In some cases, there may be opportunities for companies to explore other short-term investment products such as money market funds (MMFs) and high-rated short-term debt. “Alternative instruments exist today, both on- and off-balance sheet, from a bank’s perspective,” says Tombazzi. “These include notice deposits, notice accounts and flexible term deposits (on-balance sheet) and liquidity/money market funds and fixed income securities (off-balance sheet).” He adds that while take up of these alternatives is low at this stage, “they are increasing in popularity and we expect the demand to increase materially starting from this year.”
Indeed, the use of money market funds is becoming more widespread in Asia. Money market funds are relatively new to the region in comparison to the more established industry in the US and Europe. However, Asia’s MMFs have grown considerably over the last year: China’s MMFs now represent 12.6% of the global market according to ICI data.
Bank deposits are not the only short-term investment vehicle to be affected by regulatory change: money market funds are also undergoing a period of considerable change in the US and Europe. During the financial crisis, the Reserve Primary Fund ‘broke the buck’, meaning that its Net Asset Value (NAV) fell below US$1. An investor run ensued and the fund collapsed. The MMF industry has subsequently been the focus of increased regulatory scrutiny, paving the way for significant changes.
The money market fund reforms recently introduced in the US required funds to move away from the previous model whereby investments usually had a constant net asset value (CNAV) of US$1 a share, with certain funds now required to adopt a variable NAV instead. Other changes include the introduction of liquidity fees and redemption gates in certain situations. As a result of the changes, which came into effect in October, the industry has seen outflows of around US$1 trillion over the last year, with many investors moving cash from prime funds to government money funds.
Change is also on its way in Europe, following years of negotiation. In November 2016, an agreement was reached between the European Parliament, Council and Commission on the draft regulation. The proposed rules include the introduction of a new category of funds: Low Volatility NAV (LVNAV) funds. The new rules are not expected to come into effect before the end of 2018.
Reviewing investment policies
When seeking to respond to the challenges brought by Basel III, it is important to have the right policy in place for short-term investments. An investment policy should reflect the company’s investment goals and risk appetite and should set out guidelines covering approved investment instruments and counterparties, as well as currencies and maturity limits for investment instruments.
“A corporate’s short term investment policy is fundamentally about managing risk, including interest rate risk, foreign exchange risk, counterparty risk, liquidity risk, operational risk and more,” says Ong. “In Asia, developing countries have stringent regulations on capital outflow and currency control, liquidity risk stands out even more for regional or global corporate treasurers to take into account when setting investment policies for such restricted countries.”
An investment policy is unlikely to be updated very frequently – but market changes may prompt treasurers to revisit their policies to make sure that they remain relevant both for the company’s needs and for the prevailing market conditions. While companies in Asia continue to favour bank deposits, the challenges brought by Basel III may therefore act as an impetus to revisit existing policies and consider whether alternative investment products might be suitable.
When it comes to choosing or amending an investment policy, there are a number of factors to consider. Jaccard points out that an investment policy should include the following points:
Long and short-term credit rating of banks.
Tenor and ability to break funds on very short notice.
Underlying liquidity risk if investment is in securities other than bank deposits.
Currency transferability and convertibility.
Cash flow forecasting accuracy.
Accounting treatment, eg mark-to-market of securities.
In practice, not all treasurers will choose to revisit their investment policies in light of Basel III – and treasurers in Asia may be less likely to do so than treasurers in other regions. Ong says, “We observe that most corporate treasurers are risk averse and not taking drastic steps to change their short-term investment policy or rejig their portfolio mix of safe and liquid investment options.”