European money market funds face year-end liquidity crisis, says Fitch

Jonathan Boyd
clock • 2 min read

Structural weaknesses in the European money market fund industry are set to leave funds desperate for liquidity at the end of 2016, according to research from Fitch Ratings.

The problem stems from growing reliance on custodian banks to manage liquidity amid struggles to invest the money that is within the funds. Fitch said that the supply of overnight deposit and repo facilities from banks, which money market funds rely on, have been decreasing over the past three years, as banks face increasing regulatory demands relating to liquidity coverage ratios.

“Our discussions with MMF managers suggest this year-end may be the toughest yet and many money market funds are therefore likely to leave large sums un-invested with their custodian banks.”

But this high level of reliance on custodian banks comes with a price: money market funds are being forced to pay high prices to leave money in situ – Fitch cites an example of 100bps cost versus the overnight Euribor rate of -0.35% as of mid-December.

“Money may only be left with custodian banks for a short time, but the associated cost will further reduce the already ultra-low yields generated by these funds,” Fitch added.

Europe’s money market funds face other challenges too; Ucits rules mean they can only keep up to 20% un-invested with their custodian banks. It expects the funds affected by the liquidity crisis to allocate more to sovereign, supranational and agency issued instruments. These tend to be rated high quality credit, which should be positive for the affected funds.

Still, Fitch said that euro and sterling denominated money market funds face liquidity difficulties in the short term. Dollar denominated European money market funds are better placed because of reforms already implemented to the US money market funds sector, which has already shifted significant assets, leaving less of a shortage of non government debt.