The European Systematic Risk Board (ESRB)'s European System of Financial Supervision recently published an "NBFI Monitor" titled, "EU Non-bank Financial Intermediation Risk Monitor 2024," which includes a chapter entitled, "The International Dimension of the EU Money Market Fund Industry." The piece explains, "This report considers the main risks and vulnerabilities associated with investment funds and other financial institutions (OFIs), as well as crypto-assets and associated intermediaries, in 2023. The size of the monitoring universe increased in 2023, mainly as a result of valuation effects. Total assets of EU investment funds and OFIs increased to €44.8 trillion and accounted for 41% of the EU financial sector.... In 2023 risks to the financial stability of the EU financial system coalesced around the impact of higher interest rates. As the full effect of tighter financing conditions may not yet have fully materialised, these risks also remain relevant looking ahead.... Higher interest rates and stretched asset valuations may also increase the risk of disorderly market corrections amplified by a reduction in market liquidity."

It continues, "This report includes three special features that complement the assessment of risks and vulnerabilities. The first special feature focuses on the ownership structure of management companies of EU-domiciled investment funds. It highlights that most EU fund managers belong to banking groups, unlike in the United States, where most asset managers are independent. These ownership ties can be relevant from a financial stability perspective, as they can create reputational risk or step-in risk.... The third special feature explores the international linkages of EU-domiciled money market funds (MMFs). It concludes that the global role played by EU-domiciled MMFs denominated in USD and GBP and the regulatory reforms occurring outside of the EU call for a comprehensive assessment of the EU regulatory framework for MMFs. Given the global nature of MMFs, less stringent prudential regulation of EU-domiciled MMFs compared with those operating in the United States and the United Kingdom might pose risks to financial stability, as EU MMFs might be less resilient and more susceptible to transmitting shocks to global markets."

The ESBR tells us, "The NBFI Monitor 2024 discusses the main systemic risks and vulnerabilities associated with investment funds and OFIs. The report covers the main developments in 20231 and considers a range of risks and vulnerabilities associated with financial intermediation outside the banking system, focusing on those related to liquidity and maturity transformation, use of leverage and interconnectedness. The report covers all investment funds and OFIs.... As investment funds and OFIs participate in a range of financial markets -- including derivatives, securities financing and securitisation -- entity-based monitoring is complemented by activity-based monitoring to provide a holistic assessment of financial stability risks."

They write, "Investment funds have a large footprint in many markets for financial instruments. Of all euro area institutional investors, investment funds were the most important holders of long term debt instruments and listed shares issued by euro area non-financial corporations (NFCs) in 2023.... Euro area MMFs held a large proportion of all euro area private short-term debt instruments. The sizeable market footprint highlights the important role played by investment funds in the provision of funding to the real economy and the financial sector. At the same time, it points to potential vulnerabilities, i.e. heightened market impact and contribution to negative price dynamics in stress events, as well as high interconnectedness within the financial sector."

The paper says, "Banking sector stress from March to April 2023 and impact on non-bank financial intermediation In March 2023 some US regional banks came under strain. Solvency concerns related to losses on their bond portfolios triggered large deposit outflows and a drop in stock prices. In particular, concerns mounted for banks with large exposures (relative to capital) to long-dated bonds, as higher interest rates resulted in large mark-to-market losses. Some banks with concentrated depositor bases (such as Silicon Valley Bank and Signature Bank) failed, while others were acquired by larger banks. The stress resulted in large deposit outflows from regional banks and cash inflows into larger US banks and government money market funds (MMFs). Banking sector stress spread beyond the United States with valuations of EU banks falling temporarily, although they were less exposed to interest rate risk and had a more diversified depositor base. Stress was particularly acute for Credit Suisse, which experienced large deposit outflows and outflows from its managed investment funds.... [I]nsurers and pension funds shifted from bank deposits to MMFs, albeit to a relatively small extent. This shift might have reflected the diversification benefits MMFs offer compared with banks, as MMFs invest in a range of short-term bank and non-bank financial claims."

