Published: November 01, 2008
“Call on God but row away from the rocks”
(Indian Proverb)
As I said in my Letter this month, I am not going to begin to try and explain, or even comprehend the economic situation in which we find ourselves. Whatever the background, this downturn is characterised more than previous ones by a lack of trust - between banks and other banks, and banks and corporates. From a corporate treasurer’s perspective, the immediate reaction is often to look at their bank financing. After all, as John Busby, Greenwich Associates consultant discusses in a recent Greenwich Associates Report,
“In past market downturns, US banks have drastically pulled back on their credit commitments to the least qualified borrowers, but they largely continued to generate revenues by extending loans to companies with solid, investment grade ratings.
What we are now experiencing is something different and deeper than perhaps anyone imagined. This is a true crisis of liquidity - even the strongest companies are struggling to get short-term financing.”
Credit Market Seizure Deepens and Hits Companies Large and Small, October 2008
However, the lack of trust, which permeates the market, is not simply about the way that banks assess their corporate clients. The recent spate of government intervention to shore up many well-respected banks has also changed the way that corporates view their banks. Banks and corporates have a symbiotic relationship, so it is in neither party’s interests to be suspicious or short-sighted in their dealings with the other. As the opening proverb implies, it is easy to seek help from third parties - banks, governments, regulators, even divinities, but fundamentally, every organisation has to protect its financial interests proactively. In the case of corporate treasurers, a primary concern is preserving short term liquidity. Chris Oulton, Chief Executive Officer, Prime Rate Capital Management LLP explains,
“While we have been through a tricky period over the past 15 months, since then the liquidity crisis has got considerably worse. The collapse of Lehmans changed the financial landscape permanently and radically. Many assumptions have had to change, and there is an increasing awareness that no single counterparty is impervious to market conditions or “too big to fail”.”
With recent announcements of recession in Japan and a growth slowdown in China, the current crisis is truly global. On the one hand, companies all over the world have the same need to manage risk and liquidity; on the other, the opportunities for liquidity management differ across regions. In this article, we look at one aspect of liquidity management, namely short term investment, and the trends in Asia in particular.
Chris Furness, Managing Director, Transaction Banking, Standard Chartered, based in Singapore, summarises how he sees corporates in Asia responding to the situation,
“Treasurers are becoming increasingly cautious about where they place their cash. We are seeing companies continuing to put cash into traditional instruments but with banks with whom they may not have worked in the past. Some of these companies may not have had a formal investment policy before, or they may have sought returns over security or liquidity in the past. Now, treasurers are implementing more conservative investment policies rigorously and seeking Board approval on their actions.”
“Treasurers are also looking to invest their cash over a shorter time horizon, although their banking partners would generally prefer them to be investing longer term so they can structure their balance sheets more effectively. There is a strong emphasis on cash management, such as tools for concentrating cash and increasing the visibility of funds. Equally, there is a greater focus on cash flow forecasting.”
“We see a strong demand for liquidity solutions to release trapped cash. There is also a sustained interest amongst treasurers in appropriate hedging solutions particularly around credit and interest rate risk.”
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Every company, wherever they are based in the world, and in whatever countries they do business, shares the need to maintain liquidity, which includes ensuring that their short term cash is secure and easily accessible. Chris Furness highlights that one issue is the maturity of companies located in different parts of the world,
“These issues affect companies across our client base in Asia, from foreign and Asian multinational companies (MNCs) through to more domestically or regionally-focused mid-market companies. There are some differences between Asian and foreign multinationals. For example, as many Asian multinationals have started to expand their geographic reach, they are seeking a banking partner to help them devise their treasury and cash management strategy as well as its implementation. Foreign multinationals generally have a strategy already defined at group level, but need to ensure that this is implemented consistently and in line with local regulations and clearing requirements.”
Furthermore, regulation in different locations can create challenges for companies of all types. Chris Furness continues
“Unlocking liquidity is not easy in countries with restrictive regulatory controls, with issues of return, balance sheet constraints, and providing appropriate capital as well as working capital support in the medium and long term. Companies do not want to tie up too much working capital in these markets, which not only applies to countries but provinces within countries such as China.”
Banks and corporates have a symbiotic relationship, so it is in neither party's interests to be suspicious or short-sighted in their dealings with other:
However, for a variety of reasons, both operational and regulatory, non-Asian multinational companies need to maintain cash in Asia and obviously want to invest this cash with the same degree of security and liquidity as other parts of the world. Similarly, Asian companies are seeking the same level of assurance. As Chris Furness of Standard Chartered indicated earlier, traditional instruments such as bank deposits remain an important repository for funds although potentially with a broader range of counterparties. In addition, the use of money market funds (MMFs) for short term investment is increasing in Asia as it is in Europe and North America. Travis Spence, Vice President and Head of JPMorgan Asset Management’s Global Liquidity Business in Asia, explains,
“Money market fund assets have experienced tremendous growth globally, with a shift in focus by investors towards greater security driving this flight to quality. Treasurers are increasingly scrutinising the assets underlying the fund and there is an increased dialogue directly with the fund managers. Between June 2007 and the end of October 2008, global money fund assets grew by 36% and international money funds increased by 17%.”
