The U.K.-based Treasury Today magazine profiles BlackRock's Bea Rodriguez, Managing Director, Co-Head of International Cash Management and Chief Investment Officer for the Sterling and Euro Cash team, who discusses the challenges facing European money markets. It begins, "With negative rates, increasingly scarce liquidity in the money markets and regulatory upheaval in both Europe and the US, these are very challenging times for the corporate investor." Rodriguez explains "How the liquidity management environment for corporates is changing, and outlines some of the alternative investment opportunities now being explored as a consequence." Also, below, we highlight a new white paper by BofA Global Capital Management called "Adding A-2/P-2 Commercial Paper to Separate Accounts."
In describing the liquidity management environment for corporates, Rodriguez says, "'Challenging' is the word most of our clients are using to describe it. In any other historical period, a negative money market environment would probably have led to the vanishing or the 'gumming up' of that market completely. What negative rates tend to do is take out liquidity in an extreme way and collapse flow. What's different this time around is that we are undergoing enormous change in regulatory architecture with Basel III which is dislocating money from banks and setting money in motion. It is this new dynamic which also means that negative rates may not only be a feature of currencies with negative deposit rates and we are still discovering the new steady state for money markets in general."
When asked what the best strategy is for corporate investors with respect to yield she responds, "Our advice to treasurers is to be very wary of stretching for yield because we think that the risk is asymmetric. Even with the ongoing support of the European Central Bank (ECB) there are many scenarios out there that could throw the market; we have seen a number of such incidents over the past year. Moreover, the volatility attached to these events may be much higher now than it has been in the past. I think conditions will get more challenging from here, not less. Therefore, from a high level perspective, investors need to understand that from here the upside to investing is much harder to achieve than the downside."
Rodriguez continues, "The yield environment has spurred some interest in other types of investment products: separately managed accounts being one example. Interest in these products is not driven purely by the desire to offset negative yield though; for many, capital preservation is still the core of that strategy. Overall, corporates are realising they need to become far better and more targeted at segmenting their cash and finding ways to make it work that little bit harder. Unfortunately, the reality of the environment we are in today is that even if you are doing that, in euros you will probably still end up with a negative yield. It is a really difficult hurdle to get over."
On the regulatory environment and the proposed low volatility (LVNAV) funds Rodriguez says, "On the face of it, we think the proposed LVNAV will be more palatable for our corporate clients, it being much closer to the constant NAV (CNAV) funds many of them use today. Conceptually, it could deliver some of the key CNAV features that investors cherish such as same day liquidity, intraday liquidity and a stable net asset value. We remain somewhat sceptical, however, with respect to the detail of the regulation. How that is mapped out over the coming months will be crucial. At the moment, the proposal has a sunset clause in it, which we do not see as being particularly helpful. The technical and the operational build around creating a product that has the ability to switch to VNAV on a day's notice is actually really complicated. It is expensive to create."
She explains, "But if the sunset clause is not there, then where the trigger threshold is set will be the main determinant for the success of LVNAV. If that ends up at a reasonable place -- and the industry is comfortable with Parliament's proposed 20bps threshold -- then this could be a really workable solution, one which will deliver some of the key features that our corporate investors like. Realistically, from an investment side, the tightness of the trigger threshold will obviously de-risk the proposition, because from a fund manager's perspective there is no incentive to want to be hitting those thresholds, at any point, and the best way to avoid doing so is to de-risk the fund. That is effectively what will happen if the regulators impose a trigger materially south of 20bps."
On how the investment market will develop for the corporate treasurers, she adds, "One trend that we are already seeing a lot of in the post-Basel III environment is an increase in structured paper being offered. We are seeing more structured repo; more term repo; and we are seeing a lot more structured CP being offered. That's existed in the past, of course, but there is more of it being issued."
The BofA paper, "Adding A-2/P-2 Commercial Paper to Separate Accounts", by Robert Piepenburg, Director of Credit Research, and Susan Chevalier, Director and Senior Client Relationship Manager, explores the benefits of looking at A-2/P-2 securities in certain portfolios. It says, "With their strong focus on principal protection, many cash investors limit themselves to securities with gold-plated credit ratings on the assumption that investing in only the highest-rated issues will reduce portfolio risk and thus help insulate their portfolios from market volatility. While it is true that restricting one's investment universe to the highest-quality names typically reduces credit risk, it also makes it more difficult to achieve attractive yields, particularly when interest rates are near historic lows."
It explains, "Fortunately, protecting principal and pursuing attractive risk-adjusted yields are not incompatible. Investors with separately managed accounts -- managed portfolios customized to the needs of each investor -- may be able to achieve both objectives by tapping securities rated A-2/P-2 by Standard & Poor's and Moody's Investors Service, respectively. Rated just one notch lower than short-term securities with top-tier credit ratings (A-1/P-1), credits from the second credit tier may deliver 33 to 46 basis points more yield than A-1/P-1 issues with the same maturities, according to the Federal Reserve. That incremental yield comes at the cost of marginally higher credit risk, but by enhancing portfolio diversification, the addition of A-2/P-2 credits actually may decrease overall portfolio risk, potentially reducing portfolio volatility."
The paper continues, "Including A-2/P-2 paper in a separate-account portfolio presents investment managers with opportunities to enhance yield. Broadening a portfolio's investment universe also gives a manager greater flexibility to invest the account's assets during periods when supply of top-tier paper becomes tight, as during a flight to quality brought on by a financial or geopolitical crisis. To capture these opportunities without adding undue risk, the manager must incorporate A-2/P-2 issues in a strategic way. A strong focus on diversification is central to this task."
It continues, "Of course, investing in securities with slightly lower credit ratings does mean accepting modestly higher credit risk. However, separate-account managers can mitigate that additional risk through thorough credit research and duration positioning. Rigorous credit analysis is central to the effective integration of A-2/P-2 paper into cash portfolios because it can provide a clearer view of a security's credit risk than a credit rating alone. Indeed, while credit ratings provide a useful starting point for investors, they do not substitute for in-depth credit research."
The BofA Global piece concludes, "The investment policies that define allowable securities in organizations' cash portfolios traditionally have excluded A-2/P-2 debt due to concerns about credit risk. However, companies may want to amend their investment policies to allow the inclusion of A-2/P-2 paper with maturities of 120 days or less, because it may offer meaningful yield enhancement without substantially increasing portfolio risk. Assuming sound portfolio construction, the inclusion of specific second-tier issues may help managers capture greater yield in today's challenging interest-rate environment, while maintaining risk levels that are appropriate for investors whose top priority is capital preservation."
