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Christian Weistroffer

27 June 2016
OCCASIONAL PAPER SERIES - No. 174
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Abstract
This paper first highlights the structural features of shadow banking in the euro area, focussing on investment funds. It then discusses the potential systemic risks that the recent expansion of the investment fund sector presents. While investment funds provide important intermediation services to the real sector, including market and liquidity risk-sharing and the bridging of information gaps, their rapid expansion may present systemic risks that need to be detected, monitored and managed. In particular, the risk of fund outflows and the possible negative impacts on the wider financial system have risen due to the rapid expansion of the investment fund sector, its growing involvement in capital markets, its use of synthetic leverage, and the inherent and growing maturity and liquidity mismatch arising from the demandable nature of fund share investments. While available data suggest that vulnerabilities within the investment fund sector are growing and links to the wider financial system and real economy have strengthened, data limitations prevent drawing a definitive conclusion on the sectors' contribution to systemic risk.
JEL Code
G01 : Financial Economics→General→Financial Crises
G20 : Financial Economics→Financial Institutions and Services→General
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
27 July 2016
OCCASIONAL PAPER SERIES - No. 10
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Abstract
Owing to the disruptive events in the shadow banking system during the global financial crisis, policymakers and regulators have sought to strengthen the monitoring framework and to identify any remaining regulatory gaps. In accordance with its mandate, the European Systemic Risk Board (ESRB) has engaged in developing a monitoring framework to assess systemic risks in the European Union (EU) shadow banking sector. This assessment framework provides the basis for the EU Shadow Banking Monitor, which will be published each year by the ESRB. The framework also feeds into the ESRB’s Risk Dashboard, internal risk assessment processes and the formulation and implementation of related macro-prudential policies. The ESRB’s Joint Advisory Technical Committee (ATC)-Advisory Scientific Committee (ASC) Expert Group on Shadow Banking (JEGS) has accordingly engaged in: conducting a stocktake of relevant available data and related data gaps; defining criteria for risk mapping in line with the work of the Financial Stability Board (FSB) in this area; deriving indicators using this methodology for the purposes of the ESRB’s risk monitoring and assessment. Shadow banking can be broadly defined as credit intermediation performed outside the traditional banking system. This is consistent with the definition used at the global level by the FSB. Against this background, this paper describes the structure of the shadow banking system in Europe and discusses a range of methodological issues which must be considered when designing a monitoring framework. The paper applies both an “entity-based” approach and an “activity-based” approach when mapping the broad shadow banking system in the EU. In turn, the analysis focuses primarily on examining liquidity and maturity transformation, leverage, interconnectedness with the regular banking system and credit intermediation when assessing the structural vulnerabilities within the shadow banking system in Europe. This approach appears the most appropriate for the purpose of assessing shadow banking related risks within the EU financial system. On this basis, the paper complements the EU Shadow Banking Monitor by providing further methodological detail on the development of risk metrics. The paper presents the analysis underpinning the construction of risk metrics for the shadow banking system in Europe and highlights a number of areas where more granular data are required in order to monitor risks related to certain market activities and interconnectedness within the broader financial system.
JEL Code
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G18 : Financial Economics→General Financial Markets→Government Policy and Regulation
24 November 2016
FINANCIAL STABILITY REVIEW - ARTICLE
Financial Stability Review Issue 2, 2016
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Abstract
Alternative investment funds (AIFs) in Europe operate without regulatory leverage limits. Competent authorities within the EU have the legal power to impose macroprudential leverage limits on AIFs, but no authority has implemented this tool so far. This joint European Central Bank-De Nederlandsche Bank (DNB) special feature (i) presents a macroprudential case for limiting the use of leverage by investment funds, (ii) develops a framework to inform the design and calibration of macroprudential leverage limits to contain the build-up of leverage-related systemic risks by AIFs, and (iii) discusses different design and calibration options. By way of example, it uses supervisory information on AIFs managed by asset managers based in the Netherlands. The article concludes by recommending a way forward to develop an EU-level framework for a harmonised implementation of macroprudential leverage limits for AIFs, which forms a key part of the agenda of the European Systemic Risk Board (ESRB) to develop macroprudential policy beyond banking.
