By Kevin Ehinger, VP Market Operations at C2FO
As a former corporate treasurer who works with global corporate treasurers every day, I pay attention to the treasury issues that keep these executives up at night. Recent rules changes from the U.S. Security and Exchange Commission (SEC) are among those concerns.
On October 14, 2016, new rules took effect that require institutional prime money market funds to forego their fixed $1 share price and instead take on a floating net asset value (NAV). The rules also set forth short-term liquidity restriction options for any non-U.S. Government money market funds, including the ability to block investors from withdrawing cash or charging fees to investors for redeeming shares during periods of economic stress.
Over the summer, The Wall Street Journal article, “New Money-Fund Rules Test Need for Liquidity Versus Yield,” described a worst-case scenario: corporate finance executives pulling hundreds of billions of dollars out of prime money market funds in response to the rule change, potentially disrupting short-term lending markets.
In contrast, the results of the Association of Financial Professionals (AFP) Annual Liquidity Survey indicated their member corporates were unlikely to move that much money out of prime money market funds. In their view, “Industry estimates range from $200-$800 billion will move from prime to government funds, but our data shows that segment will not be from cash invested in cash equivalents and short-term investments from companies. It will be from other institutional investors and which have different risk tolerances for the most part.”
The problem with the change to a floating NAV is that it introduces principal risk. With the new regulation, money market funds become less appealing for corporate treasurers because they are now subject to market fluctuations that could change the price and wipe out earned interest through a temporary reduction in NAV.
Treasurers are inherently risk-averse – yield isn’t worth anything if you take on more risk than you are being paid to. When I was a corporate treasurer, I had a very clear investment policy in terms of when, where and how I could take principal risk. A low-yield prime money market fund is not worth taking principal risk. It’s certainly not worth the incremental 5-10bps yield compared to government funds that are exempt from the new rules.
With all the talk of a mass exodus of investments from money funds and into other alternatives, it’s likely that most companies will ultimately diversify between bank deposits, government funds, and high-grade corporate and government bonds.
Companies have already been changing their investment policies regarding what is considered a short-term liquid investment. At one time, a week was considered short term. Now, many companies have multiple tranches of investments that might be invested up to a couple of years. For example, three tranches might be operational cash (used for everyday expenses), short-term cash (allocated for forecasted needs within one year) and excess cash (no forecasted need within a year). Corporates may choose to invest that third tranche cash for a longer duration at higher risk in pursuit of increased yield.
When you’re looking at the balance between safety, liquidity and yield, other economic factors in play are more significant for corporates than this prime market fund rules change. With central banks in Europe and parts of Asia moving to negative yields on cash deposits, even the most conservative treasurers should be seeking alternatives to paying for depositing their short-term cash.
Of course, overnight yields in markets such as India, China and Brazil can still be quite high, comparatively, but that is due to local economic volatility and inflation. On a risk-adjusted basis, performance in these markets can be unattractive.
If a company doesn’t want to take principal risk, C2FO is an option that allows them to earn a materially larger yield than alternative investments. If your company doesn’t have cash limitations, it makes sense to steer as much volume as you can away from low-earning and negative-earning investments. Even if your company is less than flush with cash, the yield opportunity is enough that arbitrage can make sense.
With C2FO, companies set aside cash to pay approved supplier invoices early at discounted rates. It’s a proven way to generate higher incremental returns on cash without adding risk.
C2FO solves a number of problems with no downside: corporates can avoid negative yields, put trapped cash to work in markets where they have suppliers needing cash flow and improve the health of their supply chain at the same time.
As treasurers continue to evolve their investment policies during ongoing economic uncertainty, we expect more and more of them to find that C2FO is an attractive alternative to more traditional investments.