Treasury Today Country Profiles in association with Citi

Introduction to short-term investment instruments

Lighthouse in the middle of a sandstorm

Across the globe, the cash and liquidity landscape is changing. Once the dust settles from today’s extensive regulatory and market changes, the new short-term investment world could look very different for the corporate treasurer. It is therefore more important than ever to re-familiarise ourselves with the short-term investment instruments available, providing a brief overview of the current state of play.

In a period of ongoing regulatory upheaval and ultra-low – in some cases negative – interest rates, corporate treasurers are being encouraged to review and update investment policies to allow them the flexibility they require to operate in the new short-term investment paradigm.

In 2015, for instance, Fitch Ratings published a report suggesting that if treasurers are not already looking at a policy review in this context, then they really should be. The report said that it is high 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.

Money market funds (MMFs) and bank deposits remain the most important short-term liquidity products for corporate treasurers. But as we learned in Section 1 of this handbook, there is now a growing interest amongst corporate treasurers for less conventional products. In this section we will provide an introduction to the staple instruments used for short-term liquidity management before moving on to consider some of the alternatives where, by accepting an additional degree of duration risk, an investor might be able to secure higher returns on liquidity surpluses.

Short-term investments

To align the company’s cash with its investment policy and diversify risk, treasurers typically invest their cash into high quality, short-term instruments and investment products, including:

  • Bank deposits.

  • Money market funds (MMFs).

  • Treasury bills (T-bills).

  • Certificates of deposit (CDs).

  • Commercial paper (CP).

  • Separately managed accounts (SMAs).

  • Repurchase agreements (repos).

  • Tri-party repos.

  • Exchange traded funds (ETFs).

  • Medium-term (MTNs) and floating rate notes (FRNs).

  • Short-term bond funds.

  • Enhanced cash funds.

Bank deposits

Types of bank deposits used by corporates include:

  • Deposit accounts.

    Deposit accounts are interest-bearing, typically at a fixed rate (although it may vary over time). They provide greater yield than current accounts, although this is still potentially lower than most money market instruments.

  • Term/time deposits.

    Cash is placed in term (or time) deposits for a fixed period. Alternatively, a bank may require an advance notice period to withdraw the deposited funds. A minimum deposit amount is usually required. Interest is typically paid on maturity or, for longer deposits, at interim periods.

  • Call deposits.

    Also known as on-demand or instant access deposits, they provide immediate access to funds without applying a penalty. This convenience means interest rates will be lower than for term deposits, but are usually better than current accounts. Spreading short-term wholesale deposit business around the market enables counterparty risk to be diversified and can improve returns. But, it can be counter-productive, particularly where there is no obvious bank relationship angle and the improvement in returns for short-dated cash might be marginal at best. It can also be highly time-consuming for any thinly-staffed treasury.

In Europe and North America, bank deposits remain the primary investment vehicle for corporate cash holdings, a trend that looks likely to continue for the foreseeable future. According to the 2016 Association for Financial Professionals (AFP) Liquidity Survey, more than half (55%) of all US corporate cash holdings are still maintained at banks, the second largest share of cash holdings held at banks in the ten-year history of the survey. The report notes that, in 2008, treasurers were keeping approximately half of their short-term liquidity in the capital markets, by way of MMFs, T-bills, and other such instruments. Around one-fifth meanwhile was being stored in traditional bank deposits. Now we are seeing the reverse.

Depending upon the jurisdiction and the funding mix of a bank, the pricing of corporate deposits will have natural breaks at one month, three months and one year. For corporates, overnight deposits have traditionally yielded only minimal returns – especially so in an era of historically low interest rates – near whereas longer-term time deposits will offer higher yield but restrict the availability of cash.

“The most impactful change for the corporate treasurer is that it’s no longer the company that defines which of their deposits are operating versus non-operating, rather it’s now a result of a quantitative measure which can be substantiated in line with the regulations.”

