[Initial Insight] Must Prevent Recurrence of Short-Term Financial Product Redemption Confusion

Securities Firms Sell Short-Term Financial Products for Long-Term Management
Continued Practice of Mismatched Long- and Short-Term Fund Management
Could Trigger Liquidity Crunch in Crisis Situations

[Asia Economy Reporter Lim Jeong-su] Demand deposit-type specific money trusts (MMT) and money market wraps (MMW) are considered the safest financial products among securities firm products invested in by companies. Securities firms sell these products to companies and, when funds are received, invest in ultra-short-term call loans and commercial papers (CP) with short maturities. As the name "demand deposit-type" suggests, redemptions are possible at any time, so companies treat these products almost like cash. On financial statements that list items in order of liquidity, they are recorded as "short-term financial products" just below cash and cash equivalents (bank checking assets, demand deposit accounts). Because they invest in ultra-short-term instruments, the yield (around 0.5%) is extremely low, but the possibility of principal loss or redemption failure is close to zero. Although these are performance dividend-type products like equity funds, both the selling securities firms and the purchasing companies perceive them as principal-guaranteed products.

However, the reality seems different. At the end of last year, when bond market interest rates surged, a company requested redemption of its short-term financial products but received a notice of non-redemption from the securities firm. Upon protest, the response was that redemption was possible but would inevitably result in a large principal loss. When a redemption request is made, the securities firm must recover or sell the held assets in the market to return the money, but due to the interest rate surge and liquidity crunch, they had to sell investment assets at prices lower than the principal. There was even talk of litigation, but Company A had to "grin and bear it" by extending the maturity. Fortunately, this company’s cash liquidity situation was not poor, so it did not lead to management problems, but for companies needing urgent funds, this could have led to a major crisis. It is reported that many companies faced similar or identical situations at that time.

The cause of this situation lies in the securities firms’ management methods for short-term financial products. Most short-term financial products have maturities of about 1 to 2 days. If redemption is requested today, the principal and interest are to be paid tomorrow or the day after. When securities firms receive redemption requests, they must recover or dispose of the short-term assets in the trust or wrap within a day or two to return the principal and interest. However, if the average maturity of the included assets is not 1 to 2 days but longer?1 to 3 months or more?the situation changes. The securities included in the product must be sold in the secondary market before maturity without being redeemed, which can lead to losses depending on interest rates or market conditions.

Securities firms engage in maturity mismatching in fund management due to yield competition. Even though these are short-term products, they must offer companies slightly higher yields to remain competitive and sell more. Having sold products with high yields, they are compelled to invest in high-yield assets. However, it is not easy to find assets that are short-term, safe, and also offer high yields. Therefore, securities firms invested part of the product portfolio in CPs with maturities of 3 months to 1 year. It is also known that some products included asset-backed commercial papers (ABCP) from project financing (PF). This is why redemptions became difficult immediately amid the interest rate surge and liquidity crunch.

Maturity mismatching in short-term financial product management is not a new issue. The same problem has occurred during past crises, placing significant burdens on the liquidity situations of related economic actors. One might argue that this is natural since these are performance dividend-type products, but the market size of short-term financial products is so large that it could act as a trigger for liquidity crunches. Unless measures to reduce or mitigate mismatched management are introduced, it is hard to guarantee that the same problems will not recur during the next crisis.

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