The year 2016 was a ‘watershed’ year for many corporate treasurers with surplus cash. Regulations such as Basel III are impacting their banks’ willingness and ability to accept short-term deposits, newly introduced reforms in the US are having a significant effect on prime money market funds (MMF), while the low, and in the Eurozone, negative interest rate environment is also impacting corporate investment strategies.
What’s happening to corporate cash balances?
Corporate cash balances continued to rise in 2016, a consistent trend since 2012, but the rate of growth is slowing.
Furthermore, the proportion of companies whose cash levels had not changed increased for the first time since 2012, from 31% in 2015 to 44% in 2016. Even so, nearly half of corporations surveyed have increased their cash balances over the past 12 months. The reasons why companies hold this cash are also shifting. In 2015, over a third of companies held cash to finance capital investment and M&A, but this dropped to 19% in 2016. Conversely, while 23% of companies held cash to finance working capital in 2015, this rose to 43% in 2016.
2016 also marked an important change in treasurers’ primary cash investment challenges compared with previous years. Sixty per cent noted that the low or negative interest rate environment was their number-one concern. This contrasts with visibility, regulatory, asset availability and trapped cash that have topped treasurers’ list of investment challenges over the previous five years.
What are treasurers’ preferred investment instruments? And what changes are taking place?
The importance of deposits
Deposits remain treasurers’ investment instrument of choice with 82% of participants noting that they used deposits, investing an average of 48% of cash. Treasurers first look at the available limit headroom with authorised dealing banks when depositing cash, but beyond this, yield is more important to treasurers than whether a bank is a relationship bank. This would appear to contrast with many banks’ and treasurers’ emphasis on ‘share of wallet’, and reflects the growing importance of yield as an investment objective.
The importance of yield is also reflected in the growing use of independent dealing portals to transact deposits. Treasurers are increasingly recognising the value of price discovery and competitive quotes in an environment where short-term deposits (i.e., less than 30 days) are becoming less readily available and new deposit products are starting to emerge. In addition, they are keen to integrate transactions directly into the treasury management system (TMS) for better efficiency and control.
The changing future of deposits
Basel III is already impacting banks’ ability and willingness to accept some types of cash onto their balance sheet, particularly in the US and Europe, where banks are implementing capital and liquidity requirements more quickly than in other regions; ultimately, however, all banks will be obliged to do so. Specifically, under the liquidity coverage ratio (LCR), different sources of liquidity no longer have the same value to a bank. A deposit received from a non-financial corporation is more valuable to a bank than a deposit received from a financial institution, which is considered to have a higher run-off rate. Furthermore, as banks need to demonstrate their ability to weather a period of 30 days of stress, deposits need to have a tenor of 31 days or above to be attractive to the bank, unless deposits can be shown to be linked to operating activities.
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Consequently, treasurers need to focus more on cash segmentation to identify cash that can be held for a term of 31 days or more. A new generation of deposit solutions is also emerging, such as notice deposits and 31-day plus deposits that balance bank and corporate objectives more precisely. In addition, banks are taking a wider view of their corporate relationships. In some cases, this includes linking interest on deposits to the volume of flows across an account, reflecting the use of balances for day-to-day, operational activities. In others, banks are netting notional interest against bank fees.
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Participant profile
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A new era for money market funds
MMFs are also a very popular investment choice for corporate treasurers, a trend that originated in the US. It has since extended to Europe and more recently, a number of other countries, including China. In particular, treasurers recognise the liquidity and security benefits of MMFs with same-day access to cash and inherent diversification of high quality assets.
Since the global financial crisis, there has been greater regulatory scrutiny of MMFs and a series of reforms. Most recently, in October 2016, the U.S. Securities and Exchange Commission (SEC) reforms took effect that require US prime funds to publish net asset values (NAV) based on the current value of the assets they hold, rather than maintaining a constant value of $1 a share. As a result, the fund’s price will fluctuate in line with market conditions, which has accounting and valuation implications. Thirty-nine per cent of respondents noted that the floating NAV is a disincentive to investing in these funds.
In addition, MMF boards have new tools, such as the ability to impose liquidity fees and redemption gates, to prevent or limit runs. This has led to concerns amongst many investors (34% of respondents in this study) that the ability to withdraw cash from prime MMFs could be suspended. Twenty-eight per cent also noted concerns about liquidity, some of which are related to the new regulations.
These changes have already resulted in an exodus of more than $1tr from prime money market funds between January and mid-October 2016, much of which has flowed into government MMFs which are not subject to the same rules. These in turn have increased their assets from $1tr to $2.1tr over the same period. While it is difficult at this stage to anticipate what treasurers’ longer-term strategies are likely to be – particularly if interest rates rise, therefore increasing the incentive to invest in MMFs – 65% of survey respondents that invest in US prime funds currently expect to reduce their holdings, more than half of whom expect this to decline materially.
While investors in the US are most directly affected by these changes, the China Securities Regulatory Committee (CSRC) has also introduced rules to bring MMFs closer to international standards. Similarly, European reforms that are comparable to those in the US moved a step closer in November 2016 with the detail of the changes having now been outlined, including a new low volatility NAV (LVNAV) fund. The time scales for introduction will become clearer following final technical work and plenary approval.
Whether treasurers continue to invest in constant NAV (CNAV) funds (such as government funds in the US and short-term MMFs in Europe) or increase their holdings of VNAV and LVNAV funds, it is essential to research, collate and analyse fund information in a systematic way, and execute transactions efficiently, securely and transparently. MMF portals have become well-established over recent years as an efficient and convenient means of transacting MMFs and integrating information with the TMS or enterprise resource planning (ERP) tool. There were two particularly significant developments in 2016. Firstly, the proportion of companies using telephone dealing fell, from 38% in 2014 and 2015 to 23% in 2016. Secondly, the use of independent portals exceeded proprietary, single-provider portals for the first time in 2015, and the gap widened further in 2016, with 37% now using independent portals compared with 23% using proprietary portals.
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What is 2017 likely to bring?
Treasurers’ awareness of the impact of regulatory change, particularly Basel III, on their investment strategy still appears to be low with 76% of respondents expecting to use deposits in the same way as they do today, and 51% planning to use CNAV MMFs to invest a large proportion of their cash. For many companies, particularly those with either large permanent or occasional cash balances, this strategy requires urgent review. An increase in US interest rates may prompt this review and encourage treasurers to return to prime funds over government funds. However, as it can take some time to conclude changes to treasury policy, treasurers should anticipate market changes, but also ensure that their policies are flexible enough to support new instruments that emerge over the year ahead.
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Tips for treasurers
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