Liquidity Funds: A Smart Choice for Asian Treasurers?

• Money market funds facilitate corporate governance, through proper diversification of assets, same-day access to funds and the opportunity for competitive returns, and minimise the counterparty and transaction numbers required to manage cash surpluses.
• On the other hand, the effective management of liquidity across Asia remains difficult and is hindered by various regulatory barriers.
• Money market funds are centred primarily on major currency funds. Local currency offerings lack some of the required characteristics that make them attractive investment vehicles to companies.

When the Federal Reserve raised its target rate for federal funds in July 2004, it validated what all market players already knew, i.e. that the interest-rate cycle had finally bottomed out and that US rates were now expected to go up, not down. The second rate hike in August 2004 further confirmed this view. Owing to the strong links between the US dollar (USD) and most Asian currencies, these developments will no doubt affect domestic interest rates and one would thus expect the cost of money to increase gradually across the region.

While this development will no doubt prompt treasurers to review how and where they invest their company’s liquidity, it will not in itself trigger a wholesome change in their short-term investment strategy. Within Asia, the effective management of liquidity remains affected by widespread regulatory barriers that hinder a treasurer’s ability to maximise returns on surplus balances. Yield is also not the only consideration driving the choice for an investment vehicle, with liquidity and security often taking precedence.

The environment is nonetheless changing together with the evolution of product offerings from the financial industry. Money market funds are a well-established feature of the US market and are growing rapidly in Europe. There is now a growing awareness about such funds in Asia where they are gaining in popularity. On the other hand, Asia also offers a set of specific challenges with regard to making use of liquidity funds and integrating them into an efficient liquidity management structure.

The Traditional Bank Offering Still Hindered by Regulatory Constraints

The investment proposition from banks is still primarily centred on traditional products, which usually require the treasurer to make a compromise between the interest rate yield and liquidity. These products include demand deposit accounts, call deposit accounts and fixed deposits.

Demand deposit accounts offer easy access to liquidity, but a relatively low return on the underlying balances. Where credit interest is paid, the corresponding benchmark rate is usually based upon the local prime rate (though rates based upon the overnight or the one-month interbank rates are also increasingly available).

Call deposit accounts provide slightly better returns than demand deposit accounts in exchange for providing the bank with appropriate notice before funds are withdrawn (typically 24-hours’ or 7-days’ notice). Fixed deposits offer the opportunity for higher returns at the price of committing the funds to a bank for a specified tenor. Using fixed deposits therefore requires the treasurer to have an appropriate cash flow forecasting discipline. The quality of the rate and the width of the spread taken by the bank are also a function of the value that the bank places on the business it receives from a company.

When using bank deposit products, the security of the underlying assets relies upon the standing of the chosen service providers. Diversification can only be achieved by investing funds with multiple institutions, albeit at the cost of a less efficient liquidity management structure, additional transfer fees, and the additional time required from the treasurer to manage this process.

Apart from the above generic limitations affecting the traditional bank offering, the Asian market continues to be affected by regulatory constraints limiting the treasurer’s ability to invest surplus funds effectively:

• In China, banks are allowed to pay interest on demand deposit accounts. However, the corresponding rates are regulated and are set by the People’s Bank of China.
• The payment of interest on current accounts is prohibited in a large number of countries across the region, including India, Korea, Malaysia, the Philippines, Taiwan and Thailand.
• India and Malaysia do not allow companies to open savings accounts. India also imposes a minimum tenor on bank deposits.
• Overnight sweeps are possible in Korea, the Philippines and Thailand, albeit at the cost of maintaining additional bank accounts and possible additional fees imposed by the bank to support the sweeps.
• The interest income received from banks may be subject to withholding tax, including a resident withholding tax as in Japan or New Zealand.
• The Hong Kong Special Administrative Region (SAR) and Singapore deregulated interest rates a few years ago. However, banks have largely resisted paying interest on current accounts owing to the surplus liquidity available in these markets.
• The ability to manage liquidity regionally remains a feature limited to the few markets not affected by foreign exchange controls.

The Drivers of the Treasurer’s Short-term Investment Strategy

At a basic level, a company’s short-term investment decisions are driven by a limited number of factors. Essentially, the treasurer needs to know:

• how much there is to invest and in what currency;
• for how long the funds will be available; and
• the company’s attitude to risk as defined by the appropriate internal policy.

This relatively simple process is however increasingly affected by various pressures and market developments, which may sometimes be seen as putting conflicting demands on a company’s treasurer.

The competitive nature of the market and the growing recognition of the value that treasury can generate to a business drive ever-growing demands for improved returns as well as costs containment. Developments in technology are also pushing companies to operate their treasury operations on a realtime basis.

On the other hand, awareness of potential market risks, growing concerns over corporate governance and the introduction of the Sarbanes-Oxley Act in 2002 reinforce the drive for the centralisation of treasury operations, the need for more control and visibility over the accounts, and tighter treasury guidelines and procedures.

All these developments reinforce the strategic value of treasury to a business, but also typically lead to an
increasing workload on treasury, which fuels market demand for outsourcing solutions. Money market funds
can be seen to provide an attractive alternative that can save time and cost in managing the company’s short-term
investment. This is achieved by eliminating or minimising the need to manage multiple bank counterparties
while not compromising the safety and liquidity of the underlying assets.

What are Money Market Funds?

Money market funds are mutual funds that invest in a diversified portfolio of high-grade, short-term debt
instruments. As such, each investor who invests in a money market fund is considered a shareholder of the
investment pool, a part-owner of the fund. Such funds are structured to provide the institutional investor or the
corporate treasurers with the desired combination of:

• Safety: through the appropriate management of risks associated with credit, interest rate, diversification
  and operational processes;
• Liquidity: same-day settlement and availability of funds is a prerequisite for triple-A funds, as they position
  themselves as a viable alternative to bank deposits; and
• Yield: the collective nature of the product provides the opportunity for competitive rates.

