Published: August 18, 2014
Treasurers around the world are approaching a watershed in the way that they formulate cash investment policies and processes. Persistently low interest rates, local and global regulatory and market developments, and changing global cash and liquidity management needs, are placing ever-increasing demands on treasurers. While security and availability of cash will continue to be key investment priorities for corporations, the ways in which treasurers will manage these priorities in the future will undoubtedly change. Consequently, treasurers need to keep informed of global, regional and local investment trends and opportunities, and maintain their investment policies and processes accordingly, in partnership with a trusted asset management partner.
There is inevitably no single factor that is driving change in the cash investment environment; furthermore, these differ within each region and indeed within individual markets:
Globally, as banks progress in their implementation of Basel III before the 2019 deadline, their appetite for different types and tenors of investments will change. This is leading to the emergence of new investment products and more competitive rates for instruments that meet banks’ capital and liquidity requirements. Consequently, investment solutions that may be considered less attractive today may become more compelling and vice versa – indeed there is potential for a disconnect between a company’s need for short-term options to invest surplus cash and a bank’s need for longer-term stable funding.
In addition to Basel III, the development of bank recovery and resolution regimes (such as the Dodd-Frank Act in the United States, and the Recovery and Resolution Directive in Europe - which comes into force in early 2015) means it is no longer sensible to factor in the concept that a bank is ‘too big to fail’.
Developed market governments appear no longer willing to accept putting tax payer money at risk, and whilst arguably the probability of bank default has reduced since the crisis, the size of loss given a default risks rising substantially. It is worth noting also that in some cases a bank’s rating currently includes an implied level of state support, which would need to be revisited if the potential for that support is explicitly removed.
In a world where the concept of ‘too big to fail’ is in question, there are two clear options to manage the risk: robust credit analysis is required to better manage credit risk; and diversification of issuer risk is required to reduce the impact if a default occurs.
Regionally, there are further challenges. In Europe and North America, regulatory reform of money market funds (MMFs) is likely to lead to some changes in the structure of funds that are used by corporate investors, even though there is now some uncertainty about the timing of reforms in Europe since the postponement of recommendations by the European Parliament’s Economic and Monetary Affairs Committee. In addition to regulatory uncertainty, corporate treasurers continue to struggle to find sufficient repositories for cash that meet their investment criteria. These investment policies have often become more rigorous since the global financial crisis, resulting in a declining pool of appropriate investments, exacerbated by constrained market liquidity. The prolonged low interest rate environment further aggravates the dilemma for treasurers, as company boards become more focused on investment returns without sacrificing security or liquidity.
The MMF industry will continue to play an important role in meeting the needs of corporate investors in regions such as North America and Europe where these funds are already well established, even though there may be changes to the way that these funds operate. A key proposal from regulators is the greater use of variable net asset value (VNAV) funds, which have the potential for a small degree of volatility in the fund’s yield as well as the potential removal for a funds ability to pay for the fund to be rated. For these reasons, investors will need to review their investment policies and relevant processes in order to adapt to the new environment.[[[PAGE]]]
Where companies have entered new markets, for example European or North American multinationals developing businesses in Asia and elsewhere, much of the focus of cash and working capital management has been on investment in the business. As many companies are now moving to a growth stage in these markets, generating healthy cash flows, the treasurer will pay more attention to managing surpluses so they are invested in line with central or global guidelines that are comparable with those on the companies’ home markets.
In addition to markets where MMFs are already well-established, MMFs are likely to become increasingly important in regions such as Asia and Latin America as multinational corporations seek the same degree of security, liquidity and diversification in the investment of surplus cash as that to which they have become accustomed in more mature markets. There are some challenges, however, not least due to the different cultural, market and regulatory environment that exists in each country.
In China, the MMF industry is only 10 years old, and comprises two tiers of funds: local funds that are structured in line with local custom and regulation and funds offered by international asset managers that are more consistent with MMFs available in Europe and North America. For multinational corporations headquartered outside China, it is important that investments comply with global investment policies, meaning many opt for MMFs offered by the main international asset managers offering MMFs in China. In China, bank interest is liable to income tax and the rate paid is regulated, meaning that the returns on MMFs can be higher than traditional bank deposits.
In India, where MMFs have a longer track record, investors are typically more conservative than in markets such as China, with recent regulatory changes to further manage risk, influencing the composition of MMFs. For example, the maximum tenor of instruments held in a MMF is 91 days, compared with 397 days in United States and Europe. MMFs play an important role for multinational corporations in particular to ensure security and liquidity of cash and diversification of investment holdings.
In Latin America, in countries such as Brazil and Argentina, we are witnessing increased interest in MMF investment. As a largely USD-based market, many multinationals will use global funds; however, as the use of local currencies by foreign multinationals and growing local companies increases, local fixed income products and MMFs are becoming more attractive. There is significant potential for companies headquartered in the region to take advantage of these products; whilst there is less familiarity with these solutions currently, it is increasing.
Investment in maturing markets may bring some challenges in that local customs, regulations and investment solutions may differ from those in other markets. In addition, the use of investment portals (widely used in the US and parts of Europe due to their efficient, straight-through processing of transactions) is less well-established for MMFs in Asia and Latin America. Consequently, treasurers need to ensure that policies are being applied consistently and that processes demonstrate an appropriate degree of efficiency and control. For example, a number of centralised treasury centres in Europe and the US, whilst setting investment guidelines centrally, are still transacting investments either regionally via SSCs (shared service centres) or at the local operating company level. This means the need for visibility and a full audit trail on investment and subscription transactions that can be monitored from all treasury touch points across the business has never been more important.
Treasurers with surplus cash need to keep abreast of changing regulatory and market conditions, and explore investment opportunities in markets in which they are, or are becoming, cash-generative. This may result in revisions to investment policy to ensure that companies are able to take advantage of new opportunities as they materialise. This can take time, so it is important to act now to work with your global asset manager to leverage their expertise in credit and risk management, investment management and execution across their global footprint. This will ensure that organisations have investment policies and processes that support changing regulatory and market conditions, and global liquidity management requirements, therefore avoiding delay in the efficient management of global cash.
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