The Financial Stability Board, "an international body that monitors and makes recommendations about the global financial system," published a "Holistic Review of the March Market Turmoil," which discusses issues involving money funds and short-term funding and "highlights the need for action to address vulnerabilities from non-bank financial intermediation." The report tells us, "The breadth and dynamics of the economic shock and related liquidity stress in March were unprecedented. As in previous cases, the shock caused a fundamental repricing of risk and a heightened demand for safe assets. However, the stress also led to large and persistent imbalances in the demand for, and supply of, liquidity needed to support intermediation. On the demand side, non-financial corporates attempted to tap capital markets; demand for US dollar liquidity increased from foreign borrowers; non-government money market funds (MMFs) experienced significant outflows; and some open-ended funds also experienced redemptions. On the supply side, reductions in risk appetite, regulatory constraints and operational challenges may have reduced dealers’ capacity to intermediate larger flows in some core funding markets."

The FSB says an update on "Money market fund (MMF) resilience" with the goal "To make policy proposals, in light of the March experience, to enhance MMF resilience including with respect to the underlying short-term funding markets," will be included in a report to the G20 in 2021. It explains, "First, there was an extremely high demand for cash and near-cash assets. This ‘dash for cash’ was underpinned by precautionary demand for liquidity in the real economy. Corporates’ and households’ concerns about the loss of a substantial part of their revenues, investor fears about the outlook for the global economy, and cash needs by financial institutions, resulted in the broad-based selling of financial assets -- even the safest and most liquid ones. In the financial system, redemptions from investment funds, margin calls resulting from increased volatility and the need of some non-banks to unwind leveraged positions may all have contributed to sudden spikes in the demand for cash (the mechanisms are discussed in detail in section 4)."

The FSB writes, "The commercial paper (CP) and certificate of deposit (CD) segments of money markets started to exhibit signs of severe stress, with outflows from non-government MMFs in the US and EU leading to selling pressures on the assets held by these funds. Equity and bond funds in emerging market economies (EMEs) as well as advanced ones experienced very large outflows as investors liquidated their positions. The selling also started to affect assets that would normally be seen as safe havens, such as US Treasuries and other advanced economy government bonds. At the same time, government MMFs experienced considerable inflows."

They continue, "Financial and non-financial corporate issuers were also unable to issue more commercial paper due to a shortage of demand, including by MMFs. CP and CD markets shut down for a number of days. The resulting tightening of financing conditions pushed corporates towards selling their investments and further drawing down their existing bank credit lines and revolving credit facilities. This large-scale draw down, taking place partly on a precautionary basis, put pressure on the balance sheets of the providers of those facilities."

The review comments, "Increased demand for less risky and more liquid assets, including those with a shorter maturity, manifested in the selling of certain assets and shifts in the portfolios of some MMFs. While the impact of the COVID-shock differed among jurisdictions (see Box 4.1) two distinct patterns were observed in European and US MMFs: There was a surge in redemptions from non-government (prime and tax-exempt) MMFs, i.e. those that invest in short-term CP and CDs. Outflows from US prime MMFs by the end of March amounted to US$125 billion (roughly 11% of AUM), with the majority of these redemptions in funds that were publicly offered to institutional investors. This contributed to the effective closure of the market for short-term funding and a sharp increase in demand for short-term government debt. There was a surge in inflows into government MMFs that invest in short-term government securities. Government MMFs, which invest in cash-like short-term debt, saw record inflows in excess of US$800 billion in March, roughly 30% of their assets under management. These inflows were partly attributable to a reallocation from prime MMFs and other short-term funding market investors, but also driven by disinvestments from other less-liquid asset classes in order to meet demand for cash (see below). Corporates and households also increased their deposits at banks (deposits at US banks increased by around US$476 billion over the course of March)." (See the sidebar on MMFs on page 19 too.)

Discussing the "Propagation through short-term funding markets," it states, "Stress was propagated through the interaction of investors in CP markets.... Amid increased risk aversion and desire for liquidity, investors became less willing to advance funds in the short-term unsecured market and fund CP with a maturity greater than a few days. Significant redemptions from non-government MMFs, which threatened to deplete the funds’ holdings of liquid assets, may have exacerbated strains in the short-term funding market. In the EU, some funds that held a significant portion of CP and other short-term debt adjusted their portfolios by selling less-liquid and riskier assets such as term CP and CD, and shortening the maturity of their unsecured debt. Some funds also attempted to raise funds by requesting issuing banks buy back their CP. Some banks accommodated these requests, others discouraged them with aggressive pricing. A few requests were, in the absence of contractual obligations, denied."

