Converging Choices

by Aidan Shevlin, Head of Asia Pacific Liquidity Fund Management, and Ben Ford, Head of Global Liquidity Sales, South East Asia and Australia, J.P. Morgan Asset Management

Corporate investors in Asia are benefiting from a broader range of investment options than ever before. While there are major differences relative to Western markets, regulatory changes and market dynamics can have similar effects on both markets, regardless of geographical location.

Since the global financial crisis, the investment and regulatory landscape for money market funds has been undergoing dramatic changes – at perhaps the quickest pace in the past forty years. Especially, in the US and Europe, the combination of exceptionally low interest rates and continuous regulatory change has created uncertainty and investment challenges for money market fund (MMF) managers and investors alike. Asian money market funds have been relatively sheltered from the challenges facing Western money market funds. However, this does not mean they are immune to global and local regulatory reforms or rapidly changing local market dynamics. Investors in Asia should be aware of these challenges and the potential impact on their investment strategies and goals.

Investor perspectives – East versus West

Treasury teams working for Western multinational or Asian-headquartered businesses share similar investment objectives: security, liquidity and yield. However, there are some important differences in how they define and pursue these objectives. For example, as Ben Ford, Head of Global Liquidity Sales, South East Asia and Australia with J.P. Morgan Asset Management notes, “In times of crisis, while global companies would follow a ‘flight to quality’ by investing in US Treasury Bills, many Asian companies would pursue a ‘flight to familiarity’, investing with local institutions perceived as strong and reliable”.

Historically, Asian corporate investors have mainly invested in time deposits for both their USD and local currency cash balances, as a lack of investment opportunities, more strictly regulated markets and close links between local banks support this choice. Meanwhile, global investors with small local currency cash balances have also been comfortable with time deposits, while sweeping larger cash balances back to their home country. However, Asian bond and money markets are developing rapidly while interest rate liberalisation and broader investment choices are creating opportunities for increasingly sophisticated Asian and Western corporate investors to diversify, boost yield and reduce their risks.

In Europe and the US, money market funds are well understood by corporate investors, regulators and the wider market. In contrast, the money market fund industry in Asia is relatively young and dynamic; however, both awareness and adoption of this relatively low-risk investment vehicle is expanding. As Ben Ford notes, “Both Western corporations that already use MMFs in other regions, as well as fast-growing, sophisticated Asian corporations that are seeking to emulate global best practice in their treasury departments, are very receptive to the development of Asian local currency money market funds”.

According to the results of the recent J.P. Morgan Global Liquidity Investment PeerViewSM 2015 survey (it surveyed over 400 treasurers, CIOs and other senior decision-makers, representing more than 400 unique entities around the world), stable net asset value (NAV) MMFs account for 34% of cash balance allocation in the Americas, 30% of cash allocation in Europe but only 11% in Asia. Yet 21% of all respondent organisations are planning to increase their allocation to stable NAV MMFs over the next twelve months.

The emerging role of MMFs in Asia

In the US and Europe, money market funds have a long history with well-established and widely understood guidelines and characteristics. Whilst standardised rules, especially for AAA rated money market funds help ensure high-quality and liquid investment vehicles, they also severely limit the potential range of returns available from different providers.

Across Asia, most countries regulators have their own unique guidelines for money market funds; typically, these guidelines are looser than Western standards and allow a wider degree of discretion and flexibility in management of the funds. In addition, the wide range of regional sovereign ratings from AAA for Singapore and Australia down to BBB- for Indonesia make it challenging to apply global rating agency standards to local money market funds.

This is not to say that regulators in Asia are complacent or behind the curve: in fact, in China, Australia and Japan, regulators are closely monitoring developments in the US and Europe, and are keen to ensure that their respective funds industry operates according to accepted international best practices. The China Securities Regulatory Commission (CSRC) recently issued draft guidelines for consultation which, when adopted, will represent the most significant change in the MMF industry since it was established in 2003. These new guidelines will align Chinese MMFs far more closely with their North America and European counterparts, with tighter concentration and duration limits, higher liquidity requirements, and more rigorous credit constraints, all of which will promote better fund liquidity and security. Finally, the size, liquidity and sophistication of local bond and money markets also play a critical and differentiating role in determining how successful local money markets can be in achieving their three objectives; security, liquidity and yield.[[[PAGE]]]

While it would appear relatively straightforward to launch AAA rated money market funds in high credit quality countries like Singapore and Australia, as Aidan Shevlin, Head of Asia Pacific Liquidity Fund Management with J.P. Morgan Asset Management notes “Launching, managing and growing money market funds across a range of Asian currencies is challenging: It requires an in-depth understanding of local investment markets, detailed knowledge of local regulations and requirements and maintaining a balance between achieving the high standards required of a J.P. Morgan money market fund while offering a product with necessary yield and features to attract local and global investors”.

Nevertheless, the growing range of money market funds available across Asia and the growing AUM of these funds are testament to the efforts of fund managers offering these products, as well as the appeal of such products to investors seeking safe and liquid investment opportunities for their local currency cash balances.

