The number of European money market funds (MMFs) with exposure to Chinese banks has doubled in the last two years, driven by their search for yield and falling short-term issuance from western banks while offshore issuance from Chinese banks has doubled, Fitch Ratings says.
Exposure is concentrated in major state-owned commercial banks, which we believe would receive very strong state support if needed. But these holdings could be sensitive to tension in the Chinese market that could result in price volatility or limited liquidity. We believe that this risk remains manageable as Chinese issuers remain a relatively small part of MMFs' overall portfolios.
According to our analysis, 30% of European MMFs had exposure to Chinese banks at the end of March, up from 14% at the end of 2012. This corresponds with a doubling of short-term offshore bond issuance by Chinese banks over the same period.
Exposure is limited to four majority state-owned 'A' rated commercial banks (Bank of China, Industrial and Commercial Bank of China, China Construction Bank and Agricultural Bank of China) and the wholly state-owned policy bank, China Development Bank, which is rated 'A+'. Together these five have an average allocation of 3.4% among European MMFs.
These banks all have an 'F1' short-term rating, but CDS spreads are materially higher than for similarly rated western banks, indicating markets perceive them as higher risk.
The potential for liquidity and/or market volatility stress on Chinese issuers was highlighted in the first half of 2013, when actions by the Chinese central bank to curtail lending in China's shadow banking system led to sharply reduced liquidity and increased volatility in the Chinese interbank and money markets. Increasing issuance by Chinese banks is intended to both support lending outside China and to bolster capital to reduce risks from potential asset quality deterioration.
The increase in exposure to Chinese banks is part of a broader trend of increasing diversification. 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. Unsecured debt from financial issuers fell below 60% of euro-denominated MMF holdings for the first time in 1Q15 and corporate issuer Procter & Gamble became the largest single unsecured exposure for these funds. The total number of issuers across rated funds also rose to 150 from 120 a quarter earlier.
