MMF and Basel III rules are dramatically changing cash management options.
Treasury cash managers have to be more proactive about their investment policies as money fund reforms and Basel III begin to transform the options available to them. At a recent webinar featuring investment specialists from StoneCastle Cash Management, Fitch and PIMCO, moderated by iTreasurer, participants hashed out the potential consequences of the Securities and Exchange Commission’s recent MMF reforms on the attractiveness of that market going forward, as well as how Basel III and the liquidity constraint ratio (LCR) will affect the attractiveness of bank deposits. In both cases, the rule changes will require many treasurers to rethink their strategies and possibly revise their investment guidelines.
The SEC’s money fund rules, which allow managers of prime funds to gate and/or impose withdrawal fees to avoid runs, and which require floating NAVs, have not yet caused any outflows from these instruments. Nonetheless, a poll of webinar participants showed that floating NAV and redemption gates are the two aspects of the reforms that concern treasurers the most.
According to Fitch director Greg Fayvilevich, polls of treasurers and other MMF investors put the potential outflows all over the map – from 10 percent to as high as 50 percent. There will be more clarity as the October 2016 implementation date nears, he said, noting that the impact of the rules will vary widely depending on how specific companies use MMFs. Apple, for example, puts only 3 percent of its cash in MMFs, while Amazon puts 38 percent in the instruments.
Meanwhile, the LCR rule announced in September, which affects banks with over $50 billion in assets, will make non-operational deposits unprofitable for lenders when it kicks in on January 1, 2015, said Brandon Semilof, managing director at StoneCastle Cash Management. He quoted Jamie Dimon of JPMorgan Chase as saying, “This makes non-operational deposits hugely unprofitable; therefore, over time, banks probably will minimize this type of deposit, and clients will seek other alternatives, probably in the money markets.” Banks are already reaching out to their treasury customers to inform them that the rates they earn on deposits will be going down as bank appetite for these deposits falls off dramatically.
The LCR’s effect on bank deposits is potentially even more worrisome than the new MMF rules effect on prime funds, Mr. Semilof noted. According to the 2014 AFP Liquidity Survey, on average nearly 50 percent of short-term cash and investments is allocated to bank deposits, while just over 10 percent is allocated to MMFs.
Aggravating the situation is the dramatic fall in bank ratings since before the financial crisis, which means there are fewer institutions that meet the credit requirements written into many investment policies, said Fitch managing director Roger Merritt. There is also little chance that yields will rise to their historical norms, said PIMCO product manager Brian Leach. PIMCO, like the market overall, expects the Fed to hike rates mid to late next year, but in what the asset manager calls the “New Neutral”, it thinks rates will go to 2 percent, lower than the historical 4 percent average. If inflation is 2 percent, that means 0 percent real yield.
Mr. Merritt noted that the ongoing below-average rate environment limits the economic viability of many alternatives to MMFs and bank deposits. “One idea that gets talked about are money funds that operate with a weighted average maturity of 60 days or less,” he said. “These don’t make economic sense, but in a normal yield environment, they could be offered.”
Build in Flexibility
All these factors require treasurers to take a careful look at their guidelines, in order to ensure they have the flexibility to respond to changes in the cash investment landscape. Corporate treasurers face a dramatically shifting landscape,” Mr. Merritt said. “Now more than ever it’s important to take a proactive, dynamic approach to investment guidelines.”
This can be as simple as ensuring a company’s guidelines do not restrict investments in money funds to those with a stable NAV. But in most cases, they will require a more thorough strategic re-think.
For example, PIMCO’s Mr. Leach said his firm suggests a strategy of cash tiering to its treasury clients. It divides the portfolio in thirds. The first tier, which he called “lunch money”, is the cash that must be completely liquid and free from credit and market risk because it is needed for day-to-day needs. This will be the toughest tier on which to get a positive yield, since cash managers will be restricted to bank deposits and money funds.
The second tier will consist of semi-permanent allocations to cash used for acquisitions and capital expenditures. To enhance returns on this tier, PIMCO recommends a short-duration core strategy.
The third tier is designed to grow the cash balance over the longer term using a longer duration core strategy. This cash consists of excess liquidity and that set aside for long-term spending needs. For example, cash held overseas and not intended for repatriation would be a good candidate for the third tier.
Alternative Investments
Fitch’s Mr. Fayvilevich noted that there are currently no ideal alternatives to MMFs and bank deposits. “None have gained a lot of traction; fund managers are testing the waters with alternatives like ultra short-term bond funds and private money funds.” There’s not much of a consensus among treasurers either (see chart below. Source: “Investment Policy Considerations & Amendments,” Fitch Ratings, PIMCO, StoneCastle Cash Management and iTreasurer). It lists the answers to the webinar poll question, “Which alternative liquidity product are you likely to use instead of prime money funds (check all that apply).”
What will treasurers use instead of prime money funds?
The government money fund alternative is the most obvious, since these instruments will have a stable NAV and are not subject to gates, Fitch’s Mr. Fayvilevich said. However, they have low yields and there is limited supply. Treasurers hoping to roll into bank deposits will run into the lack of bank appetite and very low rates due to the LCR rule. Some institutions are testing the waters with private money funds, under the belief that the SEC would not regulate them. However, it is uncertain whether the SEC would allow this.
This isn’t keeping asset managers from devising new approaches. StoneCastle’s Mr. Semilof outlined one type of instrument his firm offers, called a structured bank product. There are some 6,500 banks in the US that fall below the asset threshold for the LCR, and are therefore not subject to it. However, these banks have limited capacity to absorb large amounts of cash. A structured bank product essentially daisy chains a number of these banks together, with each providing $250,000 – the cut-off for FDIC insurance – in order to put together a deposit account that is liquid, insured and offers a better yield. The deposit accounts are limited to $50 million per tax ID due to low appetite for deposits, even among small banks, Mr. Semilof said.
Cash managers would most likely need to amend their investment guidelines to allow them to use structured bank products, Semilof said, but firms like his can offer suggested language to insert into guidelines to make it work. But even treasurers who do not plan on using newly devised investments clearly need to give their investment guidelines a close look to ensure they allow the degree of flexibility necessary to cope with the new cash investment environment.