by Helen Sanders, Editor
Ring out the old, ring in the new,
Ring, happy bells, across the snow:
The year is going, let him go;
Ring out the false, ring in the true.
Alfred Lord Tennyson, In Memoriam, 1850
Finding clarity amidst noise and confusion is a problem for many treasurers, faced with a barrage of regulations, market volatility and geopolitical shocks. So in the world where Black Friday, Cyber Monday, Christmas markets, short days and long nights prevail, where should treasurers be focusing their time and attention?
Corporate cash balances continue to grow to record levels, both in companies’ home market and overseas, creating a growing challenge for corporate treasurers. In September, for example, Capital Economics calculated that US companies alone are holding $2.5 tr outside the US, an increase of nearly 20% in two years and nearly 14% of US gross domestic product (GDP). While the rationale for holding large surplus cash balances varies across organisations, depending on their working capital, business investment, tax and M&A strategies, the task of managing this cash falls to treasurers.
Not every corporation or industry is enjoying a feast of plenty, however: while the top 50 companies in the world are sitting on huge cash piles, particularly those in the technology and healthcare sectors, many others are having to tighten their belts. This does not mean that cash investment issues are not relevant: Even those that are not enjoying a cash-stuffed turkey this Christmas still face challenges on how to manage (and avoid erosion of the value of) cash required for working capital purposes, to provide a buffer against changing revenue dynamics, pay down debt or fund planned investment/M&A. In the past, rolling overnight deposits or money market funds (MMFs) may have been the default investment options for these companies, regulatory and market challenges are forcing treasurers to revisit their investment policies and strategies. A new era brings apprehensions, uncertainties and the end of some things that were familiar, but it also brings new potential and opportunity.
Mapping the regulatory pathways
Treasurers are typically well-versed in the need to understand and manage the impact of regulatory change, and I can think of few periods over the past 20 years that treasurers have not had one or more regulatory or accounting change on their agenda. Today, however, the number and degree of these changes is unprecedented, not only those that impact directly on corporate treasurers, such as changes to money market fund (MMF) regulations in the US, but also indirectly, including banking regulations such as Basel III. As Jennifer Doherty, Global Head of Commercialisation, Liquidity & Investment Products at HSBC illustrates,
“2016 has been a very busy year with a number of regulations taking full force. MMF reform in the United States and now more recently in Europe as well the bedding down of Basel III in its various forms has seen a step change in the way we are all approaching liquidity. Added to this is the continual low interest rate environment in Europe which is a juxtapose to the rising rates environment in the US.”
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MMF reforms
Looking first at MMF reform, new measures have now taken effect in the United States so the net asset value (NAV) of prime funds must now be published based on the current value of assets, so the value is therefore variable, as opposed to maintaining a constant value of $1 a share as in the past. Furthermore, fund managers can impose liquidity fees and redemption gates, to prevent or limit spikes in investor redemptions.
The situation is different in Europe, where changes have been made since the global financial crisis, but further reforms are taking shape. In mid-November, the European Parliament, Council and Commission finally reached agreement on the proposed regulations following more than three years of negotiations since the Commission published the original proposal. This presages the introduction of a new type of MMF: the low volatility NAV (LVNAV) MMF. Characteristics of the LVNAV include a strict portfolio fluctuation band, where the constant NAV cannot deviate by more than 20 bps from the actual NAV. This is stricter than the 50 bps band used by constant NAV MMFs. There are also conditions on portfolio concentration and asset categorisation; limits on the use of the amortised accounting method for the valuation of assets; daily and weekly liquidity requirements; reporting requirements; daily valuations, and rules on fees and gates.
It is not yet clear what the timing of these changes will be, but with final technical agreement and a plenary vote to take place, plus an implementation period, investors will not be affected during 2017. Consequently, as Jim Fuell, Managing Director, Global Liquidity for J.P. Morgan Asset Management continues,
“Regulatory change, the low to negative interest rate environment and ongoing market volatility continue to impact on the short-term investment space; however, in Europe, it is not MMF reform that will have the greatest impact, but banks’ ongoing implementation of Basel III. Although some larger banks are ahead, others are at different stages of implementation, and ultimately, all banks will need to comply. Banks are moving cash off their balance sheets, which will have an impact on their clients.”
