Published: June 01, 2010
This article describes the accounting issues often encountered by many treasurers when they invest in money market funds (MMF). The IMMFA (Institutional Money Market Funds Association www.immfa.org) has recently issued two interesting policy papers about the international standards IAS 7 and IFRS 7. These documents aim to provide guidance for fund users.
The accounting issues related to investments in treasury-style money market funds, such as those offered by members of IMMFA, are two-fold:
(1) The classification as ‘cash & cash equivalents’ in order to be deductible from gross debt or to increase the company’s net cash flow, and
(2) More recently, the methodology used and reported in IFRS for Fair Value Measurement.
IMMFA’s aim was to explain how to account for these short-term investments and to facilitate the work of users with their external auditors (www.iasb.org). These elements also need to be put into perspective with IMMFA’s recently revised Code of Practice, as well as several other similar initiatives aimed at redefining better the criteria of treasury-style MMFs (e.g., CESR – Committee of European Securities Regulators – published in May 2010 and effective in July 2011, cfr. www.cesr-eu.org).
IMMFA has issued a document intended to provide investors in its own money market funds with further guidance on the treatment of investments under IAS 7 statement of cash flows (effective since July 1994). These are recommendations that need to be confirmed by external auditors and to comply with internal accounting policies of the concerned reporting entities. The purpose of this standard (IAS 7 para. 6) is to give information to users on the ability to generate cash and the utilisation of this cash, as well as the net liquidity position. The tenor of the investments is a key element to assess the highly liquid character of a placement. These days, after the financial crisis, this classification is not neutral for companies having a large indebtedness and highly leveraged.
The standard gives a definition and sets out the four main criteria to be met for such a classification.
1. Short-term
2. Highly liquid
3. Readily convertible to known amounts of cash
4. Subject to insignificant risk of changes in value
This analysis is determined on a case-by-case basis, each quarter. It consumes a lot of treasurers’ time and does not bring any added value.
IFRIC (International Financial Reporting Interpretation Committee) received a request in December 2008 to provide guidance on this definition of ‘cash equivalents’. It answered in March 2009 that ‘MMF which operate under a specific regulatory regime (such as rule 2a-7 of investment act 1940 in the US) should meet the definition of cash equivalents[1]. It also later stated that ‘existing criteria within IAS 7 were sufficiently clear’. It is not because an investment can be converted to cash at any time that it is automatically cash equivalent. The amount of cash to be received must be known at the time of the investment. The last criterion on the change in value is also very important for this analysis. Ideally, what IMMFA and treasurers would recommend is the automatic classification of their MMF’s into ‘cash equivalents’ without having to demonstrate these criteria are met. Being IMMFA funds should be a sufficient proof that these criteria are fully met. They wanted to give some guidance on this de facto accounting treatment. Furthermore, this determination should be feasible from the terms and conditions of the instruments and without having to look though the whole underlying assets. At least, it gave us an idea of IFRIC thinking and gives elements for discussions with external auditors on this classification.[[[PAGE]]]
How to demonstrate criteria are met?If you have invested in IMMFA triple-A funds, the criteria should be met. They are ‘convertible at all times’ (1) as requested in the fund’s prospectus and the IMMFA Code of Practice. Their MMFs provide same-day liquidity, enabling an investor to access his cash on the day of his request (if sent before cut-off times of course). But it is also invested into ‘a known amount of cash’ (2) as required (again) in the prospectus and code of practice.
IMMFA funds provide Constant Net Asset Value (CNAV) allowing ascertaining the value of the investment at all times (3). On the limited change in value, the criterion is met because of the short-term nature of the investments and the high quality of underlying assets (4). However, IMMFA has stringent criteria that help (e.g,. triple-A rating imposing high quality of assets; 5% minimum of assets available on overnight basis and 20% within five days; WAM – Weighted Average Maturity of not more than 60 days as requested by CESR, rating agencies and IMMFA code; WAFinalM of not more than 120 days; escalation procedure to monitor variances between amortised cost and mark-to-market value of assets (material variance commences at 10 basis points). All the criteria demonstrate that the propensity for IMMFA funds to deteriorate in value is therefore extremely limited. Eventually, with restricted WAM, the short term of three months or less from date of acquisition is respected too.