This growth is not restricted to the countries which have historically invested in MMFs such as the United States and United Kingdom. In Asia for example, while initially investors were primarily regional treasuries of MNCs already familiar with MMFs, this trend has developed more widely, as Travis Spence continues,
“When we first started in Asia, many of our initial investors were subsidiaries of multinational companies whose headquarters were already familiar with our funds and clients of ours in other regions. Since then, the rapid growth in the industry in Asia has come from local companies and we now see as many local companies as MNCs investing in our MMFs, particularly in our key focus markets of China, Taiwan, Hong Kong, Japan and Singapore.”
In many ways, this is not surprising. After all, as Travis emphasizes,
“The investment requirements of companies across the board are similar when it comes to holding cash: security, liquidity and yield. We have observed a shift from across our client base from yield to security as the primary investment criteria, especially during the past 2 years.”
However, two of the issues which have hindered MMF investment in Asia are Currency and Credit Rating. Until relatively recently, MMFs in local currency have not been available, so use of MMFs by Asian investors has been limited to USD, EUR and GBP MMFs domiciled elsewhere in the world. This is changing now, with other funds, including those in JPY, SGD and RMB now available from major fund managers in the region. Travis Spence explains JP Morgan’s strategy in this area,
“In 2005, we launched the first of our local currency money market funds in China. The fund is denominated in RMB and operated through our local joint venture company, China International Fund Management Company Limited. It is still the only AAA-rated money market fund in China, rated by both Moody’s/CCXI and Fitch, and appeals to both local and foreign companies based in China. Since then, we have launched AAA-rated JPY and SGD funds.” [[[PAGE]]]
This leads on to the other issue, namely concern that an AAA rating in China is less reliable than the same rating in other countries. However, firstly, credit ratings are not the only criteria used to assess MMFs. Secondly, as Travis Spence says, the AAA rating in countries such as China may, in fact, be more reliable than elsewhere in the world as the funds are less complex,
“Investors are no longer relying exclusively on credit ratings as a basis for evaluating risk, following many examples where highly rated securities experienced downgrades or defaults in the last year. Prior to the financial crisis, AAA-rated funds were perceived to be similar, so investors typically made their decision based on yield. Investors have seen that even within the AAA-rated money market fund space, funds are managed differently, with varying approaches to credit selection, asset allocations and liquidity positions.
Those funds who have successfully navigated the credit markets with sufficient liquidity in their funds have seen the largest inflows. While domestic AAA-rated funds in Asia follow many of the guidelines of funds in other markets, such as IMMFA in Europe and 2a-7 funds in the US, they are adapted to the local markets. In many cases, these funds have been insulated from the issues that have plagued international markets. In China, for example, arguably investors have viewed the AAA-rating on domestic money market funds as more reliable since the complexity of the underlying securities is less and therefore there is greater transparency in the way that the rating is applied.”
We see a strong demand for liquidity solutions to release trapped cash.
The point about investors’ use of credit ratings is an important one. Increasingly, investors globally are seeking greater transparency over the assets which make up the fund, and also diversifying across different funds, even though MMFs are already diversified. The initial reaction to the credit crisis was a ‘flight to quality’, specifically moving to government debt. This does not mean turning away from MMFs as many MMFs are themselves government debt-based. Furthermore, as Travis Spence, JPMorgan Asset Management describes, this trend is now starting to reverse,
“Government guarantees of financial issuers of CPs and CDs mean that MMFs are now benefiting in terms of security and yield. We are now seeing a reversal in the flow of capital to government debt back into traditional money market funds across all regions, which is a positive sign of confidence returning to the markets.”
The government guarantees of financial institutions, and wider guarantees such as the US government’s support of 2a-7 funds is of particular interest in this regard. As Chris Oulton, Prime Rate suggests,
“With the government bailouts which started in the UK and have now rolled out globally, the concept of risk has also changed completely, and banking risk is now as much about country or sovereign risk as opposed to simply counterparty risk.”
Financial stocks will have a higher yield than government debt but as they are government-backed, there is the potential to benefit from higher returns without compromising security and liquidity if a MMF invests in these assets. By way of example, Chris Oulton, Prime Rate continues,
“Our fund is between 85% - 95% government-supported. We have concentrated on financial stocks as with their government backing, bank stocks effectively become ‘high yielding T-bills’. Before Lehmans, corporate debt has been the better bet, but now we are avoiding corporate issues, as although these may be high-quality, it is better for our investors if we invest in guaranteed stocks.”
This is potentially a loophole, which could be closed, but financial institution issuance may be worth considering, particularly for treasurers who are not currently investing in MMFs.
Chris Oulton summarises,
“Treasurers should keep their cash investments simple and liquid. There are other priorities other than cash management and cash needs to be held securely, but if invested properly, it should not have to become a distraction.”
This advice is applicable for treasurers of companies globally. Treasurers are investing for shorter tenors than they were 18 months ago, and are increasingly diversifying their cash investments, both across banks and across MMFs. With government guarantees of many financial institutions and financial institution issuance, there may be a case for looking at financial institution issues as MMF assets. However, as always, diversification is key and few investors would want to have a significant exposure to one particular type of asset, although there may be some additional yield.
Investors based in Asia are able to invest in AAA-rated funds domiciled offshore in Luxembourg, Dublin etc. but these are limited to convertible currencies such as USD, EUR and GBP. However, with Asian currency funds increasingly available, with the same or greater transparency as AAA-rated funds in Europe or United States, MMFs are becoming a viable investment alternative for regional treasuries of MNCs based in Asia and local companies alike. Many of these newer funds have been driven by investor demand, so if the currency or type of fund you are seeking is not available, it may be worthwhile to approach fund managers about establishing a new fund.
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