One of the key takeaways from State Street Global Advisors' new white paper, "2015 Global Cash Outlook: The New World of Cash," is that the era of "one fund fits all" is over. Low interest rates and sweeping money market reforms have transformed how investors should approach cash management, they say. The paper offers a "guide to the new world of cash," explaining the changes and why it's important to segment cash into different buckets. The 6-page report begins, "Between regulatory overhauls and unprecedented market conditions, cash investing has changed more in the past five years than in the previous 40, and it is likely to continue shifting for the balance of this decade."
It explains, "The financial crisis which peaked in 2008 has ushered in regulations that have upended the way money market funds and the issuers of short-term securities operate. Occurring against a backdrop of record-low yields -- itself an outgrowth of the crisis -- these developments have forced investors to reassess the role of cash investments and the structures used to hold them. Where once institutional cash was practically synonymous with the prime money market fund, it has now become much more complicated for institutions to capture the three primary cash goals -- safety of principal, liquidity and attractive yield -- using a single type of account."
SSgA explains, "But these challenges are also creating opportunities. For example, regulations that impose constraints on money market funds may drive investors to hold more government paper. This increased demand will keep Treasury rates fairly well bid, but it may also boost rates on non-government securities, offering a potentially favorable reward for investors.... If there is a common theme to our 2015 cash outlook, it's this: Compared to the old world of cash, the new world of cash requires an articulated set of tools to meet one's objectives."
The paper discusses the impact of several upcoming changes to the market. The first is the SEC's floating NAV requirement for institutional prime money funds. "Prime money market funds may be used less by institutional investors needing absolute stability of capital. Markets may in turn see a commensurate increase in demand for vehicles that provide stability, such as government money funds and direct bank deposits."
It also looks at the impact of the Basel III banking regulations on MMFs. "Among other changes, Basel III (and subsequent Federal Reserve) LCR rules require banks to hold enough capital in high-quality liquid securities to fund 100 percent of their projected outflows over the next 30 days.... These regulations make institutional deposits more costly for banks to hold. To offset the cost, some have begun charging fees to a range of institutional depositors on accounts that were previously free. Banks are also encouraging these depositors to seek alternative places to put their cash."
SSgA's piece continues, "The rules penalize banks for issuing debt that comes due in 30 days or less, which will lead to lower supply of short-maturity bank debt at the same time the 2a-7 regulations are requiring money market funds to hold a higher percentage of short-term debt. Simultaneously, Basel III increases banks' own demand for high-quality assets, decreases the incentive for banks to hold institutional deposits, and likely makes it harder for banks to find repo agreements to meet their short-term funding needs -- all further adding to the demand pressures on the short-end of the Treasury curve."
On the impact of the fees and gates requirement, they say, "The SEC gave money market fund providers two new tools to prevent runs on institutional prime and tax-exempt money funds -- but not government funds -- during times of market stress: liquidity fees and redemption gates. In the event that weekly liquid assets fall below 30 percent of the fund's assets, money fund boards may now impose redemption fees of up to 2 percent or prohibit withdrawals altogether.... Investors may be unable to make "on demand" withdrawals during times of crisis in the short-term markets. As a result many may stop using prime and tax-exempt funds to hold assets that require immediate liquidity, and will likely shift assets into government money funds, prompting lower yields on government debt."
SSgA adds, "These regulatory reforms all add up to the same conclusion: more demand for government securities, less supply of high-quality substitutes at the short end of the curve, and lots of pressures weighing down Treasury yields. Meanwhile, if assets flow into government funds and out of institutional prime funds -- where floating NAV requirements begin in 2016 -- credit spreads on money market investments could widen substantially.... One effect of the new regulations is that money market funds could -- at last -- generate a meaningful spread above government bonds."
So how will these factors play out in 2015 and beyond? They write, "[W]ith Basel III's new LCR requirements, and related fees for institutional depositors, institutions now have an impetus to start moving their cash. Once Treasury rates inch up, that incentive will grow. Many will choose to shift into government securities because of regulations that increase demand for highly liquid, risk-free assets. This likely will create a feedback loop that mutes the effect of Fed rate hikes and helps keep Treasury yields from rising more than they might have. Meanwhile, prime money market funds may temporarily become less attractive because of the complexity of a floating NAV. This should serve to widen the spread gap between government funds and other money market structures, including commercial paper, time deposits, and short-term notes. And this spread widening should create opportunities for investors to pick up yield in non-government-only funds."
These factors all point to the need for a segmented cash strategy. "Since its birth in 1971, the money market fund has served as a catch-all solution for cash investors, providing an attractive balance of stability, liquidity and yield. Since one fund can no longer serve all of those goals effectively, it is time for investors to become more intentional in their cash management decisions. With new market technicals and new limitations on traditional cash vehicles, investors have to rethink how they are managing cash, and for what purpose.... By dividing, or "bucketing," their cash into three purposes, clients can uncover insights into the most effective ways to invest their assets."
SSgA concludes, "Bucketing is an important step to managing risk and liquidity. Without it, cash management could operate from the flawed perspective that "all cash is operating cash." The three fundamental objectives in cash management still hold: security of principal, liquidity and yield. But corporate treasurers may want to focus more on liquidity for operating cash buckets. Or, for strategic cash, they may be more concerned with attractive yields, and be willing to take on additional counterparty or maturity risk. After examining and assessing their own cash goals and purposes, institutional investors can better gauge their risk tolerance, and decide to what extent they are able to remain in prime funds once floating NAV is implemented. Where they want to maintain a precise focus on stability and liquidity, they may opt for vehicles now more suited to meeting those needs, such as bank deposits and government money funds. Elsewhere, they may choose to stay in a prime fund, or, depending on their circumstances, pivot to pursue even higher yield."
Finally, they add, "For all it has changed, the cash investing landscape will be even more transformed in 18–24 months.... Those who understand the implications of the new world of cash will be in the best position to meet its challenges, capture its opportunities, and achieve the full range of their operational and long-term strategic goals."