China’s innovative MMFs

With limited options for investing surplus cash in China, most local and Western corporations typically deposit cash with a handful of higher-quality commercial banks at specific rates and specific tenors set by the People’s Bank of China (PBoC). Although we are starting to see a little more flexibility across interest rates offered by different banks, there continues to be little differentiation across China’s commercial banks – regardless of their credit quality or the credit quality of the investor.

Until recently, this lack of credit quality insight was not perceived as a concern due to the widely held assumption by both foreign and domestic investors in China that all banks and bank products have an implicit government guarantee. However, as Aidan Shevlin highlighted, “The Chinese government introduced a deposit guarantee scheme in May 2015, which transforms the implicit guarantee that all bank products enjoy into a limited, explicit guarantee on deposits only”. This scheme is a key step on the path to full interest rate liberalisation and a sign of the government’s efforts to encourage investors to take more responsibility for managing credit risk.

The combination of increasing risk awareness, low official time deposit yields and inflexible time deposit tenors created an excellent launchpad for RMB money market funds which offered higher, more market-driven yields, better liquidity and diversification of risk. Industry assets under management have increased rapidly as retail investors embraced these new products and the innovative ways such products allowed them to access and spend their cash balances.

In the institutional space, RMB money market funds were slower to gain acceptance as a genuine alternative to time deposits as conservative corporate investors attempted to reconcile the differences between these funds and their Western counterparts. A key hindrance to approval was the lack of available independent ratings for RMB money market funds; in Western markets, on the other hand, obtaining independent ratings has been a well established process. As Aidan Shevlin commented, “We had to work closely with rating agencies to develop domestic rating scales and a set of criteria that would give investors confidence in the quality of these funds”.

This strategy has proved to be very successful with CIFM’s AAA rated RMB money market funds [1] which are now widely accepted by both international and local corporate investors. The more restrictive guidelines combined with rating agency oversight and a focus on security and liquidity has transformed the money market fund into an important investment option for corporates. A number of other local fund providers now also offer AAA rated funds, adding depth to the market and greater choice for investors.

Implementing Basel III

Turning our attention to perhaps the most sweeping of global financial regulations, Basel III will have a significant impact on banks and fund providers in Asia. The new rules change how banks manage their balance sheets, making them unable or less able to accept some types of corporate deposit. As a result, Basel III has already had a significant impact on the relative attractiveness of MMFs as compared with bank deposits. In the US and Europe, implementation of Basel III is well under way, but the timing, and specific nature of adoption in Asia will depend on regulators’ interpretation of the global rules.

J.P. Morgan Global Liquidity Investment PeerViewSM 2015 shows that while 63% of respondents in the US and 61% in Europe stated that their banks have encouraged them to move cash deposits off their balance sheets, the same held true for only 11% of respondents in Asia.

Even so, corporate investors need to anticipate these changes, and include Asia in their wider investment strategy review. J.P. Morgan Global Liquidity Investment PeerViewSM 2015 emphasises that 60% of companies surveyed are planning to maintain their existing investment allocation over the next twelve months. Although there is some appetite for additional allocation to MMFs, as discussed earlier, 18% of respondents are planning to increase their allocation to bank deposits. Furthermore, 100% of respondents in Asia (compared with around half in other regions) noted that if their first choice of bank was unable to accept a deposit, they would simply select an alternative deposit bank rather than exploring a wider choice of instruments. This seems unlikely to be a sustainable investment strategy. Basel III must be fully implemented by 1 January 2019, and that will directly affect the choice between MMFs and bank deposits. As well, in a changing rate environment, the diversification and yield advantages offered by MMFs is likely to become more attractive to corporate investors.

Considerations for investors

One of the challenges for Asian investors is the effort and complexity of revising investment policies, as noted by 52% of J.P. Morgan Global Liquidity Investment PeerViewSM 2015 respondents; more than double that of other regions. When considering revisions and updates to their investment policies, investors should focus on diversification and segmentation of cash.

Indeed, it is essential for corporate treasurers to segment cash between working capital, for which same-day liquidity is required, and core and strategic cash, which can be invested for a longer-term period. In this way, investors can gain a wider choice of investments to support their business strategy more precisely, whilst also demonstrating that the excess cash they manage is accessible, securely held and generating value to the organisation.

Note

[1] This refers to money market funds managed by China International Fund Management Co., Ltd (CIFM). CIFM is a joint venture between J.P. Morgan Asset Management (UK) Limited and Shanghai International Trust Co., Ltd. 

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Given their investment objectives of capital preservation, flexible liquidity and market-driven yields, MMFs offer an attractive means to diversify exposure to different types of assets and counterparties whilst serving as an effective vehicle for cash segmentation – this is a powerful combination in any market or regulatory environment.

Conclusion

Asian money market funds have developed rapidly over the past decade as they have benefited from increasing investor acceptance, deregulation and disintermediation. Across Asia, there is still enormous growth potential and the opportunity for innovation. But local funds and regulators cannot ignore the huge market and the regulatory-driven changes that are affecting Western money market funds and, potentially, presenting implications for Asian money market funds. Such reforms should improve the safety and liquidity of money market funds while providing corporate investors with an excellent opportunity to revisit and update the firm’s investment policies, thus ensuring they are well positioned to accommodate and benefit from these changes.