China puts ‘important’ money market funds in the crosshairs as they balloon

Balances at China’s money market funds (MMF) ballooned in the second quarter of 2022, hitting a record RMB11 trillion ($1.6 trillion), to overtake Europe as the world’s second-largest MMF after the United States.

China now accounts for about 18% of global MMF assets, after the US (55%) and before Europe (17%).

With Chinese MMFs expanding at a five-year compound annual growth rate of about 16% to end-June 2022, total assets under management reached a record RMB11 trillion in May 2022. Nevertheless, they decreased slightly to RMB10.6 trillion in June, according to the Asset Management Association of China.

Even though yields in China’s MMFs have slumped to 1.6% this month from 2.7% in 2020 as short-term interest rates moved downwards, investors seeking any kind of yield have flocked to domestic MMFs.

Trading has jumped 44% from a year earlier amid signs of more leveraged trading.

STRONGER REGULATION

While regulatory reforms since 2015 have brought Chinese MMFs closer to international standards, there is still a substantial discrepancy between MMFs in China and those in the US and Europe.

The focus of regulation, too, is operating from different motivations.

Li Huang, Fitch

“Proposed MMF rules in the US and Europe focus on addressing threshold issues, enhancing MMF liquidity and imposing liquidity management tools, such as swing pricing,” Li Huang of Fitch Ratings said in a report. “Meanwhile, China’s regulators are targeting a reduction in the risks associated with large individual MMFs.”

Another key factor that distinguishes Chinese MMFs from US and EU MMFs, she says, is the use of leverage. Chinese MMFs are permitted to use up to 20% leverage.

US and EU MMFs, meanwhile, do not use leverage.

The rapid growth and large scale of China’s MMF market, as well as concentration in some major MMFs, has now drawn the attention of regulators who are seeking to tighten rules surrounding large or “important” MMFs.

WHAT ARE IMPORTANT MMFs?

The proposed rules define MMFs with assets under management (AUM) exceeding RMB200 billion or more than RMB50 million investors as “important”.

Also, if an asset manager manages multiple MMFs under a single distribution channel, then those MMFs are deemed ‘important’ if the aggregate AUM exceeds RMB200 billion.

Under the proposed reforms, “important” MMFs would need to meet a higher requirements, hitting a minimum asset credit rating of "AAA" on the national scale, against "AA+" for other MMFs.

“Important” MMFs would also be required to be shorter-dated, with a maximum weighted average maturity (WAM) of 90 days, compared with the maximum WAM of 120 days for other MMFs.

Similarly, “important” MMFs would be required to hold a minimum of 20% weekly liquidity, compared with 10% for other MMFs. The proposed rules also state that leverage at “important” MMFs would be limited to 10%, while MMFs whose AUM exceeds RMB500 billion would not be permitted to use leverage at all.

With the aim of lowering investor and issuer concentration limits and exposure to certain investment products, Fitch is hailing the reforms as a necessary cooling measure.

“We believe the rules would further develop China’s MMF sector, with the tighter standards reducing systemic risks associated with MMFs,” Li Huang said.

WHO WILL IT AFFECT?

The reforms, which are expected to come into effect in third quarter of this year, will only affect the very largest MMFs. Currently, China only has one MMF with AUM in excess of RMB200 billion at end-March 2022: Yu’e Bao MMF, with AUM of RMB777 billion.

Meanwhile, 19 mutual fund asset managers have more than RMB200 billion in MMF AUM, with more than RMB7.2 trillion AUM in aggregate. This represents 71% of total industry assets.

“The new rules, if adopted, would only affect these funds. However, we believe the number of MMFs actually affected would be lower,” Li Huang said. “Some asset managers may diversify their distribution channels before the new rules come into effect.”

For China’s asset managers, the draft rules propose that asset managers of "important" MMFs put aside at least 40% of management fees as a risk provision, up from the current 10%.

Custodians and distribution channels would also need to put a minimum of 20% of their respective fees aside as a risk reserve.

“We believe increased risk provisioning would lead to higher costs for 'important' MMFs and that some fund managers may choose to cap the size of funds by launching new MMFs,” Li Huang said.

Chinese MMF growth is being largely driven by demand from retail investors, with retail assets accounting for about 61% of total assets at end-2021. The remainder are institutional assets from financial institutions, including commercial banks and insurance companies, as well as corporates.