Change dynamic for tech industry treasurers continues.
The Tech20 Treasurers’ Peer Group kicked off its 15th Anniversary with a meeting May 4, 2016. This meeting pointed out additional nuances of change in the tech industry. Financial regulation continues to reshape the relationship between treasurers and their banks, and the nature of money market funds is fostering a further focus on tech-firm cash and what to do with it—in the immediate and longer term. To survive the change, tech firms will need to think about the following:
1) Implications of Money Market Fund Reform. Members are shifting out of Prime funds and mixing and matching alternatives to offset MMF reform.
2) The Current M&A Landscape in the Tech Sector. Present a viable plan to bring down added leverage to avoid rating penalties.
3) Enabling Technologies: What Treasurers Need to Know About Blockchain. Distributed ledgers technology may have the potential to transform cross-border payment.
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MMF Reform Prompts Investment Policy Changes
Tech20 members are watching MMF reform closely. According to NeuGroup Peer Research, nearly one-third (31%) have already changed investment policy, yet another 15% remain undecided about whether they’ll make any change. With regard to MMF reform, 54% of members said they’ve considered switching to Government-only MMFs, while 15% say they’ll stick with Prime funds. Just under one-tenth (8%) have already switched to SMAs, but 31% are considering them.
Implications of Money Market Fund Reform: The Landscape; What Has Happened, What Can We Expect?
Ahead of October’s money market fund reform, members discussed demand trends affecting shifts between Prime and Government funds and their market implications. They also touched on the supply available in the government space to accommodate the upcoming shift (Treasury bills, Fed RRP facility, etc.) and other alternatives that offer an outlet for investors affected by the changes.
Key Takeaways
1) Know what’s coming. The key aspect of MMF reform is that Prime and Muni funds will require floating NAV for institutional investors, with “fees” (liquidity fees up to 2% on redemptions) and “gates” (suspended redemptions) in instances when “weekly liquid assets” fall under 30%.
2) Tech20 shifting out to Government only. A majority of the members who participated in the Tech20 pre-meeting survey reported that they were either always limited to Government-only MMFs, or were planning to switch to them as a result of coming reforms. This may be the most rational response too, because of tax implications of gains and losses associated with FNAV products, as well as accounting headaches.
3) The MMF reform and Basel III collide. MMFs are demanding shorter duration while banks need to lengthen the duration of their funding to comply with funding ratios. To help counter this restricting supply of short-term liquid assets, the Fed reverse repo facility (RRP) was created and it is predicted to remain unlimited this year (treasury-only funds cannot use this facility, and the Fed wants to phase it out over time). However, BAML expects the RRP will “stay with us until excess funds are close to zero” (now at about 2.3 trillion). BAML also expects a $225 billion net T-bill supply this year; in addition, the US Treasury is introducing a 2-month treasury bill.
4) One door closes, another opens? La-Yona Rauls, Director and Western Region Sales Manager for US Short Rates Sales at BAML, remarked that there is product innovation happening as reform closes the door for many corporates to invest in Prime funds after October. She noted in particular a Government 2a-7 fund that meets SEC requirements for maturity, quality, diversification and liquidity, and has a fixed NAV, no gates or fees, and is cash equivalent for GAAP purposes. In addition, there are shorter-duration mutual funds and private funds, and, what many in Tech20 already have–separately managed accounts (SMAs).
Outlook
With MMF reform looming in October, the shift out of Prime funds is already happening, and the Prime managers—in their caution—are accelerating their own decline (see sidebar “When Will Money Shift Out of the Prime Funds?”). Many Tech20 members are already in Government-only funds, and those who are not will shift out of Prime funds entirely. Rather than dealing with accounting nightmares from tracking a floating net asset value, and potentially also with tax consequences, they will pair their Government funds with SMAs, and “fill in with time deposits,” as one member put it.
When Will Money Shift Out of the Prime Funds?
Shyam Rajan, Director and Head of US Rates Strategy at BAML, highlighted that cautious Prime fund managers were already shifting out of longer-term securities and increasing their liquidity over recent months, and Prime fund weighted-average maturity had decreased more than government funds (measured in days) so the difference in February was already about 7 days. Yield differentials will determine the outflow size and timing: at the time of the meeting, Joe said the Prime-to-Government spread was about 15 bps.
With shorter maturities in Prime funds as October approaches, spreads will decrease further. The Prime fund “Catch 22” is that the uncertainty about the outflows will cause Prime funds to shorten durations, lowering their yield, in turn prompting more outflows due to lack of yields. While Mr. Rajan noted that the Prime fund managers’ caution is accelerating their own decline, investors are loath to give up Prime returns before they need to. So, the key question is when and how much money will shift out of Prime funds between now and October. The speakers cited a 2015 survey of corporate treasurers, 50% of whom would look for a yield pick-up of 35bps or above.
The Current Tech Sector M&A Landscape
Among the drivers of tech M&A are the robust balance sheets of tech firms (blue-chip tech firm cash balances are at historic highs; the top 15 alone hold $396bn); continued activist engagement, supporting strategic transformation and transactions; sizeable private equity activity both acquiring and disposing of company assets; intensifying cross-border activity fueled by Chinese outbound deals; and senior management and board-level confidence in pursuing strategic M&A, given that markets are rewarding such action. However, subsequent discussion with the treasurers led by the BAML team revealed that some of these drivers may not be quite as strong this year.