Lori Schwartz, Head of EMEA Liquidity, Treasury Services, J.P. Morgan

Overnight deposits are being priced higher or paying lower interest because banks are trying to hold onto cash for longer, giving themselves more certainty and increasing their capital ratios in accordance with Basel III rules. “Basel III has introduced an additional level of scrutiny to what defines reliable, quality funding for banks. With its introduction, banks are now required to establish and be able to justify quantitative measures that classify deposits as operating or non-operating, or reliable funding versus less reliable funding. Typically these measures relate to the intended use of the deposit, specifically the relationship to upcoming payments,” explains Lori Schwartz, Head of EMEA Liquidity for Treasury Services at J.P. Morgan. Effectively, banks are finding overnight deposits less attractive and longer dated deposits – such as 35-, 65- or 90-day term deposits – much more attractive.

A cash investor looking to maximise the return on its liquidity portfolio must understand the nuances of Basel III and consider a bank’s likely treatment of its cash balances. All else being equal, deposits deemed to be non-operating cash will be less attractive to banks than operating balances. For that reason, properly segmenting cash balances into operating and non-operating pools and making investments that maximise returns on both pools is key. For treasurers, “it’s important to consider the distribution of their cash management business and the increased importance of aligning payments with deposit placement”, says Schwartz.

Over the past two years, as Schwartz explains: “The most impactful change for the corporate treasurer is that it’s no longer the company that defines which of their deposits are operating versus non-operating, rather it’s now a result of a quantitative measure which can be substantiated in line with the regulations. As a result, the market has changed and as appetite for non-operating deposits continues to reduce the demand deposit account is no longer an unlimited home for excess cash.”

Against the backdrop of a negative interest rate environment, she adds, it’s a key focus for banks to understand corporates’ cash management and currency needs with a view to identify opportunities to optimise as well as leverage new market solutions to increase efficiency. “For companies, it’s important to ensure that investment policies are reviewed and reflect the considerations of negative interest rates.”

As the banks’ appetite for non-operating deposits continues to decline, corporate treasurers with non-operating cash will be best placed to consider off balance sheet alternatives, says Schwartz. “The traditional option of money market funds (MMFs) and others will have separate considerations as countries implement their own regulatory reforms in this space, though.”

Money market funds (MMFs)

An open-ended mutual fund that invests in short-term debt such as money market instruments (fixed income securities with a very short time to maturity and high credit quality). MMFs are run by asset management companies which are either bank-sponsored or independent.

Money market instruments traditionally include treasury bills, commercial paper or certificates of deposit. The original concept of the money market fund thus was one based on mutual investment in pool of securities with the aim of delivering a highly liquid short-term investment that gave higher yield than might typically be found in bank deposits.

Indeed, in order to preserve their capital, corporates in Europe, the UK and the US have traditionally turned to MMFs, as a means of avoiding losses on principle without, importantly compromising safety or liquidity. The three key attractions of MMFs for treasurers, therefore, are: capital protection, daily liquidity and the ability to account for the investments as cash on corporate balance sheets.

According to the 2016 AFP Liquidity Survey, MMFs are storing 17% of corporate short-term investment balances, up two percentage points from the 15% reported last year. How the incoming regulatory changes alters this picture remains to be seen, but some impact is certainly to be anticipated. According to the same AFP study, the majority of treasurers (62%) say their organisations are likely to make significant changes to their approach in light of the incoming SEC rules.

You can read more about choosing and using MMFs, as well as the latest on regulation, in the subsequent sections of this handbook.

Treasury bills (T-bills)

Said to be the ‘backbone’ of the money markets, Treasury bills (T-bills) are short-term instruments issued by national monetary authorities through dealers that participate in regular primary auctions at a discount to par for maturities up to one year (most commonly, maturities do not exceed six months). The value to the corporate investor comes from the difference between the discounted value originally paid and the amount received back.

Investors typically acquire bills through the dealers and settlement would be into a depositary or custodian account. In the UK, the minimum investment is £500,000 and issuance is aimed at institutional and corporate investors. In contrast, the US market encourages retail level access with bill denominations as low as $1,000.

T-bills are considered (credit) risk free in their national markets and, as a consequence, are the first option of any treasurer wishing to minimise risk at times of market stress. Equally, markets for all the leading countries’ bills are deep and liquidity is never in doubt. The downside is low yield which, although designed to mirror official rates, can be negative.

Certificate of deposits (CDs)

CDs are widely used by corporates – particularly in the UK and Europe – in place of fixed-term bank deposits. They are issued by banks and are typically fully negotiable (ie transferable by delivery), which enables them to be bought and sold in the secondary market with relative ease. For this reason, they will normally be issued at yields below those available for term deposits.

