Money Market Fund Makeover Innovation in Short-Term Investments

The doom-mongering around money market fund regulation has now stopped. Instead, talk has moved on to low interest rates, credit quality, digital investment channels, and the rise of environmental, social and governance investment criteria. Treasurers are also exploring different short-term investment options, such as separately managed accounts, and their curiosity is being piqued by a new product, the fixed-term fund.

This time last year, money market fund (MMF) reform in Europe was still the hot topic in the short-term investment space, with some industry commentators predicting a significant decline in corporate usage of MMFs as a result of the new regulations (see Box 1 for a summary of the changes). Despite a surprise alteration to the reforms late in the day, investors have largely taken the new regulations in their stride since they came into force across the EU on March 21 2019.

According to recent global survey results from trading and investment risk management platform ICD, there has been “minimal impact on MMF investment post US and EU money fund reform,” with 88% of investors planning on increasing or maintaining their current level of investment in MMFs. In fact, zero European respondents to the survey indicated a decrease in USD and GBP MMF investments due to European MMF reform, and only 2% said they would decrease EUR MMF investments.

Kathleen Hughes Managing Director, Global Head of the Liquidity Solutions Client Business, Goldman Sachs Asset Management

Jim Fuell, Head of Global Liquidity Sales, International, J.P. Morgan Asset Management, agrees that the regulatory changes have gone smoothly: “The transition by corporates into the new MMF environment was fairly straightforward with minimal disruption, particularly for short-term money market funds,” he says. However, he notes that “the somewhat unfortunate last-minute decision by regulators to eliminate the use of a reverse distribution mechanism – used to manage the current negative interest rate environment in the euro space – resulted in short-term investors having a more limited set of options for their euro investments”.

Asset managers have been proactive in keeping treasurers interested in MMFs, however. As Reyer Kooy, Managing Director, Head of Institutional Liquidity Management, EMEA & Asia, DWS, explains: “I believe the regulation has struck the right balance between increasing the security of MMFs for investors and yet preserving their usefulness. Post-regulatory reform, MMFs remain fundamentally the same – certainly at DWS. Clients have continued to treat the fund as a cash equivalent and it has retained its T+0 accessibility.”

As for the last-minute change to the regulation that Fuell mentioned, Kooy notes that this “decision to ban the reverse distribution mechanism caused some concerns initially. But at DWS we did not lose a single MMF investor as a result of that change, thanks to clear communication around the impact.”

Kathleen Hughes, Managing Director, Global Head of the Liquidity Solutions Client Business, Goldman Sachs Asset Management, also sees sustained interest in MMFs: “In the dollar space, where interest rates are higher than sterling and euro, corporates are becoming much more active with their cash. They are quickly realising that if they’ve not been paying close attention to how their cash was invested, they’ve potentially been leaving money on the table.”

As such, Hughes is seeing growth in MMFs, with “inflows into US dollar products”. She continues: “There is still interest in the short duration space, but that varies significantly by client and is driven by the inversion of the USD yield curve in the front end.” Meanwhile, the sterling market, she says, “is being impacted by Brexit and the overall political environment in the UK. Clients are therefore placing cash in MMFs while they wait for the uncertainty to clear”.

In Europe, however, the “euro negative rate environment remains a significant challenge. Corporates are therefore exploring short-term investment vehicles beyond MMFs, notably in the ultra-short or short duration space. This is resulting in more interest in separately managed accounts because clients are looking to be very customised in terms of their credit exposure,” says Hughes.

Battling low rates

With the prolonged low rate environment expected to continue (see Box 2), Fuell also sees “investors seeking to achieve incremental returns in ultra-short duration or short duration type strategies, many of which can be accessed in fund format, through a separately managed account or perhaps an exchange traded fund (ETF)”.

Hughes adds: “Separately managed accounts are arguably more popular in the US than in Europe. But they can certainly make sense as a short-term investment tool for European treasurers today – in particular those who have good visibility over their cash flow and their liquidity needs.”

