Our clients had been faced with the prospect of negative yields for some time and many planned contingency investment policies accordingly. With the imminent prospect of negative MMF yields, clients looked at what alternative short-term options were still on the table. We saw a number of banks holding the interest line at zero for their deposit products during this time and investors evidently played the available investment universe to their advantage until the banks realigned their pricing.
However, we always felt that once we saw a wholesale market move to negative interest rates, the relative value of the MMF proposition remained intact and the potential benefits of diversification and high credit quality would become evident to investors once again. As the banks began passing on negative rates to deposit holders, thereby, in our view, levelling the playing field somewhat, we started to see a steady return of investors to our funds and, as of July 2016, assets under management (AUM) in both our rated and unrated EUR prime liquidity funds were back at the levels we saw in October 2014.
In our opinion, negative interest rates also affect the way in which MMFs are managed. We have seen reduced levels of liquidity in the market as a result of the negative interest rate environment, particularly during the transition from zero through to negative. Combine that with the effect of Basel III, and the upshot, in our view, is a reduction in front-end issuance in favour of the longer part of the curve, with the sub-three month part of the curve most impacted. We have found investing portfolios to align liquidity needs with market supply has therefore been increasingly challenging in euro portfolio management.
DD: The regulatory backdrop means that banks have to be constantly evolving, in both how they manage these changes internally but also how they apply these variations to different client types.
In terms of what we have already seen, overnight markets are challenged and access is becoming increasingly relationship-driven. It has been essential for us to leverage our firm-wide relationships to maximise our counterparty supply without undermining the high credit quality of our MMFs.
Secondly, with banks shrinking their balance sheets, there is reduced secondary market liquidity, and we are increasingly seeing banks passing securities through the secondary market rather than holding anything on their balance sheets. We believe the banks are essentially looking to match buyers and sellers, as the cost of balance sheet has risen. This increased cost of balance sheet has contributed to some widening in bid/offer spreads from pre-crisis levels. In our view, these three themes – reduced overnight access, reduced secondary market liquidity and wider spreads – are particularly heightened over bank reporting dates, most notably quarter-end, half year-end and year-end.
The next phase for Basel III will be the implementation of the Net Stable Funding Ratio (NFSR) through 2018 and 2019. Repo markets are a low-margin business, and it is our opinion that these already-thin margins will come under further pressure, particularly under the NSFR asymmetry of repo and reverse repo. The NSFR is therefore going to make repo an increasingly costly business for the banks. This could drive many banks to restructure in a manner that allows them to remain profitable, including passing that cost onto clients, and could result in others walking away from the business. We have seen a consistent contraction in repo markets in recent years, a trend that we expect to continue under the implementation of the current NSFR.
We always felt that once we saw a wholesale market move to negative interest rates, the relative value of the MMF proposition remained intact and the potential benefits of diversification and high credit quality would become evident to investors once again.
Beccy Milchem, Director, Head of International Corporate Treasury Cash Sales
What we have yet to see fully play out from a regulatory perspective, is the way in which the banks organise themselves in the post-Basel III world to pass on the true cumulative cost of regulation. There remains some divergence in the way banks are organising themselves departmentally and holistically, to deal with the impact of the regulation. Some banks – notably in the US – are already incredibly well organised and holistically take into account the full cost of Basel III to ensure it is fully passed onto clients at the departmental level. However, in our view, there are also banks that are less advanced in this respect and will be playing catch-up over the next several years, with costs yet to be borne by clients.
BM: In light of these trends, there are a couple of things that we think investors need to be mindful of, outside of how they place their short-term liquidity on a day-to-day basis. Firstly, with respect to activities like M&A and tapping the bond markets, treasurers should really consider the challenged liquidity conditions throughout the planning stage. Something we have witnessed recurrently in the past several years is companies being caught out after having raised a significant amount of cash at quarter-end or year-end for which they need a short-term home. Secondly, treasurers should also look to work closely with their asset management partners to see what capacity there is in the market for taking short-term cash at certain points in the economic calendar. That way, if their banking partners do not have the capacity for a deposit at any given time, they have a backup plan in place.