Generally fixed rate, CDs can also be floating rate and even pay returns geared to external reference rates. They can be issued bilaterally or under established note programmes. The majority of CD issuance is now in non-materialised form and deliverable electronically though securities depositories such as DTCC and Euroclear, although it is still possible to request physical (security printed) primary issuance.

As with any instrument that can be traded, secondary market pricing can be affected – sometimes dramatically – by market sentiment. This means that negative news events for any bank issuer can result in withdrawal of demand for, and an increase in supply of paper in the secondary market.

A corporate investor intending to trade the paper prior to maturity should be concerned with secondary market pricing. In this instance, auditors may require market valuation of the instrument, which would otherwise be accounted for as a deposit with a maturity value of par.

Apart from a possible yield differential, the main drawback of CDs, compared with term deposits, is the need to be able to accept delivery of the dematerialised form of the CD. This poses no issue for a treasury operation that has a regular custodian holding accounts with a group like DTCC or Euroclear. But for those investors that are without this, custodial arrangements will need to be made, managed and paid for.

Commercial paper (CP)

CP is an unsecured, short-term debt instrument that can be issued by non-financial corporate and by banks. Bank issuance is most regularly associated with securitisation programmes, where bank assets are transferred into a conduit vehicle and from which CP is issued to investors. Whilst there may be little direct name association between a bank and its conduit(s), CP issuance is generally considered to carry full faith and credit of the bank sponsor, not least given credit, servicing and liquidity undertakings by the sponsor to support an external credit rating. That said, such asset-backed CP (ABCP) programmes have to be explained (and understood) and secondary market liquidity can be patchy.

However, for corporate investors that have the capacity both to assess and manage such assets and that are willing to live with the possibility of constrained liquidity, investment in ABCP can generate improved investment returns.

Most highly-rated non-financial corporates have active CP programmes, whether in the US or offshore. In the US, the domestic CP market is highly developed and is a mainstay of short-term money markets. In contrast, Europe is not so well placed. France and the UK both have relatively modest domestic CP markets and the concept of non-domestic, cross-border issuance (ie euro commercial paper or ECP) is well established.

Maturities on CP range from one to 365 days, however in the US they are rarely longer than 270 days because after that date it must be reported to the SEC. The debt is usually issued at a discount, reflecting prevailing market interest rates.

Separately managed accounts (SMAs)

Various banks and asset managers offer a short-duration strategy within SMAs, a product that is essentially a portfolio of assets under the management of a professional investment firm. SMAs are typically used by large institutional cash investors who wish to place significant sums of cash, typically above €100m, directly into a basket of investments that suit their risk, liquidity needs and performance objectives. Smaller sums can be invested but the fees may outweigh the benefits due to the cost of running a diversified and well-managed SMA mandate.

One or more portfolio managers are responsible for day-to-day investment decisions, supported by a team of analysts, operations and administrative staff. SMAs differ from pooled vehicles like mutual funds in that each portfolio is unique to a single account (hence the name).

SMAs provide an attractive option for those investors in search of higher yields. In order to fully embrace this tailored portfolio approach, however, corporates would be well advised to ensure they have a good, strategic hold over their available liquidity from the outset.

For those corporate investors who have the flexibility to consider a broader scope of relative-value opportunities across slightly extended time horizons, a bespoke SMA can be constructed to capitalise on a wider range of strategies, sectors, and securities than those available through constant NAV vehicles.

Table 1: Separate accounts at a glance

Advantages Disadvantages
Customisation
Treasurers can select the parameters for their investments and specify a risk-reward profile that suits their requirements.
Set-up
Separate accounts require detailed guidelines, documentation and legal agreements, along with the appointment of fund managers and custodians.
Potential to earn higher yield
Separate accounts can enable the generation of improved yields when compared with MMFs or bank deposits.
Understanding
Treasurers require a high level of understanding of the risks and rewards associated with each type of security in order that they can agree the investment guidelines for their portfolio.
Flexibility and control
If investment circumstances change, the investment guidelines can be rapidly changed to reflect this and keep in line with the treasurer’s goals.
Minimum investment
A higher minimum is typically required when compared to MMFs.
Minimum investment
A higher minimum is typically required when compared to MMFs.
Loss of liquidity
In comparison to a MMF the corporate’s money may be tied up for a minimum period of time rather than being available on a same day access basis (one of the major benefits of a pooled MMF).
Fees
Separate accounts attract higher fees than MMFs.

