By Ted Howard
With deadlines looming, fuzzy or otherwise, treasurers will need to start planning for new cash investing and continued attacks on profits from tax collectors.
This year will be all about planning for a distant future; in this case, short-term cash and taxes. Unfortunately, the former offers some certainty while the latter offers a mixed bag of kinda, sorta, maybe and who knows? Nonetheless, 2015 should be the year when both issues will be examined closely.
MMF demise begins?
For short-term cash investment, money market funds could be going the way of Palm Pilot, as new rules kick in at the end of 2016. But while that is nearly two years away, it is not the time to procrastinate. That’s because another rule is quickly hemming in corporate investments and that’s the liquidity coverage ratio, which is forcing many banks to close doors to corporate operational cash or make it too painful with fees and low rates for it to be worth their while. This means 2015 and part of 2016 will be a new age of discovery, as companies look for new ways to manage their cash in the time-honored fashion of maintaining liquidity, safety and a decent yield.
“LCR is an added incentive to get out of bank deposits,” says Brandon Semilof, managing director at StoneCastle Cash Management, referring to one haven corporates have been going to (or staying in) as uncertainty of MMFs grows. “Banks are telling clients, ‘We love you but from a regulatory standpoint, we can’t keep your money.’”
Basel III’s LCR rules require banks to hold enough capital in high-quality liquid securities to fund 100 percent of their projected outflows over a 30-day period. Additionally, banks are required to hold a certain amount of high-quality liquid assets (HQLA) based on expected cash outflows. For the usual outflow projections for retail deposits, banks are required to hold HQLA equal to 3 percent of stable retail deposits.
“However, because of assumptions that institutional depositors could withdraw much more of their assets at virtually any time, banks must hold HQLA equal in some cases to their total institutional deposits,” according to an outlook report to clients from State Street Global Advisors. “These regulations make institutional deposits more costly for banks to hold. To offset the cost, some have begun charging fees to a range of institutional depositors on accounts that were previously free.”
new journey of discovery
So with MMF rules looming—particularly the dreaded floating net asset value—and banks forcing money out of deposits, what’s a treasurer to do? The first thing is to ramp up the research and explore new assets and funds that asset managers and others are creating to meet the demand for MMF outflows.
“Treasurers will need to take a dynamic approach in 2015,” says Brian Leach, Vice President, product manager at PIMCO. “On the one hand, money market funds yield around zero percent, which limits their viability. But with rates likely to rise at the front-end, they should not stretch for yield either. The answer is flexibility. Don’t passively invest and concentrate exposure.” Rather, Mr. Leach says, “look for areas that offer better return to risk profiles, and can act as shock absorbers to US interest rates.”
Currently fund managers are developing a host of new products that could serve as alternatives to institutional prime money funds, according to Greg Fayvilevich, a director at Fitch Ratings. These include private unregistered money funds and short-term bond funds. “As treasurers review their investment guidelines to potentially include these new products, they should also ensure other aspects of their investment guidelines maintain flexibility and reflect developments in the capital markets in recent years,” Mr. Fayvilevich says. Particularly important is an understanding of every aspect of the new products. “Treasurers will need to make sure they understand the new products being presented to them, as these products will exhibit greater variability in their portfolios than highly regulated money funds.”
The risks treasurers should consider with regard to these new liquidity products include potentially longer maturity and lower credit profiles, as well as governance and transparency issues, not unusual for thoughtful portfolio management. PIMCO’s Mr. Leach says treasurers will have to keep a sharp eye on volatility.
“It is more important than ever for front-end investors to anticipate where volatility may come from and position portfolios to avoid it,” Mr. Leach says. In the coming year, he thinks that a “disproportionate amount” will come from rate volatility. “Moreover, there is scant compensation for this—for example, the two-year is yielding somewhere around 70 bps. So it may make sense to diversify from this, into areas like high-quality corporate credit or non-US rates that aren’t tied so closely to what the Fed does.”
Mr. Fayvilevich thinks many companies will stay in MMFs even after the change, as well as bank deposits, despite the LCR. Meantime, he says, others will choose to move it to government money funds, private unregistered money funds and short-term bond funds. However, he says, this will depend on the spread differentials between the various products, “as well as the specific needs of the treasury department.”
