In addition to its recent "2017 Liquidity Survey, the Association for Financial Professionals, an organization that represents corporate treasury management professionals, also recently published, "AFP Executive Guide to Investment Strategy and Policy." Underwritten by J.P. Morgan Asset Management, the guide's Executive Summary explains, "With interest rates starting to rise and new regulations being applied, now is a good time to review treasury investment policy to ensure it will permit the company to respond as the market environment evolves. The guide recognizes that improved technology gives treasurers better visibility of cash and the ability to build more accurate cash position forecasts. In turn, this information enables treasurers to stratify cash into buckets, so that companies may be able to tolerate different levels of risk for each one."

It tells us, "This guide has been written to help treasury practitioners develop an investment policy that permits the adoption of an investment approach, which reflects the company's various different tolerances for risk. The guide is structured in two parts. The first part reviews the current market environment. It outlines the changes in the market, notably the prospect of rising interest rates and the nature of bank and money market reform, and assesses how these are affecting treasurers managing surplus cash. The second part has been designed to support the treasurer’s decision-making process when classifying cash and drafting a new investment policy, or reviewing an existing one."

On the "Market Environment," the AFP piece says, "The first part of the guide addresses the current market environment affecting treasurers with the responsibility for investing short-term cash. First, as US interest rates start to rise, it highlights some of the risks associated with investing in a higher rate environment. Second, it identifies how reforms designed to strengthen the financial system are affecting corporate treasurers with surplus cash to invest."

They comment on the topic of "Asset management," "Funds following the SEC rule 2a-7 and similar money market funds play a valuable role in providing liquidity to the money market. First, they provide an important source of short-term funding to banks and other borrowers seeking to raise short-term finance via commercial paper and Certificate of Deposit issuance. Second, because investments can be redeemed overnight, they offer a diversified location for the corporate deposit of working capital cash. Regulators have also recognized this critical role and, as with bank reform, are concerned about the impact on the wider economy should a future credit crisis result in a 'run' on a fund and possible market contagion. Regulators have responded by strengthening liquidity requirements of funds under their jurisdiction. Reforms to US 2a-7 funds were introduced in October 2016. Similar reforms are being introduced in the European Union, likely within the next two years. The detail of the reforms is summarized below."

The Guide states, "In the US, the immediate effect of the reform was that investors moved cash out of variable net asset value prime funds and into constant net asset value government funds. The money market fund industry had expected USD 550 billion-USD 800 billion in assets to move from prime to government MMFs between announcement of reform in 2014 and its implementation in October 2016. Figures released by the SEC show that there were USD 1.7 trillion assets under management in prime funds in May 2014, when the reforms were announced, compared to USD 983 million in government funds. By the end of October 2016, these figures had changed to USD 562 million in prime funds and USD 2.2 trillion in government funds. Including tax-exempt funds, the total value of assets under management in all funds has remained about USD 3 trillion throughout this period."

It tells us, "The nature of this movement was anticipated for a number of reasons, not least the fact that many corporate treasury investment policies required the use of constant net asset value funds. Investors were also concerned about the potential imposition of a liquidity gate or fee. As a result, the spread between government and prime funds has widened to about 40 basis points, a significant level when the Fed's target interest rate is 0.75-1.00%. Corporate treasury practitioners will need to review their policies to check whether investment in floating, or variable, net asset value funds is permitted and in which circumstances it should be in the future."

In a sidebar on Money Market Fund Reform, AFP writes, "While the money market fund reforms introduced in the US in October 2016 and agreed by the EU in May 2017 have the same objective, there are some significant differences between the two.... There are two central parts to US money market fund reform: The restriction of constant net asset valuation (CNAV) to government and treasury money market funds. All other prime funds must report a variable net asset value (VNAV). The imposition of liquidity fees and redemption gates. A money market fund board can impose a liquidity fee of up to 2% if weekly liquid assets fall below 30%. If weekly liquid assets fall below 10%, a board is required to impose a liquidity fee of 1%, unless it determines that it is not in the best interests of the fund to do so. A board can also chose to impose a redemption gate (restrict redemptions from a fund) for any 10 out of 90 days if weekly liquid assets fall below 30%."

On European Union reform, they tell us, "The EU reforms were agreed in May 2017 and are likely to be introduced by the end of 2018. As with the US, there are two main elements to the reform: The introduction of a third category of fund, the low volatility net asset value (LVNAV) fund, alongside existing CNAV and VNAV funds. As in the US, post-reform, only government funds will be CNAV. The new LVNAV fund will be able to report a stable price, as long as the value does not move outside a 20 basis point collar. The LVNAV will be able to invest in similar assets to existing EU prime CNAV funds. Also as in the US, the EU reforms include the imposition of liquidity fees and redemption gates, although the application is slightly different, especially because they will apply to CNAV and LVNAV funds. The triggers for applying a gate or fee will be same as for US funds, although asset managers may choose between applying a gate or a fee or both.

The piece quotes our Peter G. Crane, President & Publisher, Crane Data, "When EU regulations come into force, probably at the end of 2018, there will be some slight and subtle differences in the regulations between the EU and the US. These will not make life easier for investors using funds in both places.... One of the biggest pieces of advice to cash investors is to stay calm and to keep your options open. The last thing investors want to do is to ban the use of an investment and then find they need it."

In "Part Two: Setting and Executing an Investment Policy," the Guide comments, "This changing environment is leading many treasury practitioners to review their cash management. There are two stages. First, practitioners can assess whether they can obtain better visibility and understanding of their cash to be able to stratify it effectively. Next, treasurers can review their investment policy. For companies with existing policies, it may not be necessary to draft a completely new policy. However, it is worthwhile reviewing the existing policy to ensure it remains relevant and will allow the practitioner sufficient flexibility to act appropriately in different potential scenarios."

It quotes John Donohue, Head of Global Liquidity at J.P. Morgan Asset Management, "Cash segmentation allows you to maximize return while making sure you have the cash at hand that you need." The piece also quotes `Ted Ufferfilge, Head of Global Short Term Fixed Income Product at J.P. Morgan Asset Management, "From our recent PeerView survey more than 70% of respondents can forecast their cash flows out for a month or longer. Just under half can forecast out a quarter or longer. The better your cash flow forecasts, the more efficient you can be at segmenting cash.... At certain asset under management levels, it is not worth replicating a money market fund in a separately managed account."

The report also quotes Peter Crane, "Since the reforms to US money market funds, asset managers have been required to disclose much more information about the instruments they use. Large investors need enough information to perform due diligence, but it is easy to get lost in the data. To paraphrase Ronald Reagan, look at yield, trust the market and then verify.... Increased disclosure requirements has not been extended to funds' investor bases. Understanding your fellow investors is important. How might they respond to a liquidity crisis?"

Finally, AFP's Guide concludes, "With interest rates starting to rise and new regulations being applied, now is a good time to review treasury investment policy. Improvements to treasury technology mean it is easier than ever before to achieve accurate visibility of cash, which in turn enables more effective cash position forecasting. Higher interest rates should mean treasurers should have greater opportunities to exploit, if they can stratify cash more effectively. A policy review should help a practitioner assess whether the policy is flexible enough to allow the company to take advantage of any such opportunities, as long as doing so reflects the company's tolerance for risk."

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