The FSB says, "Dealers also faced difficulties absorbing large sales of assets, amplifying turmoil in short-term funding markets. Dealers’ intermediation capacity was limited with the holdings of large amounts of other securities contributing to constrained balance sheets. Banks became less willing or able to supply hedging services and faced increased credit drawdowns by corporates, while prime MMFs that traditionally supply dollar funding faced redemptions and were forced to sell assets. Some intermediaries’ balance sheets may have been particularly inflexible given the looming March quarter-end. This pullback in the supply of dollars resulted in a sharp increase in funding costs. As a result, activity in CP and CD markets decreased markedly, primary issuance decreased sharply and issuers (both corporate and financial) struggled to roll over funding."

They continue, "The cost of funding for financial institutions increased, contributing to tighter funding conditions. Short-term funding cost surged as measured by, for example, interest rates on CP, CD and unsecured interbank lending. Bank funding conditions tightened not only because banks received less funding from MMFs, but also because corporate borrowers who were no longer able to obtain short-term funding via MMFs drew down their credit lines with banks, thereby crowding out other forms of bank lending."

The report adds, "Tighter dollar funding conditions affected entities that borrow in US dollars worldwide. Nongovernment MMFs are important holders of US dollar CP issued by non-US banks and non-financial corporates. Amid outflows from these funds, stresses intensified in the US dollar funding markets -- particularly in the case of banks headquartered outside the US. Portfolio outflows from US dollar-denominated bonds issued by EME borrowers were significant. At the same time demand for funding (including US dollars) increased amid lower revenues (especially for commodity exporters) and fiscal expansion. These factors contributed to an increase in the US dollar bond yields for EME borrowers -- increasing the repayment cost for those without natural hedges. Funding conditions tightened as a result of rising domestic interest rates and depreciating exchange rates."

The FSB's review also states, "Amid increased demand for cash and shorter-maturity assets, investors sold large volumes of longer-dated Treasuries in favour of shorter-dated assets. There were large, though orderly, inflows in to Treasuries up to early March -- with yields falling to record lows for all maturities. Government MMFs, investing in Treasury bills received significant inflows, pushing the short maturity T-bill rates to zero. However, during the dash for cash there were also strong selling pressures in Treasury bonds with longer maturity, and those yields increased temporarily but sharply, especially in less liquid off-the-run Treasuries."

Finally, under "Policy implications and areas of further work," the paper says, "First, the review of specific risk factors and markets would encompass the areas identified in this report as contributing to the amplification of the shock in March. These include examining: 1) liquidity risks, core functions and aspects of the structure or regulations in nongovernment MMFs which experienced large outflows and contributed to the stress in short-term funding markets; and, 2) whether and how other types of open-ended funds invested in illiquid assets could amplify liquidity stress, recognising the variety of fund structures (including interactions between mutual funds and ETFs), underlying assets (including their role in facilitating investment for the real economy) and the availability and use of liquidity management tools across different jurisdictions."

New Investment Company Institute President & CEO Eric Pan, comments, "The market turmoil of March was first and foremost a health crisis, triggered by COVID-19, that quickly escalated into a global economic shutdown prompting market volatility that struck every sector of the financial system. We welcome the Financial Stability Board's holistic review of the March market turmoil and its description of those events as 'unprecedented.' As noted by the FSB, liquidity stress was the product of both demand- and supply-side events, ranging from increased demand by nonfinancial corporations on the capital markets, including funds, to the regulatory constraints and operational challenges that affected the role of dealers, as well as the substantial sale of US Treasuries."

He adds, "We appreciate that the FSB will coordinate an assessment by the international regulatory community to consider possible policy options. We encourage international regulators to continue to take an empirical, data-based approach; to draw careful distinctions among market participants and products; and to look carefully at market structure and the interactions between banks and other market participants. To this end, ICI looks forward to sharing with the FSB its extensive research and expertise regarding regulated funds." See also, Reuters' "Regulators target money market funds after COVID-19 turmoil".

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