Is your Treasury organization working with an investment policy that properly protects the business from unacceptable risk, provides the flexibility to best manage volatility and has the ability to generate optimal return?
If not, now is the time to reconsider, given the economic, financial and regulatory challenges that continue to impact corporates globally. It’s critical that a company has policies that are adaptable enough to meet the demands of market fluctuations and enable it to achieve its goals, such as preserving capital and creating yield. As your Treasury looks to help shape an investment policy, there are several market and regulatory factors to consider:
The current economic, financial and regulatory landscape continues to impact corporates globally. Investment policies are critical to achieving a company’s goals—but many are no longer suitable for this environment.
Treasurers looking to shape their investment policy are facing a number of challenges:
Treasurers should consider re-writing the investment policy to address these challenges. Working with the board, Treasurers should take this opportunity to create a dynamic and flexible investment policy; one that establishes the key principles—objectives, liquidity targets and counterparty risk limits—but at the same time allows for enough flexibility to respond to quickly changing market conditions.
Taking a proactive approach to this task will help your Treasury protect, manage and grow the business.
|A negative rate environment||
This unprecedented situation means that Treasurers may breach their investment policy as negative yield erodes capital. Treasurers should question whether it makes sense to hold cash that is not generating a return, and if not, find the most effective place to hold it.
|A raft of regulation||
New regulations are impacting how Treasurers manage their cash efficiently:
|A holistic view of counterparty risk||
As a result of Basel III, Treasurers will need to review their banking relationships and find ways to manage and reduce counterparty risks.
A number of central banks in the European Economic Area have introduced negative interest rates, posing new problems for clients. Treasury may now be faced with the prospect of paying to hold overnight deposits—in other words, cash is no longer an asset that guarantees capital preservation. As a result, Treasurers may be breaching their investment policies as negative yield erodes their principal.
Treasurers are facing two choices. They can:
Under Basel III, the definition of cash deposits changed significantly. The regulations, not the bank or the company, now determine how deposits are classified (either as operating or non-operating deposits), which will directly affect how banks value these deposits.
As the regulations phase-in, it is expected that companies with limited flows, large spikes in balances and limited product usage will see more of their deposits designated as non-operating. Appetite for these deposits will decline significantly as they are expected to generate low and, in extreme cases, negative returns. Passing the costs for non-operating balances on to the deposit holder has the potential to put principal at risk.
Basel III will profoundly affect the overall relationship between a company and their banks. Treasurers should reassess their counterparty limits with respect to how their banks would rate under the new Basel III requirements, specifically in regard to the bail-in-debt resolution. This is a scenario in which uninsured depositors risk losing principal when the bank’s Basel III capital ratios near their required minimum.
Additionally, under this regulation deposits will have to be used to support daily business activity to be designated as operating. The practice of separating transaction activity between a liquidity bank, a payments bank and a receivables bank will be less viable. Since banks will require operating flows to justify holding balances, companies may want to place operating cash with fewer providers to consolidate payment flows and liquidity with the banks where they can maintain and cultivate a holistic relationship. This has the potential to drive companies to seek greater efficiencies for their operating business, and ultimately for the broader company.
In July 2014, the Securities and Exchange Commission approved substantial changes to the rules governing U.S. Money Market Funds (MMF). Two key changes will take effect in October 2016, following a two-year transition period:
In Europe, ECB policy actions mean that the performance of most EUR-denominated constant net asset value money market funds now reflects the negative yields being paid on the short-term bank and government issued paper in which they typically invest. These same funds, however, continue to attract investors who seek the credit and risk management oversight of an experienced asset manager and who have a focus on capital preservation, diversification and daily liquidity. Despite paying negative yields, the return on money market funds continues to represent good relative value for many short-term investors in comparison to various eligible alternatives.
Thus, Treasurers using money market funds today need to understand these provisions so that they may continue to use this valuable liquidity vehicle. As always, Treasurers should think strategically about cash segmentation, identifying what cash must be immediately available and forecasting potential surplus cash.
An investment policy will need to be flexible enough to adapt to changing market conditions. This may mean a total revamp of the investment policy versus making minor tweaks to the historic guidelines. It is an opportunity for Treasurers to drive an investment policy for the next economic cycle and improve control over both centralized and decentralized operations.
The policy must be sufficiently comprehensive to protect the business from unacceptable risks, such as circumventing protection measures without proper authorization. Conversely, an overly restrictive policy that leaves little or no room for maneuver could prevent Treasury officers from employing their skill and experience to add value.
To achieve the best possible outcome, Treasurers need to work with the Board to create an updated investment policy that establishes guidelines and an appendix that carries the full detail of permissible instruments and counterparties. While the high-level document can typically only be amended with Board approval, the appendix can generally be tweaked by investment, giving Treasurers some flexibility.
Ultimately, the objective is a dynamic investment policy that reflects careful consideration of attitude towards risk and return at the Board level and establishes a regular review of objectives, liquidity targets and counterparty risk limits helping to ensure the policy is fit for purpose.
In this environment, being proactive and reviewing your investment policy is critical. Doing so will help you protect, manage and grow your business.
New regulations are impacting the definition of cash deposits. The result: banks and companies will need to change the way they partner to do business.Explore about A Defining Moment
New regulations and a shifting rate environment offer opportunities to liquidity investors.Download report about Changing Complexities
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