Navigating Negative Rates
by Ben Poole, Ben Poole Editorial Services
Low or negative yields are commonplace in Europe today, across a range of short-term investment instruments. A well-attended workshop on the first day of the 8th BNP Paribas Cash Management University in Paris examined the current market conditions and how corporates can position themselves to best navigate the new environment.
The panel included Séverine Le Blévennec, director EMEA treasury, Honeywell, Philippe Renaudin, manager, fixed income money markets team, BNP Paribas, and Patrick Barbe, CIO - euro sovereign and aggregated fixed income, also of BNP Paribas.
The environment for short-term investments is a challenging one for treasurers. Short-term interest rates on investments have been low or even negative for some time. BNP Paribas’ Renaudin commented that the European Central Bank (ECB) has a policy of combining low rates with injections of liquidity - monetary policy rates are at record lows, while measures such as the targeted longer-term refinancing operations (TLTFO) and quantitative easing (QE) have been implemented in an attempt to boost the effectiveness of monetary policy.
At the same time, opportunities to add value via credit allocation continue to reduce. There has been a tightening of short-term credit spreads ever since the ECB’s rate cuts of June/September 2014, with banks and a number of large corporates increasingly reluctant to issue short-term paper.
Renaudin said that euro liquidity is increasingly expensive, particularly on highly rated and liquid government instruments such as treasury bills (t-bills). He noted how t-bill levels even in Germany had dropped into negative rates in all three month, six month and 12 month maturity levels since this time last year.
The current low rate environment is certainly putting a squeeze on money market funds (MMFs), particularly in Europe. There have been a number of recent fund downgrades and a decreasing bank appetite for cash balances, while costs of MMF liquidity pockets are now extremely high. Even the safest of MMFs for yield have been falling towards negative yields.
Taking the treasury temperature
The bleak situation regarding the short-term investment landscape has spurred corporates into action, as a short survey of treasurers in the workshop highlighted. A large majority (77%) said that their company has modified or adapted its cash investment policy in the past 12 months. A follow-up question of whether companies were considering adapting their cash investment policy found 59% said yes due to market concerns, while a further 16% said yes due to the potential evolution of the regulatory framework.
The regulatory point was confirmed when 84% of treasurers in the audience said that they would either reduce investment in MMFs or stop this investment completely if constant net asset value (NAV) MMFs were to be converted to variable NAV MMFs. Interestingly this 84% were split right down the middle as to whether they would reduce or halt investment in MMFs.
With pressure on MMFs, BNP Paribas’ Barbe suggested that short-term euro bonds offered an opportunity for treasurers to gain a positive return while still being able to effectively manage risks. Barbe noted that the ECB’s forward guidance policy offers stability for fixed income investors, with measures such as quantitative easing, the announcement of no key rate hike before 2017, and the decoupling of shorter-term maturity euro bonds from global bonds. The non-financial one to three year corporate short-term euro bonds offer liquidity at a very low risk compared with US corporates, explained Barbe, as the Eurozone market offers comparable diversification and low risk while the ECB remains on hold.
Flexibility is key
One corporate participant outlined how the company had segmented its cash into three types, with different investment approaches in each case: short-term core domestic cash, short-term offshore cash, and long-term surplus cash.
With short-term core domestic cash, the low yield environment is a challenge, while the Rule 2a-7 MMF reforms have affected liquidity and added complexity to accounting processes. The solution for this company has been to move out of MMFs and into money market deposit accounts (MMDAs) with high credit quality institutions, while closely tracking counterparty credit risk and exposures. The benefits of making this switch have included the addition of high credit quality counterparty exposures, while simplifying reporting. The yield pick-up has been in the region of 15-20 bps. The potential downsides of MMDAs are that certain liquidity restrictions apply, while there can also be a concentration of counterparty exposure.
With short-term offshore cash, not only does the low yield environment persist, but trapped cash can also prove a headache for treasurers. One way of addressing this is to look for opportunities in higher-yielding currencies: for example, converting foreign currency to GBP or AUD, while also assessing any foreign exchange (FX) costs associated with holding currencies. Additionally, treasury continuously reviews global cash balances and actively manages holdings between operating accounts and short-term investment instruments. The company has also expanded its investment policy statement to include EMEA, Japan and the rest of Asia Pacific.