Repurchase agreements (repos)

A repo is the sale and contractual repurchase of qualifying securities for cash with delivery and settlement though a central clearing counterparty (CCP) on a delivery-versus-payment (DVP) basis. Collateral provided is typically government securities or other assets subject to an agreed additional collateral margin (or ‘haircut’).

Repo maturities can be overnight or term and, depending upon the agreement reached, collateral may be substituted during the course of a transaction. The key feature is that underlying collateral is legally owned by the investor who would have a right of sale if the repurchase counterparty were to default. The risk is that the collateral haircut is insufficient to cover market risk at a time when the counterparty has defaulted on its obligation to repurchase the securities.

Repos can be administratively burdensome which is why investors are typically institutional market participants with an infrastructure to suit. Repo pricing tends to mirror the underlying cash market for the term of the repo with adjustment for collateral quality. Accordingly, for example, overnight sterling investment in repo collateralised with general collateral (ie government securities) would normally trade around 0.05% per annum below LIBOR.

Tri-party repos

Repos are often perceived as difficult to administer by the inexperienced user: this is almost certainly criticism levelled at bi-lateral deals where a corporate must find a custodian, manage a complex contract and have valuation, settlement and variation margin capabilities. But as an antidote to such issues tri-party repos are gaining ground as a short-term investment instrument.

With tri-party repos, an appointed collateral agent does most of the background work so that beyond fine-tuning the standard contract (the Global Master Repurchase Agreement or GMRA), establishing any policy restrictions and preferences, and issuing instructions to go to market, the operational involvement of the treasurer is minimised.

The agent may seek to manage a number of counterparties on behalf of its corporate client to make it worthwhile. In policy terms, this may in any case be desirable, as not only will treasurers feel more comfortable lending more to counterparties with covered cash than without, it also means they can lend against the quality of collateral, not the borrowing institution, and this in itself may generate more scope for deals.

This may even open up safe non-bank financial institutions as viable deposit counterparties – insurance companies and pension funds sitting on high quality securities from time to time need short-term cash. At least one London broker has software enabling these transactions.

Since tri-party repos offer means of diversifying investments without degenerating credit quality, interest from the corporate investor has understandably been growing in recent years. As long as there is full understanding of what is being done, and that it does not conflict with policy, then arguably any collateral is better than no collateral in risk management terms. Some treasurers have in the past complained, however, that the process for setting up tri-party repo arrangements remains lengthy and convoluted and that the yields on offer are not too different to what they are receiving for their MMF investments.

This is due to the fact that repos and tri-party repos originated in the interbank market, says Gösta Feige, General Manager & Director, Euroclear. Therefore, in the beginning, tri-party agents that look after collateral management, like Euroclear, had not adapted to accept corporate clients, he admits. But, corporate treasurers began to question “why, when we are cash long, should we deposit our cash in a classic unsecured money market, while in the interbank market, it is largely done in a secured way?” Agents like Euroclear have now adapted, however, in order to ease the onboarding process so that corporates can enjoy the benefits of tri-party repos which, Feige says, include:

  • Better protection.

    Securities collateral back up the trade and, as such, there is reduced counterparty risk.

  • Better returns.

    Better returns than can be expected in the unsecured money markets. This is due to regulations and funding pressures on banks to refinance themselves secured on a longer term.

  • Improved onboarding procedures.

    In addition to Euroclear’s own internal simplification, the company has worked with the International Capital Markets Association (ICMA) to come up with a simplified and standardised version of the GMRA to ensure treasurers only have to go through it once.

Exchange traded funds (ETFs)

Amid all the uncertainty created by the forthcoming regulatory changes to MMFs, corporate investors may wish to consider short-duration bond funds or exchange traded funds (ETFs) as an alternative. As Beccy Milchem, Director, BlackRock Cash Management, says: “Upcoming US MMF reforms and eventual updates in Europe are prompting many corporate clients to review their investment policies. Those that are able to bucket stickier portions of operational and core cash balances have looked for additional solutions to add to their investment toolkit.”

