As we mentioned earlier this month, over 30 comment letters have been posted in response to the European Securities and Markets Authority's (ESMA's) "Consultation on EU Money Market Fund Regulation - Legislative Review." Today, we excerpt from letters from French fund association AFG; ALFI, the Association of the Luxembourg Fund Industry; and German association BVI. The AFG writes, "Money markets are key short-term financing markets and money market funds are major investment vehicles in France. At the end of December 2020, the net assets of French MMFs amounted to €371,5 bn. They are all managed as VNAV (Variable NAV) funds, and they make the bulk of Euro-denominated MMFs throughout the EU. These MMFs are thus financing European issuers in the sole EU currency. As of end of December 2020, 44% of the total € 1.4 trillion of MMFs domiciliated in Europe were Euro-denominated MMFs."
They explain, "As two introductory comments relating to their main conclusion of the COVID-19 crisis episode regarding French VNAVs, AFG's members would like to state that: 1 - Unlike the 2008 episode, no issue is to be reported linked to the composition of the portfolio, especially in terms of the quality of assets; funds are sane and resilient in their construction and composition. MMFR increased funds resilience and proved to be efficient. 2 - Exogenous shock to money markets: As the sanitary Covid-19 crisis took in March a global dimension and impacted both real economy and financial markets, money markets underwent a sudden series of brutal imbalances where: many corporates withdrew their money (from credit lines, deposits and MMFs) to face a brutal drop in their revenues due to the economic quasi shutdown trigged by the pandemic; in consequence, MMFs stopped purchasing MMIs and requested bids from the banking system to buy some of their holdings in order to rebuild their cash buffers."
The letter states, "AFG would like to share some fundamental elements of analysis before diving into the MMFR related questions and options as proposed in this consultation paper. Freeze of the Underlying market: MMFs are dependent on the well-functioning of the underlying market (money markets) to operate. They are an important player of this market, but not the only one. Many other actors are part of this ecosystem and are investing in money market instruments CDs, CPs, short term govies, short term credit bonds, reverse repos, etc. ... we cannot assume that MMF can keep providing liquidity whilst the functioning of the underlying market is totally impaired."
It continues, "The process of market liquidity evaporating concerned a large spectrum of assets, at some time even 'the highest quality government assets' as explained by the Bank of England: 'The sharp pickup in asset price volatility, as markets struggled to process the news about the onset of the virus, increased margin calls -- forcing funds to unwind some of their basis trades, selling USTs to generate cash. Initially these trades were conducted quietly. But as time went on, their speed and size -- running to hundreds of billions of dollars -- began to overwhelm dealers' intermediation capacity, which was itself shrinking as the result of rising volatility and the operational challenges of remote working.'"
The AFG suggests a "Precise calendar of market freeze and fund net outflows, and comments, "before any conclusion is drawn, a subtle analysis should be done by type of money market funds (LVNAV, VNAV) but also other types of funds (including ETFs) and by region ... regarding the net outflows and the timing at which it took place, in parallel to the market freeze. Our view is that French VNAV funds did not experience anticipated outflows, but only redemptions linked to the need for cash due to the pandemic and the urgent need for financing working capital needs. These were due to massive drops in revenues, due themselves to a generalized lockdown especially for corporates which was very specific in that crisis."
They also discuss the "Need for cash," and tell us, "French VNAV MMFs are subscribed mainly by institutional investors. At quarter end for instance, their outflows are generally important and are dealt in anticipation in a business-as-usual manner by asset managers. During the crisis, the need for cash expressed by some of them, especially corporates, amounted to high levels of redemptions from MMFs. MMFs are liquid funds that were used in priority compared with other types of assets, even if the redemption was high almost in all asset classes. Other European countries, where MMFs were not part of the funds' spectrum, suffered outflows from other types of funds. If the general COVID 19 crisis (which is a sanitary crisis and in no way inherent to money markets) would have continued, the need for cash would have been expressed also by redemptions in other asset classes. We would thus like to highlight that it should be recognized that it is also 'normal' to expect that MMFs can experience earlier redemptions compared to other asset classes and where a major shock arises, it is expected that risks are re-correlating and all markets suffer alike."
