European money market funds push back against calls for post-Covid reform

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Calls for tighter regulation on the EUR1.4 trillion European money market funds sector have been called “misguided” by the industry, which disputes the claims that central bank intervention prevented a fund liquidity crisis in March.

The coronavirus pandemic caused a “dash for cash” among investors in March, with many companies and funds that were holding illiquid assets, such as real estate and corporate debt, drawing on money market funds for short-term funding.

Euro area money market funds suffered outflows of nearly 8 per cent of assets under management in one week from 13 to 20 March, according to data from the ECB.

Central banks’ injection of billions of euros in bond-buying schemes and market support has been credited with allowing money markets to continue providing liquidity throughout the crisis.

In November, the European Securities and Markets Authority (ESMA) said that “further reforms of money market funds are needed” in order to address shortcomings in the fund management sector’s ability to cope with shocks.

“We have identified a number of priority areas that funds and supervisors should focus on to address potential liquidity risks in the fund sector,” said ESMA’s chairman Steven Maijoor.

Policymakers in the US have also recently urged a review of the regulations on money market funds, while the International Monetary Fund (IMF) has said the non-bank financial sector needs a stronger regulatory framework after the pandemic.

The European Fund and Asset Management Association (EFAMA) has hit back at these suggestions, saying that attempts to single out money market funds as an area for further regulatory reform are “misguided”. 

“Calls from parts of the European and global financial policy-making community suggesting that the ECB’s intervention would have allegedly “bailed-out” segments of the money market funds industry is in our view unfounded,” writes EFAMA in a recent report.

The industry body also notes that European money market funds entered the volatile month of March with liquidity levels “well above their regulatory minima”.

The ECB’s Pandemic Emergency Purchase Programme, announced on 18 March, “only had a limited impact on European MMFs”, according to EFAMA, due to the programme’s strict eligibility requirements that excluded purchases of financial commercial paper.

EFAMA concludes: “Recent market pressures were essentially driven by the absence of liquidity in the underlying [money] markets, and in no case by intrinsic flaws with MMF structures per se.”

Concerns have also been raised that the current regulation for money market funds to keep a minimum liquidity threshold beneath which it can suspend redemptions, may have been part of the motivation for investors to withdraw money in March.

Harm Carstens, head of short duration portfolio management EMEA at DWS, welcomed EFAMA’s remarks, noting that DWS’s money market funds “remained resilient under testing market circumstances”, as some faced increased liquidity pressure. 

“Our MMFs were able to meet all redemption requests in full and continued to maintain sufficient liquidity, in line with regulatory obligations. This was achieved despite market volatility and in challenging secondary market conditions.”

Carstens added that the “sizeable increase in assets under management since March” showed continued confidence in the sector.

Data from the International Money Market Funds Association shows that the sector bounced back to assets under management of EUR869 billion by July, 22 per cent above March’s lows.

Euro-denominated money market funds’ liquidity levels also rose from 39 to 53 per cent between the end of February and the end of August, according to Fitch. 

Carstens continues: “While MMFs have proven to be very robust during the crisis, it became obvious that the money market itself was not working properly. Market participants and regulators have pointed to the role that securities dealers played in the intermediation of short-term markets, and that dealers were stepping back from intermediating these markets impacted liquidity during the recent stress.”

In its report, EFAMA noted the role of dealer banks, which typically act as intermediaries when money market funds sell assets. 

According to EFAMA, dealers’ “ability and willingness to act as market-makers… began to dwindle in the face of rising balance sheet constraints, reflecting their own regulatory requirements”, which made it more difficult for money market funds to sell assets during the crisis.

Carstens concludes: “We therefore would like to invite regulators and central banks to focus on finding solutions to avoid similar situations in the future, rather than coming up quickly with a new set of rules for MMFs that would probably not help preventing market failure in the time ahead.”

Some are anticipating reforms in the industry on a par with those implemented in the wake of the global financial crisis in 2008.

Isabel Schnabel, member of the Executive Board of the ECB, noted at a recent conference that earlier reforms, including tighter regulation and higher capital ratios, were “key factors enabling banks to act as shock absorbers rather than shock amplifiers during the coronavirus (Covid-19) pandemic”. 

Schnabel continues: “At the same time, the crisis has been a stark reminder that there are still considerable vulnerabilities in the financial sector. In particular, there has been a divergence between the comparatively lean regulation of the non-bank financial sector and its increasing role in financial intermediation across the globe.” 

Non-bank financial intermediaries, which includes investment funds, owned almost half the world’s financial assets at the time the coronavirus pandemic struck, up from 42 per cent in 2008, according to the Financial Stability Board.

According to Schnabel, the current regime for money market funds “may be inadequate in certain aspects” and regulatory reform “could be needed to mitigate liquidity mismatches and reduce the risk of suspensions during periods of stress”.
 

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Madeleine Taylor
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