Key Takeaways
1) Premiums are in decline. As tech multiples have increased, deal premiums are declining modestly, which will dampen seller appetite to consummate transactions.
2) Questions about magical unicorns. There are more than 75 private US tech companies with $1bn valuations (aka “unicorns”) that will draw attention. These are stratified between those with enough funding in place to carry them to the next level and those that will require a nearer-term liquidity event. The latter group will get lower valuations, and if acquired before they can IPO, may take some of the air out of M&A stats this year.
3) DCM uncertainty remains. Also, while debt capital markets and bridge lending have been and will likely remain strong, the early part of this year cast a shadow of doubt in everyone’s mind that this will remain so, especially for lesser credits. All firms in the sector will be watching the Dell-EMC deal closely to see what is possible with financing in current markets. The pre-meeting survey results also reflect some of this uncertainty. A third of members generally look to hedge planned debt issuance, but another 17% are looking at hedging, even though they have not generally done so.
Outlook
Ultimately, tech firms, whether looking to acquire or be acquired, have to carefully consider valuation and drivers of value in today’s global environment before assessing a transformational transaction. The recent market trend to reward acquisition decisions, which has not been the historical norm, has become increasingly selective, say M&A experts. Thus, to be rewarded for a bold M&A decision this year, it will really have to be the right one. Treasurers can then keep their fingers crossed that relatively easy financing still will be there to get the deal done.
Counterparty Risk: Managing Growing Risk, Including Your Risk to Others at Risk
According to a pre-meeting survey of Tech20 members, the top metrics used for measuring bank counterparty risk were ratings, actual government guarantees/backing, CDS spreads (5-year), followed by key financial ratios and the net fair value of exposure. The majority of members judged their risk analytics system to be good (77%), with 15% deeming it very good and 8% poor.
With their extensive knowledge of customers and customers’ frank dialog with them, insurance carriers can be an effective credit risk mitigator and a cheap form of credit analysis outsourcing. In North America, the opposite is true, as customers are more willing to share information directly and carriers have fairly limited data on customers.
As more technology migrates toward mobile, the customer portfolio of tech distributors gains more and more small entities that are more difficult to gauge from a credit-risk perspective. In response, firms need to segment how they manage the credit risk, setting risk limits that warrant further investigation (e.g., any customer over $100k gets a visit), bringing in another pair of eyes via credit insurance and tapping new sources of credit in the FinTech space for the small-customer segment.
Enabling Technologies: What Treasurers Need to Know About Blockchain
Wellington Sculley, Director of Business Development for Ripple, shared how his company is utilizing blockchain technology to modernize cross-border payments. In short, Ripple is seeking to apply the mechanics that support bitcoin (namely, blockchain/distributed ledger) to real currencies. After considering practical-use cases, the focus turned to global payments due to the increasing demand for faster payment processes.
Key Takeaways
1) Direct connections to different payment systems. Blockchain technology offers a means to connect the different payment systems without needing to create a single, new global system to replace them all, which would be politically impossible to scale. Ripple is focused on doing this, with its Interledger version of blockchain, by enabling FIs to make payment directly into other payment networks. This will speed cross-border payments, reduce settlement risk, cut cost and ensure information flow.
2) Global dynamic discounting is a potential-use case. In addition to the general improvements to global payments, treasurers can expect to see other use cases in the coming years. For example, a pilot with a hard-drive maker is also looking at utilizing this mechanism with dynamic discounting for its global supply chain to take out frictional costs.
3) Multilateral netting in the cloud. Yet another use case involves multilateral netting, which could be done with real physical payments in the cloud vs. on internal ledgers (which some tax departments prefer). Netting processes would be conducted using real-time smart payments that are transacted automatically following automated workflow or processing triggers.
Outlook
A direct-connect method for country-level payment systems to transact with one another without the need for intermediaries would be a big step forward for global payments. If the “Ripple Phone” connector is more efficient than Swift connectivity, then Ripple-enabled FIs will have to either decide to de-emphasize their Swift cooperative or have it adapt to Ripple or something akin to it. Meanwhile, allusions to pilot programs with other corporates may prompt members to consider practical use cases involving blockchain and help make them real by joining or launching a related pilot.
Green Bonds
“Green” bond issuance targets investors with green mandates by representing that the proceeds will be used for environmentally friendly projects. One of the Tech20 members shared some of the thinking behind and lessons from his company’s recent issuance as a tranche of its debt raise.
The green bond framework is not overly strict. Other than requiring the use of proceeds to be put toward green initiatives, there are not really any restrictive covenants on green bonds. EY (or its peers) will audit the use of proceeds, and you can also retain a specialist advisory firm to provide further audit credibility (this member’s company used Sustainanalytics)—plus, the CFO and treasurer will attest to the environmentally friendly use of proceeds.
Green bonds offer a bondholder diversification benefit. In these volatile times, treasurers want to have buy-and-hold investors holding their bonds, plus those with diverse mandates. Green bonds fit the bill as, given the current newness to green bond issues, one-third to 50 percent of all green investors will participate in any issues.