What is your take on the regulatory environment for money market funds that is now taking shape? What sort of challenges might the emerging regulatory environment pose for your clients?
BM: Although the reality is that things are going to be different in Europe compared to the US, in the near future we believe there is still a considerable amount of negotiation to take place in the European reforms. Even after a deal is struck, following the trilogue process, we expect two years to be set aside for the implementation of any changes.
So, whilst this is certainly something clients will have to consider in the coming years they need not, in our view, be too concerned at this moment in time. After all, given the nature of the MMF product, investors can theoretically make the switch just before the new rules come into play. Regulatory changes are finally being implemented in the US however, and we would advise treasurers in Europe to keep an eye on how the changes in the US markets play out. MMF regulation in Europe is likely to take a somewhat different form in comparison with the US, but we do not think the final rules will be massively dissimilar.
For treasurers who are interested in products like SMAs, engaging with a professional asset manager that has the resources and credit, portfolio and risk management perspective can be very beneficial.
Damien Donoghue, Managing Director, Co-Head of International Cash Management
In the end, we consider that MMFs will continue to be a viable tool for corporate treasurers, whatever is agreed by the regulators in Europe. Yes, treasurers will have to consider a different short-term investment product; one that will require a different approach operationally. Yet, in a post-Basel III world, where certain types of balances are becoming less attractive to banks, we think the value proposition of MMFs will persist.
The ECB’s corporate sector purchase programme (CSPP) is now under way. What impact have we seen so far on corporate access to short-term money market instruments like commercial paper (CP)? What are the implications of this programme over the long-term?
DD: As we discuss this today, the CSPP program has been in operation for just over a month and is tracking a healthy stock of purchases across industries and European geographies.
In terms of market impact, since the ECB announced that it was embarking on the CSPP, there has been a trend of financial spreads widening over corporates across the curve. This tendency has not been quite as evident in the money markets, which are characterised by low tier 1 corporate supply and broader supply/demand imbalances, naturally making corporates expensive. The CSPP may be enticing a flurry of new issuance in the corporate market to meet new investor demand and capitalise on tighter funding costs, but, in our view, this is benefitting the longer fixed income markets rather than the front-end. Furthermore, the ECB at this stage has not yet ventured into commercial paper markets, despite allowing themselves the flexibility to buy down to six-month maturities.
It will be interesting to see the impact of the CSPP as markets emerge from the typical summer lull and the nature of CSPP purchases evolve.
Are today’s regulatory and market realities pushing clients to think more creatively about their short-term investment instruments?
DD: For the vast majority of our investors, we understand cash needs to be in a product with daily liquidity. So, whilst there has been a lot of industry chatter in recent years around how treasurers should be considering other product types – separately managed accounts (SMAs) and so on – these products are not always appropriate for many of our clients. That is because they need those cash balances for day-to-day activities.
BM: While it is certainly true that that the vast majority of clients we work with need regular access to cash, the current investment environment has prompted corporate treasurers to think about how they are segmenting their cash buckets. They are giving a lot more thought now to what is required day-to-day and what, perhaps, can be given a more strategic allocation. Off the back of this, we have seen a greater number of clients coming to us in recent years to enquire about ultra-short bond funds or SMAs.
For treasurers who are interested in products like SMAs, engaging with a professional asset manager that has the resources and credit, portfolio and risk management perspective can be very beneficial. The majority of treasury teams today are extremely lean with slim resources allocated to credit assessment. We believe there is a risk therefore that companies will stretch too far for yield if they attempt to invest by themselves. An SMA can be a useful option for companies sitting on large pockets of idle cash, but treasurers really need to identify the cash that they can extend in duration and credit and be able to tolerate potential spells of market volatility across the lifetime of the investment.
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Beccy Milchem
Damien Donoghue
