A week ago, Crane Data hosted its most recent virtual event, European Money Fund Symposium Online, which featured a series of discussions on European and "offshore" money market mutual fund topics. (See our Nov. 23 News, "European MFS Online: IMMFA's Iommi Says MMFs Resilient During Crisis.") During the "French & Continental Money Fund Update" panel, Alastair Sewell of Fitch Ratings gave an update on Asian money funds, focusing specifically on China. We quote from his remarks below. (The replay is available here in case you missed it, and join us for our next event, "Money Fund Wisdom Demo & Training," on Dec 16, 1-2pmET.)
Sewell begins, "The first observation I wanted to make is that the relative growth rate has slowed really quite dramatically in China. If you look back a few years ago, China was growing extremely rapidly in terms of assets under management, and the share of China in the global asset pools was increasing very dramatically as well. Now, growth has continued in China; it has increased slowly over time. There's been some changes recently. But what's interesting is that the rest of the world has actually grown a lot faster in recent years, and a key part of that has been the fact that there have been such significant inflows into money market funds in the other regions. Obviously, there was that period in March of volatility, but overall, when you simply look at the headline figures, the growth in other parts of the world has actually begun to outpace China."
He continues, "Let's unpack that a little bit and dig into some of the issues in China. In terms of assets in China, you can see that they peaked back in late 2018, at around 9 trillion Chinese yuan. Since then, they declined steadily for a period of time before the Covid event broke in the early part of the year. That led to a very conventional investor response to market stress, which was to move out of risk assets and into cash and into low risk assets. And we saw that dynamic playing out clearly in China with the increase in allocation to money market funds. We saw that allocation, in fact, in other markets around Asia as well. `What was quite interesting to observe was how the Covid shock spread around the world from its initial outbreak in Asia, and you can see that in money fund flows in various different countries as [it] got closer to Europe, then the U.S., this response -- the dash for cash."
Sewell says, "Current assets on management in China are 7.2 trillion Chinese yuan at the end of September, which is roughly 1.1 trillion US dollars. Which is quite interesting because given the fact that there are no government funds in China, I believe that would actually make China the largest prime money market fund domicile in the world ... and Yu'e Bao, the monster money market fund in China, is the world's largest prime money market fund.... It has been shrinking, so maybe not forever."
Referring to his slides, he explains, "You see a pattern of various spikes of inflows turning neutral [then] various spikes of outflows from money market funds. Why is this happening? Well, there are really three important drivers. Number one, yields. Yields on Chinese money market funds have been falling fairly steadily. They've actually increased since May of this year, but they have been falling fairly steadily for a sustained period of time. Number two, the spread between bank deposits and money market fund yields has been compressing and in fact, went negative for a period of time. So therefore, the relative benefit of the money market fund compared to a deposit for those investors, and we know these are retail investors who tend to be yield oriented, it's definitely a factor. Then number three ... is the fact that the Chinese A-share market was roaring in the early part of the year and there was certainly a reallocation effect with investors, a post-Covid event pulling cash out of money market funds and putting that into the Chinese A-share market."
Sewell comments, "This yield-seeking behavior, we think it may well increase fund risks. If you look at the maturity profile of the Chinese money market funds ... for Chinese money market funds we are dealing with a different world, of course. They have a relative short maturity profile. And in fact, if you were to put this into WAM language, the average WAM across the industry is well below the maximum amount, which is 120 days. So, there is the possibility that funds may seek to extend WAM ... with the yield curve to add incremental return."
He states, "The other factor ... is leverage. You did hear that correctly, leverage. Chinese money market fund regulation allows funds to lever, structurally lever rather, operational overdraft up to 20 percent. And the fact is, the vast majority of funds in China do use leverage to some extent. On average, it's around about five percent, but you can see the peak line on the chart that shows that there are some funds out there that will actively use the full regulatory risk bucket afforded to them, and use that leverage out to the 20 percent mark. So, in our view, this clearly increases risks. If a fund extends maturity, if it increases leverage and then moves into an outflow environment, the fund will face a cornucopia of challenges."
Finally, Sewell adds, "Obviously, China is the giant panda in the Asian market, it has the vast majority of assets. But when you dig a little bit closer, you'll see that there are actually money market funds represented in many other jurisdictions." Sewell's slides list 14 Asian countries with MMFs present, including: China (with 69% of Asian MMF assets), Japan (8%), South Korea (7%), India (6%) and Other (10%).
Fitch Ratings also recently released a report entitled, "Assessing Future Money Market Fund Regulatory Scenarios." Their update explains, "Market stress in March 2020 put pressure on some money market funds' (MMFs) liquidity positions and net asset values (NAVs), and in turn MMFs' behaviour had a material impact on short-term markets. Fitch Ratings believes the MMF sector, and hence MMF ratings, could have been more adversely affected if not for the policy measures in March 2020."
They explain, "The Financial Stability Board (FSB) has also recently highlighted the significant effect of central bank facilities in mitigating stress on MMFs, underlining the coming regulatory focus on MMFs. The previous episode of severe stress affecting MMFs in 2008 led to significant regulatory changes. The Securities and Exchanges Commission, Federal Reserve, ECB and other regulators and policy makers have called for a review of MMF regulation. The FSB stated on 17 November 2020 that it will: 'make policy proposals, in light of the March experience, to enhance MMF resilience including with respect to the underlying short-term funding markets.' It expects to make these proposals by the end of 2021. Specifically, it identifies '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' as areas for investigation."
Fitch writes, "This report reviews some of the potential regulatory changes that have been discussed by market participants following the most recent stress and their potential impacts on ratings. Fitch cannot predict the probability of regulatory change, nor which particular proposal (if any) is likely to be adopted. Rather, Fitch is simply examining the potential implications for its MMF ratings of some of the potential changes."
The report adds, "Market participants and regulators have pointed to the role that securities dealers play in the intermediation of short-term markets, and that dealers' stepping back from intermediating these markets impacted liquidity during the recent stress. Accordingly, any market structure changes enacted that improved the incentives for dealers to continue intermediating in short-term markets during stress periods could be beneficial for secondary market liquidity and hence for MMFs' ability to sell securities, if needed, to meet redemption requests. These developments, if realised, would be relevant in Fitch's rating analysis because it rates MMFs both to their ability to preserve principal and provide timely liquidity."
