London - Europe's money market funds fear the twin threat of being charged to park cash at the European Central Bank and tougher regulation could push them to the brink of extinction.
The industry is worth around 850 billion euros, but the funds, which traditionally buy only top-rated, short-term debt, are finding life increasingly difficult as record low rates leave them struggling to make a profit.
The health of money market funds is also important for the region's governments and banks for which they are a reliable source of funding.
Almost 400 of the 1,555 funds that existed at the start of 2011 have closed, and with the ECB now flagging that its deposit rate could go below zero - effectively charging those who park cash - many of those remaining are fearing for their future.
Though funds do not park money at the ECB themselves, sub-zero rates would hurt because the yields on the government, corporate or bank bonds that make up the bulk of their portfolios are also be likely to become unprofitable.
“It could be the final nail in the coffin for money market funds,” said Patrick Simeon a fund manager at money market giant Amundi in Paris.
“The fact we can still get a credit premium on non-government issuers means we still get a slight positive return but if the central bank puts its deposit rate into negative territory we will have no chance of achieving this goal.”
ECB data shows euro zone-based money market funds have already suffered 57 billion euros of outflows this year, over 8 percent of their total worth.
Many analysts suspect if there were major closures in the industry, money would simply find another home, though some fear it could kill off a reliable source of funding for euro zone governments and banks at a time when much of the region is still struggling to get back on its feet.
According to Barclays, Europe's money market funds currently hold 22 percent of all short-term securities issued either by governments or corporates in the region and almost 40 percent of all short-term debt issued by EU banks.
SUB ZERO CHILL
A recent Reuters poll showed that money market traders still don't think the ECB will go sub-zero with its deposit rate but some of its policymakers including Board member Joerg Asmussen are clearly warming to the idea.
Despite the scepticism of some traders, markets are nevertheless starting to position themselves for an ECB move.
There has been a surge in options that would pay out if the ECB does go negative (), while the euro took a temporary dive last week following a report that a -0.1 depo rate was being eyed.
Big money market funds have been preparing themselves for the possibility some time.
A number of them have already suspended or limited the number of new investors they take, while others have expanded their range of investments to give them a fighting chance of a profit.
Jon Boyle, head of Fidelity's Institutional Liquidity Fund, thinks despite all the gloom the industry will survive, but only if investors are prepared to keep paying management fees even though they know the funds may lose money.
“It (ECB going negative) is a Rubicon. If you are making 5-10 basis points wherever you are at the moment with a 10 basis point cut you are into negative territory,” said Boyle.
“The critical determinant of how long people (funds) remain is whether they can continue to earn a management fee and whether investors accept a small negative yield in a negative yield environment.”
REGULATION SQUEEZE
But negative rates are not the only threat hanging over money market funds. New regulations brought in response to the financial crisis are also hacking away at profitability.
After the collapse of Lehman Brothers in 2008, the US government had to step in to halt a run on its money funds and in Europe, Germany and Luxembourg also had to take measures to stabilise their industries.
Recent changes mean they can only buy debt that gets paid back quicker and if additional plans go through as proposed constant net asset value (CNAV) money funds will have to keep a higher 3 percent capital buffer in future.
Authorities are still finalising the changes though and there are questions over whether an agreement can be found before Parliamentary elections next year, meaning it could still be another 18 months before the new rules come into force.
“If we had an eonia (overnight rates) at 3 or 4 pct then it would not be as acute an issue, but we would definitely struggle to cope at the present level,” said Amundi's Simeon. “It would be very, very difficult to survive.” - Reuters