Interactive Investor

Bank of England calls for money market funds to improve liquidity

The Bank is monitoring the stability of funds that offer ‘cash-like’ returns, reports Sam Benstead.

11th October 2023 11:33

by Sam Benstead from interactive investor

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Money market funds, which offer investors cash-like returns by investing in relatively safe bonds set to mature soon as well as bank savings accounts, have soared in popularity over the past two years due to higher interest rates.

Without the volatility of a traditional bond portfolio, they allow investors to capture higher yields on offer, with some money market strategies now yielding more than 5%.

Popular funds include Royal London Short Term Money Market (5.19% yield); L&G Cash Trust (5.2%); abrdn Sterling Money Market (5.29% yield) and BlackRock Cash (4.75% yield).

However, the Bank of England is looking to improve the resilience of the fund sector in the event of market stress, where investors rush to withdraw assets from such funds.

In its latest Financial Policy Committee meeting, it said that money market funds should up their allocation to liquid assets, therefore making it easier for lots of investors to withdraw their money at the same time.

“Significantly more liquid assets than currently required is likely to be the most effective way to increase money market fund resilience and so reduce risks to financial stability, since higher levels of liquidity increase the range of stresses money market funds are resilient to,” the Bank said.

Its analysis suggests that weekly liquid asset levels in the region of 50-60% of assets would give a high level of assurance that sterling-denominated money market funds would be resilient to severe but plausible stresses.

To meet these liquidity requirements, funds would have to invest in more shorter-maturity assets than currently required. If funds had a greater stream of maturing assets then they would have more resources to return money to investors without having to resort to asset sales, the Bank argues.

The analysis built in assumptions around contagion given that the failure of a single fund or funds could lead to wider concerns or confidence effects in the sector more widely.

“This could exacerbate outflows, and increase the stress on other funds,” the Bank said.

The Bank of England found that having 15% or greater in assets redeemable daily would have been sufficient to meet the high demand for cash experienced in March 2020, which was towards the start of the Covid-19 pandemic.

Money market funds are currently permitted to include as weekly liquidity assets certain assets with a maturity up to 190 days that are issued or guaranteed by governments and other public bodies, up to of 17.5% of total fund assets, according to the Bank of England.

It says that some of these assets can still be difficult to sell if there was a dash for cash, and therefore these funds may not be able to raise as much liquidity as anticipated.

The Bank of England’s close monitoring of the sector should not spook investors, but it does show that while “cash-like”, these funds own investments and are not the same as having your money in a bank account.

There is no £85,000 FSCS protection on money market funds, as there is for bank deposits in the event of a collapse.  

The Financial Conduct Authority, the city watchdog, has also expressed concern that there are “underlying vulnerabilities” in the sector and “threats to financial stability remain”.

There is currently £30.6 billion invested in money market funds (across the Investment Association’s short term money market fund and standard money market fund sectors) by UK-based retail investors. This about 2.5% of the UK funds sector.

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