Central Banks' Support of $ 90 Billion Underscores Systemic Risks in Mutual Funds: Fitch
During the coronavirus (COVID-19) pandemic, mutual funds (MFs) have become much larger relative to the global economy than at the time of the last global crisis. Fitch Ratings estimates that central banks around the world have provided facilities in excess of $90 billion to support MFs amid the coronavirus pandemic. The scale of support shows regulators' sensitivity to the potential systemic risks that MFs pose through potential spill-over effects to financial markets, it added.
MFs' assets under management (AUM) were $55 trillion (64% of global GDP) at end-2019, compared with $24 trillion (38% of GDP) at end-2008, according to ICI Global.
Fitch says, "Fund stress could lead to increased financial market volatility in regions or countries where central bank facilities are less widespread or comprehensive, or where their effectiveness is constrained. The magnitude of support brought to bear also suggests that the liquidity management tools available to funds may be inadequate for a severe stress scenario."
India is the latest country to implement a MF support facility, providing Rs500 billion (about $6.6 billion) of 90-day repo funding to banks to extend liquidity to funds or purchase commercial paper and debt securities from them. This followed the suspension of redemptions in six schemes with combined AUM of $4.1 billion.
Fitch says it is sceptical about how effective the support will be as India's banks have low capital headroom and could be reluctant to extend liquidity to funds given the lack of capital relief on the facilities.
The largest facility has been the US money market mutual fund liquidity facility (MMLF). This was launched in March 2020 with an initial term of just over six months, in response to severe illiquidity in the secondary market and large redemptions from money market funds (MMFs).
It had $51 billion of outstanding loans at 14 April 2020. "There is no comparable facility in Europe but stress in European MMFs decreased due to improved secondary market liquidity when the MMLF was activated. A key element of the MMLF's effectiveness is that advances are without recourse to the borrower subject to collateral eligibility requirements, in contrast to the Indian facility," the ratings agency says.
Thailand and Colombia have implemented or expanded central bank repo facilities allowing mutual funds to exchange certain securities for cash to meet redemption requests. No Colombian funds have suspended redemptions but four Thai funds, with combined AUM of $4.6 billion, suspended redemptions in March before Thailand's repo facility was implemented. Thailand's facility covers eligible assets of about THB1 trillion (around $31.2 billion). Colombia's pre-existing facility was increased to COP20 billion (about $5 billion) after being made available to mutual funds.
According to the ratings agency, countries that have implemented support facilities have not experienced additional redemption suspensions. "In Europe, however, where facilities have not been introduced, more than 80 funds with combined AUM of over $40 billion implemented extraordinary liquidity management measures in March. Nevertheless, liquidity in European funds has improved following broader market support initiatives and several funds have re-opened," it added.
Mutual funds are a conduit between investors and financial markets. Most funds exhibit liquidity risk, offering investors the ability to redeem daily but investing only a limited part of their portfolios in highly liquid assets. Liquidity mismatches are most acute in schemes investing in illiquid assets such as properties.
Fitch says, "Redemption suspensions and the implementation of support facilities during the pandemic suggest that regulation has yet to fully address the liquidity risk that may materialise amid severe stress. This is despite increased regulatory attention to liquidity in recent years."
In 2019, Fitch had highlighted that without extraordinary liquidity measures such as redemption suspensions, runs on funds could have spill-over effects to financial markets, particularly during macroeconomic stress such