“Beyond the spectrum of traditional short-term MMFs, there are a number of ‘ultra-short’ and ‘short’ duration bond funds and ETFs that can be the next step for an investment policy,” her colleague Ashley Fagan, Director, iShares, BlackRock, adds. ETFs are securities that track an index, a commodity or a basket of assets like an index fund, but trade like a stock on an exchange. Due to this, an ETF does not have its NAV calculated every day in the way a MMF does.

ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features. This isn’t to say ETFs are for everyone, though, as Fagan explains: “This universe is much more diverse, with variances across credit and/or duration, so it is critical that investors understand the funds’ objectives, permissible securities and maturity limits and select those that meet their investment requirements.”

“Beyond the spectrum of traditional short-term MMFs, there are a number of ‘ultra-short’ and ‘short’ duration bond funds and ETFs that can be the next step for an investment policy.”

Ashley Fagan, Director, iShares, BlackRock

Indeed, to date, MMFs are still much more popular with European corporate treasurers. One reason, perhaps, is that these types of fund typically assume greater levels of risk, compared with traditional MMFs, in order to secure marginally higher yields. Another significant difference is that the shares of short-duration ETFs, unlike CNAV MMFs, fluctuate during trading hours – much in the same way as stock prices.

Therefore, as Milchem says: “Short-term MMFs will most likely remain the most appropriate solution for operational cash with daily liquidity requirements. Ultra-short duration bond funds and ETFs often offer liquidity in terms of T+1 to T+5 settlement but investors will need to be mindful that these products are typically designed for longer investment horizons and more frequent trading may result in losses. Many corporates hold the core values of capital preservation, diversification and active risk management throughout their investment strategy and thus look for strategies that have low volatility in the NAV and low value-at-risk (VaR) figures.”

Medium-term (MTNs) and floating rate notes (FRNs)

MTNs are bonds and other types of debt notes that have a maturity period somewhere between five and ten years. This type of financial note may include a term that is very different from the period of maturation, ranging anywhere from a single year to 50 years. An MTN may be structured as a fixed-income security or as some type of floating coupon, and is usually made available for purchase through a dealer.

Asset-backed MTNs could be collateralised by mortgages, equipment trust certificates, amortising notes issued by leasing companies, or subordinated notes issued by bank holding companies. However, most MTNs are based on the creditworthiness of the issuer.

Floating-rate notes (FRNs) are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a quoted spread. The spread is a rate that remains constant. Almost all FRNs have quarterly coupons, ie they pay out interest every three months. At the beginning of each coupon period, the coupon is calculated by taking the fixing of the reference rate for that day and adding the spread.

Issuance is dematerialised (as with CDs and T-bills) and delivery is through a CCP such as DTCC or Euroclear, with a requirement to enter into a custody agreement either with the dealer/vendor or separately with a dedicated custodian.

Most note programmes permit the issuance of a variety of instruments and can be designed to accommodate note issuance tailored to individual investor requirements. In some cases, they can also provide for the issuance of short-term CP, although maturities tend to be longer (say 180 days plus) than for regular CP.

Short-term corporate investors in MTNs or FRNs are unlikely to be participating in the primary market in view of the longer-term nature of the issuance. Instead, they will be looking to invest in secondary paper offered by the programme dealers that maintain a market in the issues or by holders/vendors directly.

Short residual life bank-issued FRNs that are into their final fixing period tend to fare best in the secondary market since the repayment obligation has, by this time, the same status as a bank deposit (ie fixed maturity and fixed rate). Generally, however, paper with a short residual credit life is difficult to find and, where it does exist, would not necessarily offer yields superior to that when the bank bids directly for cash. For short-dated FRNs, secondary market liquidity may be less than for CDs issued by the same obligor depending upon market conditions.

For corporate investors with a suitable risk appetite and credit process, longer-term bank – and even non-financial corporate – issuance can offer a significant yield pick-up but secondary liquidity (if required) could be an issue.

Short-term bond funds

Fund providers are devoting considerable effort to the development of their short-term bond fund offerings as a response to investors’ demand for higher yielding short-term investments and the inevitable disruption by regulators of the more traditional CNAV MMF product. They are hoping that the fund price volatility (and some capital losses) experienced in the aftermath of 2007/08 will be accepted as part of the story; however, investors will be wary.