Nevertheless, she also emphasises the importance of understanding the requirements of separately managed accounts, such as having tax and accounting closely involved because rather than owning shares in a fund, the company owns an individual security. Clients also need to have a custodian, which may or may not be bundled in with the asset manager, she notes.

“Having a clear sense of the risk/reward trade-off will also assist when evaluating separately managed accounts versus MMFs,” she says. “It is important to have concrete answers to questions such as: are you willing to take non-sovereign risk and corporate risk? Is that in the form of financials or is it in the form of non-financials? How far do you want to go out in terms of duration?”

Fuell, meanwhile, notes that it is critical for investors to fully understand the underlying strategy in which they are investing, as well as the differences in mechanics of the various mechanisms used by investment managers to deliver ultra-short duration or short duration strategies. This, he says, “is particularly critical for those corporates who have traditionally only invested in MMFs as there is often less conformity as you step outside of the robust regulatory environment in which MMFs now operate”.

A sustainable shift

Reyer Kooy Managing Director, Head of Institutional Liquidity Management, EMEA & Asia, DWS

Interestingly, Hughes notes that “separately managed accounts are also enabling clients to have more customisation in areas such as environmental, social and governance (ESG). This is a growing topic in client discussions, with more balance sheet investors becoming interested in ESG,” she comments. “European regulators are also leading in the world when it comes to looking to regulate ESG and what it means for asset managers who provide ESG products. So, it’s an exciting time as we are starting to see standards and taxonomies emerge that will help to define the ESG investing landscape.”

Kooy also sees ESG as growing priority – and a catalyst for innovation in the MMFs space. “Increasingly, we are seeing European regulators move towards including ESG criteria in their regulations. While investor demand for ESG products is not yet strong, it is certainly growing. As such, we are hoping to offer an additional suite of ESG-specific MMFs in the near future, as well as ESG-driven solutions in the ultra-short duration space, which leverage sophisticated engine-analysis to ensure ESG criteria are properly met.”

In fact, ESG is one of DWS’ three key priorities for the years ahead. And Kooy is “hopeful that ESG will enter the mainstream DNA of all MMFs across Europe, in one way or another”. Fitch Ratings believes this shift is already under way, with a new research report from the firm stating that ESG considerations have become “more integrated” into MMFs in Europe and the US.

Recent launches of ESG-focused funds and existing fund conversions have driven AUM (assets under management) growth, says Fitch. “These include BlackRock’s environmentally focused MMF (the BlackRock Liquid Environmentally Aware Fund) in April 2019 and, most recently, the State Street Global Advisors ESG Liquid Reserves Fund in July, the first MMF offering only investments that meet ESG criteria at the time of purchase. While ESG MMF AUM remain low in aggregate at USD$57.2bn at the end of last year, AUM increased 16% in the first half of 2019.”

Digital uplift

Jim Fuell Head of Global Liquidity Sales, International, J.P. Morgan Asset Management

Elsewhere, the short-term investment arena is evolving as a result of technology. Kooy notes: “Another interesting trend we are seeing in the MMF space is the growing drive towards digital channels. Corporates want to integrate all of their investment holdings into a single dashboard, along with their cash balances and so on. While many asset managers and banks offer portals that can integrate with existing treasury systems, we’re also seeing TMS vendors step up and explore ways of seamlessly integrating MMF investments into those dashboards. I believe we will see more of this, which will be beneficial for all parties, as it will bring greater simplicity and transparency.”

Hughes also sees technology as a driver for change: “Clients are becoming more comfortable with prime funds in the US, but they also want to monitor those funds more closely. Being able to rely on technology to get good reporting, solid risk analysis, and effective monitoring of different elements of a fund, is an additional area in which clients are keen to leverage technology,” she notes.

Product innovation is also resulting from technological advances. In July 2019, we saw what has arguably been the biggest shift in the short-term investment space since the advent of MMFs: the introduction of a completely new financial instrument called a fixed-term fund (FTF).

Understanding Fixed-Term Funds

An FTF shares many of the characteristics of a term deposit, in that it is a term product that can be acquired without the need for any infrastructure. “However, instead of providing exposure to unsecured bank risk, as with a deposit, an FTF can offer exposure to any short-dated, investment grade fixed-income obligation, such as a single government bill, a single secured bank loan or a single investment-grade corporate loan, for example,” a press release from TreasurySpring, the London-based financial technology company which has designed FTFs, reads.

