Fitch Ratings estimates that central banks around the world have provided facilities in excess of US$90 billion to support mutual funds amid the coronavirus (COVID-19) pandemic.
In its latest report released on Tuesday, the global rating agency said the scale of support shows regulators’ sensitivity to the potential systemic risks that funds pose through potential spill-over effects to financial markets.
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.
Mutual funds it added have become much larger relative to the global economy than at the time of the last global crisis. Mutual fund assets under management (AUM) were US$55 trillion (64 per cent of global GDP) at end-2019, compared with US$24 trillion (38 per cent of GDP) at end-2008.
“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,” it stated.
According to Fitch, India is the latest country to implement a mutual fund support facility, providing INR500 billion (USD6.6 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 funds with combined AUM of USD 4.1 billion. Fitch 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 it said, has been the US Money Market Mutual Fund Liquidity Facility (MMLF). This was launched in March 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).
Fitch further explained that 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 US$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.
Liquidity mismatches are most acute in funds investing in illiquid assets such as properties. 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 Fitch says.
The agency highlighted in 2019 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 as that currently being experienced.
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