Earlier this month, Fitch Ratings published its "2022 Outlook on Global Money Market Funds," which reviews a number of factors to watch in the New Year. They write, "Fitch Ratings' 2022 sector outlook for global money market funds (MMFs) is neutral, with conditions broadly unchanged from 2021. Fundamental credit conditions are improving as issuer-level rating Outlooks are increasingly being revised to Stable from Negative. Furthermore, potential interest rate rises should be manageable for MMFs and could contribute to increased revenues for MMF providers. However, regulatory changes being under consideration introduces uncertainty and may lead to outflows from prime funds or a restructuring of certain products."
The piece tells us, "Fitch believes ongoing considerations of regulatory changes create uncertainty for investors and fund managers. Regulators globally have suggested several draft proposals, but no final rules have been implemented. We expect an extended lead time before any regulatory changes are finalised given the length of prior regulatory review cycles, giving investors and MMF providers time to adapt. Fitch expects to review its rating methodology in response to final regulatory proposals, once available, to reflect any potential changes in MMFs' expected risk profiles."
It explains, "Fitch's 2022 global economic outlook highlights inflationary pressures, which are likely to lead to central bank policy rate tightening in the US and Europe. We expect fund managers to reduce weighted average portfolio maturities (WAMs) to position for rising rates. Low WAMs in rated MMFs reduce mark-to-market value declines in portfolio securities and hence funds' net asset values. Low WAMs also mean that potentially increased market yields can be passed on to investors more quickly, depending on managers' approaches to fee reductions."
Fitch's Outlook states, "Revisions of underlying issuers' Outlooks to Stable from Negative continued in 2021 as economies recovered from the pandemic. Nonetheless, a higher share of widely held issuers in MMF portfolios remain on Rating Watch Negative (RWN) or Negative Outlook than before the pandemic, signaling the continued risk of credit deterioration. Fitch expects more RWNs and Negative Outlooks to be resolved or revised to Stable, and anticipates continued stabilisation in the credit environment in 2022."
Discussing "What to Watch - Regulatory Changes," they comment, "Global regulators are actively considering changes to MMF regulation. However, the three main MMF regulatory agencies (SEC (US); ESMA (Europe); CSRC (China)) have not published final policy proposals. The regulatory end-state is uncertain, but eventual changes could be material: the Financial Stability Board, a coordinating body for international financial market regulators, suggested recently that multiple changes may be necessary to address MMF vulnerabilities.... There is material overlap between global regulatory agency proposals."
Fitch continues, "Most of the proposals could be incrementally positive for ratings, but some would likely be negative for the sector, specifically prime funds, in terms of product demand or manager economics. This could lead to second-order effects on fund liquidity if investors reallocate large volumes of money quickly (i.e. in a disorderly manner). Mild reforms, such as de-linking funds' weekly liquidity levels from their ability to impose redemption fees or gates, would be unlikely to cause material fund outflows. However, if prime funds were banned or material structural changes introduced, large prime fund outflows would be expected, with money largely moving to the same fund managers' government funds, based on previous experience."
The piece also says, "Fitch anticipates an initial US interest rate hike in 2022, with more in 2023, but expects EU policy rates to stay at current levels until 2025. MMFs in the US and Europe have been reducing and waiving fees to keep positive or zero net yields since the low rate environment began in 2020. This has pressured fund providers' revenues, and led to fund consolidations and liquidations, particularly for US institutional prime MMFs, which only yielded 1bp more than government MMFs on a net basis as of 1 November 2021. As policy rates increase, MMF managers can up investor fees, improving profitability. This could slow sector consolidation."
It adds, "The Federal Reserve Bank of New York increased the overnight reverse repurchase agreement program (RRP) rate to 0.05% from 0.00% in June to keep interest rates above 0%. This has given MMFs a venue to park excess cash, which otherwise may have gone into Treasury, Agency, and repo markets, and pushed interest rates lower. MMFs' demand for the RRP is driven by low interest rates, the RRP's rate increase, a decrease in Treasury Bill supply, and pandemic-driven inflows into government MMFs. As low interest rates continue, so will increased RRP demand. This is not ratings-material given RRP exposures' high credit quality."
The update tells us, "Fitch expects Chinese MMF assets to continue to grow gradually due to loose monetary policy and ample market liquidity in 2022. Total Chinese MMF assets peaked at CNY9.8 trillion (USD1.52 trillion) at end-August. Total MMF assets fell slightly to CNY9.7 trillion at end-October -- up 20% from end-2020, in line with Chinese mutual fund asset growth. The Chinese MMF market has become more diverse as the assets in Yu'E Bao, the largest Chinese MMF, have declined.... Their detailed portfolio holding information is not available, but funds with exposure to China Huarong Asset Management or China Evergrande Group could have less capability to preserve principal and provide liquidity. Credit selectivity will be important to MMF managers in 2022."
Finally, a sidebar on a "Potential Disruptive Factor - ESG Adoption," comments, "We expect growth of global AUM in ESG MMF, primarily via fund conversion, to continue in 2022. In Europe, Fitch rated EUR215 billion AUM in ST MMFs classified under SFDR Article 8 at end-3Q21.... There were USD9 billion US ESG MMF at end3Q21. The latest conversion at end-2020 increased total US ESG MMF assets by over 40%. Increased ESG activity, beyond just MMFs, has attracted regulatory attention."
