US reforms boost European USD money market fund yields

New rules in the US for the regulation of money market funds (MMFs) – agreed in April and introduced last month – have boosted the yields from European prime US dollar (USD) MMFs, reports Fitch Ratings.

In its latest MMF Dashboard, covering the third quarter of 2016, the credit ratings agency (CRA) reports that the yield differential between European US dollar prime MMFs – which invest in financial and non-financial prime securities – and those investing exclusively in government debt have increased sharply since July, reaching close to 40 basis points (bp) at end-October 2016, from 17bp a year ago.

A sharp drop in demand for short-term corporate and bank debt following the US’s MMF reform triggered a rise in short-term borrowing costs for these issuers, reports Fitch. This supports yields for US dollar-denominated prime MMFs domiciled in Europe, which can still buy prime securities discarded by their US counterparts. The one-year US dollar London Interbank Offered Rate (LIBOR) rate rose to 1.56% at end-September from 1.17% in January and the overnight rate edged up to 0.42% from 0.37%.

The report also finds that Canadian and Australian banks are increasingly looking at Europe-domiciled US dollar MMFs for their short-term dollar funding to replace MMF funding sources lost in the US. The Commonwealth Bank of Australia, Australia and New Zealand Banking Group, Toronto Dominion Bank and Bank of Nova Scotia have seen their exposure increase in US dollar MMFs over the past year. Similar trends are evident in sterling and, to a lesser extent, euro MMFs, with allocations to these banks swiftly rising over the past 12 months.

The sustained demand for European MMFs saw European constant net asset value (CNAV) assets in euro (EUR), USD and sterling (GBP) increased in Q316. They reached €569bn at end-September, close to their end-2015 highs.

Other findings from the Q3 2016 report:

Euro-denominated European MMFs:

Unsecured and repo counterparty exposure to financials increased to 67% at end-September, the highest since Q4 2014 before gradually falling to a historic low at end-2015. DZ Bank, BNP Paribas, Standard Chartered, Svenska Handelsbanken and Norinchukin Bank drove most of the Q3 increase in financials, together with a few new issuers. BNP Paribas is the most largely held issuer with close to 5% of average portfolios’ allocation across Fitch-rated MMFs.

The average portfolio’s weighted average maturity (WAM) was flat at 48 days, while their weighted average life (WAL) increased to 57 days from 55 days, reflecting growing interest in floating-rate securities. After observing wider WAL ranges in Q2, the dispersion of fund positioning reverted to below the historical average, indicating a broader consensus.

The average maturity of bank exposure fell to 48 days in Q3 from 57 days in Q2, signalling that the rise in bank allocations is largely in short-dated exposures (below 30 days). Banks used to comprise most of the longer-dated exposures; most of it is now government bonds and notes.

Japanese corporate exposure, driven by Toyota and Mitsubishi Corporation, rose markedly in Q3, although most of the Japanese issuers’ exposure (9.7%) still stems from banks.

Sterling-denominated European MMFs:

The UK government remains the largest issuer in sterling MMFs, but the exposure reduced to 6% at Q3 from the 7.3% high reached in June, when funds built high UK government exposures to protect against uncertainties around the European Union (EU) referendum, and to accommodate potential unexpected redemption requests or reinvestment difficulties.

Exposure to financials increased by 6 percentage points (pp) to 76% in 3Q16, with ABN Amro, Commonwealth Bank of Australia, Mitsubishi UFJ FG and DZ Bank the main contributors. DZ Bank is now the most held bank in sterling MMFs. Exposure to government and agencies decreased by 5pp to 14% during the post UK referendum period to end-September, primarily driven by the UK government and France’s ACOSS. The decline partly reflected shifting liquidity needs, as the UK referendum was on June 23.

Exposures to the largest Japanese banks, which have negative rating outlooks following the downgrade to Japan’s rating outlook, remain at around 11% on average at end-September. Sumitomo Mitsui Financial Group, Mitsubishi UFJ Financial Group and Mizuho Bank were among the largest exposures in sterling MMFs.

Exposures to Canadian issuers reached 7% by increasing 1.6pp. Toronto Dominion Bank, Bank of Nova Scotia and RBC were among the largest exposures in sterling MMFs at end-September. The decrease in UK country exposure is largely driven by the large decrease in UK government holdings.

Portfolio maturities increased in Q3 after the June 23 referendum led to shortened portfolio maturities as a conservative portfolio management measure. The average portfolio WAM and WAL rose to 51 days and 70 days, respectively over the quarter. Certain funds had materially lengthened their WAL, ahead of the Bank of England (BoE) rate cut from 0.50% to 0.25% in August, which drove sterling MMF yields down.

US dollar-denominated European MMFs:

While Canadian and Australian banks increased their exposure in Q3, direct and indirect exposure to Japanese banks declined over the quarter to 9.5% at end-September. Exposure to Mizuho Bank was the largest at 2.2% on average across US dollar funds, reaching up to 4.4%. Mizuho Bank’s rating is most vulnerable to a downgrade should the Japan sovereign be downgraded.

The share of financial institutions’ exposures decreased in Q3, reaching 71.4% at end-September; due in part to reduced repo transactions to 4% from 5.2% the previous quarter. Bank of Nova Scotia was the largest increase and DZ Bank is now the most held issuer. However, there is a decline in French issuers primarily driven by smaller allocations to SG and Credit Agricole.

Asset-backed commercial paper (ABCP) securities exposures increased to 13.2% in Q3 from 10.3% in Q2. About 70% of the US dollar funds Fitch rates regularly invest in ABCPs.

The average portfolio WAM edged up to 33 days in Q3 from 31 days previously. Similarly, portfolios’ WAL slightly increased in Q3 to an average of 53 days from 51 days.

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