16 August 2021

ALFI RESPONSE TO FSB CONSULTATION ON MMF RESILIENCE

The crisis was rather an evidence of the resilience of the MMFs...

Response to the consultation  Overall 1. What are the key vulnerabilities that MMF reforms should address? What characteristics and functions of the MMFs in your jurisdiction should be the focal point for reforms?

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 (ESMA report on Trends, Risks
and Vulnerabilities, September 2020, p. 29). 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 (ECB Financial Stability
Review, May 2020 p. 7 and the respective graphic 1 in our attachment).

European investment funds experienced outflows for different fund types, including, but not limited to, Money Market Funds (MMFs) (ESMA report on Trends, Risks and Vulnerabilities, September 2020, p. 35 and the respective graphic 2 as well as graphic 1 in our attachment).

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 (ESMA report on Trends, Risks and Vulnerabilities, September 2020, p. 32 and the respective graphic 3 in our attachment). 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 (see e.g. EFAMA, European MMFs in the Covid-19 market turmoil, November 2020 p. 11).

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.

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
(ECB Financial Stability Review, May 2020, p. 86 f.). This could also be observed for Luxembourg
MMFs (IOSCO Thematic Note, Money Market Funds during the March-April Episode, November 2020,
p. 8 and the respective graphic 4 in our attachment).

In the USA, similar developments took place with a large rebalancing between Prime MMFs and Treasury & Government MMFs (here and the following: ESMA report on Trends, Risks and Vulnerabilities, September 2020, p. 32 f.). The US Federal Reserve started to support US MMFs through lending facilities for dealers purchasing assets from MMFs, the so-called “Money Market Mutual Fund Liquidity Facility” and through outright purchases of money market instruments via the “Commercial Paper Funding Facility”.

In the Euro area, the European Central Bank (ECB) put in place a purchase programme of commercial paper issued in euro by non-financial corporates, the so-called Pandemic Emergency Purchase Program (PEPP). However, it has to be noted that European USD MMFs were neither eligible for the US Federal Reserve facilities, nor for the ECB Commercial Paper programme. Overall, the PEPP only provided limited support to MMFs as it covered only debt issued by non-financial companies and denominated in euro whereas European MMFs invest predominantly in commercial paper and certificates of deposits issued by financial institutions and denominated for the most part in non-euro currencies (EFAMA Market Insights October 2020 – Money Market funds in Europe – State of Play, p. 6). According to our understanding, the Central Bank intervention also rather aimed in the first place at addressing systemic risks in general that arose during a market liquidity crisis than at addressing risks in MMFs in particular. At the end of the first quarter 2020, the situation relaxed and inflows into MMFs were observed as graphics 1-3 show.

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 page 4, second paragraph, last sentence of the consultation report  which states Secondary markets for CP and CDs are generally not liquid as investors, including MMFs,
tend to buy and hold these instruments to maturity. In normal market conditions there is sufficient
liquidity.

The portfolio construction of MMFs organically has high levels of liquidity as it holds at least
30% WLA. Assets within the WLA will generate cash due to natural maturity schedule without the sale
of any position. Therefore, the need to sell to meet redemptions from investors is very limited in normal
times due to the nature of the instrument. Moreover, it should be noted that short-term European MMFs
entered March 2020 already with weekly liquidity levels well above their regulatory minima and that the
average liquidity levels for the whole first half of 2020 remained at around 50% (EFAMA, European
MMFs in the Covid-19 market turmoil, November 2020 p. 17).

In addition, it is worth mentioning that when the crisis evolved, the demand for cash resp. liquidity existed predominantly in the US, as the existing market conditions had already been tighter and the banking system did not contain reserves in the same way as it was the case in the Euro area (ECB Financial Stability Review of May 2020, p. 39). Moreover, despite the liquidity challenges faced by European MMFs, none of them had to introduce redemption fees or gates or suspend redemptions during the market turmoil in March 2020 (ESMA report on Trends, Risks and Vulnerabilities, September 2020, p. 34). This as well as the quick recovery show that the systems operated well. The crisis was rather an evidence of the resilience of the MMFs...

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