The money markets play a key part in the short-term investment programmes of treasurers. Reforms have helped them ride out the worst of recent events. But money markets could be better still, says one leading participant – and treasurers can help shape their development.
Money market fund (MMF) reforms in 2016 and 2018 respectively in the US and Europe made sweeping changes, and yet, for better or worse, the longer-term impact for treasurers has been minimal.
Initially, the effects were most notable in the US where investors quickly switched from what were traditionally seen as prime products – funds that owned corporate and credit-related items such as commercial paper, credit default swaps, medium-term notes, and floating rate securities – to government MMFs with their ultra-safe US Treasury securities.
In Europe, the gates and fees ‘issue’ translated into little more than a slight shrinkage in the traditional prime markets, simply because there is not as large an active short-end treasury market here. Of course, EU investor exposure to negative rates also contributed substantially to the more muted reaction in the region.
In both cases, it wasn’t necessarily the mechanism itself that made investors nervous, explains Deborah Cunningham, Chief Investment Officer, Global Liquidity Markets, Federated Hermes, rather the fact that the weekly liquid assets number, which although high at up to 50%, was tied to the gates and fees, imposed by reform, which would be triggered at 30%.
“Any time funds started to go near the trigger point, investors became wary and wanted out before it got to 30%,” she recalls. While fund liquidity was actually plentiful, the 30% hurdle effectively meant 30% liquidity couldn’t be used without the fees and gates being deployed – “and nobody wanted to go down that path”.
The EU, perhaps wisely (and certainly after the US fact), imposed a two-step trigger that clearly soothed most investor concerns. It tempers the threat of weekly liquid assets going below the 30% hurdle level with a daily redemption level of at least 10%. “Nobody has even gotten close to this level,” notes Cunningham, “that’s why Europe, with its two-part test, did not see as much of a reaction when the pandemic hit as the US did with its singular test”.
MMF investor nerves during the early days of the pandemic also saw some outflows from the market altogether. Again, this was more evident in the US than in Europe. By April 2020, Cunningham says, most of the flows had returned. “It was a short-lived issue, but it was an issue.”
Of course, the lack of yield for investors in the short-term markets has become a long-term frustration. However, Cunningham notes that the economic rebound in the US, and the green shoots of one in Europe and the UK, is starting to show a pickup in inflation. She feels low rates are unlikely to persist as long as they did after the 2008 financial crisis and suggests central bankers will soon have to start unwinding some of their stimulus activities, probably by tapering their bond purchases. Rate policy adjustments will not be long in coming over the horizon, possibly arriving in the second half of 2022.
“If the market starts to anticipate that, which it will, more positively sloped curves will emerge – being at zero is not the normal state of the short-term markets,” she comments. “Inflationary expectation has been null and void since the pandemic began, but it is starting to resurrect itself now.”
Until then, going further out on the yield curve is an option for investors, but most will know that doing so risks loss of principal while creating possible delays in accessing the cash, which in current volatile trade conditions would be unacceptable for most treasurers who need operational cash.
Those with the luxury of cash that will not be needed for next six months or so may wish to venture out on the curve to pick up a few more basis points, says Cunningham. “It’s probably a good strategy because even if they lose a penny or so on the NAV [net asset value] from a price return perspective, the additional income they are earning incrementally during that period should more than make up for that.” This, she adds, makes a strong case for treasurers engaging in cash segmentation.
Even given events of the past 18 months or so, the industry currently remains healthy. It will do so “as long as there’s not a problem in the broader market”, comments Cunningham. She believes that the market for high-quality short-term products that are purchased by MMFs currently has adequate market-making capacity “as long as there are no constraints on these markets”.
With financial institutions, which constitute the industry’s largest credit exposure, going into the pandemic with healthy balance sheets, “there was really never a concern about credit in the market” for most participants; it was the ability to provide secondary market liquidity that was constrained.
Indeed, Cunningham recalls market makers “literally having no capacity on their balance sheet, from a regulatory standpoint, to even buy back their own paper, let alone the paper that, as dealers, they’d placed in the market”.
With the market’s current healthy vista, she suggests that the industry now has an opportunity to review and improve its approach to market-making in stressed periods, which will benefit all stakeholders. Of course, she understands that any changes will be hard to measure “during anything but a crisis” but argues that the solution is to figure out ways to make the short-term markets more transparent.
A dealer on a commercial paper programme will know all the nuances of that programme but will be unlikely to know those of which it is not a dealer. Transparency is therefore essential for progress. In the US, electronic trading platforms such as Boom and Tradeweb allow for better dissemination of inventory, and therefore secondary market-making, but these are dedicated ‘banker-to-investor’ platforms.
What’s really needed, says Cunningham, is an investor-to-investor as well as issuer-to-investor platform where one participant communicates the inventory it has for sale to another. “If purchasers and sellers can meet in the middle without the banks having to have that excess capacity on their balance sheets, it would be a good end to the recent reforms that would enable a better functioning market, not just during normal times, but in stressed time too.”
As a case in point, she says that during the last two weeks in March 2020 – the most challenging in terms of MMF flows – there were other players in the cash markets with excess cash that would have been able to invest, but lack of market transparency meant buyers and sellers were not able to connect. “In the context of better elevating the capabilities of the market itself, this should be the goal.”
The mechanism to support market-making in normal and stressed times does not exist, even if Tradeweb and Boom come close, Cunningham notes. Such platforms could be expanded with the addition of a Bloomberg feed, but in the meantime, from an industry standpoint, Federated Hermes and other significant providers “are aligned with this same thinking” and are in a position to “drive the idea forward”.
From a treasury perspective, she says support has been elicited from a number of national treasury associations, as the voice of the industry, which she reports as seeking the same market transparency for its members. Commenting that “we would certainly look for support from individual corporates in addition to industry players in that process,” it may be time for treasurers seeking a more active and potentially rewarding short-term market to make their voices heard.