In the wake of the financial crisis, companies around the world are holding larger quantities of cash, the bulk of which is parked in bank deposits or money market funds. Managing that short-term liquidity could pose some challenges next year, though, as new regulations will result in changes to money market funds and new capital requirements limit banks’ interest in some corporate deposits.
A J.P. Morgan Asset Management survey conducted in June and July of this year shows that organizations around the world held an average of 47% of their cash in bank deposits, down from 50% in the previous year’s survey.
John Donohue, a principal at J.P. Morgan Asset Management, linked the decline in funds held at banks to banks’ efforts to discourage deposits of non-operating cash in order to meet Basel III capital requirements. “We’re seeing that across the board,” Donohue said. “That money is trying to find a new home.”
In fact, the survey showed that among companies that said they plan to decrease the amount they hold in bank deposits next year, 47% said their banks had encouraged them to remove non-operating cash.
While banks may be becoming less hospitable to corporate cash, the survey suggests nervousness about the changes to money funds may be fading among organizations that invest short-term.
In October 2016, Securities and Exchange Commission (SEC) regulations will take effect that require institutional prime and municipal money market funds to switch to a floating net asset value (NAV) from the current stable NAV of $1 a share. Those types of money funds also will be subject to liquidity fees and gates.
Previous surveys had suggested many U.S. corporates would avoid funds with floating NAVs. But among the U.S. respondents to the J.P. Morgan survey, 70% of those currently invested in a prime fund said they would continue to invest in the fund after the SEC’s new regulations take effect in October 2016.
Donohue, pictured at left, said that finding was a bit of a surprise.
“One of the things this number is representing: People are getting more comfortable with the changes that are coming and have a better understanding of what they actually mean,” he said. “It’s not going to be this complete disruption so many people were worried about one or two or three years ago, when they first heard about floating NAV and fees and gates.”
Even after the changes, money funds will be “a very low, low volatility product,” he said. “The product isn’t changing, just the way you account for the NAV is changing.” Donohue said the shift in sentiment also reflects short-term investors’ realization that prime funds will offer a yield pickup versus government funds.
For corporate short-term investors, one key challenge was that of accounting for funds with a floating NAV. Donohue noted that regulators had provided companies with some assistance on dealing with the accounting and tax implications: “Even though it will be a floating NAV, you will be able to categorize it as a cash or cash-equivalent and it won’t have the normal tax-loss treatment a floating NAV will have.”
Shifting from Prime Funds to Government Funds
The regulatory changes have encouraged some investment companies to convert money prime funds into government funds, in anticipation of a similar shift by investors. Among the investment companies that have announced such conversions are Fidelity Investments, Dreyfus, Oppenheimer, RBC, and T. Rowe Price.
Greg Fayvilevich, a director at Fitch Ratings, said many of the asset managers that are exiting prime funds are smaller players that might have a hard time coming up with the resources to meet the new requirements for prime funds. “There are many operational challenges for the fund managers to comply with the requirements for the floating NAV, as well as the fees and gates proposal,” he said.
Donohue noted that some of the large funds that are being converted from prime to government were funds for retail investors, like the funds at Fidelity. “Retail money funds are going to be able to remain a constant-NAV product, but they will be subject to gates and fees—and because of that, and just the infrastructure cost and technology cost of doing that on a retail fund, many decided to convert retail prime funds into govvie funds,” he said.
Donohue sees no impact on the availability of institutional prime funds. “The big players in the institutional space will all have a prime institutional offering with floating NAV and gates and fees,” he said.
Fitch estimates that asset managers so far have announced the conversions of prime funds containing $257 billion worth of assets, or 16% of the total $1.6 trillion invested in prime funds at the end of September. “Certainly not all funds are converting,” Fayvilevich said.
Looking at Alternatives to Prime Money Funds
One response to the regulatory changes is growing interest in alternative investments. For example, 20% of the Americas respondents to the J.P. Morgan survey said they intend to increase their allocation to separately managed accounts next year.
“There are going to be a lot of products that are available for corporate treasurers, once you get comfortable with the fact that you don’t need to be in a stable-NAV money market fund with all your liquidity,” Donohue said. “There are going to be opportunities to step out of the money fund space to earn a higher yield.”
But to take advantage of those opportunities, treasurers need to segment their cash, he said, so they understand what portion they need to have readily available and what portion can be invested with a slightly longer time frame.
Fayvilevich, pictured at left, said the use of alternatives such as separately managed accounts, short-term bond funds, and private money funds puts more of a burden on treasurers.
“In general, reform is going to force corporate treasurers to spend a significant amount of time on reviewing their options,” he said. “The issue is that the options that they have are quite varied, and they have to really evaluate some of them carefully.
“For a corporate treasurer, a money fund is somewhat of a commoditized product,” he said, noting the SEC’s strict guidelines for such funds. “If you decide you’re going to look at a short-term bond fund or private money fund, there are no specific guidelines as to what it can do, so a treasury has to very carefully evaluate those products.” Fayvilevich added that alternative products bearing the same name can differ significantly.
He also suggested that for companies which invest in money funds that are subject to fees and gates, the funds’ liquidity levels will become very important.
If a fund’s weekly liquid assets approach the 30% level at which the fund’s board could impose a redemption fee or a gate that restricts redemptions, “some investors may preemptively take their money out,” Fayvilevich said.
“I think once the rules come into effect, investors will need to watch that number very carefully,” he said, and predicted prime funds’ weekly liquidity will become a factor that investors consider along with yield and rating as they decide where to invest their short-term cash.
Fayvilevich expects many investors initially will shift to government funds. “But then as investors see some of these other options—private funds, separately managed accounts—and depending on the spread differentials between those products and government money funds, investors may shift assets back to prime funds or other alternatives.”