Other countries where MMFs are established are also implementing reforms. In China, the China Securities Regulatory Committee (CSRC) has introduced rules to bring MMFs closer to international standards to increase market resilience and provide both domestic and foreign investors with greater confidence and consistency in RMB-denominated funds.
Indirect regulatory effects
Basel III is a prime example of a set of rules that are designed to regulate financial institutions but that have a significant indirect impact on their corporate customers. We have described the impact of Basel III on corporate cash investment in TMI at various times in the past, but effectively, under Basel III, different sources of liquidity no longer have the same value to a bank. As banks need to be able to weather 30 days of stress, deposits that are not linked to day-to-day business activities need to have a tenor of above 30 days to be attractive. In addition, deposits received from non-financial corporations are more valuable to a bank than those from financial institutions, which are considered to have a higher run-off rate.
This has major implications for corporate treasurers who often rely heavily on deposits as convenient and liquid repositories for cash (particularly in the case of overnight deposits), and as a way of maintaining strong bank relationships. The effects of this change are exacerbated further by the impact of low or negative interest rates. As Jim Fuell, J.P. Morgan Asset Management continues,
“Tied to regulatory change, such as Basel III, is the low interest rate environment. Banks will communicate their changing liquidity strategies not only directly, but also through more or less attractive returns. When interest rates are high, the difference between a yield of 9% versus 10% may not appear material, but in today’s situation, even a difference of 25 basis points can shift yields from positive to negative territory.”
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Full of Christmas cheer?
So how are treasurers responding to the combination of regulatory and market constraints to which they are increasingly subject? In the United States, more than $1 tr flowed out of prime MMFs between January and mid-October 2016, reflecting investors’ uncertainty, much of which was invested in government MMFs which are not subject to the same rules. It is too early to tell whether the outflow from prime MMFs is a permanent shift in investor behaviour, but as treasurers become more familiar with the new MMF environment, they are likely to become more confident in them. The opportunity to pick up additional yield as USD rates rise is a more powerful incentive, however, so we may a see a rebalancing of corporate activity over the course of 2017. Jennifer Doherty, HSBC observes that the potential uplift in rates should prompt treasurers with USD holdings to review their investment strategy more widely,
“Those with large resources need to review their investment opportunities, particularly given the potential for an increase in USD yield. Indeed, with rates at a historic low over an extended period, the search for yield has now become far more of a focus than we have seen in the recent past.”
In Europe, as Jim Fuell, J.P. Morgan Asset Management comments,
“At this stage, it is too early to tell what level of sensitivity European investors may have to variable NAV funds compared with constant NAV, but in the US, the introduction of gates and fees has probably been the bigger concern. Furthermore, the situation in Europe is different to the US, as variable NAV funds are already more familiar, and regulatory changes will not exactly mirror those of the US.”
However, given that there is as yet no date for implementation (at the time of writing) this should not be an immediate concern for treasurers, and both MMFs and short-term MMFs continue to present an attractive means of meeting security, diversification and liquidity objectives.
As Jim mentioned earlier, the more immediate issue is Basel III. An issue that existed until relatively recently was lack of awareness of the implications amongst treasurers, but this appears to be changing, as Jennifer Doherty, HSBC explains,
“I would say that earlier this year, there were still varying degrees of awareness about the changes to cash investment that resulted from banks’ implementation of Basel III. However, this is changing, with far higher levels of awareness today, particularly the distinction between operating and non-operating cash, and LCR-friendly cash. What is currently less clear for treasurers is firstly, what the implications of MiFIR are likely to be, and the detail and timing of MMF regulations in Europe that have recently been approved.”
New year, new opportunities?
Inevitably, as some investment opportunities narrow, others open up, and as Jennifer continues, new investment instruments to help balance the potentially contrasting objectives between corporate and bank,
“We are likely to see a variety of new LCR-friendly instruments emerging over the next year. Looking at on-balance sheet instruments, for example, a variety of notice accounts with different tenors and yield pickups will offer treasurers more choice both for short- and longer-term cash, in addition to other longer-term instruments.”
New instruments are also emerging in the fund space, as Jim Fuell, J.P. Morgan Asset Management describes,
“The beauty of MMFs is that they deliver security, liquidity and yield – in that order. Regulatory reform is impacting on the short end and reducing yield, therefore changing the value proposition for these funds. As a result, we are likely to see a wider proliferation of new products that reflect the investment appetite and priorities of different investors, rather than a ‘one size fits all’ approach. From a JP Morgan perspective, MMFs are at the core of our short-term fixed income solutions, but we have a spectrum of products that add increments of credit or liquidity risk in order to increase incremental return, including bespoke solutions and separately managed accounts.”
