Yesterday, we excerpted from European Fund and Asset Management Association's 2022 Fact Book, which "provides an in-depth analysis of trends in the European fund industry." (See the press release here.) Today, we quote from a sidebar entitled, "Public debt ratios for European MMFs: Is the European short-term public debt market large enough?" It explains, "The market turmoil of March 2020 led some categories of European MMFs to experience significant withdrawals, with consequent liquidity concerns. However, the overall European MMF industry, aided by the comprehensive nature of the EU MMFR framework, proved robust during this recent crisis. Yet both the ESRB and ESMA have made proposals aimed at amending the MMFR, in order to make MMFs more resilient. While a number of those would indeed deliver a more resilient MMFR industry, such as the recommendation to de-link liquidity thresholds from the possible imposition of fees and gates, others would prove impractical, where not plainly unfeasible." (Note: Learn more at our upcoming European Money Fund Symposium, which will take place Sept. 27-28 in Paris, France.)
EFAMA writes, "Among these latter categories is the ESRB’s recommendation for additional public debt liquidity requirements for VNAV and LVNAV funds. Accordingly: Short-term VNAV should have at least 5% of additional public debt assets; Standard VNAV should have at least 10% of additional public debt assets; and, LVNAV should have at least 15% of additional public debt assets. Although ESMA believes that the additional public debt liquidity buffer should be optional, it nevertheless considers that the ESRB’s recommendations could provide a good working basis for these calculations."
They tell us, "These additional liquidity buffers would prove unworkable for two interrelated reasons. First, the data suggest that the portion of the EUR-denominated short-term public debt market for the constitution of an additional public debt liquidity buffer is simply not large enough. Second, other (non-MMF) players, such as banks and other financial institutions, typically rely heavily on high-quality, short-term public debt and could suffer from supply constraints were MMFs to also compete for these."
Discussing "EUR MMFs and the EUR short-term public debt market," the sidebar says, "Net assets of EUR MMFs amounted to around EUR 612 billion at the end of 2021, of which 20% were LVNAV and less than 1% PD CNAV; an estimated 53% were standard VNAV and 27% were short-term VNAV. Applying the additional public debt liquidity requirements proposed by the ESRB would result in EUR MMFs requiring approximately EUR 59 billion of additional short-term public debt assets. Total outstanding short-term debt (with less than a year of original maturity) issued in the euro area at the end of 2021 amounted to EUR 675 billion. This would mean that the additional public debt liquidity requirements for EUR MMFs would require 9% of all outstanding EUR short-term public debt. However, the MMFR imposes additional requirements, such as a maximum residual maturity of 190 days for the public debt holdings of short-term MMFs. This will clearly further limit the potential supply of short-term public debt that can be used for additional liquidity buffers."
It continues, "Data on debt with a shorter maturity than one year is hard to find. Data on the STEP (short-term euro paper) market could give an indication. STEP is a quality label for short-term debt, established to foster the integration of the European markets for short-term paper through the convergence of market standards and practices. The total size of the public STEP market with a residual maturity of less than 184 days is EUR 58 billion. However, an important caveat on this data is that several of the largest EUR public short-term debt issuers, such as France and Germany, are not included."
EFAMA comments, "Even if the total EUR short-term public debt market were, in theory, large enough to accommodate the additional public debt buffer for MMFs suggested by the ESRB, the above analysis does not take into account the other users of this type of paper. Looking at the types of investors that currently hold EUR short-term public debt, MMFs currently hold only 15% of the available total. Commercial banks are the largest holders of public debt, with about one-third of the total short-term public debt issued in the eurozone. This type of paper plays a crucial role in their liquidity ratios. In addition, other large investors -- such as insurers and pension funds (11%) and long-term investment funds (7%) -- rely heavily on short-term public debt. A sudden increase in demand for short-term public debt by MMFs – particularly for the more highly rated and shorter-dated segments - could cause significant supply shortages for these other users."
In other news, the U.S. Treasury's Office of Financial Research published a blog on "Non-centrally Cleared Bilateral Repo." It tells us, "For years, regulators have called for greater insight and transparency into the U.S. repurchase agreement (repo) market. As a crucial source of funding and liquidity for the U.S. financial system, repos provide short-term financing to banks, securities dealers, and other financial institutions to fund their liquidity provisions and leveraged investments. Currently, the daily volume of transactions on all U.S. repo markets exceeds $4 trillion."
The piece says, "Within the U.S. repo market, the non-centrally cleared bilateral segment -- where repo transactions are conducted between two firms without the involvement of a central counterparty or custodian -- has been a blind spot for regulators. Unlike other repo segments where information and data are regularly published, the wholly bilateral nature of these transactions means there is no central source of data on this segment of the repo market."
It continues, "Until recently, little was known about non-centrally cleared bilateral repos. In January of 2022, the Federal Reserve Bank of New York updated their primary dealer statistics to capture the segments of the repo market used by primary dealers.... On average during the first three quarters of 2022, the non-centrally cleared bilateral market made up $1.19 trillion of primary dealer reverse repo (60% of the total) and $0.94 trillion of primary dealer repo (37% of the total). At more than $2 trillion in total exposure, this would make non-centrally cleared bilateral repo the largest segment of the repo market in gross exposure by primary dealers. Moreover, our estimated series prior to 2022 shows that primary dealer volumes in non-centrally cleared bilateral reverse repo have been stable during the previous three years, averaging $1.10 trillion (60% of the total) in 2021 and $1.20 trillion (62% of the total) in 2020."
The OFR piece states, "Non-centrally cleared bilateral repo likely contains a greater share of riskier collateral than other segments of the repo market. One feature of the market that attracts primary dealers is the ability to lend against non-Fedwire eligible specific collateral (centrally cleared specific collateral markets are limited to Treasuries and non-mortgage-backed agency securities).... [O]ur estimates show that non-centrally cleared bilateral is the primary venue for the use of asset-backed securities (ABS), agency excluding MBS, and agency commercial mortgage-backed securities (CMBS) collateral in reverse repo for primary dealers."
It also says, "Finally, the non-centrally cleared bilateral market plays an important role in trading by non-bank financial institutions. For instance, non-centrally cleared is likely a key source of leverage for hedge funds.... Since there is no central source data on the non-centrally cleared bilateral market, OFR is laying the groundwork to fill this critical gap through a data collection. Collecting more data on this market is critical for three reasons: 1. Non-centrally cleared bilateral trades constitute a major segment of the U.S. repo market, as we have shown in this blog. More timely and comprehensive data can help regulators identify emerging risks in this market and make well-informed policy decisions."
The blog adds, "[I]n our conversations with market participants they pointed to three advantages of non-centrally cleared bilateral repo: 1. Market participants report that many institutions do not have access to sponsored repo, and that onboarding new sponsored members can be costly and time-consuming. 2. Sponsored repo has until recently been limited to overnight Treasury collateral and non-MBS agency securities, so market participants point out that non-centrally cleared bilateral repo allows for a greater variety of trades. 3. Trades by relative value hedge funds are often naturally netted, so novating them to FICC would not yield additional benefits. Meanwhile, market participants report that in non-centrally cleared bilateral repo, dealers can offer lower haircuts on these funding packages than would be imposed by FICC on sponsored trades. These responses by market participants highlight the importance of the non-centrally cleared repo market and reinforce the need for more data regarding its functioning."
