Standard & Poor's published a CreditFAQ written by Andrew Paranthoiene, Francoise Nichols, and Emelyne Uchiyama entitled, "Implications Of Negative Yields For European Money Market Funds?" yesterday. It says, "European money market funds have been coping with the prospect of near zero or negative yields for most of 2012. That's especially true for a subset of those funds, the region's government liquidity funds, which invest in high credit quality "safe haven" government debt. And following the European Central Bank's interest rate reductions effective last week -- the benchmark rate dropped to 0.75% from 1% and the deposit facility interest rate went to 0.00% from 0.25% -- all of these funds and the eurozone's financial markets are moving into uncharted territory."
The piece explains, "European government money market funds were established by the largest money market fund providers mainly in 2007 and 2008 as a "flight to quality" product for investors who were risk-averse about the European banking system. These government liquidity products offer money market investors a diversified pool of high credit quality and safety by investing in the most liquid European government securities. However, yields for safe haven assets and those sought after by euro-denominated government liquidity funds (less than one-year to maturity), like German and French six-month bills, have been close or below 0.00% since the beginning of the year."
S&P continues, "Last week we observed that German and French six-month debt sold at negative yields. Even before the ECB lowered its deposit facility rate to 0.00%, placing additional pressure on the money market industry, the prospect of negative yields for eurozone government liquidity funds was apparent. This is likely one of the main causes of the decrease in total assets of European government liquidity funds that Standard & Poor's rates. We find a 48% drop in assets so far in 2012."
It adds, "As a result of the 0.00% deposit rate, Standard & Poor's Ratings Services believes that there is an increased likelihood that negative yields on individual money market investments in the European Economic and Monetary Union (EMU or eurozone) may accumulate to produce a negative return to money market funds. This in turn would increase the likelihood of lower net asset values (NAV) per share for euro-denominated money market funds. Although money market fund yields are lagging official interest rates, persistently low to negative yields on money market funds may lead investors to redeem their shares, possibly placing additional strain on these funds. Such developments could be credit-negative for our principal stability fund ratings (PSFR) on these funds."
S&P states, "If these conditions continue or possibly even worsen should the ECB lower rates further in September, fund providers may assess the viability of these products. If they decide to close these funds, it will further reduce the amount of investment choices available to investors. In recent days, European money market fund providers have taken practical steps to protect their funds from yield dilution. This is either through implementing "soft closes," meaning that the funds are closed to subscriptions from external investors, while certain existing shareholders can continue to invest; or through "hard closes," meaning no new investment by any type of shareholders. Closing a fund to subscriptions reduces the need to invest new money at lower or negative yields, which would further deteriorate a fund's overall yield. According to our analysis, money market fund closures have reached E79 billion out of a total euro-denominated rated asset pool of E133 billion to date. Other euro-denominated money market funds have taken a different view and remain open but cautious about evolving market conditions."
Finally, the piece comments, "Another option available to managers is reassessing their current investment mandate to possibile increase duration or venture into other asset classes. However, this option may have limited attractiveness for now given uncertainties in the eurozone. As securities in the portfolios mature, it is already becoming increasingly difficult for investment managers to find suitable investment opportunities in a negative yield environment."
