With Western money market funds facing the spectre of further regulation, we take a look at how China’s MMFs have fared during the pandemic, and the short and long-term trends affecting the sector.
Western money market funds (MMFs) faced considerable pressure at the beginning of the pandemic. In March 2020, some prime and tax-exempt funds faced significant outflows – and some sponsors stepped in to provide support to US-domiciled funds.
As with the 2008 financial crisis, the result of these pressures could be the introduction of further regulation. A report published by the President’s Working Group on Financial Markets in December 2020 reviewed possible reform options for MMFs. And in March 2021, the European Securities and Markets Authority (ESMA) launched a consultation on potential reforms to the EU Money Market Funds Regulation (MMFR).
“This has been instigated by the volatility we saw in Western markets in March last year, when there was significant volatility, liquidity got very tight and there was a flight to quality,” comments Aidan Shevlin, International Head of Liquidity Fund Management, J.P. Morgan Asset Management. “And all funds – not just money market funds – suffered volatility during that period. So while I think Western money market funds did perform well during that time, there’s always room for adjustment and improvement.”
MMFs in China
In China, the picture is somewhat different. For one thing, says Shevlin, China’s money market funds were not subject to the same volatility as Western funds at the beginning of the crisis. “The pandemic escalated during Chinese New Year, and the government announced extra days of holiday while the authorities thought about how to deal with it, which helped a lot,” he explains. “Then the People’s Bank of China (PBOC) stepped in with significant amounts of liquidity, which helped stabilise the market – so there was no real degree of volatility.”
Another stabilising factor, notes Shevlin, is that MMFs in China have already seen a considerable degree of regulatory change over the last decade, “which has improved their liquidity and security, and brought them closer to Western funds in investment style.”
Nevertheless, there are some other factors affecting the direction of travel where China’s funds are concerned. In the short term, says Shevlin, China’s MMFs are inversely correlated with stock markets – “so when stock markets are doing well, domestic investors take money out of MMFs and put it in the stock market, and vice versa.” However, this historic correlation is shifting as China moves towards a cashless society: MMFs are increasingly linked to e-wallets, with excess cash swept into electronic money market funds.
Where longer term trends are concerned, Shevlin notes that while China’s fund industry as a whole has grown by around 54% since the beginning of 2019, money market funds have declined by about 3% during that time. “People are putting money into bonds and fixed income, and last year was a fabulous year for Chinese equities,” says Shevlin. “I think that’s good for the overall market – it’s not healthy to have all your funds tied up in money market funds.”
New rules ahead
While the pandemic may not have prompted regulatory focus on China’s MMFs, change is nevertheless on the horizon in the form of new asset management rules intended to address the risks associated with the shadow banking sector. The new rules were originally issued in 2018, but the transition period has been extended to the end of 2021 as a result of the impact of the global pandemic.
“The new rules are basically saying that for products in the shadow banking market, it must be clear what you’re actually buying,” says Shevlin. “Products must be marked-to-market, and there must be the correct level of risk for the type of product.” With the changes approaching, Shevlin says a lot of money in China is currently in flux, with people seeking alternative solutions. “I would expect to see a lot of that money coming into mutual funds, money market funds, bond funds and equity funds, and other bank products as well,” he says. “So it’s quite an interesting time.”
What’s more, with the PBOC balancing the need to reduce the size of the shadow banking sector against the need to manage economic growth, there is a question mark over whether the PBOC will hike interest rates in the months ahead. “If you think there’s more risk that rates could be hiked in China, rather than left unchanged or cut, then it could make sense to have more of your money in MMFs or ultra short duration products,” Shevlin concludes.