JEL Code
G00 : Financial Economics→General→General
30 November 2017
OCCASIONAL PAPER SERIES - No. 202
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Abstract
This joint ECB-DNB Occasional Paper aims to inform the ongoing discussions about an EU-level framework for operationalising macroprudential leverage limits for alternative investment funds (AIFs). It builds on, and extends, the analysis of an ECB-DNB special feature article published in the ECB’s Financial Stability Review in November 2016. First, this Occasional Paper presents new EU-level evidence suggesting that leveraged funds exhibit stronger sensitivity of investor outflows to bad past performance than unleveraged funds, which has the potential to exacerbate systemic risk. Second, it devises a framework for assessing financial stability risks from leverage in investment funds. This is applied to leveraged AIFs managed by asset managers in the Netherlands using Alternative Investment Fund Managers Directive (AIFMD) data for the two-year period from the first quarter of 2015 to the fourth quarter of 2016. Third, it discusses the potential effectiveness and efficiency of various designs for macroprudential leverage limits. To this end, it builds on the findings for the Dutch AIF sector and suggests design options for further exploration at EU level. Beyond assessing financial stability risks from leverage in the Dutch AIF sector, the case study aims to show how equivalent information on AIFs at the European level – which will be made available to the European Securities Markets Authority (ESMA) and the European Systemic Risk Board (ESRB) in the coming years – could be used when developing an EU-level framework for operationalising macroprudential leverage limits.
JEL Code
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination
2 October 2018
MACROPRUDENTIAL BULLETIN - ARTICLE - No. 6
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Abstract
This article aims to facilitate discussion on potential macroprudential tools for investment funds. To this end, the article puts forward an initial assessment based on the application of a conceptual framework and aims to inform the debate on the potential design aspects of macroprudential liquidity tools. In line with the ESRB’s approach to developing macroprudential instruments, the effectiveness and efficiency of various macroprudential liquidity tools for investment funds are thoroughly assessed. The article provides an overview of the various liquidity tools and assesses the suitability of these tools for containing the materialisation of systemic risks through various channels.
JEL Code
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination
29 November 2018
FINANCIAL STABILITY REVIEW - ARTICLE
Financial Stability Review Issue 2, 2018
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Abstract
Over the last decade, exchange-traded funds (ETFs) have grown at a fast pace both globally and in the euro area. ETFs typically offer low-cost diversified investment opportunities for investors. ETF shares can be bought and sold at short notice, making them efficient and flexible instruments for trading and hedging purposes. At the same time, the wider use of ETFs may also come with a growing potential for transmission and amplification of risks in the financial system. This special feature focuses on two such channels arising from (i) liquidity risk in ETF primary and secondary markets and (ii) counterparty risk in ETFs using derivatives and those engaging in securities lending. While ETFs still only account for a small fraction of investment fund asset holdings, their growth has been strong, suggesting a need for close monitoring from a financial stability and regulatory perspective, including prospective interactions with other parts of the financial system.
3 May 2019
WORKING PAPER SERIES - No. 2276
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Abstract
Using newly available information on euro area sectoral holdings of securities, this paper investigates to what extent the presence of institutional investors affects volatility and liquidity in secondary bank bond markets. We find that non-bank financial intermediaries, in particular money market funds (MMFs), have a positive impact on secondary bank bond markets’ liquidity conditions, at the cost of significantly increasing volatility of daily returns. The effect translates to more than a 19% improvement in liquidity conditions and up to 57% increase in daily-return volatility, assuming MMFs hold about 10% of the notional amount in the secondary market of a representative euro area bank bond. The effect is relative to the impact the non-financial private sector has on markets. Investment funds, insurance corporations and pension funds are found to similarly affect market conditions, though to a lesser magnitude. We find a trade-off between volatility and liquidity, where the stronger presence of institutional investors at the same time improves liquidity and increases volatility. The results suggest that possible structural shifts in investor composition matter for market conditions and should be monitored by financial stability authorities.
JEL Code
G10 : Financial Economics→General Financial Markets→General
G15 : Financial Economics→General Financial Markets→International Financial Markets
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
29 October 2019
MACROPRUDENTIAL BULLETIN - ARTICLE - No. 9
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Abstract
A recent ECB study shows that leverage is an important driver in investors’ redemption decisions. Regulatory changes to the UCITS framework facilitated the use of derivatives, increasing leverage for some European mutual funds which amplified investors' responsiveness to negative returns in a procyclical manner.
JEL Code
G01 : Financial Economics→General→Financial Crises
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
20 November 2019
FINANCIAL STABILITY REVIEW - BOX
Financial Stability Review Issue 2, 2019
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Abstract
When investment funds face outflows, fund managers may have to liquidate parts of their portfolio, potentially changing its composition and riskiness as a result. If fund managers respond to outflows by selling securities proportionally to the initial asset allocation, i.e. selling a vertical slice of the portfolio, the liquidity and risk profile of the fund remains unchanged. But asset managers might have incentives to reduce the portfolio non-proportionally. For example, in trying to avoid incurring losses on illiquid assets, managers might choose to sell the most liquid securities first. And in the hope of increasing returns and attracting future inflows, they might choose to take on more risk in their portfolio. Other managers, worried about future outflows, might hoard liquid securities and de-risk their portfolios. However, large sales of illiquid securities may affect their market price at times of relatively low market liquidity, with possible spillovers to other financial institutions holding the same assets.
