The Impact of Derivatives Collateralization on Liquidity Risk: Evidence from the Investment Fund Sector
IMF Working Papers, February 9, 2024
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- The Impact of Derivatives Collateralization on Liquidity Risk: Evidence from the Investment Fund Sector
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Bibliographic details
- Authors: Audrius Jukonis, Elisa Letizia, Linda Rousova
- Published: February 9, 2024
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798400267239.001
Summary and research question
- Stricter derivative margin requirements have increased the demand for liquid collateral, while euro area investment funds, which use derivatives extensively, have been reducing their liquid asset holdings.
- Research question: Would current levels of funds’ holdings of cash and other highly liquid assets be adequate to meet variation margin calls on derivatives under a range of stress scenarios?
- Data: transaction-by-transaction derivatives data used to assess funds’ liquidity needs for covering variation margin calls.
Key findings
- Between 13 percent and 33 percent of euro area funds with sizeable derivatives exposures may not have sufficient liquidity buffers to meet variation margin calls under adverse market shocks.
- Likely fund behaviors when facing insufficient liquidity buffers:
- Redeem money market fund (MMF) shares.
- Procyclically sell assets.
- Draw on credit lines.
- These behaviors are likely to amplify market dynamics under stress scenarios.
Policy implications and recommendations
- The findings highlight the importance of further work to assess the potential role of macroprudential policies for nonbanks, particularly regarding liquidity risk in funds.
- Implication: policymakers should consider tools and monitoring frameworks to address liquidity strains originating from derivatives collateralization in the investment fund sector.
Subject areas and keywords (as provided)
- Subject: Asset and liability management, Collateral, Financial institutions, Financial regulation and supervision, Liquidity, Liquidity requirements, Liquidity risk, Mutual funds
- Keywords: big data, Collateral, derivative margin requirements, derivatives collateralization, EMIR data, euro area investment funds, Global, liquid asset holding, Liquidity, Liquidity requirements, Liquidity risk, market stress, Mutual funds, nonbank financial intermediaries, Rescale liquidity shortfall, transaction-by-transaction derivatives data, variation margin, variation margin margin call
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- Working Paper