Europe's €500bn money funds risk AAA downgrade if they 'break the buck'
Negative interest rates in Europe are causing havoc for the money market industry, threatening its long-term survival
By Ambrose Evans-Pritchard
7:08PM BST 30 Sep 2014
Europe’s giant money market funds are struggling to stay afloat as negative interest rates drain the industry’s lifeblood, with many at risk of crippling downgrades by the rating agencies.
“We’re observing portfolios on a weekly basis. If there is any deviation from our credit metrics, a rating committee would determine if rating action was appropriate. In our view, any loss of capital means that the 'safety of principal’ has been breached,” he said.
“We believe investors are being fleeced,” said one industry insider. “They don’t yet seem to have understood that their capital is being eroded and that they are likely to incur losses if they want to redeem their shares. Of course it is breaking the buck.”
It is a very rare occurrence for a money market fund to fall below par. It was a major shock to confidence when the Reserve Primary Fund in the US announced in September 2008 that it had “broken the buck” due to exposure to Lehman Brothers.
The picture in Europe is entirely different. “It is a yield issue, not a credit issue,” said Susan Hindle from the Institutional Money Market Funds Association (IMMFA). Yet it is a problem nevertheless, the first clear evidence that negative rates can be double-edged.
It is no longer clear whether the funds can safely eke out a positive return as the ECB’s negative rates spread through the financial system. The EONIA overnight rate is currently -0.017pc. Even three-month Euribor is just 0.08pc.
The money market funds place their cash in a mix of short-term debt instruments, with some at the overnight rate. The average maturity is 45 to 60 days. They are not allowed to lend beyond 397 days.
The point of the industry is to provide corporations with a safe place to park cash, with enough liquidity for instant extraction if need be. The funds spread the money across a very wide spectrum of assets and are therefore safer than bank accounts. They can take on more risk but this erodes their financial purity.
The funds play a key role in the financial system. One of the reasons the US Federal Reserve never cut rates below zero was concern about the knock-on effects for America’s $2.1 trillion money markets.
Marc Ostwald, from ADM Investor Services, said the ECB’s negative rate may backfire.
“Corporate treasuries are sitting on a huge amount of cash. The real worry is that they decide to lock up the money for six months or more in longer-term debt to get a positive yield. It could end up discouraging investment,” he said.
IMMFA said the money market industry could still thrive even if returns are negative, given that banks are repelling money and there is almost nowhere else to turn. “It may well be the least bad option relative to what is on offer,” it said.