Adverse scenario for the 2023 European Securities and Markets Authority’s money market fund stress testing guidelines

The European Systemic Risk Board, ESRB, has issued a statement to inform of and published the adverse scenarios and latest guidelines for performing the next EU-wide money market fund stress test. The scenarios were developed by the ESRB’s Task Force on Stress Testing in cooperation with the European Central Bank (ECB) and ESRB Secretariat and were recently sent to ESMA for application.
##### In brief, the scenarios encompass the following systemic risks as they were identified as of November 2023:
In view of the ongoing geopolitical tensions caused by Russia’s invasion of Ukraine, the scenarios simulate further disruptions in the global supply chain, leading to higher prices and lower economic growth. Inflation is expected to further increase, not least caused by the ongoing wage-price spiral, which will in turn trigger expectations of policy responses, leading to higher market interest rates and yield curves along All maturity lines.
Additionally, as market interest rates increase, the financing costs of firms and households will rise, leading to slowing economic growth and deteriorating profitability outlooks of companies. At the same time, the increased borrowing costs increase expectations of defaults in both the business and private sector and significantly impact credit risks of banks, thereby driving up credit risk premiums and credit spreads globally. Banks will also suffer from their own high financing costs. The tightening of financing conditions worsens the economic outlook even further, leading in turn to volatility in the financial markets and sharp corrections in asset prices – also particularly in view of the large level of indebtness of countries stemming from the COVID-19 pandemic.
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To derive the adverse scenario outcomes, firms must calculate the reaction of individual variables given a particular strain imposed on chosen triggers which represent potential sources of financial stability risks. Emphasis is thereby placed on swap rates, corporate and government credit spreads, foreign exchange rates, and securitizations. The calibration process utilizes a sample spanning from January 2008 to September 2023.