The AFG adds, "This is also why, while acknowledging the important economic role played by MMFs, regulators' reactions should not over-emphasize MMFs' case in this global crisis. Like the French AMF explained: 'The re-correlation of these asset prices in the event of a major shock illustrates the limits of the benefits of diversification. Central banks' intervention was ultimately able to restore the functioning of the market for money market instruments, where both issuance and trading were able to resume at the same time. Since French money market funds have in the meantime seen the return of net inflows, their investment in the most liquid and short-term assets has substantially increased as a precautionary measure."
The second letter states, "The Association of the Luxembourg Fund Industry (ALFI) represents the face and voice of the Luxembourg asset management and investment fund community.... Created in 1988, the Association today represents over 1,500 Luxembourg domiciled investment funds, asset management companies and a wide range of business that serve the sector. These include depositary banks, fund administrators, transfer agents, distributors, legal firms, consultants, tax advisory firms, auditors and accountants, specialised IT and communication companies. Luxembourg is the largest fund domicile in Europe and a worldwide leader in cross-border distribution of funds. Luxembourg domiciled investment funds are distributed in more than 70 countries around the world."
It tells us, "At the beginning of the COVID-19 pandemic, the outlook of a potential economic crisis triggered significant risk aversion and the demand for cash started to increase.... As a result, market liquidity came under pressure and fell sharply, not only for riskier assets, but briefly also in high-quality markets, such as the US Treasury and money markets, as both financial and non-financial sectors demanded cash.... European investment funds experienced outflows for different fund types, including, but not limited to, Money Market Funds (MMFs)."
ALFI writes, "In this context also some segments of the EU short-term MMF industry faced liquidity challenges, in particular LVNAV MMFs while CNAVs recorded high inflows and VNAVs overall limited outflows although individual VNAV funds may have been subject to large outflows.... In general, outflows were amplified by seasonal, quarter-end factors in view of non-financial corporate investor redemptions in the second half of March, whereas those of other clients segments remained more stable.... In this context, we would like to point out the market impact of quarter end balance sheet pressures on liquidity. As banks reduce their balance sheets approaching reporting period ends, this directly impacts both the amount of liquidity a MMF can hold in the fund, and also how liquid the market is. Redemption pressure timed ahead of a quarter end was in our view a material factor in the lack of liquidity in markets."
They also say, "Among the outflows, the ones from both euro and USD-denominated funds were significant, especially USD-denominated LVNAV funds, while preliminary USD-dominated CNAV funds received net inflows.... This could also be observed for Luxembourg MMFs.... In the USA, similar developments took place with a large rebalancing between Prime MMFs and Treas-ury & Government MMFs.... Even though there was neither a direct support of European MMFs by the US Federal Reserve via its programmes nor a broad support by the ECB via the PEPP, their quick reaction helped to maintain investor confidence in the market and thereby limited the impact by investor behaviour. However, the intervention may have led to the impression that MMFs were not resilient enough. In this context, we do not agree with Paragraph 22 which states markets are not very liquid even in normal times. In normal market conditions there is sufficient liquidity."
Finally, another comment says, "BVI represents the interests of the German fund industry at national and international level. The association promotes sensible regulation of the fund business as well as fair competition vis-à-vis policy makers and regulators. Asset Managers act as trustees in the sole interest of the investor and are subject to strict regulation. Funds match funding investors and the capital demands of companies and governments, thus fulfilling an important macro-economic function. BVI's 116 members manage assets some EUR 4 trillion for retail investors, insurance companies, pension and retirement schemes, banks, churches and foundations. With a share of 27%, Germany represents the largest fund market in the EU."
BVI adds, "In our opinion, there is no compelling need for action to change the MMFR. With respect to the MMFs managed by our members, there were neither significant redemptions nor a significant deterioration in the liquidity of money market instruments. However, the money markets need reform, especially the regulation of intermediaries (banks, brokers, platforms) and the money market instruments should be checked, since the intermediaries -- from our point of view -- did not fulfil their role in market making and providing liquidity during the COVID-19 March crisis."