As consequence of these listed elements, an IMMFA fund must be considered as ‘cash equivalent’ under IAS 7. In addition, we should keep in mind that IMMFA funds must comply with other stringent criteria such as UCITS Directive, rating agencies’ own constraints and the newly revised Code of Practice of IMMFA. The combination of these criteria impacts underlying assets invested. They must be of a minimum credit quality of A1/P1/F1; minimum 20% in securities maturing within five business days and a final maturity of government debt of 397 days.
To see a positive side to this financial crisis, we should accept the idea that is has enabled us to enhance information and protection of all investors, including corporate ones.
The IFRS 7 imposes certain disclosure requirements in relation to the financial instruments held by the preparers. In March 2009, IFRS amended its standard to enhance disclosures about the Fair Value Measurement (FVM) and also liquidity risks. Each preparer must classify FVM according to a hierarchy which is based upon the significance of the inputs used in making measurement. It is the well-known new IFRS three-level hierarchy pyramid for fair valuation, which was highly debated and commented on last year.
The level within which the FVM is classified must be based upon the lowest level of input used for instrument’s valuation. However, when we look at MMF investments, they should be considered as an investment in equity. The investor is of course not directly investing into the underlying assets. Therefore, it seems obvious and not necessary to look through to the underlying assets within the portfolio of the MMF. It is also consistent with FAS 157 standard. Funds are themselves audited and triply rated by the major agencies. If the sponsors of a MMF are IMMFA members, for example, they have already met stringent classification requirements. Why is this not considered self explanatory?
The MMF must be quoted in an ‘active market’. The prices are regularly available to investors. The NAV is declared and published on a daily basis. These prices represent actual and regularly occurring transactions at arm’s length. The NAV represents the price at which a subscription but also redemption occurs. They have access to their investments on a same-day basis. They are eventually measured at an unadjusted price on the reporting date. The NAVs are calculated on a daily basis. There are no unobservable data which could impact FVM of a share in a MMF. It seems sufficient to demonstrate the FVM of a share in a MMF should be recorded under level 1 of the hierarchy proposed by IASB. [[[PAGE]]]
In the absence of more precise information from IASB and IFRIC (International Financial Reporting Interpretation Committee) about the qualifying criteria for IAS 7, the IMMFA document (which should be supported by all the treasurers’ associations in Europe and by the European Association of Corporate Treasurers - EACT) takes on its full meaning and usefulness. It will help convince auditors that IMMFA-type funds should be treated for accounting purposes as ‘cash equivalents’ (which seems obvious). IMMFA has not skimped on its efforts and work in the past few months in arguing for greater transparency, quality and security, particularly through its Code of Practice, which is a high-quality document. We obviously support IMMFA’s proposal to classify its members’ money market funds as Level 1 for fair value measurements, according to the three-level methodology and hierarchy established by IASB in IFRS 7. 27A-27B.
These efforts at clarification have also demonstrated the desire to better position ‘pure’ (treasury-style) money market funds. It should be remembered that some companies were surprised to see the value of their assets drop, when they thought they were investing in ‘pure’ money market funds, as they were investing in dynamic or enhanced monetary funds. It might be advisable to adopt a ‘controlled appellation’ system like the French AOC for wines, cheese and other farm products, in order to protect investors from the wrongful or deceptive use of MMF terminology. We definitely think so. To see a positive side to this financial crisis, we should accept the idea that it has enabled us to enhance information and protection of all investors, including corporate ones. This greater transparency and reliability of information disclosed was required by the London G20, last year, in order to better inform end-users. These recent initiatives from IMMFA are, in our opinion, excellent means to give their funds a real quality stamp. However, we know that some other MMFs can also fulfil these guidelines or equivalent ones (e.g., CESR). Therefore, they could apply for similar accounting treatment under IFRS.
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