Five steps to reducing uncertainty and recognising opportunities
So how are treasurers navigating a treacherous road layout given that there is no map and the signposts appear to be pointing in different directions? As the value proposition and availability of some familiar instruments declines, and other opportunities emerge, many companies will need to review, and potentially refine their investment policy, and the strategies they employ to fulfil it.
Segment cash. An immediate issue is the need to invest larger portions of cash for more than 30 days if investing in the money markets rather than funds. As Jennifer emphasises,
“In this environment, treasurers have taken a step back to look at their investment policies carefully, and identified their different types of cash more precisely, whether it is restricted or operational cash, reserve or strategic, to help with cash investment planning.”
If treasurers can improve cash flow forecasting and influence working capital strategies, they are in a better position to invest over a longer term, potentially benefiting from better yields and avoiding erosion of capital.
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Engage external partners. Jennifer goes on to note,
“Treasurers should be engaging with their banks, including cash management banks, fund managers etc. to understand what investment options are available.”
This is not a one-off event but an ongoing process, particularly during the course of 2017 as providers launch new instruments.
Revise policies and strategies. She continues,
“Once they know what’s possible, they can then revisit their investment policy and make any necessary revisions. This can take some time, particularly as the investment policy is increasingly a board-level issue. Having done so, even if treasurers do not make immediate changes to their investment approach, they have the tools to do so.”
Consider outsourcing. Fourth, given growing investment complexities and the need to dedicate increasing amounts of skilled resources to cash investment, outsourcing to specialist fund managers may be an option for many corporations, as Jim Fuell, J.P. Morgan Asset Management suggests,
“Effectively, corporate investors have three choices: first, leave cash on the bank’s balance sheet (which could be considered a ‘passive’ investment strategy) or a derivation of a bank’s balance sheet (e.g., in the form of an earnings credit, such as a preferential rate based on transactional activities); second, invest in direct securities, such as buying CP, or third, outsourcing to a third party manager. Given the unprecedented pressures on the short-term investment market, we are likely to see a stronger trend towards outsourcing. While some companies may adapt to the current and anticipated challenges by building expertise and analytical capability in-house, there is typically less appetite for this.”
Seek out advice. Finally, Jennifer Doherty, HSBC notes that treasurers should make use of the resources open to them when planning how to adapt their investment strategies to a changing environment,
“Most large corporations work with multiple banks, many of whom will have advisory teams who understand the investable cash landscape and therefore bring valuable insights. It is worth accessing these resources, which have the added advantage of being freely available, for market and regulatory updates and to understand what investment opportunities are emerging that could benefit the business.”
An uncertain horizon
As Jennifer intimated earlier, Basel III and MMF reforms are not the only regulatory challenges with which treasurers are faced, and indeed the implications of Basel III itself extend beyond deposits, given banks’ obligation to comply not only with liquidity coverage ratio but also the net stable funding ratio and other measures. MiFiD II and MiFiR take effect from 1 January 2018 too, with the intention of reflecting changes in the trading environment since MiFID was introduced in 2007, and to improve market efficiency, resilience and transparency of non-equity instruments. While these rules should bring some advantage in terms of disclosure obligations to support better decision-making, it is not yet clear what the full impact will be.
In addition to dealing with the effects of regulatory changes, treasurers will inevitably need to guide the company through financial volatility and shocks that will strain existing policies and strategies. Consequently, treasurers need to factor in regular review and refinement to their investment policies and strategies, seek out information and advice, and test proposed strategies against different market conditions.
The new year will bring known and unknown changes and events: the task is not to predict them, but to be prepared for them. In the meantime, all of us at TMI would like to wish you, your families and friends, a very happy, peaceful Christmas and our very best wishes for the year ahead.
“Stars lead us where they will. What we do when we arrive at the unexpected destination is up to us.”
Jeanette Winterson, Christmas Days: 12 Stories and 12 Feasts for 12 Days* Published by Jonathan Cape, London, 2016
* Final note: If you are still struggling to find that final, inspired Christmas gift, I recommend this book, it’s wonderful!
