Treasury Today Country Profiles in association with Citi

Japan joins less than zero club

Cardboard people joining arms in celebration

Corporates in Japan may need to rethink their approach to liquidity management following the recent decision to begin charging lenders for holding money at the central bank. But can any lessons be drawn from the experiences of their treasury peers in Europe?

A more challenging environment for cash management is emerging in Japan after negative interest rates came into effect last week, and the country’s corporate treasurers must now be busy contemplating what to do to avoid paying interest on deposits.

To better understand why negative interest rates are going to create such a dilemma for such treasurers in general it might be helpful to revisit the impact the policy has had on the behaviour of Europe’s corporate investors over the past several years.

Since the ECB introduced a negative deposit rate in 2014 numerous big banking names – including the likes of HSBC, J.P. Morgan and Credit Suisse – have started charging clients for large deposits in euros, Swiss francs and Danish and Swedish krone. It was not long before yields on euro prime money market funds (MMFs), the other main vehicle favoured by treasurers for cash balances, began to dive into negative territory too.

As the new investment environment began to take shape, there was much discussion around how corporate treasurers would have to begin thinking differently about how they manage same-day liquidity. In the event, some treasurers endeavoured to negotiate lower fees or higher rates on overnight deposits, leveraging the full relationship (even the pension spend) in the process. Some also began to explore other less-traditional investment products, most notably tri-party repos and separately managed accounts.

But by and large, the cash investment habits of treasurers remained unchanged, except, perhaps, with respect to a little extra attention being given to how cash is segmented into different liquidity buckets. Conscious of the risk-return trade-off, and with a dearth of viable alternatives, most came to accept negative yields. It is a trend highlighted by recent research from Fitch Ratings’ Fund and Asset Manager Rating Group. In its 2016 Outlook for MMFs, the ratings agency draws attention to the fact that euro CNAV funds recorded modest inflows in 3Q2015 – investment that happened despite the yield on such funds remaining firmly in the negative over the same period.

However, there are several arguments for why negative interest rates could end up playing out differently for Japan’s treasurers: the level of cash on corporate balance sheets and the frailty of the country’s MMFs. Let’s now consider the merits of each of these in turn.

The cash pile

One reason negative interest rates pose a potentially bigger problem in Japan, is the level of cash Japanese companies are currently holding. After nearly two ‘lost decades’ of stagnant growth and deflation, corporate Japan now has the most over capitalised balance sheets in the Asia Pacific region, and significantly higher cash reserves than found in any other G7 economy. Indeed, many firms now boast cash piles larger than their market capitalisations.

True, European corporates have also built big cash piles in recent years, but a cursory glance at the figures shows the two do not bare comparison. Second quarter data released by the Bank of Japan (BoJ) last year, for instance, revealed that the country’s businesses are now sitting on cash worth Y243trn ($2trn). In Europe, meanwhile, cash on the corporate balance sheet now stands at €1trn ($1.1trn), almost exactly half the corresponding figure for Japan, and in an economy over three times as large in GDP terms.

Naturally it follows that such vast cash balances will equate to higher sums paid in fees and interest on accounts for any corporate that is subject to them. Currently, no banks in Japan have officially confirmed intentions to begin passing on the fees to clients. But as preceding events in Europe demonstrate, the squeeze on interest rate spreads and the bleeding of the banks’ core businesses this results in, may make such a move inevitable in the long-run. And, once that happens, Japan’s cash pile soon becomes very expensive to hold at a bank.

Vulnerable MMFs

Japan’s money funds are unlikely to serve as a viable investment alternative either; not when the big three credit ratings agencies are of the view that the ultimate survival of the country’s MMF industry is now in doubt.

While Europe’s MMFs have managed to continue in a negative rate environment for almost two years now, the European experience is unlikely to be repeated in Japan where conditions are very different. Moody’s suggests that Japan’s MMFs are more vulnerable since the industry is far less diverse. Europe has funds that can adjust net asset values upwards or downwards (VNAV MMFs), so-called ‘standard’ MMFs (that take on more credit and duration risk), and MMFs denominated in currencies not subject to negative interest rates. In Japan, on the other hand, only short-term CNAV MMFs denominated in yen exist. Moreover, non-financial corporates and other institutional investors account for little over a quarter of assets invested in the Japanese MMF sector. In the absence of many viable alternatives for same-day liquidity, risk averse treasurers came to accept negative interest rates on the euro; yield-seeking Mrs Watanabe, conversely, may not be quite so tolerant.

Since MMFs are prohibited under Japanese market regulation to benefit from sponsor support, Moody’s believes the threat to the industry is of an existential nature. “Negative interest rates could lead to money market funds disappearing altogether in Japan,” says Vanessa Robert, VP, Senior Credit Officer at Moody’s, adding that the surprise nature of the BoJ’s announcement has compounded the industry’s problems. “Unlike what we saw in Europe, the BoJ’s decision was not anticipated by fund managers in Japan and, consequently, they did not have time to implement the same share reduction mechanisms that allowed euro CNAV funds to continue operating in a negative rate environment.”

Signs of the strain are already showing. Within a week of the BoJ’s announcement, eight investment companies had issued statements to the effect that their funds are now closed to new investors. However, should the country’s already small MMF sector soon disappear entirely, Moody’s says the $13bn currently under management could be reallocated to the money reserve fund (MRF). Indeed, MRFs would appear to be ideally suited to the purposes of the treasurer since they operate like sweep accounts, offer stable NAV, and have the advantage of being able to benefit from sponsor support in periods of stress. Nevertheless, given the small size of the MMF industry the change in institutional investment behaviour such a shift would represent, would be very minor in relative terms.

Cash becomes expensive

Ultimately treasurers in Japan – just like their European counterparts – may have little choice but to accept negative interest rates and count on improved cash forecasting and segmentation to allow to access a wider range of higher yielding investment products. Wherever they choose to park same-day liquidity now though – MMFs, MRFs, bank accounts or some other vehicle – the chances are that the investment will come at a cost. Further rate cuts are expected later in 2016, so this is likely to remain the situation for a while into the foreseeable future.

Unlike in Europe, however, the sheer magnitude of the pools of cash sitting idle on Japan Inc.’s balance sheet creates a problem that cannot be entirely solved by liquidity buckets. Under Abenomics, pressure has been growing on companies to increase capital expenditure and, reflecting that, more investment has been channelled into acquisitions in the past year (especially in overseas markets). Now the arrival of negative interest rates may well force treasurers in Japan to further question why they are still holding such large cash balances. The cause of the liquidity challenges facing treasurers in Japan may be the same as in Europe, but the effects could be slightly different.