Bank deposits remain the most popular solution for corporates in most countries in Asia with excess cash. However, now the increasing popularity of MMFs in the region is making companies think twice about their short-term investment strategy. What is the impact of regulation on the instruments available and what does the future hold?
While money market funds (MMFs) are the staple of the short-term investment strategies of many corporate treasurers across Europe and the US, the instrument is far from attaining mainstream status in the boardrooms of Asia.
The most popular product for corporates in the Asia Pacific region who are looking to invest their excess cash remains bank deposits. “The short-term investment market for investing corporate cash in Asia is still relatively new,” says Paula Stibbe, Head of Global Liquidity Sales – Asia Pacific at J.P. Morgan Asset Management (JPM AM). “Traditional bank deposits have been the primary vehicle that corporate treasurers have used to manage their non-operational cash.”
And while MMFs are far from unheard of in the region, there are significant hurdles to overcome before they become a mainstay of the Asian treasurer’s investment toolbox.
Subash Pillai, Head of Global Liquidity Management, Asia, at Goldman Sachs Asset Management, says there are two key conditions necessary for the establishment of a successful MMF market. One is a large, diversified underlying market of high-quality, liquid paper for funds to invest in. “Many markets in Asia do not meet this condition,” he says.
The other condition is likely to be met, at least in some jurisdictions, before the first: a favourable interest rate environment. “Countries such as Hong Kong and Singapore, which have high-quality underlying assets but very low interest rates may well see their MMF markets grow materially when there is a normalisation of interest rates,” he adds.
Indeed, considering Pillai’s first condition, the fact that MMFs are not widely used by Asian corporates is partly a function of the lack of depth of the capital markets in Asia; in many countries in the region, local currency capital markets are simply very small in comparison with those for dollar-denominated products.
But beyond this lack of depth in some Asian capital markets, what MMFs there are in Asia tend to be smaller-sized funds, as there is just not the range or the volume of assets available for the funds to invest in. This can in turn deter corporates, who might otherwise be favourable towards MMFs, from investing in smaller funds that they consider less diversified, and therefore less safe. “Given that most investors go to MMFs for diversification of risk rather than purely for yield, this is one of the big barriers to growth in the MMF market in Asia,” explains Philippe Jaccard, Head of Global Liquidity Management at ANZ.
Another reason for the continuing popularity of bank deposits in Asia relates to banking culture in the region, says David Blair, Managing Director, at Acarate. “Many local banks in Asia are still very focused on having big balance sheets. Some Chinese bank managers are indeed compensated based on the size of their balance sheets, whereas most Western banks want to reduce their balance sheets by as much as possible,” he explains. “On top of this, it is more common for large Asian conglomerates to have close relationships with certain banks.”
This is especially the case with companies working within a keiretsu system in Japan, and chaebol arrangement in Korea (informal business groups), whereby a bank can form the core part of a conglomerate’s operations.
However, despite the continuing popularity of bank deposits, there are signs that the nascent MMF market is starting to increase in popularity in the region.
“Over the last ten years we have started to see the types of investment tools that corporate treasurers in Asia use expand,” says JPM AM’s Stibbe. “MMFs, for example, have grown to where they are now considered a key liquidity option for treasurers to consider.”
And one of the key MMF markets of the future in Asia is undoubtedly China.
Looking to China
China is widely considered the MMF market with the biggest potential in the region, given the scale of the financial resources in China. Indeed, it already represents a significant focus for some of the biggest fund managers, although it is not necessarily the largest MMF market in Asia.
Of J.P. Morgan Global Liquidity’s nearly $18.2 billion of assets under management in Asia Pacific, almost half ($7.5 billion) is in China.
“Chinese MMFs have offered investors returns above 3.0%, and although they are not guaranteed, this compares favourably with the People’s Bank of China’s seven-day time deposit rate ceiling of around 1.35%,” says Stibbe. “This kind of yield in a AAA-rated vehicle is difficult to come by elsewhere. As a result many treasurers are now choosing to keep their cash inside China because of the attractive returns available, and solutions are starting to appear outside traditional bank deposits to help them achieve these returns.”
Several Western asset managers are increasing their presence in China, with a number of RMB MMFs emerging in recent years. However, these firms are establishing their Chinese MMFs as joint ventures with a local partner, who must be the majority shareholder under Chinese regulation. “Some corporate investors will feel more comfortable investing in Chinese MMFs through names they know,” says ANZ’s Jaccard. “But it is important to bear in mind the funds are run in collaboration with local Chinese firms.”
J.P. Morgan Global Liquidity China, for example, distributes a China-domiciled RMB fund to institutional investors in China from its joint venture, China International Fund Management (CIFM). J.P. Morgan Asset Management UK Ltd owns 49% of the joint venture, while local partner Shanghai International Trust Co., Ltd. owns 51%.
“Through locally domiciled funds like this we now have the ability to bring the depth and breadth of our product offering and insights to corporate treasurers, not only to local Asia-based companies but also to multinational US- or European-based firms with locally domiciled subsidiaries in-region,” says JPM AM’s Stibbe. “With money markets in Asia developing, especially in China, they are seeing their investment options in the region expand for a range of the functional currencies they carry.”
Goldman Sachs, too, has a domestic Chinese money market vehicle that it offers through its strategic partner Beijing Gao Hua Securities.
Furthermore, non-Asian MMFs are upping their investment in Chinese bank debt. Between April 2013 and April 2014, Fitch-rated prime MMFs increased their assets in debt from Chinese financial services groups from around zero to 0.4%. Fitch put this increase in exposure to Chinese bank debt partly down to a higher level of issuance as well as greater investor demand.
