A Measured Response to Regulatory Change
by Christopher S. Martin, Global Head of Liquidity Product, HSBC Global Asset Management
Over the past few years, the financial media have been dominated by headlines forewarning significant changes to treasurers’ short-term investment practices as a result of regulatory change. Specific regulatory changes relating to particular instrument classes, such as money market funds (MMFs), and to providers, such as banks under Basel III, have fostered the implication that treasurers will simply have nowhere to invest their short-term liquidity in the future. In reality, while new regulations will undoubtedly have an impact on providers’ and investors’ policies and behaviour in the future, it is important to avoid too myopic (or sensationalist) a view.
Taking a long-term view
Many of the recent headlines have been around the US Securities and Exchange Commission (SEC) announcement in August 2014 for new rules for 2-a7 money market funds. However, the ruling announced by the SEC relates purely to MMFs that are domiciled in the US, not to international or ‘offshore’ MMFs in USD or other currencies, including in Europe. There are a number of key parts to the new rules that the SEC has adopted. For example, all Prime Institutional and Municipal MMFs have a mandatory conversion to a floating Net Asset Value (NAV), and are required to have the ability to apply a liquidity fee and redemption gate in times of stress. However, government and Treasury MMFs are not required to convert to a floating NAV, can continue to seek to maintain a constant NAV and use amortised cost accounting, and are not required to have the ability to apply a liquidity fee or redemption gate.
In addition, a transition period of two years has been announced to allow 2a-7 MMF providers, suppliers and investors to prepare themselves for these new regulations. As there does not appear to be an early mover advantage for asset managers or their clients migrating to new funds before the 2016 deadline, treasurers should have sufficient time to engage with their fund providers and review the implications of the new regulations, and to make any necessary changes to their investment choices, investment and accounting policies, and to make any modifications to their treasury systems.
The SEC ruling is the first of two MMF-related regulatory announcements expected, with the second one being proposed by the European Commission in respect of the regulation of European domiciled MMFs. And, as with the US regulations, once the proposals are accepted, there will still be a transition period for both providers and investors.
A more immediate change
More immediate than specific MMF regulations is the introduction of new regulations under Basel III. While these regulations target the banking community, it has far-reaching and immediate implications for corporate and financial institution clients, as these investors are significant users of bank deposits, and also typically view bank deposits and MMFs as ready alternatives. Treasurers therefore need to be taking action now to understand the implications, and adapt their investment policies accordingly, as follows:
1) Explore the LCR effect
With the introduction of the liquidity coverage ratio (LCR) in particular, which will start to be enforced in 2015, banks need to have sufficient high quality liquidity assets to survive a significant stress scenario of 30 days. This requirement is changing banks’ borrowing behaviour significantly, with certain types of corporate and financial institution deposits being less attractive than in the past; for example, operational deposits will potentially carry more value to banks than non-operational (e.g., actively placed deposits), and certain deposits from financial institutions (including bank and non-bank FIs) will potentially carry less value than corporates. This may be reflected in pricing, but in some cases, due to the classification under the new regulations, banks may actually be unwilling to hold these short-term assets. With deposits representing a significant portion of corporate investors’ short-term cash, this development has considerable ramifications, so treasurers need to work closely with their banks to understand how their assets are held and classified, and how the pricing and appetite for their cash will change, if at all.
2) Continue to enhance segmenting corporate cash
Cash flow forecasting has been a priority for a number of years, particularly since the constrained market liquidity conditions that characterised the global financial crisis. Today, treasurers need to continue to evolve their measures further, not only working towards more accurate and timely forecasting, but segmenting their liquidity holdings into operating cash (for working capital purposes) core cash (buffer against liquidity restrictions) and strategic cash (long-term cash for investment purposes). By doing so, companies can better determine the portion of cash for which same-day liquidity is required, and which can be held for a longer term, therefore increasing the choice of investment opportunities and potential overall yield. Asset managers can help manage longer-term portfolios that are separated from the shorter-horizon working capital or operating cash, and target potential ‘sweet spots’ in terms of the issuance of investment instruments as well as yield.