Two years ago, the Securities and Exchange Commission (SEC) was still deliberating on new rules for prime money market funds, and Basel III banking reforms were only in the early stages of implementation. Since then, major banks have started limiting corporate cash deposits in response to new liquidity coverage ratios, and prime funds are substantially changing their risk profiles with floating net asset values (NAVs), liquidity fees and redemption gates that go into effect this October.
Add to the mix the Federal Reserve’s December rate hike after nine years of zero interest rates, and you have an entirely new cash management landscape.
Wanted: Alternatives to bank deposits and prime funds
Treasury professionals are confronting challenges on several fronts. Reforms to strengthen banks’ balance sheet liquidity have made deposits more expensive, leading large banks to reduce their proportion of uninsured deposits of corporate cash. At the same time, the SEC-mandated changes to prime funds have reduced their potential utility for liquidity and yield.
Those two developments alone have already prompted major reallocations of cash. In response to the Basel III liquidity coverage ratio (LCR) requirement, JPMorgan Chase & Co. has reduced clients’ non-operating deposits by well over the $100 billion initially planned. Other big banks chose to discourage institutional deposits by charging fees on deposits. With Fidelity’s decision to convert its $116 billion Cash Reserves prime fund into a government fund, and with other money market funds following suit, as of May 2016 approximately $290 billion of industry prime fund assets were slated to convert into government funds.
In all, Capital Advisors Group estimates that more than $1 trillion in corporate cash held in bank deposits and money funds in 2015 may migrate into new or different accounts by the end of 2016. We estimate that $450 billion of the $3.7 trillion* held in overnight deposits at the top six global systemically important banks might move into safe but low-yield government securities and other vehicles, and as much as $615 billion of the $1.7 trillion in corporate cash held in institutional money funds may move into low-yield government funds and other daily liquidity vehicles.
An obvious interim destination for cash migrating from deposits and prime funds is to government-only money market funds, which will not be subject to floating NAVs, liquidity fees, or redemption gates. However, a large influx of cash into this safe haven may depress yields. Therefore, many corporate and institutional cash managers are considering supplemental alternatives, including direct purchases of short-term commercial paper and establishment of separately managed accounts (SMAs).
Direct investments mitigate shared liquidity risks
Another important component of money fund reform is the separation of institutional shareholders from retail investors in prime funds, leading to higher shareholder risk and higher vulnerability to the risk of runs in the institutional space. Alternative pooled investments such as ultra-short bond funds, private liquidity funds and exchange traded funds present similar shared liquidity risk. Direct investments can help mitigate these risks.
A turn back to the direct purchase of fixed-income securities is a back-to-the-future moment for those with a long history in the industry. Before prime funds became the go-to repository of corporate cash in the 1990s, direct management of cash investment portfolios was a normal practice. But a generation of cash managers has come and gone since then, so many are venturing into unfamiliar territory as they assess a new mix of cash instruments in the search for liquidity and safety of principal.
But treasury professionals have already started to position themselves for dramatic changes in the way they manage their short-term cash. In the upcoming 2016 AFP Liquidity Survey, 16 percent of treasurers reported that they are planning to add separately managed accounts in response to the SEC’s money fund reforms.
Many companies may have to change their written investment policies to accommodate more alternatives to deposits and money market funds. And, because direct purchases require hands-on investment, risk and credit monitoring, many are upgrading their research and risk management capabilities as well.
New opportunities in a new era
With this new, evolving cash management landscape, the stakes have never been higher for corporate treasury professionals, who are confronting more dramatic changes in corporate cash management and liquidity than they have in years. The good news is that with the right preparations, including a renewed focus on credit and risk management and consideration of various investment alternatives, they will have the tools they need to succeed in the new era.
Ben Campbell is founder and CEO of Capital Advisors Group, a 25-year-old registered investment advisor specializing corporate cash management investment strategies.
By Benjamin Campbell