London/New York – Fitch Ratings has revised its sector outlook for European low volatility net asset value (LVNAV) money market funds (MMFs) to negative from stable, driven by price volatility affecting fund mark-to-market (MTM) net asset values (NAVs) and heightened outflows. Fitch believes that risks for the sector have increased due to investor risk aversion, unprecedented market volatility, and the increased potential for credit deterioration of underlying issuers.
LVNAV MMF ratings could be downgraded if these trends are sustained, and if material redemptions result in structurally impaired liquidity positions. The secondary market is challenged, which increases the importance of natural liquidity (near-term maturities) in the funds, and the stability and profile of their investor bases. The suspension of redemptions by a fund would lead to a downgrade to ‘BBmmf’ or below, in line with Fitch’s rating definitions.
European LVNAV MMF flows were volatile in the week to 20 March 2020, with material outflows causing some funds to sell securities to meet redemptions and reducing their liquidity buffers above regulatory minimums. Fitch-rated funds have mostly weathered outflows to date, meeting redemptions using natural liquidity and selling of securities. A limited number of funds have experienced minor or temporary breaches of Fitch’s ‘AAAmmf’ weekly liquidity rating range. Accordingly Fitch is monitoring these funds more closely to understand the extent to which they will be able to remedy the breaches in a timely manner.
Outflows were highest in USD-denominated funds (USD46.9 billion or 15%, according to iMoneyNet data). This followed the trend in the US, where investors redeemed from onshore US prime MMFs in favour of onshore government MMFs. Euro and sterling-denominated LVNAV MMFs saw outflows of GBP16.6 billion (8%) and EUR15.2 billion (15%) respectively. Following these events, euro, sterling and US dollar-denominated LVNAV MMFs averaged 33%, 34% and 36% weekly liquidity, respectively, according to iMoneyNet calculations. This was above Fitch’s minimum weekly liquidity threshold at the ‘AAAmmf’ rating level, though with limited buffers.
European and US MMF liquidity regulations differ. In the US, a breach below 30% weekly liquidity is enough to force the fund’s board to consider imposing a liquidity fee or redemption gate. In Europe, both a breach of 30% weekly liquidity and a simultaneous net outflow above 10% on the same day are needed to force the board to consider such action, although a liquidity breach alone, or even a near-breach, may accelerate outflows as investors rush to beat possible fees or gates. The imposition of fees or gates, however, is always entirely at the board’s discretion in both the US and Europe.
If an LVNAV MMF’s MTM NAV were to deviate from a stable value (1.0000) by more than 20bp, it would temporarily switch to variable pricing. (If the MTM NAV moves back within 20bp of the stable value, stable pricing would resume.) Investor reaction to a switch is hard to gauge as such a scenario has never occurred. The largest deviation between stable and MTM NAV in Fitch-rated LVNAV MMFs was 15bp at 20 March. Funds with longer weighted-average lives or higher outflows have been most affected. A breach of the NAV corridor would not, in itself, trigger a negative rating action but a downgrade would be likely if variable pricing led to outflows that resulted in severely reduced liquidity or gating of the fund.
Fitch believes that the lack of policy measures to support MMFs in Europe poses additional risks relative to US MMFs. The Bank of England’s and ECB’s recent liquidity provisions for commercial paper apply to non-financial commercial paper only, and so cannot be used by MMFs. In contrast, the US Federal Reserve’s money market mutual fund liquidity facility includes financial commercial paper. Moreover, European MMF regulation bars funds from receiving support, in contrast to several recent cases in the US where affiliated entities purchased securities from MMFs.
One mitigating factor for European MMFs is that the relative attraction of government MMFs in Europe is lower than in the US. European government MMFs have gates and fees, whereas US government MMFs do not. While breaches of liquidity thresholds in European government MMFs are unlikely, given their eligible asset characteristics, the imposition of fees or gates is not impossible.