, fund managers sought liquidity when the capacity of markets to provide that liquidity had diminished sharply, resulting in forced asset sales and the amplification of adverse market dynamics. although the extent of liquidity shortfalls is likely to have varied substantially at the fund level, outflows clearly exceeded median cash holdings for all types of corporate bond funds ( see right chart slide 7 ). leverage as an amplifier of market stress the second factor relates to fund leverage. a recent ecb study finds that investors in leveraged funds tend to respond more strongly to deteriorating fund returns, adding to volatility in a bear market. [ 9 ] tentative evidence of the sharp sell - off in march corroborates the view that leverage has probably also been a source of procyclicality during the pandemic. investment strategies reliant on low market volatility have possibly played a significant role in this. these strategies have grown rapidly in recent years. globally, there may be funds with assets under management worth around $ 300 billion invested in some 100 risk parity funds, a well - known hedge fund strategy for multi - asset funds. these volatility - targeting funds typically use leverage when market volatility is below target, as it was before the pandemic, and they have to liquidate leveraged positions when market volatility surges. this probably amplified selling pressures in march. ecb simulations demonstrate that a strict risk parity rule would have called for a large unwinding of leveraged investments when cross - asset correlations surged earlier this year ( see left chart slide 8 ). as volatility spiked and diversification benefits from cross - asset exposures vanished, volatility - targeting investors were prompted to sell assets and reduce leverage ( see right chart slide 8 ). the new portfolio would have had a cash share of nearly 25 % as a result. notably, asset sales would have extended to all asset classes in the portfolio, including the supposedly safer ones, in line with what we observed in the spring. margin calls and demand for liquidity the third factor relates to margin calls. margining requirements are an important safeguard to reduce counterparty credit risk. but they also increase liquidity risk, particularly when liquid asset holdings are inadequate. initial and variation margins collected by four european central counterparties together increased by around €60 billion during the peak of the crisis ( see left chart slide 9 ). total variation margins posted by euro area investment funds rose more than

##f9. en. html 4 / 7 20 / 11 / 2020 covid - 19 and the liquidity crisis of non - banks : lessons for the future allowing funds to become monetary policy counterparties, however, creates major operational, supervisory and regulatory challenges that cannot be solved overnight. for this reason, the governing council launched the pandemic emergency purchase programme ( pepp ), which has been designed to serve two objectives : first, to stabilise financial markets and, second, to counter the negative shock to the economic and inflation outlook caused by the pandemic. the announcement of the pepp had a strong and immediate stabilising effect on financial markets. it instantly addressed the issue of illiquidity, instilled confidence and thereby reduced systemic stress and bond spreads ( see slides 3 and 4 ). private sector purchases, which also include commercial paper, directly contributed to easing financial conditions for non - financial corporates and to reviving the primary market for corporate bond issuance. fixing the fault lines for non - banks but the success of central bank interventions should not distract from the fact that the underlying vulnerabilities in the non - bank sector need a structural fix, not least to mitigate the risk of moral hazard. a large and growing sector that can systematically count on central banks absorbing large amounts of credit and duration risk on their balance sheets in periods of stress will create bad incentives. the depth and persistence of the current shock amplifies these risks : interest rates will stay low for even longer than anticipated before the crisis, spurring risk - taking behaviour in the non - bank financial sector. indeed, many funds started to take up liquidity risk soon after the march turmoil. it is also important to reduce the related but distinct risk of financial dominance – that is, the risk that financial stability concerns may over time distract monetary policymakers from their primary mandate of securing price stability. ensuring that central banks can pursue their mandates without risking financial stability requires a rethink of our current prudential framework. it must be strengthened from a systemic risk perspective to ensure that it can be an effective first line of defence. let me highlight three areas where i see the need for further regulatory reforms. first, we need to reduce the risks of mismatch between funds ’ asset liquidity and their redemption policies. investing in illiquid assets is a central strategy of many types of fund. but such funds then need aligned redemption policies, in particular with respect to the length