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European MMFs face shrinking investment universe

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Managers of European money market funds denominated in euros and pounds face a smaller pool of high-quality bank assets that cannot be easily replaced with corporate or sovereign debt, according to Fitch. For now, concentration risk is manageable for MMFs, but at the expense of more active portfolio management.

For example, the number of financial-sector issuers whose debt is held by Fitch-rated European MMFs denominated in euros fell to 81 at the end of December 2011 from 92 at the end of September 2010. The drop reflects caution over the European sovereign debt crisis as MMFs have eliminated their exposure to banks from Spain and Italy.

Many of those 81 issuers represent only very small holdings for one or two funds, with a core of around 25 to 30 banks to which MMFs have significant exposures. Fitch Ratings believes this concentration of exposure in a relatively small number of names makes it difficult for funds to cut their exposure to one of those banks if they have concerns about the bank’s strength.

Funding conditions for European banks have improved since the European Central Bank initiated its three-year lending programme, but this has not led MMFs to reinvest in banks from countries that have been hardest hit by the crisis. However, European MMFs have become more willing to lend at longer tenors to banks in other countries.

European MMFs are attempting to balance the lower number of European bank issuers with increased investment in other sectors, including Australian and Canadian banks, corporates and sovereigns as well as increased use of repo transactions. However, there are limits to the extent that they can make this switch.

The number of non-financial corporate issuers in Fitch-rated European MMFs rose to 15 from eight between September 2010 and December 2011. However, the volume of corporate debt remains small and the strongest corporates are more likely to be investing in MMFs than issuing debt, given the amount of cash sitting on corporate balance sheets.

The eurozone crisis has reduced the pool of sovereign debt that MMFs are willing to hold, but on top of that, the market for ‘AAA’-rated European sovereign debt with very short maturities is less than a third of the size of the US Treasury Bills market. Similarly, many European MMFs are not active participants in the repo markets, limiting the ability of European MMFs to diversify their assets on a secured basis. Furthermore, European repo markets are confronted with constraints on high quality collateral availability.
 

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