Mutual fund trade association the Investment Company Institute recently argued that a "proposed [accounting] change eliminating 'cash equivalents' from financial reporting would misrepresent a company's liquidity position." The May 31 "ICI Letter on Proposal Eliminating "Cash Equivalents" from Financial Reporting," written by Director of Fund Accounting Gregory Smith to the Financial Accounting Standards Board's Nicholas Cappiello and the IFRS Foundation's Denise Gomez Soto, says, "The Investment Company Institute is writing to provide input regarding the July 2010 staff draft of an exposure draft of the International Accounting Standards Board and the Financial Accounting Standards Board for the Boards' joint project to develop a standard on financial statement presentation. A significant proposal in the Staff Draft is the elimination of the concept of "cash equivalents," which would result in the classification of shares of US registered money market funds as short-term investments."
ICI explains, "The Institute strongly objects to this result and believes that classifying shares of money market funds as short-term investments in a company's financial statements would misrepresent the purpose and use of this asset in a company's business. Further, we believe it is highly problematic to combine money market fund holdings with other instruments that may be included in short-term investments, i.e., any debt security maturing in 12 months or less, regardless of credit quality, as such instruments may present significantly greater risks than money market funds."
It continues, "The Institute believes that money market funds are, and will continue to be, an asset held by companies for the purposes of preserving principal and maintaining liquidity. Unlike a short-term investment, money market funds are well-suited to meeting a customer's cash management objectives of minimizing exposure to credit, liquidity, counterparty and market risks, and can be quickly converted to cash at a predictable value. We therefore urge the Boards to preserve the concept of cash equivalents and recommend that any final standard require that cash equivalents be presented as a separate line item on the balance sheet. A separate category for cash equivalents would address the Boards' concerns regarding the aggregation of cash and cash equivalents while avoiding the problems that we believe would result if cash equivalents are eliminated and aggregated with short-term investments."
ICI's comment continues, "In the United States, a money market fund is a type of mutual fund that has as its objective the generation of income and preservation of capital and liquidity through investments in short-term high quality securities. These funds also typically seek to maintain $1.00 net asset value per share. Money market funds, like all US mutual funds, are subject to a comprehensive regulatory scheme under the US federal securities laws that has worked extremely well for over 70 years. Their operations are subject to all four of the major US securities laws administered by the US Securities and Exchange Commission, including the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Advisers Act of 1940, and the Investment Company Act of 1940. We refer to these very specific US money market funds as 'money market funds.'
It adds, "In addition to the substantive requirements of the Investment Company Act, money market funds are subject to the strict requirements of Rule 2a-7 under the Investment Company Act. Rule 2a-7 includes several risk-limiting conditions intended to help a fund stabilize its share price at $1.00. These conditions limit risk in a money market fund's portfolio by governing the credit quality, liquidity, maturity, and diversification of a money market fund's investments. Early last year, Rule 2a-7 was amended to further strengthen investor protections through provisions such as explicit liquidity standards, stress testing, "know your investor" procedures, shorter portfolio maturities, improved credit quality, and more detailed and more frequent disclosure. The amendments have made money market funds even more consistent with the objectives of preserving principal and maintaining liquidity."
ICI continues, "The SEC has increased the transparency of money market funds by requiring them to provide updated portfolio information on their websites as of the end of each month. In addition, each month money market funds must file with the SEC new Form N-MFP, which contains detailed information about the fund and its portfolio, including the market value of each security held. The information provided in Form N-MFP becomes publicly available 60 days after the end of the month covered by the report. We also note that both industry and policymakers in the United States are continuing to consider money market funds and ways to bolster their resilience to severe market stress so as to assure their continued ability to serve investor and market interests.
The letter adds, "We believe that the proposal to eliminate the concept of cash equivalents, with the result that money market funds will instead be included in short-term investments, raises serious concerns regarding the presentation of a company's assets in its statement of financial position. As described above, retail and institutional investors alike rely on money market funds as a low-cost, efficient cash management tool that provides a high degree of liquidity, stability in principal value, and a market based yield. The reforms to date have only served to improve and strengthen the liquidity and stability of money market funds."
It also says, "In the Staff Draft, the Boards' propose to eliminate the concept of cash equivalents on the rationale that 'cash equivalents do not possess the same characteristics as cash and have different risks from cash.' The Boards believe that "presenting cash equivalents separate from cash avoids grouping dissimilar assets in the same line item ... [and that such a] presentation better reflects liquidity in the statement of financial position." We believe the proposal, however, appears to result in the same problem that the Boards are seeking to prevent, i.e., grouping dissimilar assets. If cash equivalents are eliminated, assets in money market funds will be grouped with a range of assets in short-term investments, including investments with markedly different risks, characteristics and regulatory requirements from a money market fund. We do not believe the proposal in the Exposure Draft solves the Boards' stated problem; rather, it only puts the perceived problem in a different place. We also do not believe grouping cash equivalents with short-term investments "better reflects liquidity." In fact, we believe this would obscure liquidity."
ICI's Smith explains, "The Boards have also acknowledged the difficulties and tensions posed by the elimination of the concept of cash equivalents. For example in a 2008 discussion paper, it was recognized that the elimination of "cash equivalents" would significantly increase the volume of cash receipts and payments presented in most entities' statements of cash flows. To address the issue and consequently to prevent purchases and sales of cash equivalents from giving rise to cash payments and receipts within the cash flow statement, the paper included a recommendation to continue to allow the net presentation of cash and cash equivalent flows for receipts and payments for items under circumstances in which the turnover is quick, the amounts are large, and the maturities are short. While we appreciate the rationale for this approach, it results in a differing treatment of "cash equivalents" between the balance sheet and the cash flow statement, with the former presenting money market funds as short-term assets held for investment purposes and the latter as cash-like instruments. Again, we do not think this is an optimal result, nor does it improve financial statement presentation."
It adds, "Lastly, given the long-standing view of cash and cash equivalents as closely related assets, we urge the Boards to weigh the possible unintended consequences of eliminating the concept of cash equivalents. We believe that having the accounting standards abandon cash equivalents will place financial statement standards out of step with the market and the users of financial statements. Aligning cash equivalents and short-term investments in the balance sheet (but not in the statement of cash flows) could result in confusion as it will depart from the market and operational realities of how cash equivalents are used and viewed by a variety of market participants. For example, many entities have guidelines for their corporate treasurers relating to holdings of cash and cash equivalents (and in some cases, only certain cash equivalents, such as AAA rated money market funds or government-only money market funds)."
Finally, ICI concludes, "For the reasons described above, we therefore recommend that the standards recognize a separate category of "cash equivalents" on the balance sheet, rather than wholly eliminating it. We believe that such instruments are quite different from short-term investments and that cash equivalents should not be aggregated into the category of short-term investments. As a result, we strongly urge the Boards to have a category for cash equivalents. We believe that having a cash equivalents category, rather than eliminating the concept, will more accurately present a firm's assets as well as its liquidity."
