[4] In short, key parts of the financial system froze. Liquidity dried up and price discovery was impaired. Given the exceptional nature of the shock, some of these developments may have been unsurprising. But the sharp increase in the yields of the safest global government bonds despite a flight to quality, and their marked dislocations from both interest rate swap rates and spline curves, suggest that more was going on (see slide 5). Dealer balance sheet constraints may have been one factor, especially in the United States. [5] While there are clear and undisputable benefits from having tighter leverage ratios and capital requirements, which should therefore not be watered down, the post-financial crisis architecture has made it more costly for dealers to warehouse large amounts of securities. [6] In the spring, however, the demand for liquidity was unusually high. The investment fund sector alone sold securities worth almost € billion, or 3% of their assets under management, in the first quarter of 2020 (see left chart slide 6). To some extent, this reflects the fast growth of the non-bank sector in previous years: as funds have increased in size, the extent of procyclical outflows in bad times has increased too. High-yield corporate bond funds, in particular, experienced significant cumulative outflows of more than 10% of their assets under management (see right chart slide 6). High asset valuations prior to the shock probably exacerbated the selling pressure. But evidence suggests that investment funds sold significantly more securities than those that endinvestors located in the euro area withdrew.

[15] Schrimpf, A. et al., op. cit. ; Duffie, D., op. cit. ; Liang, J.N. (2020), “  Corporate Bond Market Dysfunction During COVID-19 and Lessons from the Fed’s Response”, Hutchins Center Working Papers, No 69, October. [16] Cera, K. et al. (2020), “The role of bank and non-bank interconnections in amplifying recent financial contagion”, Financial Stability Review, ECB, May. https://www.ecb.europa.eu/press/key/date/2020/html/ecb.sp201119_1~4a1ff0daf9.en.html  6/7  20/11/2020  COVID-19 and the liquidity crisis of non-banks: lessons for the future  [17] Although LVNAV funds guarantee constant prices under normal market conditions, they are designed to lose this characteristic and convert into a variable net asset value (VNAV) fund if the price of the underlying assets changes by 20 basis points or more. The higher riskiness of the underlying assets was likely amplified by the risk of conversion into a VNAV fund, as a number of LVNAV funds were close to breaching the regulatory limits on net asset value during the recent period of volatility. Investors may therefore have redeemed early during the recent stress episode and contributed to additional outflows and liquidity shortages in these funds. [18] De Guindos, L. and Schnabel, I. (2020), “The ECB’s commercial paper purchases: A targeted response to the economic disturbances caused by COVID-19”, The ECB Blog, 3 April. [19] Swing pricing rules can discourage investors from selling shares in funds and can provide fund managers with additional time to adjust their portfolios, mitigating the risk of fire sales. There are mixed results in studies that assess the effectiveness of swing pricing.