How BlackRock Is Dealing With Negative Interest Rates in Europe
Earlier this month, the European Central Bank (ECB) announced its decision to cut benchmark interest rates further, in what is the latest attempt by the regulator to improve economic conditions in the eurozone. While the benchmark refinancing rate fell from an already low 0.15% to 0.05%, the deposit rate sunk deeper into negative territory: from -0.1% to -0.2%.  As the ECB’s decision to resort to negative interest rates in June was seen as a temporary measure, the unanticipated move signaled to the market at large that deposit rates will remain negative for several quarters – until there is visible improvement in the region’s key economic metrics.
BlackRock (NYSE:BLK) was the first asset manager to react to this change, with the firm announcing its intention to activate a mechanism that will help it maintain a stable share price for one of its money-market funds – the ICS Europe Government Liquidity Fund.  While the fund, with €1.4 billion ($1.8 billion) in assets under management, is a fraction of the $268.4 billion in money-market assets managed by BlackRock at the end of Q2 2014, the decision to switch to a Reverse Distribution Mechanism could extend to its larger Institutional Euro Government Liquidity Fund, and is likely to result in similar changes by competitors over coming weeks.
We maintain a price estimate of $355 for BlackRock’s stock, which is around the current market price.
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Negative Interest Rates Primarily Aimed At Banks
Banks make money by first borrowing at a particular interest rate and then lending it out at a higher interest rate. The amount of net interest income a bank actually earns depends on the difference between its borrowing and lending rates. In a situation where where lending rates decline drastically, banks should be able to borrow at lower rates in order to make a profit. That does not leave a bank with many options if central banks pin interest rates at near-zero levels to stimulate the economy. The situation for the banks is aggravated further when the demand for loans also declines. With few takers for their cash, the banks prefer to just park money with central banks in the form of overnight deposits.
This is what the ECB aims to curb by imposing a negative interest rate on deposits. As a negative interest rate means that the ECB will actually charge banks for overnight deposits, the banks are expected to work harder to hand out more loans by reducing lending rates further – in turn generating demand among individuals as well as small and large businesses.
There Will Be A Noticeable Impact On Other Financial Institutions Too
While banks are affected the most by a negative deposit rate, the impact on asset management firms is also noticeable – particularly for those with a strong presence in the cash management market. As the largest asset manager in the world with $4.6 trillion in assets under management, BlackRock is clearly affected by the ECB’s move. The chart above shows the size of assets under management in money market funds for BlackRock globally.
The negative deposit rate makes it very likely that yields on government securities will turn negative on certain trading days – resulting in unwanted fluctuations in the net asset value (NAV) of funds that hold these securities. BlackRock’s proposed switch to a Reverse Distribution Mechanism seeks to avoid this problem by canceling out shares in proportion to the reduction in value over a day in which returns were negative. This way, the NAV remains constant while the negative returns are absorbed by a reduction in the number of fund units. Negative returns will drag down the fees for BlackRock’s cash management business as shown in the chart below. You can see how a reduction in these fees impacts the company’s share value by making changes to this chart.
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- ECB Cuts Rates, Announces Stimulus to Combat Low Inflation, The Wall Street Journal, Sept 4 2014 [↩]
- BlackRock Money-Market Fund Prepares for Negative Yields, Bloomberg, Sept 12 2014 [↩]