Since the credit crisis, prudent financial management has led many corporates to accumulate substantial cash reserves. These reserves have usually been placed with banks or in money market funds – but recent developments are leading treasurers to reconsider how to manage their cash.
Banks have historically been the first port of call for corporate treasurers, but Basel III is having a noticeable impact on banks’ appetite for short-term cash. Where banks are accepting short-term cash investments, a lower yield is usually offered to cover the cost of new capital requirements required by the regulation. At the same time, deteriorating credit ratings since the financial crisis have driven many cash investors away from banks and towards money market funds (MMFs) as an alternative.
However, as Treasury Today has previously reported, MMFs themselves are undergoing a period of change as well.
In the US, after new regulations implemented in October, prime MMFs – which can invest in a broader range of short-dated securities than government money market funds, such as certificates of deposit, floating rate notes and commercial paper – were required to convert to variable net asset value (VNAV) pricing. This change has driven US$1trn of assets to switch into government money market funds, which have maintained a constant NAV (CNAV) under the new regulations.
In Europe, new money market regulations are being finalised, and are expected to be issued in the next few months. Under the current proposals, only funds with 99.5% of their holdings in government debt or reverse repos secured with government debt may be classified as CNAV.
Prime funds will be classified as VNAV, or placed within a new category of ‘low volatility NAV’ funds, which will be able to operate as a CNAV as long as they are managed within strict criteria, such as shortening the portfolio from 397 days to 75 days. This increased focus on shorter-dated investments may also result in downward pressure on the yield of traditional money market funds.
Cash management is changing
“The European draft regulations are complex,” says Robert O’Riordan, Institutional Business Development Director, Insight Investment. “Different outcomes in terms of the precise regulations, and the response from cash investors remain possible. But combined with the pressure on banks, trends are already emerging that suggest that corporate approaches to cash management are changing.”
O’Riordan notes that in the UK, for instance, cash investors are focusing on the gilt repo market. “This effectively allows investors to lend cash and receive gilts as security if the borrower defaults,” he says. “This compares well with other investments, which typically do not offer comparable security.”
In its current form, the repo market today might not seem that attractive for cash investors. After all, Basel III means repo transactions have become costlier for banks, which typically intermediate repo transactions. “This has led banks to pass on increased costs to counterparties. In some cases, cash investors are driven into transactions arranged with collateral that is less secure than gilts, such as low-quality bonds or even equities, to achieve higher yields,” says O’Riordan.
“It has become clear that if transactions can be arranged without bank involvement, it should be possible for counterparties on both sides of a repo transaction to enjoy better terms,” he adds. “Importantly, inefficiencies caused by bank regulations are opening up new counterparties for cash investors that have historically not been available.”
This has led some cash investors to cut out the bank intermediary by trading directly with the counterparty, allowing cash investors to receive superior returns with gilt collateral as a result.
“In light of changing regulations and market conditions we believe there is potentially value available if treasurers transact with non-bank reverse repo counterparties,” says O’Riordan. “In the cash management space, it is now possible for treasurers to achieve gilt security and liquidity without compromising on yield and crucially maintaining a CNAV even under the proposed European money market fund regulations.”