Almost eight years after the Reserve Primary Fund infamously “broke the buck”; the dust is beginning to settle around a new institutional liquidity landscape. It is clear that this new landscape is significantly different than the one we have known and requires purposeful navigation.
The effects of the rules enacted following the financial crisis are now taking shape. New US money market fund rules go live this autumn. Basel 3 is a reality and, after almost a decade, the Fed in the US has raised interest rates. The institutional liquidity management landscape is filled with an array of choices and access points. Cash professionals are re-emerging from a hiatus with new perspectives and tools— in addition to their old scars— to lead the way.
Short-term investment products such as money market funds, repurchase agreements, and other traditional outlets for liquidity management have been scrutinized by regulators. In addition, product offerings are being re-examined by manufacturers for long-term strategic viability. Bank of America, for example, sold its money market fund business to BlackRock in November 2015.1 At banks, non-operating deposits have become anathema as they are subject to the most severe run-off assumption of 100% when calculating relevant leverage ratios.
The upside in 2016 is that there is far more clarity for cash investors around the impact from changes, and paths through the new landscape are becoming clearer.
A New Liquidity Management Landscape
In the new liquidity management landscape, decisions are more complicated and their effects more visible and significant than they have ever been. Effective deployment of cash for reinvestment and collateral purposes has an impact across risk, operations, and performance, and will draw sustained scrutiny from external stakeholders. It is incumbent on cash professionals and stakeholders to create a framework to help them understand their current activity, assess available instruments, segment their cash, and optimize their investment activity.
The prime institutional money fund space represents $875 billion of the $2.7 trillion money fund market in the US.2 Approximately 40 to 60% of prime institutional money fund assets are expected to move into other products this year.3 In preparation for the new US money fund regulation many fund manufacturers have segregated institutional investors from retail and in some cases, have morphed their prime funds into government funds, allowing them to retain a steady $1 per share net asset value (NAV). Institutional cash professionals opting to stick with government funds therefore face a trade-off: sacrifice yield, in exchange for the convenience, ease, and comfort of sticking with established models and practices based on the $1 constant NAV principle.
For cash professionals, navigating the new liquidity management landscape is a matter of assessing the different instruments available, working to understand how each could affect internal operations, and understanding the costs.
While assessing instruments for risk and return, it is important that cash professionals not lose sight of the impact on internal processes. Effective liquidity management requires a clear line of sight, enterprise-wide, into portfolio composition and cash balances across service providers. An increase in the number of instruments being used by an organization makes an aggregated view difficult. Here too, new tools and techniques have become available. For example, cash professionals may consider employing a tool such as a Cash Investment Book of Records to aggregate multiple data sources and facilitate better intraday decision making. It is essential for cash professionals to segment cash into categories and solution each category based on organizational needs.
Cash Segmentation Framework
1. Intraday Operational Cash= AM Cash vs PM Cash
Prime funds will no longer strike on the hour, and it is likely the trading cycles will follow a 9am, noon, and 3pm (ET) cycle. Intraday margin calls and credit lines should be re-examined.
2. End of Day Operational Cash= Closing Enterprise Wide Balances
End of day/Late-day cash outlets for frictional cash needed to be re-examined given the balance between earlier cutoff times and the need to cover late-day settlements and avoid costly overdraft charges.
3. Short Term Cash = T+1 to T+3
This is where ETFs, short term bond funds, and other non-daily dealing products may be considered. Of note, the US Securities and Exchange Commission’s proposed Rule 22e-3 requires a fund maintain a portion of its holdings in assets that can be converted to cash in three days.4
4. Strategic Cash = T+3 and beyond
This is where private placements and SMA’s and longer dated maturities may be considered.
The post-crisis period has been a period of upheaval. As interest rates tick higher, there will be a greater opportunity cost inherent in idle, un-invested cash. In this new landscape, there is the opportunity for cash professionals to take a leadership role in defining the optimal model. As cash takes its rightful place among actively managed asset classes, the challenges are real but the reward and opportunities are great.
Liquidity Instrument Considerations & Impact
Operating Model Impact
Government Money Market Funds
- Constant $1 NAV
- Trade-off on yield
- Familiar operational processes
Prime Money Market Funds
- Floating NAVs, gates & fees
- Possibility for multiple NAVs in a single day
- Legacy processes and systems built on $1 NAV principles no longer work
- Variation in trading and liquidity cycles
Short-Term Bond Funds
Maturities that may go beyond 2a7
- Next day settlement time frames or beyond
- Entry/Exit fees may apply
Separately Managed Accounts (SMAs)
- Discretion and control
- Personalized risk tolerance
- Nuanced servicing aspects across trading, performance, accounting, and reporting
Exchange Traded Funds (ETFs)
- Convenient, easy to track and price intraday
- Investment policies being aligned with a liquidity strategy
- Extended settlement time frames
- Market access in line with equity trading vs fixed income/money market
- Lack of standardization
- 3(c) 7 / Partnership structure
- Atypical reporting requirements
- Requires investor accreditation
- Dealers may be disincentivized to offer bilateral repo under new Basel rules
- Centrally cleared repo offers offsetting exposure entries.
- Access to additional capacity/counterparties benefits needs to be weighed against any default fund contributions or sponsored access requirements
This article was originally published in the 2016 Regulatory Field Guide. The guide features insights from a number of our experts on key regulatory developments that will have the greatest impact for asset managers in the year ahead – and beyond. Visit bbh.com/regulatoryfieldguide to explore the guide.
1 Reuters, BlackRock to buy Bank of America's $87 billion money-market fund business, 2 November 2015
2 Investment Company Institute, Money Market Fund Assets, 17 December 2015
3 Ignites,The Great Money Fund Migration Kicks Off, 11 November 2015
4 Ropes & Gray LLP, SEC Proposes Rules to Require Liquidity Risk Management Programs for Funds and to Permit Swing Pricing of Fund Shares, 15 October 2015