Fitch draws up ‘what if’ scenarios for MMFs

Ratings agency Fitch has constructed three ‘what if’ scenarios for money market funds, analysing their resilience and stability.

While the agency maintains as a base case that the Eurozone will “muddle through” the debt crisis and retain currency union, with no country leaving the Euro, it has described the what ifs of: exit by one peripheral country; disorderly exit with contagion; and Eurozone break up and currency re-denominations.

In the first scenario, of one country exiting the single currency, Fitch hypothesises that the AAAmmf-rated European money market funds are resilient and would continue with the same rating as they are not directly exposed to the PIIGS countries. Funds had an average of 70% invested in core European (as opposed to peripheral) countries as of May.

Should the exit of one peripheral country cause a sharp deterioration more generally there would be an impact on the credit profiles of money market funds, which are still exposed to core European banks (which could see downgrades). A reduced investment universe would also follow. However the chief problem would be liquidity. In a deteriorating credit environment, Fitch said, investors would likely swap out of money market funds for the greater safety of treasury funds or direct T-bill investments.

“Yet MMFs are currently better positioned than in the immediate aftermath of the 2008 crisis to face large scale redemption requests,” the analysis noted. “Most Fitch-rated European MMFs hold around 40%-50% (vs. 25%-30% in H1-08) of their portfolios in assets maturing in less than a week and maintain short average portfolio maturities (weighted average life (WAL) at 45 days on average).”

In the second scenario, of disorderly exit with material contagion to banks and core Eurozone countries, a shutdown of interbank markets could affect the liquidity of MMFs. A flight to quality could cause bank runs, capital flight and loss of government market access. Money market funds with less “well-resourced sponsors” could see redemption restrictions imposed either by sponsors or by regulators trying to protect remaining investors and avoid forced selling. Funds which were unable to repay redeeming investors in a short period of time would be put on Rating Watch Negative or downgraded.

Fitch’s third scenario is of partial or full Eurozone break-up. In the case of partial break-up the agency suggests that redenomination risk is remote because funds aren’t exposed to peripheral countries. In a full break up though, both redenomination and transferability risks could be an issue. “The multiple implications including legal and operational considerations are difficult to estimate as they largely depend on how institutions would operationally organize a dismantling of the eurozone,” said the analysis, emphasising that it considers demise of the Euro “highly unlikely”.