In 2007/08, some AAA rated enhanced cash funds that had been heavily promoted as a treasury investment (but VNAV product) were caught in the wake of the failure of a number of short-term bond funds – in particular the French ‘dynamique’ funds (which had taken losses on mortgage and other structured securities).

With the prospect of variable fund pricing looming in any event, investors are showing renewed interest in accepting (through the fund) greater market and liquidity risk in return for increased yields in short-duration bond funds. In the process, they will experience daily yield volatility (as fund holdings are marked-to-market) and longer exposure to a wider range of credits. Depending on the fund and its rating, the portfolio could include tier-two names and more ‘illiquid’ securities. Whilst the funds are priced daily, investors also must accept that settlement might not be the same day, as with CNAV MMFs.

Investment in an ultra-short bond fund is a different proposition to investment in a CNAV MMF despite the fact that a fund provider may position its bond funds such that they and CNAV MMFs appear in a single continuum. In particular, fund providers are emphasising the potential for investors to exploit the yield and credit curves by investment in longer duration products. The question is whether investors can rationalise reduced portfolio liquidity and less certain returns in exchange for higher yield potential and whether their investment horizon can be long enough to ensure that the impact of any daily price volatility is mitigated.

Enhanced cash funds

A number of fund managers offer enhanced cash funds alongside their top-rated funds and, although the product suffered following the market turmoil of 2007 and 2008 (when they experienced very significant outflows and some losses of principal), it can be an efficient means of creating market exposure for those investors with longer investment horizons (say six months or more) and more predictable liquidity requirements but lacking market access. Such funds can be described in lots of ways. Confusingly, under the ESMA definitions, they may be termed ‘money market funds’ and additionally they may be branded as:

  • Enhanced cash.

  • Liquidity plus or Libor plus (both less common terms than previously).

  • Ultra-short cash.

These all try to offer a better yield.

It is important to note however that, although they may be marketed as enhanced liquidity funds (the implication being that they suit treasury liquidity investment), these funds are in reality ultra-short bond funds with VNAV fund pricing that will only suit investors with a longer investment horizon (ie those that can invest for long enough to ensure that the effect of increased day-to-day price volatility in the underlying assets is absorbed by the time shares are redeemed) and with the ability to understand fully the nature of the assets in which the funds are investing.

All these funds have extra risk in one way or another. There are two main ways of increasing return in an enhanced cash fund:

  1. Take more credit risk, so if the enhanced cash fund you are offered is rated AA rather than AAA you will know that the fund is investing in slightly lower-rated/higher-risk and potentially less liquid credits.

  2. The second way to get additional return is to invest a greater proportion of portfolio in longer maturities and thus extend the duration and reduce the liquidity of the fund. As a bond fund, this will be reflected in the volatility rating.

Arguably there is a third way and that is to invest in less liquid instruments. But many see this as a variation of the first and second options, investing for longer in lower-credit quality instruments.

The important thing for investors to realise is that once there is a move away from the top-rated short-term funds there is more risk, although the additional risk may be small. Different funds offer different maturity/duration, credit quality and liquidity combinations and, in contrast to the more standardised short-term MMFs, cannot readily be compared directly. Nevertheless, in light of forthcoming regulation of MMFs, fund providers have come more active in developing enhanced cash products.

The starting point for most investors in enhanced cash funds will be internal policy agreement on credit, market and liquidity risk appetite, willingness to accept VNAV fund pricing and deferred settlement (normally one day) and the need for cash equivalent pricing (which is less clear than for a short-term MMF).

Perhaps the most difficult element to rationalise will be the volatility of yield and, potentially, principal. Despite being positioned as ‘ultra-short’, these funds are still bond funds. They have a longer duration and would typically be permitted to invest in less well-rated names implying greater market risk.

Accepting of the risks, corporate investors are making increasing use of these funds as they search for improved returns. The portfolio nature of a fund makes the proposition less risk than a single investment.

No such thing as a free lunch

One thing is for certain, whether treasurers experiment with new products like the tri-party repo or stick with a more traditional mix of bank deposits and MMFs, today’s regulatory and market environment means a new approach to short-term investment will be needed at some companies. While cash levels are growing on the balance sheets of many organisations, cash segmentation is still not practiced universally in the corporate world.

