By Kieran Fox, Irish Funds – We are all well aware of the human and public health cost which Covid-19 has had since March of this year when its impact reverberated around the globe. Although general consensus is that we still have some way to go until there is a vaccine or other resolution to the pandemic, central banks and regulators are now beginning to look into the effect the crisis had on capital markets during the early days of its impact and seeking to learn lessons from this.
By Kieran Fox, Irish Funds – We are all well aware of the human and public health cost which Covid-19 has had since March of this year when its impact reverberated around the globe. Although general consensus is that we still have some way to go until there is a vaccine or other resolution to the pandemic, central banks and regulators are now beginning to look into the effect the crisis had on capital markets during the early days of its impact and seeking to learn lessons from this.
As the economic impact of Covid-19 rapidly unfolded in March, extreme volatility was experienced in capital markets. As might be expected, these market conditions in turn led many investors to seek to reduce their risk exposure, while increasing the liquidity of their investments, or their access to it. In the initial phase, this urgent demand for liquidity, combined with a general reduction in secondary market activity by banks due to implications for their capital requirements, led short-term markets to grind to a halt, and required central banks to act swiftly to ensure normal functionality was restored. This period impacted all fund types managing portfolio liquidity and redemption profiles but had the biggest impact on Money Market Funds (MMFs). The evaporation of secondary market liquidity for short term securities, such as Commercial Paper, meant they could not be sold (other than at stressed prices) to meet investors’ liquidity requests. The fact that MMFs in Europe successfully managed through this environment however, is testament both to the recent regulatory reform they have been subjected to and the swift action of central banks globally to restore confidence and directly purchase short term securities, including commercial paper.
Another fund type often singled out for regulatory scrutiny are exchange-traded funds (ETFs), which have been one of fastest growing fund structures of recent years and one which Ireland plays a leading role, with more than 60% of all ETF assets in Europe being domiciled here. ETFs were, like other fund types, also required to deal with the extreme market conditions in March. In periods of increased market volatility, the absolute and relative volume of ETF trading has tended to increase, and March 2020 was no exception. During this period, particularly when fixed income markets were impacted, ETFs proved useful as a secondary source of liquidity, and were widely used for price discovery and risk management purposes. As bond market liquidity reduced, ETFs continued to trade efficiently, in fact trading increased significantly over this period, providing valuable insight into bond market prices and allowing investors to rebalance positions, hedge exposures and generally manage risks.
While it is probably too early for definitive conclusions to be drawn by Central Banks from their analysis of this period, they might revisit the capital rules for banks when providing secondary market liquidity in short term securities to ensure these markets continue functioning during times of stress. Banks could for example be provided with capital relief to purchase their own commercial paper.
Another area for consideration could be to allow MMF units to be posted as acceptable collateral for bilateral margin. This would certainly go some way to ease the demand for cash by investors covering margin requirements by redeeming MMF units. There may also be other behavioural aspects of MMF regulations which regulators wish to take a second look at, for example, the rules around breaching weekly liquid asset buffers and the effect this has on maintaining liquidity.
In the period since the full effects of Covid-19 hit in March until the end of June, the funds industry in Ireland has generally demonstrated notable resilience. From data recently provided by the Central Bank of Ireland, we now know that despite large aggregate net outflows from Irish domiciled funds of EUR72.7 billion in March, net sales have rebounded strongly in the months since and now stand at +EUR89 billion for the first six months of the year. Specifically, Irish domiciled MMFs have recorded net sales of EUR52.9 billion for the first half of the year, and ETFs have recorded net sales of EUR20.8 billion over the same period, demonstrating not only the endurance of these fund products but also a significant return of confidence by investors in the allocation of assets.
Although the focus of this article has primarily looked at the resilience and functioning of investment funds during the Covid-19 pandemic, the operational role which staff, service providers and counterparts played must not be overlooked. En masse in mid-March, the industry swiftly deployed full remote working procedures, with staff members across organisations working hard to ensure there was no disruption to the management of funds or the service provided to investors. This significant effort has continued since and is likely to continue for some time as large numbers continue to work remotely.
The effort made by organisations and individuals during this time, noteworthy and significant as it is, pales in comparison, however, to the real human cost of the Covid-19 pandemic. Very much mindful of this, Irish Funds was proud to partner with local industry charity basis.point in April, promoting an emergency relief fund, which raised more than EUR200,000 to provide support for vulnerable families across Ireland.
The funds industry in Ireland, and globally, helps finance businesses and communities in a sustainable manner. It plays an important role, both in terms of the short, medium, or long-term savings objectives of citizens, but also in financing the economy and providing funding and liquidity for issuers.
Central Banks and regulators are quite rightly examining the impact the pandemic had on capital markets and seeking ways to improve their functioning at times of extreme stress, but this work must be carried in the full context of the interconnectedness of market infrastructure and of different market participants (including banks). The funds industry is ready to play a full and constructive part in this analysis, to make an already resilient industry even better, while ensuring the benefits provided to investors and issuers are retained and maximised.
