Last week, we excerpted from the Association for Financial Professionals' latest "2017 AFP Liquidity Survey Highlights and press release. (See our July 12 Link of the Day and our July 14 News, "AFP Liquidity Survey Shows Money Funds Up, Bank Deposits Inch Down.") Today, we quote more from the full report (which is available only to AFP Members). We discussed cash holdings and investment policies Friday, but the AFP also writes, "At nearly half (47 percent) of organizations, investment policies call out and/or separate cash holdings used for day-to-day liquidity from the rest of the company's cash and short-term investment holdings. This includes a policy stipulating the amount of cash holdings that are set aside for day-to-day liquidity versus other uses.... This is higher than the 41 percent of companies that had policies that call out/separate cash holdings last year."

The survey tells us, "Eighty-three percent of corporate practitioners report that their organizations' investment policies require money funds to be rated. The stipulations regarding ratings are fairly stringent: 36 percent of companies require that at least one rating agency assign a AAA rating and 27 percent mandate that money market funds earn AAA ratings from at least two agencies. Investment policies at larger organizations and publicly owned companies are more likely than those at other companies to require funds to be rated."

On cash investments, it explains (we quoted the first half of this Friday too), "The overall majority of organizations continues to allocate most of their short-term portfolio -- an average of 76 percent in 2017 -- in three safe and liquid investment vehicles: bank deposits, money market funds (MMFs) and Treasury securities. MMFs currently account for 21 percent of organizations' short-term investment portfolios, a larger share than the 17 percent reported in the 2016 survey. Organizations are investing 14 percent of their short-term investments in government/Treasury money market mutual funds, again a larger share than the nine percent and six percent reported in 2016 and 2015, respectively. The primary reason for this change in allocation is the recent money market reform that became effective in October 2016. As noted in the introduction, the massive outflows from prime funds were primarily into government funds. Larger organizations with at least $1 billion in annual revenue and those that are publicly owned continue to allocate more of their short-term investments to MMFs than do other companies."

The AFP comments, "Those organizations with cash and short-term investment holdings outside of the United States manage those cash and holdings similarly as how they manage their domestic balances: most of their cash is held in short-term investments maintained in banks, money market funds and government securities. Seventy-one percent of non-U.S. cash holdings are maintained in bank-type investments (including certificates of deposits, time deposits, etc.). Another eight percent of cash holdings are held in money market mutual funds and government securities."

They continue, "As noted above, banks are the dominant repositories for organizations' cash and short-term investment holdings. Finance professionals continue to seek the safest option for cash and investment holdings, a result of the prevailing uncertainty and volatility in the current business environment, and the lack of investment opportunities that generate yield. Finance professionals consider a number of factors when deciding where to place their organizations' cash and short-term investments. The top two determinants are perhaps self-evident: the overall relationship with a bank (cited by 92 percent of survey respondents) and the credit quality of the bank (69 percent). This is similar to the 90 percent and 67 percent reported for each of the factors in the 2016 survey report. Other important factors organizations consider when selecting a bank are: Compelling rates offered on deposits (cited by 44 percent of respondents); Simplicity of working with the bank (35 percent); and, Earnings credit rates (ECR) (34 percent)."

The survey says, "Organizations rely on various bank instruments for their cash and short-term investments which, as noted previously, currently account for more than half the typical organization's portfolio. The most commonly used bank products are time deposits; 54 percent of finance professionals report that their organizations use time deposits. That percentage is slightly lower than the 57 percent reported in 2016. Forty-three percent of respondents report using structured bank deposit products (e.g., money market demand accounts, or MMDA products), and that percentage is a significant increase from last year's figure of 23 percent. Non-interest-bearing deposit accounts are being used by 39 percent of organizations, a decrease from the 42 percent reported in 2016."

It tells us, "As long as the rank order of investment objectives remains (1) safety, (2) liquidity and (3) yield, corporate treasurers will continue to be indifferent to their bank exposure provided they value their bank relationships. It's interesting to note that the use of MMDA-type products increased the most since the 2016 survey was conducted, suggesting this is a key area where new players have positioned themselves in the marketplace with compelling products. The use of demand deposit accounts (DDAs) declined, most likely due to the lag time for interest rate increases to impact DDAs. Depending on how the earnings credit rate (ECR) is calculated by an organization's bank, there will likely be a delay before any benefit from interest rate increases is realized. Time deposits typically see the impact from interest rate increases sooner -- which is likely why the overall allocation to time deposits did not change that much from the previous survey."