Get Active
Brian Leach, a VP and product manager at PIMCO, says treasurers think about the benefits of active management in short-term funds. “Distinct from a passive strategy that invests in short duration treasuries, for example, active managers can adjust portfolios based on their expectations for different sectors,” Mr. Leach says. “Passive strategies may lead you right into the heart of the storm in 2015—so even strategies with a ‘low’ duration may expose investors to more interest-rate risk than they want or even anticipate.” However, he says, active strategies help mitigate this. “For example, we recently reduced our duration significantly, and sought to uncover high-quality opportunities less tied to US interest rates in order to achieve attractive yields, but limit volatility.”
Tax considerations
There have been louder rumblings from the White House that the president wants to take on tax reform in 2015, something Republicans have been seeking for years. Both sides basically agree that the current system of loopholes and carve-outs and special arrangements doesn’t work; and that moving to a territorial tax system would make US companies more competitive, reduce complexity and compliance costs, reduce the incentive to do inversions, and add jobs to the economy.
But while both sides are talking reform, there’s little to indicate action on reform. That’s because there’s little agreement on how the reform should take shape. And it seems even discussing tax reform beyond an abstract concept that might happen sometime, somewhere in some distant future, can get you pilloried. Take for example Rep. Dave Camp’s (R) unveiling of a draft overhaul early last year. The discussion draft, which Rep. Camp, then the House Ways and Means Chair, had only one real appeal to MNCs—a tax rate lowered to 25 from 39 percent.
And it being broad, it was hammered on both sides of the aisle. “The Camp proposal is the product of a lot of thoughtful analysis and is very comprehensive,” said William Cavanagh, a corporate tax attorney at Chadbourne & Parke at the time. “The downside of being comprehensive is that there is something in the proposed legislation for everyone to hate.”
Representative Camp also proposed that the US adopt a territorial system, which would pretty much match the rest of the industrial world’s tax regimes. This would effectively exempt US corporations from US tax on the business income they earn offshore; the downside of the proposal was a proposed tax on 5 percent of cash when the company dividended the proceeds back to the US. Representative Paul Ryan (R) is the new House Ways and Means Chairman, and has expressed openness to compromise. In a speech to a group of corporate chief executives early December, Rep. Ryan said that if Republicans and the White House “can get halfway toward comprehensive tax reform, as a step in the right direction, I think that’s great.”
Overseas threats
While companies should keep an eye on where US tax reform goes, it’s also important to keep an eye on what’s happening in Europe. There, the Organization for Economic Cooperation and Development (OECD) is working on a base erosion and profit shifting (BEPS) project to force companies to pay taxes where economic activities are generating profits and value is created. Essentially, the organization wants to stop the practice of MNCs shifting profits from high-tax jurisdictions to low-tax jurisdictions as a tax-mitigation strategy.
Treasurers have been notably wary. The next year will bring “aggressive country posturing and action to challenge transfer pricing agreements, like the start of the BEPS process,” said one treasurer at a US multinational. This means that tax structures will need to be reviewed to make sure companies are either compliant, or from a headline and reputation standpoint, not giving the appearance of shirking their tax-paying duties.
Generally speaking tax-planning strategies are intended to improve the overall tax efficiency of companies through the use of legitimate approaches. However, global tax authorities cry foul when it looks like there is just money moving around the continent tax free. This is particularly true in a digital economy which can make taking advantage of gaps in the tax laws of different countries much easier. The consequence of different tax laws results in double non-taxation, which the OECD acknowledges can be “unintended” and “due to the use of hybrid mismatch arrangements.”
But a new Congress, working with treasury, could help stave off attempts to tax US companies more. Last year, Rep. Camp and Republican Senator Orrin Hatch expressed concern the OECD was just on a money hunt.
“We are concerned that the BEPS project is now being used as a way for other countries to simply increase taxes on American taxpayers,” the two lawmakers said in a letter in the early summer of 2014. “When foreign governments—either unilaterally or under the guise of a multilateral framework—abandon long-standing principles that determine taxing jurisdiction in a quest for more revenue, Americans are threatened with an un-level playing field. Such actions put pressure on the US government to respond by asserting taxing authority over foreign activity generating US-source income on similar grounds.”
Getting busy
Not that there ever is or ever has been a time for not resting on one’s laurels (although treasurers could be entitled, given their performance through the financial crisis), but 2015 is decidedly not the year to engage in it. New MMF rules and banking regulations, along with an ever-shifting tax landscape, both at home and abroad, mean treasury must remain eternally vigilant. They also should prepare now vs. waiting until the last minute as investment policy changes and approvals can often take considerable time.