TREASURY INVESTMENT OPTIONS AND INVESTMENT RISK MANAGEMENT
This issue of the ICD Intelligencer will examine the strengths and weaknesses of the most popular treasury investment options; provide treasury practitioner survey results on portfolio allocations; explore best practices for trading and investment risk management; and review how technology, performance and reporting solutions have mitigated concerns regarding the 2016 U.S. Prime MMF regulations.
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NAVIGATING THE NEW TREASURY INVESTMENT ERA
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The solutions presented in this desk reference will help corporate treasury manage the new complexities brought about by Dodd-Frank, Basel III and MMF 2a-7 reform.
While bank deposits and Prime MMFs continue to be an integral part of corporate portfolios, regulations are forcing treasury practitioners to more actively manage those assets. Institutional Prime MMF investors should maintain diversified portfolios and use compliance, reporting and monitoring tools to avoid VNAV MMFs that tread too closely to liquidity minimums. Given this heightened liquidity scrutiny, and Institutional Prime MMF’s need to maintain their very viability, fund managers are extremely incentivized to stay above liquidity minimums where the possibility for fees and gates exist.
The nature of MMFs investing in high-quality short-term securities has resulted in nominal volatility as demonstrated by historical Market Net Asset Value MMF computations. However, even minute fluctuations can cause tax and financial reporting problems, which is why the IRS and Treasury’s proposed Simplified Tax Accounting rules for Variable NAV MMFs were so well received. This record-keeping relief eliminates the biggest MMF reform challenge as Institutional Prime MMF investors will not have to track individual purchase and redemption transactions.
The VNAV MMF settlement model is beginning to unfold with the majority of fund complexes leaning toward three intraday strikes at 9am, 12pm, and 3pm ET, enabling Prime MMF investors to receive settlement of cash throughout the day. Some fund companies are also adding an end-of-day strike at 5pm ET that would operate on a T+1 basis, which is useful for locking in the transaction and price to facilitate an early redemption settlement on the following day.
Integrated systems and automation become even more important with the complexities of intraday pricing and settlement. ICD worked with fund companies, transfer agents, clearing and custody banks, auditors, technology vendors and clients on streamlining VNAV MMF workflow to provide daily liquidity, seamless integration with treasury workstations and automated settlement solutions.
With Basel III penalizing banks for holding non-operational corporate deposits on their balance sheets and MMF Reform changing the supply and demand of various treasury investment alternatives, corporations are considering alternative investments. Ultimately, Bank Deposits, Institutional Prime MMFs and Government MMFs will still dominate corporate portfolios, with other investment alternatives getting increased attention.
Regardless of a corporation’s investment asset allocation, it is important to have a complete understanding of portfolio counterparties and to regularly evaluate the relative financial strength of those counterparties. The most efficient method for regularly analyzing counterparty exposures is through leading indicator metrics like stock prices, capital adequacy ratios and CDS spreads. Practitioners should immediately engage in additional due diligence if a portfolio counterparty has:
- insufficient capital adequacy,
- stock prices falling more precipitously than peer companies, and/or
- CDS prices widening at a much higher rate than peer companies.
There are opportunities to increase yield while maintaining, and in some cases, decreasing risk. Guided with a clear understanding of a company’s investment objectives and risk tolerance, treasury practitioners can analyze risk, liquidity and yield factors and construct their optimal portfolio. In most cases, those optimal portfolios will include Institutional Prime Money Market Funds.
BANKING ON BASEL III
The U.S. Basel III final rule was approved in July 2013 by three U.S. banking regulators: The Federal Reserve; The Office of the Comptroller of the Currency (OCC); and the Federal Deposit Insurance Corporation (FDIC). It is the most complete overhaul of U.S. bank capital standards in over two decades.
The U.S. Basel III final rule applies to the entire U.S. banking sector, from community banks to regional banks to the largest and most global U.S. banking organizations. The final rule also applies to U.S. bank subsidiaries and U.S. bank holding company subsidiaries of foreign banks.
This ICD Intelligencer provides a brief summary of the key and pertinent regulatory rules (the U.S. Basel III capital rule is more than 970 pages) that will impact corporate treasury practices, investment product selection and guide the technological implementation necessary to function in this new environment.
CLOSING ARGUMENTS: IN DEFENSE OF MMFs
Today, a battle of historic proportions is taking shape over the direction of the free market system and over the future of money market funds. It has become clear that a contentious Federal Reserve campaign is underway to intimidate SEC commissioners as the central bank pursues the imposition of a new financial landscape and banking regime for money market funds. Additionally, through the newly minted Financial Stability Oversight Council (FSOC), Fed Chairman Ben Bernanke, Secretary of the Treasury Timothy Geithner, and other government officials are using their semi-autonomous powers to exert intense pressure on the SEC and its commissioners to vote for transformative regulation – crippling regulation that was initiated, at least in part, by the Fed in the first place.
The looming condemnatory reforms – that include capital buffers, redemption holdbacks and a fluctuating NAV – are overwhelmingly regarded by industry experts, market economists, and academia as life-threatening to money market funds and potentially disastrous to the greater economy. Our industry is fighting back.