The Impact of Derivatives Collateralization on Liquidity Risk: Evidence from the Investment Fund Sector

By Audrius Jukonis, Elisa Letizia, Linda Rousova

February 9, 2024

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Audrius Jukonis, Elisa Letizia, and Linda Rousova. The Impact of Derivatives Collateralization on Liquidity Risk: Evidence from the Investment Fund Sector, (USA: International Monetary Fund, 2024) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

Stricter derivative margin requirements have increased the demand for liquid collateral, but euro area investment funds, which use derivatives extensively, have been reducing their liquid asset holdings. Using transaction-by-transaction derivatives data, we assess whether the current levels of funds’ holdings of cash and other highly liquid assets would be adequate to meet funds’ liquidity needs to cover variation margin calls on derivatives under a range of stress scenarios. The estimates indicate that between 13 percent and 33 percent of euro area funds with sizeable derivatives exposures may not have sufficient liquidity buffers to meet the calls under adverse market shocks. As a result, they are likely to redeem money market fund (MMF) shares, procyclically sell assets, and draw on credit lines, thus amplifying the market dynamics under such stress scenarios. Our findings highlight the importance of further work to assess the potential role of macroprudential policies for nonbanks, particularly regarding liquidity risk in funds.

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

Publication Details

Pages:

35
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2024/026
Stock No:

WPIEA2024026
ISBN:

9798400267239
ISSN:

1018-5941

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