The Bank of Canada published, "An update on the Canadian money market mutual fund sector," which tells us, "Money market mutual funds, also called money market funds (MMFs), are open-ended mutual funds that hold cash and invest in short-term, high-quality debt securities. They aim to provide their investors with stable returns and high liquidity and allow the daily withdrawal of funds. Investors use MMFs for different reasons, including: to park cash between investments; to place their money in a safe investment during periods of market turmoil; and, to earn higher interest than traditional deposit accounts. MMFs facilitate credit intermediation by moving cash from households and institutions to borrowers such as governments and corporations. Thus, they provide an important source of short-term funding."
The report says, "Despite their benefits, MMFs can pose vulnerabilities to the financial system, particularly through: Liquidity mismatch: MMFs offer daily redemptions, but some of their assets may be difficult to sell quickly without losses during periods of market stress; and, First-mover advantage: Liquidity mismatch can motivate investors to redeem ahead of others to avoid potential losses from funds selling assets at discounted prices to meet redemptions."
It continues, "In several notable cases, these vulnerabilities have resulted in MMFs amplifying market stresses. For instance, during both the 2008–09 global financial crisis and the onset of the COVID-19 pandemic, some MMFs in the United States faced sudden and large investor withdrawals (Anadu et al. 2021). These outflows led those MMFs to sell their holdings in secondary markets. This likely contributed to liquidity strains in short-term funding markets and reduced the capacity of MMFs to fund governments and corporations."
The Bank writes, "In response to instances like these, the Financial Stability Board (FSB) launched a comprehensive review of MMF vulnerabilities. This review resulted in policy recommendations aimed at enhancing MMFs' resilience. Since then, MMFs have remained a global focus for financial stability, and the FSB has been tracking the progress on implementing the recommendations across jurisdictions (FSB 2021; FSB 2024)."
They state, "In light of the global attention on MMFs, we examine the Canadian MMF sector. This sector has grown by 180% since 2019, yet it remains less than 3% of the overall Canadian mutual fund sector. Despite the small size of the MMF sector, MMFs hold around 5% of Government of Canada (GoC) treasury bills and 11% of non-government short-term paper. The relatively large presence of MMFs in these markets suggests that MMFs could have a significant impact on liquidity conditions."
The piece adds, "However, during the market turmoil in March 2020, when MMF outflows in several jurisdictions around the world amplified market stress, Canadian MMFs experienced inflows. This relative stability may reflect the fact that, compared with other jurisdictions, Canada's MMF sector has a larger share of retail investors. Retail investors may have more stable behaviour than institutional investors, who may liquidate their MMF positions relatively quickly because of a sudden need for cash."
It says, "Our analysis aligns with earlier work done by the FSB in which Canada was not identified as a jurisdiction where MMF vulnerabilities could raise significant financial stability concerns. However, given the ongoing international focus on MMFs and their growing role in key short-term funding markets, Bank of Canada staff will continue to periodically review the sector."
The Bank of Canada study states, "In Canada, MMF assets have grown by 180% since 2019, exceeding the growth rates of life insurers, pension funds and other types of mutual funds.... The size of MMFs has generally moved in line with the Bank's target for the policy rate, suggesting that their recent growth could be related to higher interest rates.... However, this trend appears to correlate with some lag, and there have been some brief periods -- particularly during times of high market turmoil -- when this relationship was less clear. Although the policy rate has been declining since mid-2024, the amount of MMF assets has continued to increase, likely because interest rates remain high relative to historical levels."
It says, "High interest rates raise the opportunity cost of holding cash in deposit accounts at commercial banks, which typically offer low interest rates. When rates are high, investors are more likely to shift their cash into investment products that: have returns that more closely track the level of interest rates than deposit accounts at commercial banks do; and, remain liquid compared with other investment products."
They comment, "Indeed, during the recent years of higher interest rates, while MMF assets grew, so did other comparable products such as guaranteed investment certificates and high-interest savings account exchange-traded funds. Despite their rapid growth, MMFs remain relatively small, with total assets around $100 billion.... This represents only about 3% of the overall Canadian mutual fund sector."
Finally, the study tells us, "Within MMFs' holdings of non-government short-term paper, commercial paper has represented an increasingly large share since the phase-out of the Canadian bankers' acceptance (BA) market (CFIF 2023). From 2022 to 2023, MMFs allocated between 10% and 20% of their assets to BAs. However, starting in June 2023, MMFs reduced their holdings of BAs and simultaneously increased their holdings of commercial paper from around 45% to 60% of their assets.... Overall, MMFs' growing presence in the GoC treasury bill and commercial paper markets suggests that liquidity in these short-term funding markets could be vulnerable to the trading activity of MMFs, particularly in scenarios where MMFs may sell these assets to meet investor withdrawals."
