria that could be supplemented by additional points as raised by the recent IOSCO Consultation Report on Principles of Liquidity Risk Management for Collective Investment Schemes. (5) What proportion of a fund's portfolio do you think should be dedicated to such assets? What would be the possible impacts? For funds with limited redemption, there should be enough liquid assets held to meet redemption requests. Otherwise, it seems more appropriate to focus on having robust diversification and risk management policies. (6) What kind of diversification rules might be needed to avoid excessive concentration risks and ensure adequate liquidity? Please give indicative figures with possible impacts. If a fund is aimed at retail investment then retail-style diversification limits would be a starting point, though with wider limits to allow for more flexibility in assets allocation limits. (7) Should the use of leverage or financial derivative instruments be banned? If not, what specific constraints on their use might be considered? We do not see why stricter limits than UCITS should be applied. On the contrary, for a number of asset classes allowing more flexible borrowing requirements than through UCITS may be welcome. It is also worth considering the ability for funds to take fully covered shorting positions. That said, unlike UCITS, this would require funds to be able to borrow stock to meet their commitments. (8) Should a minimum lock-up period or other restrictions on exits be allowed? How might such measures be practically implemented? As we noted above, we believe any regime should accommodate existing fund structures and the various lock-up periods and redemption provisions. The focus should, therefore, be on investor disclosure and liquidity management appropriate to the relevant redemption provisions.

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(9) To ensure high standards of investor protection, should parts of the UCITS framework be used, e.g. management company rules or depositary requirements? What other parts of the UCITS framework are deemed necessary? If existing fund structures are used, they will already be subject to management company and depositary requirements under AIFMD. Any retail vehicle will also be subject to disclosure requirements in the PRIPS KID. (10) Regarding social investments only, would you support the possibility for UCITS in units of EuSEF? If so, under what conditions and limits?

Given the capital or income objectives of the majority of UCITS, we do not see how investment into EuSEF would be compatible with the investment guidelines of most UCITS. Until the final form of EuSEF has been decided (e.g. whether or not they must appoint a depositary) it is difficult to tell whether an EuSEF would be meeting the UCITS requirements for investment into non-UCITS funds. As a result, it would more appropriate for these to be held in a non-UCITS retail scheme.

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9. Addressing UCITS IV: assessment of whether or not the rules concerning the management company passport, master feeder structures, fund mergers and notification procedures might require improvements.

Box 11

(1) Do you think that the identified areas (points 1 to 4) require further consideration and that options should be developed for amending the respective provisions? Please provide an answer on each separate topic with the possible costs / benefits of changes for each, considering the impact for all stakeholders involved.

- Self-managed investment companies

- Master-feeder structures

- Fund mergers

- Notification procedures

As a member of EFAMA and key European trade associations including the IMA we have worked closely with them in developing industry comments and on the need for certain targeted improvements to the existing UCITS IV framework. We therefore strongly support the conclusions and detailed responses provided by EFAMA and IMA notably in relation to the regulatory treatment of self-managed investment companies, master-feeder structures, fund mergers and notification procedures. To meet possible regulatory concerns regarding the fair treatment of holders in the receiving fund, it could be that the UCITS depositary confirms to the UCITS’ regulator that the concerns will result in no material prejudice to the holders of the receiving UCITS. We believe that the points raised above are generally operational in nature, do not raise significant investors protection concerns and we would urge the Commission to consider how to implement these issues as soon as possible so as to achieve the policy aims of UCITS IV to encourage asset pooling and facilitate cross border marketing. In addition, we would also recommend the Commission to take into account the points raised in both the EFAMA and IMA responses relating to:

the obligation to provide KIIDs should only apply to retail investors (not professional investors) in line with the proposed rules in the PRIPS Regulation; and

there should be an exemption from the need to appoint a paying agent where a UCITS is marketed purely to professional investors.

(2) Regarding point 5, do you consider that further alignment is needed in order to improve consistency of rules in the European asset management sector? If yes, which areas in the UCITS framework should be further harmonised so as to improve consistency between the AIFM Directive and the UCITS Directive? Please give details and the possible attached benefits and costs. We believe that apart from the alignment of the depositary regime which is already in progress under the UCITS V proposals there are no major requirements for further alignment with AIFMD given that the issues raised in the Commission question are already covered by the detailed product rules in the existing UCITS framework. In particular:

UCITS management company rules already set out detailed organisational and conduct of business rules which inspired much of the drafting in AIFMD. Additional rules of this nature in AIFMD relate to the diversity of product types in AIFMD which does not contain detailed product rules.

The existing delegation structure in UCITS appears to work without significant regulatory concerns. Typically regulators who supervise BlackRock’s UCITS funds require pre notification and in many cases pre approval of any delegations as part of the on-going product

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approval process to ensure the management company and delegate are able to comply with applicable UCITS requirements.

UCITS have a detailed risk management process

The leverage tests in AIFMD are primarily there to manage systemic risk potentially generated by AIFs.

UCITS are already subject to detailed valuation rules and oversight by the depositary over a pre-determined set of assets. The position of UCITS is different from non-regulated AIFs.

UCITS typically report their positions to their national regulators on an on-going basis and in particular local regulators in Eurozone countries also require additional reporting.