Not all cash is equal. To align the company’s cash with its liquidity requirements, corporate treasurers typically divide their cash into different tranches and manage it according to the risk/return profile needed for each tranche.
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| Jennifer Gillespie, head of money markets at Legal & General Investment Management |
Bank deposits and MMFs can offer same-day liquidity, but there are some differences. A MMF is a type of mutual fund which invests in low-risk securities. The funds used by corporations tend to be AAA-rated short-term MMFs as defined by the European Securities and Markets Authority, which have a maximum weighted average maturity of 60 days.
MMFs sit alongside bank deposits as a vehicle for short-term corporate cash. However, in the current market, there are a number of forces at work which could alter this balance.
On the one hand, there is the possibility that counterparty risk considerations could prompt companies to make a substantial shift from bank deposits to MMFs – but on the other, regulatory concerns could have the opposite impact.
Where risk is concerned, there is an argument that the introduction of the deposit tax in Cyprus last month could make MMFs look more attractive to companies which rely on bank deposits for their short-term cash.
If deposits in Cyprus over the level of the deposit guarantee can be subject to a substantial haircut, the argument goes, this could happen in other jurisdictions as well.
As the Institute of International Finance warns: “Instead of mutualization of bank liability in case of need, [the Eurogroup’s crisis-resolution plan] has become about bailing in bank creditors and depositors. Such concerns could exacerbate the current outflow of deposits from troubled countries, adding to bank funding strains.”
Unlike bank deposits, MMFs are a diversified investment. Even if a fund had an exposure to a Cypriot bank which led to a loss as a result of the deposit tax, the diversification would mean that any losses that arose would be a relatively small part of the total value of the fund.
In any case, the credit analysts employed by MMF managers would most likely have ensured that the fund did not have exposures to Cyprus banks.
These considerations might prompt corporate treasurers in countries such as Spain and Italy to consider moving cash from bank deposits to MMFs in case a deposit tax is imposed at some point, treasurers say.
However, other factors are also set to impact the way in which companies invest short-term cash – most notably regulatory considerations.
Regulatory risks
MMFs in the UK are usually run on a constant net asset value (CNAV) basis, whereby the share price is maintained at £1, €1 or $1, while the fund pays interest.
While this model is well established, regulators in Europe and the US have been focusing their attention on enforcing a variable NAV (VNAV) model, whereby the share price can fluctuate.
Regulators argue that a VNAV model is less likely to result in a run on MMFs – although this is disputed by the London-based Institutional Money Market Funds Association (IMMFA).
In its response to proposals by the European Systemic Risk Board (ESRB) to move to a VNAV model, IMMFA says it “fundamentally disagrees” with the assessment that CNAV funds are more vulnerable to runs, and that this conclusion represents a “flawed appreciation of the ways in which MMFs operate”.
Nevertheless, the move to a VNAV model appears to be edging closer. The ESRB proposals are the latest manifestation of this drive in Europe.
In the US the likelihood of a move to VNAV appeared to have diminished in August 2012 when Mary Schapiro, then chairman of the SEC, dropped a vote on the proposed reforms.
However, the Financial Stability Oversight Council has since picked up the baton and proposals are under consideration, including a move to VNAV, as well as other options such as introducing a capital buffer to absorb losses.
Regulators believe that reforms are needed to make MMFs more resilient. However, fund providers are concerned that investors are less likely to invest in VNAV funds – and their concern is not unfounded.
While VNAV funds are already used by some companies, others argue that the accounting treatment is more complex and that the funds are consequently less attractive.
“There are questions that treasurers need to start asking themselves,” says Jennifer Gillespie, head of money markets at Legal & General Investment Management. “For example, if the ESRB proposals are implemented, what impact will that have on current treasury policies? How will that change the way that companies use MMFs – and will they even continue to use them?”
Surveys have repeatedly shown that if a VNAV model were introduced, investors would be less likely to invest in MMFs. Research published by Treasury Strategies in February found that if CNAV funds were disallowed, 69% of those investing only in CNAV funds would reduce or discontinue using MMFs.
The survey also found that 72% of CNAV investors would use European bank deposits in their place. But although companies can and do use bank deposits to manage surplus short-term cash, many value the risk diversification offered by MMFs – and most do not have the resources and expertise needed to replicate this level of diversification themselves.
At the same time, many companies have in place counterparty limits reducing the amount that can be deposited with any particular bank, as well as restrictions on the banks with which the company is prepared to hold deposits.
If companies with substantial investments in MMFs decide to move their cash into bank deposits, they might struggle to do so without changing their investment limits.
For the time being companies continue to have access to bank deposits and MMFs for their short-term surplus cash – but this could change during the next few years.
Aside from regulatory considerations, low interest rates in Europe prompted the closure of several European MMFs last year. As one industry commentator observed, if investors are no longer willing or indeed able to invest in MMFs, the market might turn to product innovation to develop another vehicle offering the diversification that MMFs provide.
On the other hand, if more corporates turn to MMFs, banks’ financing costs will increase if they need to increase their interest rates to attract corporate deposits – at a time when regulators want banks to remain structurally dependent on sticky deposits rather than flighty wholesale funds.