Justin Meadows Founder and former CEO, NEX Treasury

TreasurySpring has launched an FTF platform which aims to “unlock the multi-trillion-dollar wholesale money markets by providing new digital pipelines to connect cash-rich firms to institutional borrowers from the sovereign, bank and corporate sectors,” according to the press release. As such, FTFs “enable all holders of large cash balances, from corporates to charities, private funds to insurance companies, family offices to private banks and beyond, to reduce and diversify risk on those balances, whilst simultaneously increasing returns”.

And naturally, the FTF platform, which can be accessed directly via TreasurySpring’s cloud-based web-portal, has been designed to integrate easily into other platforms via secure application programming interfaces (APIs), making it straightforward to interact with TMSs. Since issuing the world’s first FTF in June 2018 in beta phase, clients of TreasurySpring have purchased more than USD$400m of FTFs across a broad range of new products, with more than USD$300m of issuance in 2019 already.

Tim Howell, former CEO of Euroclear and investor in TreasurySpring adds: “I firmly believe that FTFs bring true innovation to our industry; indeed, I believe we are looking at the first material innovation in this space since the creation of money market funds in the 1970s.” FTFs, says Howell, “are a simple but powerful tool that can add value to treasury teams of all shapes and sizes”.

Justin Meadows, Founder and former CEO of NEX Treasury, and investor in TreasurySpring, tells TMI: “As well as being a long-term supporter of MMFs, I’m delighted to have been involved with TreasurySpring in launching a new type of fund – fixed-term funds – as a complementary, diversified investment opportunity for treasurers.”

Focus on the future

It remains to be seen how treasurers will react to FTFs. But with all of the shifts taking place in the short-term investment space – from the long shadow of regulation, to low interest rates, digital innovation, and new instruments – it is important for treasurers to keep a level head.
Treasurers may therefore wish to bear in mind a few additional considerations for managing short-term investments effectively throughout the rest of 2019. For Kooy, the importance of preparing for Brexit should not be underestimated. “Despite the majority of institutional MMFs being domiciled in Ireland or Luxembourg, and likely to be eligible for use within the UK, investors still need to be prepared for changes resulting from Brexit,” he says.

“Having conversations with asset managers around post-exit strategies should certainly be on the treasurer’s to-do list for the months ahead. DWS is of course headquartered in Frankfurt and has a significant European footprint with offices and regulated entities in the UK and across Europe,” he adds.

Fuell meanwhile advises treasurers to watch credit quality. “Since 2007/8, credit has yet to be seriously tested, and as such, I’d argue that investors should not be thinking about extending duration to generate incremental return without keeping a close eye on credit quality, certainly outside the more intensely regulated banking market.”

Finally, Hughes notes the importance of preparing for LIBOR transition. “As a result of reference rate changes, corporates need to spend some time looking at their own investments, and the contracts around them for references to LIBOR and the fall-back language. Will floating debt automatically convert to fixed debt if LIBOR no longer exists?” she questions.

Safe and sound

In summary, these are undeniably challenging times for treasurers seeking decent returns (or any returns) on their short-term investments. But these are also very interesting times, full of creativity and innovation.

Although we may see more treasurers exploring different investment options such as separately managed accounts, ETFs, or even the new FTF product, in the near future, MMFs are likely to remain close to the treasurer’s heart. As Kooy comments: “Diversification is vital in any investment portfolio, but even more so when the market is tough. The right MMFs can provide high levels of diversification for liquidity balances, spreading risks effectively.”

Nevertheless, Kooy also cautions that: “In this new regulatory era it is important that investors undertake robust due diligence on how a fund is run – especially given the high levels of geopolitical uncertainty.” Peace of mind, he says, comes with “understanding the investment process and working with stable investment teams of knowledgeable portfolio managers and credit analysts”. After all, when it comes to short-term investments, doing your homework really can pay off.