The Bank For International Settlements released its latest BIS Quarterly Review, which includes two sections involving money market funds. The first article, entitled, "Investor size, liquidity and prime money market fund stress," explains, "Massive redemptions at money market funds (MMFs) investing primarily in high-quality short-term private debt securities were an important feature of the market dislocations in March 2020. Building on previous studies of the underlying drivers, we find that large investors’ withdrawals did not differentiate across prime institutional MMFs according to these funds' asset liquidity positions. We also find that, faced with large redemptions, the managers of these funds disposed of the less liquid securities in their portfolios, marking a departure from their behaviour in tranquil times. This is likely to have exacerbated market-wide liquidity shortages. After the Federal Reserve's announcement of the Money Market Mutual Fund Liquidity Facility, all funds strengthened their liquidity positions, with those hardest-hit by outflows attempting to catch up with peers."
Authors Fernando Avalos and Dora Xia tell us, "As the Covid-19 shock gathered momentum in March 2020, large withdrawals beset money market mutual funds (MMFs) investing primarily in high-quality short-term private debt securities (prime MMFs). Since these funds are major global providers of short-term dollar funding to banks and non-financial corporates, their stress had system-wide repercussions (Eren, Schrimpf and Sushko (2020))."
The BIS review continues, "This run on prime MMFs was different from other prominent financial runs in history. The bank runs during the Great Depression and the 2008 run on the very same MMF sector were triggered by concerns about the credit quality of the intermediaries' portfolio of assets. In March 2020, credit quality was not an obvious concern, partly reflecting the strengthened requirements introduced by MMF regulatory reforms in the aftermath of the 2008 crisis."
It says, "Previous studies of MMF stress have pointed to concerns over funds' liquidity. Li et al (2020) find that prime institutional funds with relatively weaker liquidity positions suffered more pronounced outflows. Cipriani and La Spada (2020) note that the funds' investor base also played a role: while funds' liquidity was relevant for prime institutional funds, it was not for their retail counterparts. One complicating factor in these assessments is that prime institutional and retail funds are subject to different regulatory rules, making it hard to disentangle the effect of the investor base from that of regulation."
The BIS writes, "To further investigate the role of the investor base, we focus on prime institutional MMFs. Focusing on funds facing identical regulations allows us to study other determinants of redemption patterns. To distinguish investor types, we differentiate between funds with large and small minimum investment sizes, as they tend to cater to large and small institutional investors, respectively. Other studies have shown that these two groups of funds behaved differently during past stress episodes (eg Schmidt et al (2016), Gallagher et al (2020))."
The Quarterly Review piece posits, "We find that investor size was an important determinant of the pattern of redemptions from prime institutional MMFs in March 2020. Possibly owing to their own cash needs, large investors massively redeemed fund shares, paying little attention to the liquidity of the funds' asset portfolios. By contrast, the liquidity of funds' positions was relevant for small institutional investors. However, to the extent that the characteristics of funds' assets were not the sole driver of redemptions, this was not a classic run."
It summarizes, "In the second part of this feature, we shift the focus from the behaviour of investors to that of the fund managers. We find that managers disposed of the less liquid assets in their portfolios. Such sales may have exacerbated market-wide liquidity shortages during the heightened market stress in the first half of March. This stress eased after the Federal Reserve announced its Money Market Mutual Fund Liquidity Facility (MMLF) in mid-March, which stemmed withdrawals. Managers proceeded to rebuild their liquidity buffers, raising them to higher than pre-pandemic levels. Ultimately, funds that had experienced larger withdrawals saw a stronger subsequent build-up of liquidity buffers."
The BIS study adds, "This feature proceeds as follows. In the next section, we present a brief introduction to the MMF sector and survey attendant developments during the March 2020 stress, both at the sector and the fund levels. In the second section, we focus on liquidity positions and investor size as potential drivers of the March stress at US prime institutional MMFs. The third section studies such MMFs' liquidity management before, during and after the stress episode. The last section concludes."
Finally, the "Conclusion" tells us, "The inability of prime institutional MMFs to provide liquidity on demand in March 2020 called for central bank intervention (FSB (2020a)). Unlike banks, which proved to be useful elastic nodes during the pandemic-induced turmoil (Shin (2020)), the funds' dash for liquidity added to the stress across financial markets. Thus, the provision of central bank liquidity was pivotal in restoring calm (CGFS (2011)). The events of March 2020 have left an indelible mark. They echoed those during the Great Financial Crisis in September 2008, when the MMF sector suffered a comparable massive seizure and also required central bank assistance. Our findings are offered as a contribution to the ongoing debate about the policy measures that could enhance the resilience of MMFs."
The BIS Quarterly's other article, "Dollar funding of non-US banks through Covid-19," states, "Non-US banks' on-balance sheet dollar liabilities rose in 2020 despite the decline in funding from US and offshore money market funds (MMFs). Other non-bank financial institutions were behind this increase, as they drove the strong rise in deposits booked inside and outside the United States. Non-US banks' issuance of international debt securities in US dollars remained resilient in 2020. Additionally, the currency composition of banks' total bond issuance tilted towards the dollar after March. Overall, our findings point to changes in funding relationships that could have long-lasting effects on the functioning of dollar funding markets."
It explains, "The 'dash for cash' episode during the height of the Covid-19 crisis in March led to severe strains in dollar funding markets (FSB (2020), BIS (2020)). A prompt and forceful policy response by central banks through emergency lending programmes and central bank swap lines averted a dollar funding crisis (Cetorelli et al (2020)). Subsequent developments indicate that this episode triggered large shifts in how non-US banks source funding in US dollars."
This BIS piece adds, "On-balance sheet dollar liabilities of non-US banks reached record levels over the first three quarters of 2020. At end-Q3 2020, they stood at $12.4 trillion – $800 billion above their pre-pandemic level at end-2019. This is in contrast with the Great Financial Crisis (GFC), when these liabilities declined substantially and in a sustained manner. To show the sectors and instruments that drove these headline numbers, this article combines the BIS banking and international debt securities statistics, money market funds' (MMFs) portfolio holdings, bank balance sheet data and central counterparty (CCP) disclosures."
A section on the "Decline in money market fund funding," states, "The March turmoil illustrated once again that MMFs are an important, yet flighty, dollar funding source. Non-US banks lost a substantial amount ($300 billion) of MMF dollar funding between end-2019 and end-2020.... Around 85% of the decline was unsecured funding, booked either inside or outside the United States. The contraction was particularly intense during the 'dash for cash' episode in February and March 2020, when MMFs reduced their dollar funding by around $207 billion -- close to 2% of non-US banks' aggregate on-balance sheet dollar funding. MMF funding did not recover even as market conditions normalised."
It explains, "Some national banking systems lost more funding than others. Unsecured funding contracted the most for Canadian, Japanese and Australian banks ... all of which were among the largest recipients going into the pandemic.... In contrast, French banks faced only a limited decline. While their repo borrowing declined somewhat, they remained the largest repo counterparties to MMFs among non-US banks."
Lastly, it adds, "The maturity structure of funding by US MMFs changed both during the March turmoil and later in 2020. At the peak of the market turmoil, the reduction in the volume of this funding went hand in hand with a maturity shortening (Eren, Schrimpf and Sushko (2020), Avalos and Xia (2021)). In the second half of 2020, banks were able to lengthen the maturity of some of the funding they obtained from US MMFs.... Notably, however, the share of more flighty overnight unsecured borrowing also increased for many banks."