The fact that foreign MMFs are increasing exposure to Chinese bank debt demonstrates that China certainly has the underlying assets to sustain a buoyant domestic MMF market too.
And if regulators soften to the extent that 100% foreign-owned asset management entities are permitted, the options available to investors will proliferate. “If the Chinese market continues to open up in the way it has been, and foreign asset managers are allowed to have majority-owned joint ventures, more firms will surely want to expand in the country,” says JPM AM’s Stibbe.
Short-term investments elsewhere
Beyond China, the prevalence of MMFs and related instruments among corporates in Asia Pacific is varied.
In India, where the market for instruments known as liquid funds, which are similar to MMFs, is well established, the underlying assets are already in place. “India has an especially developed bond and commercial paper market, which provides the instruments needed for a sound MMF market,” says Acarate’s Blair.
Here liquid funds offer corporate investors an access point to other asset classes. “India has an established liquid funds industry offering various degrees of liquidity. They also offer a tax advantage to investors if funds pay a dividend rather than an interest rate,” adds Blair.
In January 2014, the liquid fund market in India was worth around $40 billion, and it has grown at an annual rate of 15% over the past five years.
Japan also has a significant MMF industry, although currently the yield environment is highly unattractive, with rates barely above zero on most short-term instruments.
In certain other jurisdictions in the Asia Pacific region, such as Australia, Hong Kong, and Singapore, MMFs have similarly languished in their challenging interest rate environments, with slim spreads between the rates on bank deposits and MMFs, and bank deposits remaining the vehicle of choice for many corporates with excess cash, although Australia stands out in that its MMF industry is larger and more developed.
Australia is also notable in that it will be one of the first countries in the Asia Pacific region to implement Basel III in January 2015. This is significant because Basel III will, among other measures, lead to banks being penalised for holding large amounts of corporates’ non-operational cash. This will likely drive investment in MMFs as corporates, discouraged from depositing excess cash with their banks, will seek off-balance sheet solutions.
This impact of Basel III on the MMF industry is not limited to Australia, nor indeed to the Asia Pacific region; it is set to be a worldwide phenomenon. However, it will be interesting to observe how Australia’s head start in implementing the regulation will affect the development of its domestic MMF industry, as will the subsequent spread of Basel III in other Asian jurisdictions have on their respective MMF industries.
One of the biggest challenges in Asia is dealing with the variety of regulatory environments, some of which are much more tightly controlled than others (China, for instance, being one of the more controlled jurisdictions, although this may well change considerably over the coming years). For fund providers, this means packaging and distributing their products according to local regulation, and adhering to cross-border currency movement controls. As we have already seen, it can also mean having to team up with a local partner.
Regulation from European and US legislators is also likely to affect the MMF industry in Asia. However, while the Securities and Exchange Commission’s (SEC) shakeup of MMF regulation in the US is likely to have repercussions on MMF vehicles throughout the world, no regulators in Asia Pacific have for the moment put in place an articulated plan to move to variable net asset value (VNAV) pricing of funds. That is not to say, however, that such a shift will not take place in some Asian jurisdictions.
In terms of country-specific regulation, China, not surprisingly, is one of the fastest-changing regulatory environments in Asia Pacific for short-term investment products. And in many cases, regulatory change can be advantageous for corporates, with the relaxation of some rules proving a benefit of both providers and investors.
For example, while MMFs in Europe and the US are typically settled on a same-day basis (T+0), Chinese MMFs were until recently settled on a T+1 basis. For treasurers used to same-day settlement, this made cash planning and forecasting more challenging in China. Now that a recent change in CSRC regulations has allowed MMFs to settle redemptions on T+0 in China, there is an opening for more products with international standards.
For instance, CIFM launched a new RMB MMF in August 2014 that offers institutional investors in China the capability of T+0 settlement on redemption for the first time (although subscriptions will continue to operate on a T+1 basis).
“New products, enabled by the changes in regulation are allowing corporate investors to earn higher yields than bank deposits, while also giving them the ease and convenience of having access to their cash on a same-day basis on redemption,” explains JPM AM’s Stibbe. “The direction China is moving in is allowing providers to launch products more consistent with international standards, and is boosting the growth of MMFs in the country.”
Besides regulation, another major challenge to the growth of the MMF market in Asia is that some investors do not fully appreciate the key advantage of the instrument.
“In recent investor memory in Asia there have not been the near misses or indeed failures of financial institutions that we have seen in other regions,” says Goldman Sachs’s Pillai. “While corporates in Europe and the US have witnessed the potentially catastrophic consequences of not diversifying their short-term investments, companies in Asia have not had this call to action to invest in MMFs.”
He says the diversification benefits of MMFs – one of the key selling points of this type of fund – are yet to resonate as strongly with Asian investors. “Providers continue to educate corporates in Asia about how they can diversify their risk by investing in MMFs,” he says. “As investors in the region recognise this, market growth will accelerate.”
Given that corporates in Asia Pacific may not have as much experience in investing in MMFs as some of their western counterparts, it may take time for some to get to grips with investing in MMFs or other short-term investment options, other than bank deposits. ANZ’s Jaccard says there are three steps companies in the region should follow.
A company needs a board policy outlining the excess cash ‘buffer’ it will retain. The size of this buffer is a function of the amount of funds it estimates it will require in a stress scenario.
Excess cash should be spread across as many legal entities, in as many currencies and in as many countries as possible. The more diversified the buffer, the better.
There should be a mechanism in place for controlling excess cash once it is invested. For example, there are usually conditions attached to the withdrawal of funds from an MMF. What’s more, exposure to counterparties and instrument types should be frequently monitored.
Following these steps will not guarantee the success of a corporate’s short-term investment strategy but it could help prepare the company for the expanding range of instruments available to them in the coming years.