[15] To meet redemptions or margin calls, funds sold large amounts of US Treasuries beyond the capacity of dealers to accommodate the demand for liquidity, contributing to the highly unusual decline in Treasury prices in this period of stress. Similar developments may have played a role in euro area sovereign bond markets. The crisis also exposed the strong interconnections between banks and non-banks through direct exposures and overlapping portfolios, and demonstrated how these can increase the risk of contagion. [16] For example, MMFs play a particularly important role in the short-term funding of banks. They hold around 10% of outstanding debt securities issued by euro area banks. During the crisis, many of these funds, in particular low-volatility net asset value (LVNAV) funds, which account for almost half of the euro area MMF sector in terms of total assets, came under severe liquidation pressure as investors redeemed large amounts of shares (see left chart slide 10). [17] Large outflows, in turn, led to a freeze in the demand for commercial paper and a measurable rise in their issuance rate for both banks and non-financial corporates, draining liquidity from the system at a time when it was most needed (see right chart slide 10). [18] While some investment funds and MMFs took exceptional measures to cope with their liquidity stress, these were not sufficient to prevent systemic stress. Some investment funds used quantity-based measures, such as the suspension of redemptions and redemption gates to address liquidity issues.

(2020), “Volatility-targeting strategies and the market sell-off”, Financial Stability Review, ECB, May. [11] According to ECB simulations, assets worth nearly 225% of the portfolio’s capital had to be sold in order to meet the volatility target. The simulation assumes a leveraged investor with a diversified portfolio including equities, corporate and government bonds. In this stylised model, relative portfolio weights are adjusted on a daily basis to equalise the risk contributions of the constituent assets of the portfolio considering the daily estimates of portfolio variances and covariances. The level of leverage is set in a way to bring the expected portfolio volatility in line with the volatility target. For more details, see Vassallo, D. et al., op.cit. [12] The liquidity effects of initial margins are likely to increase further in the future. Today, around two-thirds of non-banks’ derivative exposures are not centrally cleared. Initial margin requirements remained fairly stable for these contracts during the turmoil. However, as the implementation and application of the over-the-counter derivatives reform progresses, an increasing number of contracts will be moved to central clearing and an increasing number of non-centrally cleared contracts will become subject to initial margin payments. See also Fache Rousová, L. et al. (2020), “Derivatives-related liquidity risk facing investment funds”, Financial Stability Review, ECB, May. [13] Surveys confirm that variation margin calls led to strained liquidity situations for some non-banks. See the results of the June 2020 survey on credit terms and conditions in euro-denominated securities financing and over-the-counter derivatives markets (SESFOD). [14] ECB (2020), Financial Stability Review, November, forthcoming.