The European Central Bank's decision to stop paying interest on its deposit facility will push euro-denominated money market funds down the same road as US money market funds in 2008, starting with the temporary closure of some funds to new investments, followed by fee reductions to keep returns positive, Fitch Ratings says.
The European Central Bank’s decision to stop paying interest on its deposit facility will push euro-denominated money market funds down the same road as US money market funds in 2008, starting with the temporary closure of some funds to new investments, followed by fee reductions to keep returns positive, Fitch Ratings says.
While these actions will help protect existing investors from potential negative yields, the high cost investors now pay for liquidity could increase demand for products that have a longer investment horizon.
In the last few days, JPMorgan Chase, BlackRock and Goldman Sachs have restricted access to some money market funds (MMFs). JPMorgan spokeswoman Kristen Chambers told the New York Post the bank’s investment arm temporary closed the funds “because we think it will help prevent further dilution in yields, which is in the best interest of clients.”
Some funds may opt for more flexible investment strategies to meet these demands and avoid negative yields, Fitch said. Not all strategies may be able to withstand the liquidity shocks associated with a ‘AAAmmf’ rating and would therefore more likely be rated ‘AAmmf’ or ‘Ammf.
The cut in the ECB’s deposit rate to zero will soon push the Euro overnight index average (Eonia) to historical lows, and since most overnight bank deposits will soon pay between -15 and +5bp, there is a risk of MMF yields turning negative.
In this environment, the decision by some funds to temporarily close to new investments is a prudent one to protect existing investors and will not have any direct impact on ratings.
Fitch said it expects to see more temporary soft closures across the sector.
“These tend to last until the current portfolio has matured and is reinvested at prevailing rates, at which point new investments no longer pose a risk of dilution for existing investors,” the agency said.
The average maturity of Fitch-rated euro-denominated MMFs currently stands at 45 days and 60% of portfolios mature in less than a month.
Experience in the US suggests that fee waivers will be the next development. These will probably come first at banking groups that offer MMFs as part of their multiple services to corporate and institutional customers, while managers that see MMFs primarily as a profit centre are more likely to resist lowering fees if possible.
The current low interest rate environment means investors are paying a particularly high cost to hold highly liquid portfolios.
Fitch research indicates that maintaining a high degree of liquidity can cost around 20bp to 30bp of yield.
This high liquidity premium means certain MMF investors are increasingly willing to compromise on liquidity or duration risks in their portfolio, but not on credit risks, leading to increased demand for MMFs with longer investment horizons.