Central bank measures are causing your bank deposits to yield in the negative, but your investment policies prohibit you from investing in products that don’t produce positive returns. Regulatory changes mean that your money market fund is switching to floating net asset value (VNAV), but your investment policies prohibit you from investing in all but CNAV funds. Is it time to update your investment policies?
Negative rates, banks turning away non-operational cash deposits, and a changing regulatory environment in the money market fund (MMF) space to boot: has there ever been another time when the liquidity management environment has seen such a powerful concurrence of headwinds?
Roger Merritt, Managing Director, Fitch Ratings certainly cannot recall one. “It’s clearly an extremely challenging environment,” he says. “I cannot think of a time, certainly in the past 25 years, that treasurers have faced so many different challenges at the same time with regards to how they can effectively manage their liquidity.”
Defining a strategy fit for this new external environment is tricky enough, so the last thing that treasurers will want is the task is being made all the much harder by internal factors like investment policies. Yet for some treasurers it would appear that this is precisely what has been happening.
We hear a lot of treasurers saying, for example, that their investment policies do not permit negative yields. But for those that are depositing money at a bank in euros or investing in money funds denominated in euros there is, right now, little else besides.
Similarly, when European MMFs are obliged to convert to VNAV in accordance with the recently agreed new regulatory proposals, some treasurers lament that their investment policies only permit them to deposit into constant net asset value funds (CNAV).
Other treasurers may be finding, meanwhile, that the new instruments they are now considering (ever since the Liquidity Coverage Ratio (LCR) made it harder to park some of their excess with a bank) are not covered in their investment policies either.
Time for a review
It is quite possible, therefore, that there are a few treasurers out there thinking now may be the time to revise the rules that govern their liquidity investments. In fact, earlier this week Fitch Ratings published a report suggesting that if they are not already, then they really should be. The report said that it is indeed time for “a proactive, strategic update of investment guidelines” and that corporate investors should give particular thought to future changes in cash management products and ratings coverage.
“If the world of cash management is changing and the products that you are used to investing in are not available anymore – or perhaps not available to the same degree – then flexibility with regard to the type of products that fit with your investment guidelines is important,” Merritt explains.
There are three areas treasurers may wish to focus on, says Hugo Parry-Wingfield EMEA Head of Liquidity Product at HSBC Global Asset Management. First, as Ratings Agencies continue to review and in some cases downgrade banks, corporates should be thinking about whether polices remain ‘fit for purpose’. “Companies should not simply adjust their criteria downward in response,” says Parry-Wingfield, “rather there should be a deep analysis to decide whether they have the right (and sufficient) counterparties.” The second area for consideration is the investment products referenced in an investment policy. If the ability to place some short-term deposits with banks is becoming limited, then perhaps treasury needs to explore if other instruments are needed, such as money market funds or direct securities. There is likely to be innovation in both the bank and asset management markets to launch new products that meet emerging investor and regulatory demand. Finally, in light of Basel III and the introduction of the LCR, corporates should also be thinking about how their investment policies define their liquidity profile. “The treasurer should now be reviewing what liquidity they really need to run the business. There is always an opportunity cost to holding too much liquidity but we believe that is going to be accentuated in the months to come,” adds Parry-Wingfield.
The ratings game
While investment managers and Fitch largely agree on the need for corporate treasurers to review investment policies, there is a slight difference in emphasis when it comes to the question of how credit ratings should be used with reference to MMFs and other liquidity products.
Fitch believe best practices dictate an approach that takes into account all of the ‘big three’ global ratings agencies (Fitch, S&P and Moody’s). This is the norm for most banks, institutional investors and other sophisticated financial players, they point out, and should be for corporates too. If it is not then investors could potentially be missing out on a large segment of the market. Merritt offers an example. Since 2010, there has been over $2.5trn of debt issued that has a rating from Fitch and one other agency. So although one might expect a credit ratings agency to promote the use of credit ratings, an investment policy referring only to S&P or to S&P and Moody’s is indeed likely to represent investment opportunities missed.
“If you have not looked at your guidelines in a number of years, there has been significant change in terms of the coverage of the three global ratings agencies across the various segments of the fixed-income markets,” Fitch’s Merritt says. “We point out that having inclusive guidelines with respect to ratings is also, we think, very important and reflects the best practice we see in other segments of the market.”
On the other side of the coin, however, there is a growing body of opinion that says market participants can – and have in recent years – become excessively over-reliant on credit ratings. This concern is particularly pronounced in the money fund space. In fact, the original MMF reform proposals of the European Commission – but not crucially in the most recently agreed draft – included a ban money funds soliciting an external credit rating. “I would say that the direction the industry is going in – and this is very much concurred with by the regulators – is that there should be much less of a reliance on ratings,” says Jason Straker, Client Portfolio Manager, JP Morgan Asset Management. “Treasurers need to look into the background of the manager, the holdings, the expertise and experience of the portfolio manager.”
HSBC’s Parry-Wingfield agrees, and adds: “ratings should be but one input into an investment decision.” Like most investment managers, HSBC perform their own fundamental financial and credit analysis on any counterparty they use in their money market funds. It is a useful proxy for how corporates should approach their own investment process. “There is a benefit to outsourcing that to an investment manager if you don’t have the resources or expertise to do it in-house,” he says.
Keep it flexible
Any treasurer that does conclude there is now a need to review departmental policies around investments should try to maintain a long-term view though. If there is anything at all to be learned from the investment policies that have struggled to keep pace with the developments we have seen over recent years, it is that any parameters should not be so rigid that they are unable to accommodate changing conditions.
“Investment policies are not supposed to be something that change every six months,” says Jim Fuell, Head of Global Liquidity, EMEA at J.P. Morgan Asset Management. “They are broadly written, but with a level of constraint. Having said that, though, I think it is also important to build in some level of flexibility that allows you to navigate through some of the impending changes without necessarily having to go back to the board for further approval.”
That would be helpful, not least because when the investment environment changes (especially to the extent that we have seen it do of late) a VNAV MMF that once seemed so unpalatable might, when options are constrained elsewhere, suddenly look like the best option. That is a particularly useful example since MMFs is an area where there still remains considerable uncertainty as to how things will ultimately play out. “I would say that the full implementation of MMF reform in Europe still seems some time away and potential changes being discussed that you might not like today might not seem as objectionable in several years’ time when other alternatives have also changed – ie the bank that used to accept your deposits is less accommodating than it once was ,” adds Fuell.