19 May 2020
WORKING PAPER SERIES - No. 2413
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Abstract
Does leverage drive investor flows in bond mutual funds? Leverage can increase fund returns in good times, but it can also magnify investors’ losses and their response to bad performance. We study bond fund flows to provide new evidence for the link between mutual fund leverage and financial fragility. We find that outflows are greater in leveraged funds during stressed periods and after bad performance, compared with unleveraged funds. We provide supporting evidence that leverage exacerbates the negative externality in investors' redemption decisions. In this regard, we find that fund managers in leveraged funds react more procyclically to net outflows compared with fund managers in unleveraged funds. Such procyclical security sales in leveraged funds may increase investors’ first-mover advantages and their response to bad performance. These findings suggest that leverage amplifies fragility in the bond mutual fund sector.
JEL Code
G01 : Financial Economics→General→Financial Crises
G20 : Financial Economics→Financial Institutions and Services→General
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
25 May 2020
FINANCIAL STABILITY REVIEW - BOX
Financial Stability Review Issue 1, 2020
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Abstract
Euro area money market funds (MMFs) provide short-term credit to banks and non-financial corporations (NFCs) through purchases of commercial paper (CP). MMFs also play an important role in non-banks’ cash and liquidity management, given that the funds offer stable value and the possibility to redeem at short notice. As the coronavirus crisis deepened, euro area MMFs experienced large outflows and a number of them had difficulties in raising sufficient cash from maturing assets and liquid positions. Stress in MMFs can impair the financial system’s and the real economy’s access to short-term funding and liquidity during crises. Monetary policy action helped to improve financial market conditions more broadly, thereby also alleviating liquidity strains in the MMF sector.
JEL Code
G10 : Financial Economics→General Financial Markets→General
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
12 April 2021
MACROPRUDENTIAL BULLETIN - ARTICLE - No. 12
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Abstract
Large differences between the liquidity of investment funds’ assets and liabilities (i.e. liquidity mismatches) can create vulnerabilities in the financial system and expose funds to a risk of large outflows and sudden drops in market liquidity. From a macroprudential perspective, the current regulatory framework may not sufficiently address the risks stemming from liquidity mismatches in investment funds. By modelling the liquidity management of an open-ended fund, this article provides theoretical justification for pre-emptive policy measures such as cash buffers that enhance financial stability by helping to increase the resilience of investment funds.
JEL Code
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
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12 April 2021
MACROPRUDENTIAL BULLETIN - ARTICLE - No. 12
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Abstract
The turmoil seen in March 2020 highlighted key vulnerabilities in the money market fund (MMF) sector. This article assesses the effectiveness of the EU’s regulatory framework from a financial stability perspective and identifies three important lessons. First, investment in non-public debt assets exposes MMFs to liquidity risk, highlighting the need to limit investment in illiquid assets. Second, low-volatility net asset value (LVNAV) funds are particularly vulnerable to liquidity shocks, given that they invest in non-public debt assets while offering a stable net asset value (NAV). Enhanced portfolio requirements could strengthen their liquidity profile. And third, MMFs seem reluctant to draw down on their liquidity buffers during periods of stress, suggesting a need to make buffers more usable.
JEL Code
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G01 : Financial Economics→General→Financial Crises
12 April 2021
MACROPRUDENTIAL BULLETIN - ARTICLE - No. 12
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Abstract
During the market turmoil of March 2020, many money market funds (MMFs) and other investment funds which were exposed to liquidity risk through a liquidity mismatch between their assets and liabilities experienced significant outflows. Those funds reacted in a procyclical manner by either selling assets in already stressed markets or curtailing investors’ access. That behaviour resulted in knock-on effects on other sectors of the economy and amplified the stress within the financial system. This overview article discusses financial stability risks arising from liquidity transformation by MMFs and other investment funds, a subject which is then explored in greater depth in the three other articles in this issue of the Macroprudential Bulletin. While the liquidity transformation carried out by investment funds serves an important economic function, by intermediating savings and real economy financing, it can also generate risks to financial stability. With this in mind, this article argues for a macroprudential approach to the regulation of investment funds to enhance their resilience and facilitate a stable provision of funding to the wider economy in both normal market conditions and periods of market stress.
JEL Code
G01 : Financial Economics→General→Financial Crises
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
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