JPM on Brexit and Offshore MMFs
J.P. Morgan writes in a recent "Mid-Week US Short Duration Update" about "Brexit and offshore MMFs. They explain, "With less than a month to go before the UK transition period ends, the chances of a no-deal Brexit increased [last] week as talks between EU and UK officials ended in deadlock.... UK Prime Minister Boris Johnson and European Commission President Ursula von Der Leyen are poised for further discussions.... Notably, the Brexit uncertainty has not necessarily impacted USD funding costs of UK banks. In fact, unsecured CP/CD transactions of UK banks have been trading around 0.20%-0.25% in the 3-month tenor this month, within the vicinity of other banks. Still, UK banks are not entirely immune from Brexit-related market implications. Under the EU's MMF regulation, offshore money market funds must face counterparties that have their registered offices in a Member State or in a third country where the counterparties are 'subject to prudential rules considered equivalent to those laid down in Union law.'" The piece continues, "This means that post year-end, unless the EU grants UK equivalence with respect to prudential banking regulations as part of the Brexit deal, offshore MMFs will face increased restrictions around what they can invest in. In particular, offshore MMFs will no longer be able to engage in time deposits with UK counterparties. Furthermore, repos with UK counterparties will require an extra haircut above the current standard on certain types of collateral (e.g., bonds greater than 5 years). Other eligible asset classes do not speak to equivalence for counterparties, and as such we suspect they won't be impacted post Brexit." JPM adds, "Based on Crane Data, as of October month-end we find there's about $11.6bn of time deposit and repo exposures with UK counterparties in offshore USD-denominated funds, £22bn in offshore GBP funds, and about 1.4tn of exposures in other currency-denominated offshore MMFs.... Realistically, impacted exposures are likely less than the above as not all repo collateral are affected. To this end, while UK banks and offshore MMFs may need to find alternative sources of funding and investments respectively in the run up to and post Brexit, we don't foresee this as a significant source of concern. Even with US G-SIB pressures increasing over the past few days as evidenced by the widening in the FX-OIS and cross currency basis markets, we suspect offshore MMFs will have no issues finding other homes for that cash. Indeed, offshore MMFs face a diversified set of counterparties with respect to their time deposits.... As for UK banks, given the abundance of liquidity in the marketplace, we also believe that they will have no issues in finding alternative sources of funding." (Note: Crane Data published its Nov. 30 MFI International Portfolio Holdings earlier this week.)