It comments, "In 2023 no review of the MMF Regulation was proposed, although the ESRB and ESMA had suggested reforms to strengthen their resilience, resulting in the uneven implementation of Financial Stability Board (FSB) policy proposals across jurisdictions. In July 2023 the European Commission published a report on the functioning of the Money Market Fund Regulation (MMFR). The Commission concluded that 'the MMF Regulation has enhanced financial stability and overall successfully passed the test of the recent market stress episodes' and did not propose a revision of the legislation at this stage."

The ESRB says, "By contrast, the United States has already introduced new requirements for MMFs, while the United Kingdom launched a consultation in December 2023; in both jurisdictions liquidity requirements for MMFs have been or are planned to be substantially increased (see also special feature on the international dimension of the EU MMF industry). Nevertheless, the report of the European Commission identified several areas that should be further assessed with a view to strengthening MMF resilience, including decoupling the potential activation of LMTs from regulatory liquidity thresholds, which is similar to what the SEC has implemented and the United Kingdom is proposing. The FSB noted in its review of MMF reforms the uneven implementation across jurisdictions of its 2021 policy proposals."

They also state, "Risks related to external support and step-in risks are addressed in regulatory frameworks for banks and MMFs. The Basel Committee on Banking Supervision adopted guidelines to enhance the framework for identifying and managing step-in risk and alleviate potential spillovers to the banking sector. For MMFs [in Europe], sponsors are prohibited from providing external support with the intent or effect of guaranteeing liquidity or stabilising the share price. This provision was introduced to avoid contagion effects between MMFs and bank sponsors, as seen in 2007-0853. MMFs may still enter into transactions with affiliated or related parties provided certain conditions are met, such as if the transactions are not carried out at an inflated price where they are executed at arm's length conditions."

Discussing "The international dimension of the EU money market fund industry," the report tells us, "The EU is the second largest market for MMFs globally. The NAV of EU-domiciled MMFs amounted to €1.6 trillion as of 2023, making the EU the largest market globally after the United States.... It is home to three of the top five jurisdictions in terms of MMF assets (France, Ireland and Luxembourg). The large share of MMFs denominated in non-EU currencies highlights the global dimension of EU-domiciled MMFs. Although EUR-denominated MMFs account for the single largest share of EU-domiciled MMF NAV by currency (42%), the majority of EU-domiciled MMFs are denominated in other currencies. MMFs denominated in USD and GBP account for 37% and 20% of total NAV respectively, while other currencies play a minor role."

It explains, "EU-domiciled MMFs are by far the largest segment of the global GBP-denominated MMF sector but account for a small share of the USD-denominated MMF sector. With an NAV of around GBP 280 billion in 2023, EU-domiciled GBP-denominated MMFs account for around 90% of the global GBP-denominated MMF sector, compared with GBP 27 billion for United Kingdom domiciled MMFs. By contrast, with an NAV of around USD 570 billion in 2023, EU-domiciled USD-denominated MMFs are estimated to account for around 10% of the USD-denominated MMF sector."

The report then says, "This special feature focuses on potential financial stability implications arising from the global dimension of EU MMFs. There are several aspects to the global dimension of EU domiciled MMFs. First, they are held by investors outside of the EU. Second, they provide more funding to non-EU issuers and borrowers than EU entities. Third, they can have a large footprint in short-term funding markets outside of EUR, and in particular in GBP. This global dimension of EU domiciled MMFs underscores the financial stability challenges related to (i) the different regulatory reforms already finalised or being discussed outside of the EU, and (ii) options to provide support to MMFs and/or to the markets they operate in during times of stress."

Finally, the report adds, "EU-domiciled MMFs are key participants in unsecured short-term funding markets. They hold around 52% of short-term debt securities issued by euro area banks, 37% for euro area NFCs and 7% for euro area general government.... EU-domiciled GBP-denominated MMFs are particularly important for GBP short-term funding markets. First, they hold around 90% of GBP financial CP and CDs outstanding. They also hold around 30% of debt securities issued in GBP by euro area banks, making them an important source of GBP funding.... EU-domiciled USD-denominated MMFs also have a large footprint in USD short-term funding markets. Although they account for 10% of the USD-denominated MMF universe, they hold around 10 to 15% of USD unsecured short-term debt (CP and CDs) according to the FSB. Given low trading volumes on secondary markets, asset sales from EU-domiciled USD-denominated MMFs could negatively affect prices on those unsecured markets."

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