Barry Harbison

Senior Product Specialist, Liquidity, Americas

Olivier Gayno

Chief Investment Officer Wealth and EMEA Liquidity, France

John Chiodi

Chief Investment Officer Liquidity, Americas

Investors in the short-term money markets, already coping with the continued low-rate environment, have also been subjected to reduced money market issuance over the last few years, depleting the pool of suitable assets to invest in. Whilst life is slowly coming back to the sector as economies begin to emerge from the gloom – and measures taken by certain authorities to provide relief start to take effect – the fact remains that the short-term money markets continue to feel unsettled.

Money market funds can help treasurers deal with the changing nature of the short-term money markets and professional fund managers can provide the essential understanding and analysis investors require to steer their way through the uncertainty, particularly if policy dictates that they no longer have access to some of the issuers they previously felt most comfortable with.

Supply uncertainty

Regulation

The reduction of supply may be attributed to a number of factors. Regulatory developments have played a key role in transforming the markets over the years and in particular Basel III liquidity requirements. But liquidity ratios contained within Basel III will see banks seeking longer-term funding, reducing the amount of short-term issuance and making certain short-term deposits less attractive. Even though they are not required to comply with the requirements until 2017, many banks are pre-emptively making the changes, notes Barry Harbison, Senior Product Specialist, Liquidity, HSBC Global Asset Management, Americas. “Every financial quarter we are seeing more banks voluntarily getting their positions in place to comply with the requirements, potentially further reducing supply in the short-term space.”

As the Basel III deadline looms, the progressive reduction in opportunities for treasurers will gain momentum. Banks will necessarily revisit their treatment of various deposits, and businesses will pay for those changes accordingly; deposits that do not help the banks meet their liquidity requirements will either fall well short on acceptable returns or even present negative rates. “A corporate treasurer will typically be dealing with a fairly narrow group of approved issuers,” Harbison notes. “The constraints applied by regulations such as Basel III exacerbate the issue.”

To a certain degree, supply in the US market has been impacted by regulatory reform of the repo market, suggests John Chiodi, Chief Investment Officer Liquidity, HSBC Global Asset Management, Americas. Stemming from the failure of Lehman Brothers, investors and issuers are now required to match their repo agreements by midday. Where previously it was an end-of-day operation this is now deemed too late for the regulators to be able to assist a stressed institution. The intention of earlier matching is well-founded but, notes Chiodi, “the fact that the majority of repos are now taken care of prior to noon leaves investors fewer options later in the day”. Other US-specific issues include the reduction of Treasury issuance, possibly based on factors such as increased tax revenues or even continued dividend payments from mortgage giants, Fannie Mae and Freddie Mac (which both seek billions of dollars in cash from the US Treasury Department every quarter, mostly to pay a required 10% dividend on preferred shares that goes straight back to the Treasury).

Monetary policy

Eurozone-specific factors accounting for a reduction in supply have included the European Central Bank’s (ECB) long-term refinancing operation (LTRO). This was intended to provide a liquidity buffer for banks holding illiquid assets to maintain inter-bank lending (and other loan origination). It had the unintended consequence of removing the short-term bank paper supply as banks favoured cheaper longer-term funding. However, Olivier Gayno, CIO, Wealth and EMEA Liquidity, HSBC Global Asset Management, notes that recent more favourable market conditions have meant that many banks have paid back on the LTRO “sooner than expected” causing short-term inter-bank borrowing rates to increase.

Although LTRO did take supply out of the market this is now perhaps returning. But it is not over yet. “We must keep in mind the fact that if the economic recovery in the Eurozone falters, the ECM might launch another LTRO; it is something openly being discussed,” warns Gayno.

Credit concerns

Another ongoing issue being faced by investors is the credit-rating changes that have pushed some issuers outside the boundaries of approved lists for some investors. Whilst increased regulatory pressure has decreased supply, these measures have also served to improve the credit profile of some banks. In some instances this causes investors to consider investing in issuers who had previously been removed from approved lists. The strengthening profile of some banks may see them return to favour for individual investors, says Harbison, but in the manner of Pandora’s Box, now that the topic of institutional credit ratings has been raised to such a high profile, investors are “mindful” that they can and do change. The removal of an issuer from an investor’s approved list – which typically contains just five or six preferred providers – may still mean it is reluctant to add it back onto the list if and when ratings improve.

In a diminishing pool of providers, the security of diversification becomes increasingly difficult. If this is the case, treasurers must consider a wider range of potential issuers than in the past. For example, they may need to seek out non-US issuers in USD, and issuers from outside the Eurozone issuing in euro, from countries with perceived strength such as Canada, Australia, the Nordics, the UK and some of the stronger Asian countries. There may be more confidence now in the credibility of ratings agencies, notes Chiodi, but exposure of treasurers to a wider market generates an increased need for market intelligence and independent credit analysis, resources and skills which are not on-tap in most treasuries.

Indirect relief

There is some light at the end of the tunnel. Some changes in money market fund supply are providing relief, albeit indirect, for some investors both in terms of supply and rates, comments Harbison. The ongoing roll out of the US Federal Reserve’s reverse repurchase facility is increasing eligible investments for US money market funds; money which is thus not buying up some of the other short-term supply. And by setting a floor on overnight rates it has had a knock-on impact on the rest of the short-term markets as there needs to be some premium over the ‘risk-free’ Treasury rate. Treasury Floating Rate Note issuance has seen prime money market funds become increasingly interested given the reduction in supply elsewhere and given that they are considered highly liquid. Reduction in the Fed’s asset purchase programme (so-called ‘tapering’) has also seen a gradual increase in the amount of repo collateral available, also indirectly opening up availability for investors.

Money market funds: finding the balance

In a rapidly changing market, there is an ever greater reliance on thorough credit research and market knowledge. Investors should consider the strengths of a money market fund in this context.

Credit analysis

“Credit analysis is a fundamental part of the money market fund solution,” says Harbison. Its value is clear where investors experience reservations regarding the strength of the rating agencies’ decisions about existing providers. But, he adds, it takes on a new level of importance with the introduction of new issuers to a portfolio. Whereas some treasurers may invest in government or treasury-type issuances to avoid all or most risk, others may see what looks like an attractive rate from an issuer with which they are not familiar but in reality could be exposing the business to more risk than they understand. “From a money market perspective, we have the capacity to offer thorough credit analysis and to find the right balance for the client, setting credit and maturity limits appropriate to that issuer,” says Harbison.

Diversification

In a market environment that has in recent times demonstrated a propensity for rapid change, if a treasurer were to lose just one or two approved issuers from a typical list of five or six it still represents a significant threat to short-term availability.

For Harbison, a fund manager’s capacity to analyse and offer an approved list of 100 or more issuers not only creates a broader potential supply than would be available to many (or indeed most) investors but also lessens the impact of a reduction in supply of certain issuers.

Liquidity

The Basel III liquidity requirements are pushing banks away from certain types of short-term funding. This may mean that investors face a choice between overnight deposits at unattractive rates or longer-term deposits with reduced access. “Another key strength of a money market fund is that it can offer daily access to investors, which is typically not the case for fixed term deposits or other similar products,” Harbison explains. For Chiodi that means investors comparing one- or seven-day direct investments with a money market fund that can have up to a 60-day weighted average maturity.

In a constantly changing short-term investment environment, where uncertainty prevails, money market funds can offer treasurers a level of independent credit analysis, portfolio diversification and liquidity that could strike a balance between yield and protection. That is an offer the alternative short-term solutions may find hard to match let alone beat.

For further information on our liquidity capabilities visit us at www.globalliquidity.hsbc.com