Rating agency Fitch said the June 23 vote to leave raises questions over whether global financial institutions, including investment banks, would continue to issue debt in sterling.
Money markets are liquid parts of the financial market where money is borrowed and lent in the short term, and such debt instruments are an efficient way for retirement funds to manage their collateral and liquidity portfolios.
Several banks have threatened to move people and functions away from the UK if the country ceases to be part of the European single market.
Many non-UK financial institutions issue debt in sterling to fund their operations in the country more efficiently, while others use the liquid market to raise capital to spend overseas, but this may become too expensive if the pound remains weak against the major currencies.
Sterling has declined about 8% against both the dollar and the euro since the Brexit result was announced on June 24. Assets in sterling-denominated money-market funds have reached around £150 billion in 2016, according to Fitch data.
Alastair Sewell, a senior director at Fitch, said: “Whether supply remains depends on whether non-UK banks want to continue issuing in [UK] local currency to fund local operations or not. In the medium to long term, if they do not, money-market funds could have a reduced supply [and] lower diversity, which could be further diminished in challenging circumstances should we see rating downgrades [of UK banks].”
The extent of the threat is considerable, since non-UK banks are responsible for around 80% of all debt held in sterling money-market funds, according to Fitch. UK banks issue around 6.5% of all inventory, Fitch said, with the remainder largely made up of government-issued bonds.
Mette Hansen, an investment consultant at Redington, said: “Money-market funds are increasingly important for pension funds, who in the past have held small amounts of cash. Now, with changing regulations around swaps, many of which are in their LDI portfolios, they have to hold cash against them. This cash is usually held in money market funds.”
Liability-driven investment has become increasingly popular for pension funds. A report by KPMG in June found that UK schemes’ use of LDI expanded by 13% during 2015, to £740 billion, out of total pensions assets of around £1.3 trillion. While the majority of pensions use gilts to hedge their liabilities, a significant number use swaps. Recent regulation has compelled pensions to hold collateral against these vehicles.
Hansen said: “There are no other options that offer same day liquidity, which is needed for swaps. Not even gilts are as liquid. Bank deposit accounts are not really an option either, as there is no pick-up nor a guarantee for such large amounts, and banks are not that happy about accepting large deposits.”
However, Dennis Gepp, chief investment officer, cash, at US-based asset manager Federated Investors, said pension funds still had options: “As banks have been reducing the funding they have been able to source from money-market funds, [these funds] have diversified into other highly rated issuers including sovereign, quasi sovereign and corporate names.”