“Why is this?” asked Alastair Sewell, Senior Director Fitch Ratings and Charlotte Quiniou, Director Fitch Ratings in an article on Fitch’s The Why Forum in 2015. “Until now, money funds have been the ideal vehicle to meet liquidity needs, providing cash managers with a “free lunch” of yield, liquidity and preservation of capital. However, looming market changes means the free lunch is over and the cost of same-day liquidity will go up. Corporate treasurers may well have to rethink their investment priorities as they come to terms with the changing cash management environment.”

Investment management: the fundamentals

The choice of the investment instruments used by a company may also be affected by the degree of management they require. When looking to invest surplus cash, a company can:

  • Invest funds independently.

    Using this method, the treasury will need to identify and monitor investment opportunities and undertake the investments itself. This may not always make effective use of the treasurer’s time as treasurers are not necessarily investment specialists. In order to build up the necessary expertise and systems, companies require large treasury operations and significant cash volumes to make the investment worthwhile.

  • Invest in money market or enhanced liquidity funds.

    Liquidity funds can be regarded as investment management outsourcing as the funds will be actively managed by the fund manager. Investing in a liquidity fund eliminates the need to continuously track rates and monitor credit relationships and is also relatively easy. As a result, the costs of trading and the required personnel are much lower than when the invested instruments are actively managed by the company itself. Investing in a fund also achieves diversification of investment instruments. In addition, overnight fund transfers to MMFs from cash pool master accounts can be automated.

  • Outsource investment management.

    Employing a third-party investment manager effectively outsources the investment of cash. Working within agreed guidelines or using bond funds, investment managers are not as restricted as money market funds in terms of maturity and rating. While this may entail more risk, investment managers will be able to exploit certain market opportunities that are unavailable for MMFs.

Before opting for investment management outsourcing or investment in liquidity funds, the treasurer needs to carefully assess the risks involved, such as concentration, correlation and credit risks, as well as the track record of the investment managers.

Best practice: investment policies

All of a company’s investments should be governed by pre-determined criteria, designed to balance risk and return in a way which meets the company’s risk appetite: in other words, by an investment policy.

The investment policy sets out who has permissions to carry out certain investments, which funds, banks and other counterparties are permissible and in what amounts (percentage limits can be set), the credit ratings, returns and maturity lengths which are acceptable and how the policy may be updated in future as the company’s risk profile changes, new investment products become available or counterparties change. Rules like Sarbanes-Oxley (SOX) and IFRS place responsibility for internal controls on the senior management team. In line with this, the board, CFO or a specially constituted treasury committee may have roles in determining the investment policy and keeping it up-to-date. It is generally approved at a senior or board level.

If a treasury investment policy has not recently changed to reflect the ‘new normal’ of regulatory reform, market volatility and low interest rates, then it will almost certainly need to in the near future. There are three areas treasurers may wish to focus on when revising policy, says Hugo Parry-Wingfield, EMEA Head of Liquidity Product at HSBC Global Asset Management. These are:

  • Are policies still fit for purpose? Companies should not simply adjust their criteria downward in response to ratings agencies reviewing – and downgrading – banks, says Parry-Wingfield. “Rather there should be a deep analysis to decide whether they have the right – and sufficient – counterparties.”

  • Are new investment instruments needed? 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 those listed above.

  • How much liquidity is needed to run the business? In light of Basel III and the introduction of the Liquidity Coverage Ratio (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,” says Parry-Wingfield.

Keeping up

The combination of a stressed global economy, divergent monetary policies and the leveraging of technology has seen a tentative shift by some corporate investors away from traditional investments towards those that might yield a greater return whilst upholding their policies of security of principle.

The changes to short-term investment strategies necessitated by new realities such as negative interest rates will in some cases mean treasurers will need to go to board to propose changes to investment policies. Whether a treasurer expects to maintain or revise their current investment policy, either by choice or necessity, there are a number of steps treasurers might wish to consider to ensure they remain on the right investment track:

  • Talk to your banks and fund providers to understand the implications of regulatory change for your business.

  • Talk to your treasury committee, internal and external auditors to check that your policies and processes are consistent with the changing regulatory environment.

  • Talk to your system providers to make sure that your systems and processes support the full range of instruments that are permitted within your treasury policy.

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