European money market funds have doubled their exposure to China in the last couple of years buying up debt of some of the country’s top-rated banks, according to Fitch Ratings. The MMFs, like many other funds, are going with the returns are and also going where they can still get short-term debt – in the West regulations from Basel III has banks short-dated paper.
“Changes to liquidity and capital regulatory rules have made short-term debt issuance less attractive for western banks, which have historically provided the core holdings of MMFs,” Fitch said. One rule, the new Liquidity Coverage Ratio (LCR) requirement, is meant to ensure banks have enough liquidity to manage a cash run-off in a 30-day period. This means that the expected run-off rate will need to be offset by the bank holding low-return High Quality Liquid Assets (HQLA). Unfortunately those HQLAs don’t involve the short end.
Fitch says that while the risks contained in these investments are high, investors believe the Chinese government will back the backs if something were to go wrong. However, “these holdings could be sensitive to tension in the Chinese market that could result in price volatility or limited liquidity,” Fitch said. “We believe that this risk remains manageable as Chinese issuers remain a relatively small part of MMFs’ overall portfolios.”
According to Fitch’s analysis, 30 percent of European MMFs had exposure to Chinese banks in the first quarter of 2015, up from 14 percent at the end of 2012. “This corresponds with a doubling of short-term offshore bond issuance by Chinese banks over the same period,” Fitch noted.
Fitch said the MMF exposure is limited to the four mostly state-owned A-rated commercial banks, including Bank of China, Industrial and Commercial Bank of China, China Construction Bank and Agricultural Bank of China. The MMFs also hold the wholly state-owned policy bank, China Development Bank, which is rated A+. “Together these five have an average allocation of 3.4 percent among European MMFs,” Fitch said.