The European Central Bank published "Financial Stability Review May 2020," which comments, "Money market funds (MMFs) came under severe liquidation pressure as financial and non-financial investors redeemed large amounts of shares. This is turn led to a freeze in demand and issuance of commercial paper, an important source of short-term funding for financial and non-financial corporates.... High demand for precautionary cash buffers and a diminishing supply of term interbank loans have also increased funding costs in unsecured money markets, predominantly at longer maturities. Central banks across the globe intervened swiftly to ensure liquidity in financial markets." We excerpt from this publication and also quote a recent update from Moody's on European MMFs, below.
The ECB writes, "Even securities deemed as highly liquid, such as commercial paper, were shed by MMFs to meet rising redemption pressure. In the United States, sovereign and sub-sovereign bonds as well as mortgage-backed securities (MBS) temporarily came under selling pressure, reflecting inter alia the winding-down of leveraged positions in these markets. Overall, the demand for cash was more pronounced in US markets as monetary conditions had been tighter going into the stress, and the banking system had not been as well equipped with reserves as in the euro area. The Federal Reserve, in turn, provided large amounts of liquidity by intervening in various securities markets, such as those for Treasuries, MBS, MMF shares as well as corporate bonds, including in the form of ETFs."
The piece continues, "From 12 March, euro area money market and sovereign funds also began experiencing rapid outflows, driven by rising cash demand from end-investors. As the real economy shock, margin calls and large outflows from investment funds put increasing pressure on the liquidity positions of both financial and non-financial actors, redemptions spread to asset classes typically seen as safe havens. Outflows from MMFs in the week of 12-18 March were the second highest on record, surpassed only in September 2008."
It explains, "Stress in MMFs could have systemic implications, reducing the financial system's and the real economy's access to liquidity during a crisis and reducing confidence in the financial system as a whole.... Low liquid asset holdings reduced the capacity of the investment fund sector to absorb these outflows, likely resulting in forced asset sales and the amplification of market dynamics. Cash holdings of bond and equity funds have declined consistently over previous years."
A section entitled, "Recent stress in money market funds has exposed potential risks for the wider financial system," tells us, "Euro area money market funds (MMFs) provide short-term credit to banks and non-financial corporations (NFCs) through purchases of commercial paper (CP). The total assets of euro area MMFs amounted to €1.26 trillion in December 2019, of which €307 billion and €295 billion were debt securities issued by credit institutions domiciled in the euro area and in the rest of the world, respectively.... Most securities are denominated in euro (51%), followed by US dollars (27%) and British pounds (21%). MMFs are particularly important for the short-term funding market, holding €251 billion and €40 billion in short-term securities issued by euro area banks and firms, respectively, including commercial paper."
The ECB adds, "Although commercial paper is a minor source of bank funding, covering less than 3% of total funding needs, it provides a meaningful source of wholesale unsecured short-term funding, especially in US dollars, for internationally active banks.... Moreover, the recent strains in the MMF sector ... point to a potential risk of contagion to insurers given the important role of MMFs in insurers' liquidity management."
The piece also states, "Monetary policy action, including the PEPP, helped improve financial market conditions, thereby also alleviating liquidity strains in the money market fund (MMF) sector. A number of MMFs had difficulties raising sufficient cash from maturing assets, as liquidity deteriorated rapidly also in the commercial paper market.... In the euro area, the expansion of asset purchases to non-financial commercial paper, in particular, provided an important backstop in this market against a backdrop in which private sector investors – including MMFs – became reluctant to invest in commercial paper or tried to sell it in a search for cash. Following the announcement of these measures, liquidity conditions in financial markets improved, and outflows from MMFs and other investment funds abated."
Another section, "Outflows from MMFs were mostly concentrated in LVNAV funds," tells us, "Lessons from the recent stress in the MMF sector should be drawn, including for regulation. While a number of MMFs saw large outflows and were forced to sell illiquid assets, stress was particularly concentrated in low-volatility net asset value (LVNAV) funds ... which represent almost half of the euro area MMF sector in terms of total assets.... These funds are allowed to offer a constant share price as long as the fund's NAV at amortised cost does not deviate from the corresponding market value. Otherwise, the fund will trade at a variable price, which can result in mark-to-market losses for investors. A number of funds were close to breaching the regulatory limits on NAV and on weekly maturing assets during the recent period of volatility. This may have provided unintended incentives for investors to redeem during the recent stress episode and contributed to additional outflows and liquidity shortages in these funds."
In related news, Moody's published the notice, "European money market funds remain resilient amid coronavirus storm." It explains, "European money market funds (MMFs) are maintaining cash reserves and prioritizing short-dated investments, amid continued uncertainty over the pace of the economic recovery from pandemic-related slowdown and over investor behaviour in the event of a resurgence in COVID 19 cases, says Moody's Investors Service in a new report."
The release continues, "Redemptions from European funds totaled €45.6 billion in March, subjecting the sector to the most intense stress it has experienced since the 2008 financial crisis, as investors switched to safer funds investing in government securities, or were forced to raise cash. In spite of this, prime low volatility net asset value funds were able to maintain constant net asset values while still honouring redemption requests."
Marina Cremonese comments, "The industry's capacity to manage a surge in redemptions and absorb external shocks, such as the coronavirus pandemic, has improved thanks to EU MMF regulations that took effect in January 2019.... These regulations required funds to have higher liquidity levels."
Finally, Moody's writes, "During the spike in redemptions, Aaa-mf rated money market funds maintained high daily and weekly liquidity levels, and reduced their weighted average maturities. The conservative approach ensured that their credit quality and liquidity of their portfolios remained strong throughout March. Since April, after central bank efforts had ensured abundant liquidity across financial markets, the flow reversed with European funds reporting positive inflows. April recorded €56.4 billion new money, more than the previous month's outflows. The industry also reported positive inflows in May and June. Nonetheless, the sector has maintained a highly conservative stance amid persistent coronavirus related uncertainty."
