For much of his tenure in the treasury department at Atlas Air Worldwide Holdings, Emidio Carrico has invested the company’s cash in money market funds and bank deposits. Treasury director Carrico was in sync with most of his peers in the corporate world, as well as those at insurers, asset managers and even hedge funds. After all, money market funds have long been prized for their stable net asset value and highly liquid nature, and bank deposits earned an allowance (earnings credit rate, or ECR) to offset Atlas’s banking fees.
Today those bastions of liquid asset investment are rapidly disappearing, forcing treasurers, CFOs and others to look elsewhere to park cash. Offerings insured by the Federal Deposit Insurance Corp. are one option. “Over the past several years, we have expanded our cash management arrangements to include several FDIC-insured products such as FICA [Federally Insured Cash Account], which focus on safety and liquidity while providing competitive yields relative to money market funds,” says Carrico, who has worked at Atlas, a Purchase, New York–based outsourced aircraft and aviation provider, for nearly a decade.
Lethal fallout from the 2008–’09 financial crisis, including a wholesale rewrite of the global regulatory framework, threatens to close off the old ways of investing short-term assets, or at least make them unattractive or significantly constrained. As clients seek alternatives, cash management providers are stepping up with solutions.
The global money market industry is worth roughly $3.3 trillion, according to an August report by Goldman Sachs Asset Management (GSAM), with the U.S. accounting for $2.7 trillion of that total. “Not too many multitrillion-dollar industries are facing the challenges cash is facing right now,” says Brandon Semilof, head of institutional business at StoneCastle Partners, a New York–based cash manager with more than $10.2 billion in assets.
The cash management debacle has two root causes. The first dates back to July 2013, when three U.S. banking regulators — the Federal Reserve, the FDIC and the Office of the Comptroller of the Currency — approved the new global regulatory standard for bank capital adequacy, stress testing and market liquidity risk under Basel III.
One of the key rules, implemented in January 2015, is the liquidity coverage ratio, which defines how many “high-quality liquid assets” a bank must retain. That is forcing banks to purge their balance sheets of so-called hot money: nonoperational cash, or assets that move in and out of accounts swiftly.
As banks begin to give back cash, some depositors are bigger targets than others. “J.P. Morgan has been the most aggressive in telling hedge funds to go somewhere else,” explains Semilof, who has helped move some of these unloved assets into StoneCastle’s proprietary cash fund. For hedge funds, the bank isn’t just reducing its ECR or charging a fee. “It’s, ‘Hey, you gotta go,’” he says.
Mark Aldoroty, head of sales and relationship management at Pershing Prime Services in Jersey City, New Jersey, has observed the same trend. “Most prime brokers are shying away from keeping cash on their balance sheets or taking deposits,” says Aldoroty, whose firm provides custody for hedge funds.
During JPMorgan Chase & Co.’s third-quarter earnings call in October, CFO Marianne Lake reported that the bank had unloaded $150 billion in nonoperational deposits so far this year. Lake expects to match that amount in 2016. Clients being handed back their cash reportedly include some of the largest hedge fund firms.
Other banks acknowledge that the cash-parking hunt is on even among the hedge fund giants. “Let’s say a hedge fund has $1 billion,” Stephen (Biff) Bowman, CFO of Northern Trust Corp., said on the firm’s second-quarter earnings call in July, responding to an analyst’s query. “We will want to dialogue about what the other opportunities are with them, other than what we would say is a very transactional-oriented deposit or a very rate-sensitive deposit.”
Basel III is only the first of two regulations changing the way cash is managed. With the Securities and Exchange Commission mandating money market reform, treasurers must weigh their options. This rule, which takes effect on October 1, 2016, will end the long-time practice of setting a $1 net asset value for prime funds — those invested in short-term corporate debt known as commercial paper. It will also allow fund directors to stop redemptions and impose redemption fees at times of extreme stress in the financial markets. The new regime will also affect certificates of deposit, but not government money market funds.
GSAM’s August report estimates that as much as 70 percent of the $1.4 trillion in U.S. prime funds will migrate elsewhere, thanks to uncertainty about how the transitional period will play out, along with the fact that many institutions, governments and agencies allow cash to be invested only in stable value instruments.
To create extra capacity and skirt the SEC reform, more than 20 money market funds will convert from prime to government vehicles, according to Fitch Ratings’ third-quarter report on the U.S. industry. But this increased room won’t come close to filling the massive need for a diversified array of low-risk, stable and highly liquid investments. As a result, cash management giant Institutional Cash Distributors, headquartered in San Francisco, has seen a 10 percent increase in assets among existing accounts over the past six months.
“We have certain clients who used to put all their cash in money market funds,” says Tory Hazard, president and COO of ICD, which administers $70 billion in assets and offers thousands of cash investment options through its web portal. “Sophisticated treasury departments are now adding other products.” So are prime brokers: Pershing’s Aldoroty reports that his firm is looking for new ways to help its hedge fund clients.
ICD has just inked a deal with StoneCastle to offer the latter’s FICA product. Although this product is popular with hedge funds, big corporate names like Apple and Coca-Cola Co. won’t be using it any time soon because investors are limited to between $35 million and $50 million in FICA investments per taxpayer identification number.
There is another surprise awaiting investors, warns Jerome Schneider, head of the short-term and funding desk at Pacific Investment Management Co. in Newport Beach, California. With net yields on money market funds remaining near zero for the past few years, many fund managers have waived their fees. As monetary policy begins to return to normal, with a first expected U.S. interest rate increase of 25 basis points, managers coming back for those fees will eat up any modest rate hike. “Investors could be rudely awoken to the fact that even as interest rates increase in broader markets, money market funds won’t recalibrate,” Schneider says.
Although banks haven’t imposed higher deposit fees on the biggest institutions or asked them to take back cash, those investors are considering new options. Just ask Lance Doherty, treasury director in cash management at Newport Beach–based Pacific Life Insurance Co., which already uses a StoneCastle product for diversification. “The problem we have is with the gates [redemptions] and fees,” Doherty says of money market funds. To mitigate that problem, large institutions like Pacific Life can build their own short-term funds in-house by purchasing the same securities that money market funds hold.