AFP also writes, "Finance professionals report their organizations continue to place most of their short-term investment portfolios into instruments with very short maturities. On average, 69 percent of all short-term investment holdings are in vehicles with maturities of one month or less -- a result unchanged from the 2016 survey, but a three-percentage-point decrease from 2015. Another 15 percent of short-term investments are held in vehicles with maturities between 31 and 90 days. Larger organizations with annual revenue of at least $1 billion manage their cash in instruments with shorter maturity horizons than do smaller organizations with annual revenue less than $1 billion."

They state, "Banks support organizations in their cash and short-term investment strategies by providing them with information on economic indicators and trends, the direction of the bond market, yield-curve changes and credit ratings information. In the current business environment which is mired with uncertainty and volatility, finance professionals are more likely to seek this type of support from their banking partners. The survey results bear this out: the vast majority (87 percent) of finance professionals identifies banks as resources their organizations use to access cash and short-term investment holdings information. Other information resources include: Investment research from brokers/investment banks (cited by 43 percent of respondents); Credit rating agencies (31 percent); Money market portals (28 percent); and, Money market funds (25 percent)." The survey also said 43% utilized "Data feeds from other sources.

The 2017 Liquidity Survey continues, "AFP asked survey participants what would be the necessary spread between government funds and prime funds to incentivize organizations to stay invested or return to investing in prime funds. Forty percent of finance professionals indicate that regardless of the spread, their organizations would not invest in prime funds. This is a 10-percentage-point larger share than those who held this view last year when the question addressed intended actions. It also suggests that their decisions are final since the SEC changes have been implemented. One-third of respondents reports that their organizations would invest in prime funds if the spread were at least 50 basis points or more. An additional 18 percent would invest if the spread were at least 15 bps."

It tells us, "Finance professionals anticipate other changes in their organizations' investment policies as their companies plan for changes resulting from SEC money market fund reform. Nearly a third of respondents (31 percent) are considering separately managed accounts in response to the new regulations, 21 percent are planning to extend maturities and 26 percent cite ultrashort funds as a strategy they will implement in response to the implementation of the rules. Other changes organizations are considering as a result of the new SEC rules are: 2a-7 like funds with stable NAV (cited by 26 percent of survey respondents); ETFs bond or cash strategies (16 percent); and Doing direct repo transactions (14 percent)."

It adds, "For the past three years, adding separately managed accounts to investment policies has been the most common change organizations are making as a result of money fund reform. Using separately managed accounts underscores the importance of having a defined investment policy with specific investment parameters for permitted asset classes, credit quality, duration and maturity to enable asset managers to effectively manage these accounts consistent with each organization's investment profile rather than by a broad investor base governed by each fund's specific investment parameters. The costs associated with this type of product and the economies of scale needed to support the asset levels often makes the option cost-prohibitive for some organizations."

The report also comments, "In light of money fund reform and increased regulations, the number of new product ideas from the money fund marketplace has been somewhat limited. One area of innovation is in repo and bank collateral products. Bank collateral products are similar to MMDA/FDIC-insured products and several are new to the market. Based on the results this year there has been limited traction on these products since they continue to have to "prove" themselves to companies that are often prudently skeptical and need to see more of a track record. In terms direct repo programs, only large publicly held companies with significant balances typically enter into those arrangements or those that have the administrative and legal capacity to warrant using the products."

Finally, the report concludes, "Three key themes have come in the wake of SEC reform during this transition period: historically low Federal Funds rates, money market fund reform in tandem with other banking regulations (Basel III, Dodd-Frank, Bank Secrecy/Anti Money Laundering, and FATCA, to name a few), and banks changing their own risk profiles to address regulators' concerns regarding client risk. The result is a money market fund industry with a more risk-averse mentality that starved financial innovation that companies could have used to invest their operating cash. Instead, more money flowed into bank products, creating more demand for deposits when banks were risk-profiling their customers as a result of regulatory mandates. This created an imbalance in the market, less innovation, and companies relied on earnings credit rates to subsidize their bank fees and gave up interest income in the process. As yields have increased for the first time in seven years, there is more differentiation in yields, but money fund yields have not kept pace with the rise in rates due to the fees they are recapturing."

The AFP adds, "Finance professionals anticipate other changes in their organizations' investment policies in the next 12 months as their companies deal with the effects of SEC money market fund reform. Twenty percent of survey respondents indicate they will implement changes in defining counterparty risk limits for bank deposits, and 20 percent also plan to make changes with cash segmentation with specific policy parameters for each bucket of cash. Other changes survey respondents anticipate in their investment policies over the next 12 months are: Adding separately managed accounts (cited by 18 percent of survey respondents); Maturity changes (16 percent); Buying direct commercial paper (14 percent); Spread duration risk (13 percent); and Ultra-short bond fund strategies/funds (13 percent)."

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