Regulatory Watch – EU Money Market Fund Reforms a Big Deal for Rates?

by: Fouad Mehadi , Kim Liu

  • Following the reforms in the US in 2016, money market funds (MMFs) had less demand for bank paper and banks had to resort to unsecured interbank funding.
  • However, they had to face other banks in a similar situation. This had increased lending rates and led to a decrease in liquidity in the interbank market and led to a rise in Libor
  • So with the new EU money market fund regulation – which will come into force in Q2 2018, with an 18-month implementation period starting soon – the question is whether we will see the same jump in interbank benchmark rates in Europe
  • The current maturity restrictions remain the same under the new regulations. However, the reforms will lead to the emergence of new MMF types, which are expected to change the investment behaviour of MMF investors
  • This could lead to a slight reallocation of capital between the different MMF types as corporates and financial institutions would still need a better alternative than a bank deposit
  • Therefore a proportion of capital invested in Euro bank paper in prime MMFs – which are subject to a conversion to mark-to-market valuations – would need to find its way to MMFs that are permitted to use amortized cost accounting. With the latter having the main preference for investors
  • On the other hand, as corporate treasuries and institutional investors don’t have many options to park their excess liquidity, the expected capital flow away from bank paper into EGBs could be muted
  • We therefore calculate that a maximum of EUR 50bn invested in prime MMFs would be subject to this reallocation into short-term EGBs, but it will likely be much lower
  • In contrast to the US MMF reforms, we don’t expect a tightening of unsecured interbank lending conditions

 

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