Money market funds first started in the US in the 1970s and have become a major factor in the US short-term investment market. Such funds are tightly regulated by Rule 2a-7 of the Investment Company Act of 1940. US-style money market funds were introduced in the UK in the mid-90s. Lacking the history of the US market, or the corresponding regulatory framework, funds providers also strove to achieve triple-A ratings from one of the major houses such as Standard & Poor’s or Moody’s.

Funds provided out of Europe are now also covered by the Undertakings for Collective Investment in Transferable Securities (UCITS) directive, which legislates the mutual fund industry in the European Union. The introduction of this directive has made it easier to sell money market funds in Europe and Asia.

Global institutional funds are mainly located in offshore centres for tax considerations. Doing so allows money market funds to pay out their income gross of withholding taxes. The responsibility for declaring income and paying tax in their home domicile(s) is then down to the investor.

Most global institutional money market funds are located in Dublin, which has established itself as the preferred domicile for this product. Dublin has been able to promote itself successfully to the money market fund industry by leveraging the favourable tax environment provided by the establishment of the International Financial Services Centre in the Dublin dockyards.

Liquidity Funds in the Asian Context

Within the Asian context, the corporate or institutional investor is faced with two possible offerings to address his local and foreign currency investment needs.

USD, euro and sterling money market funds are widely available from the providers of global institutional funds. The demand in Asia focuses primarily on USD funds, thereby reflecting the primacy of the greenback over the region’s trading flows. This offering is essentially an extension of the product offering available in Europe and is based upon the global institutional funds available out of Dublin.

Local currency offerings are also available in a number of markets across the region, including Australia, the Hong Kong SAR, India, Indonesia, Japan and Singapore. However, these funds do not usually meet all the requirements attached to standardised money market funds and, as such, do not always meet the needs of a corporate treasurer:

• Most of the local currency funds are retail in nature and are not tailored to institutional customers. Investment goals may therefore not be in line with the corporate investment policy.
• The average size of these funds is relatively small and not sufficient to manage large injections or redemptions of cash.
• Liquidity is also constrained by the absence of same-day redemption.
• Local currency funds are usually not rated.

Although local currency funds do represent an alternative to bank deposits, their appeal to corporate treasurers remains limited by the above issues. Hence, the use of money market funds across the region is still centred on funds denominated in one of the major currencies, primarily the USD.

This situation also implies that the prime users and prime beneficiaries of money market funds in Asia are companies either operating with the USD as their main functional currency or entities that have already developed the ability to manage their regional liquidity effectively, e.g. through the implementation of a regional treasury structure and the set-up of a regional USD cash pool.

From this perspective, the ability to integrate your short-term investments with your cash-management structure is an important consideration. This explains why corporations will often opt for the money market funds distributed by their cash management bank.

Linking Up Your Investment to Your Liquidity Management Structure

Investing in USD money market funds also presents specific challenges to corporations operating in Asia, primarily because of the potential difficulties generated by the management of time-zone differences. The investment process is relatively straightforward and does not present any significant problems. When investing, time-zone differences actually work in favour of the Asian treasurer who should therefore have no difficulties meeting the trading deadline of the funds.

On the other hand, the redemption process brings potential difficulties for the Asian treasurer keen to maintain the liquidity of the company’s funds. While USD money market funds typically offer same-day redemption as a standard feature, this does not necessarily guarantee the availability of the corresponding funds in the company’s bank account on a same-day basis. If the company’s USD account is located in Asia, it is likely that the funds will be received the following day.

This issue can be addressed in different ways:

• The first option is to locate your USD account with a bank in the US. Doing so will maximise the operating hours during which your account is available for initiating payments or receiving funds, and will also eliminate the potential value-dating issue described above. On the other hand, the Asian treasurer will need to be comfortable operating on that basis, or will need to choose a banking partner capable of providing the appropriate customer service support within the Asian treasurer’s own time zone and geography.
• The second option allows the company to maintain its accounts in Asia. To do so, it needs to choose an institution that has integrated the distribution of money market funds into its locally provided cash management proposition. Essentially, it implies that the bank is able to manage the settlement risk associated with crediting the proceeds of any redemption to the company’s account immediately upon processing the corresponding order, and before the bank actually receives the redemption orders settlement proceeds in its own USD nostro account.
• A third option is to maintain USD operating accounts in Asia, and to sweep surplus funds to accounts maintained in the US from which the investment process can be managed without specific issues related to time zones.

Conclusion

The use of money market funds has grown strongly and steadily in Europe over the past few years. There is now a growing awareness about these products in Asia Pacific as well, as providers of global institutional funds seek to tap the potential of the Asian market. When appropriately used and integrated into a company’s liquidity management structure, these products can provide an effective alternative to bank deposits.

Money market funds make it possible for the corporate treasurer to address issues associated with the tightening of companies’ investment policies as a result of the greater concerns expressed by shareholders and companies’ board over corporate governance, through proper diversification of assets, same-day access to funds and the opportunity for competitive returns. They also help the corporate treasurer manage his time and costs better by minimising the number of counterparties and the number of transactions required to manage the investment of the company’s day-to-day cash surpluses.

On the other hand, while money market funds may help overcome some of the idiosyncrasies of the Asian market, the effective management of liquidity across Asia remains difficult and is hindered by various regulatory barriers.

Money market funds are also centred primarily on major currency funds (USD, euro etc). Local currency funds offerings, while available in a few markets, are not specifically tailored for institutional or corporate investors and lack some of the features (e.g. same-day settlement, size of fund) required to make them attractive investment vehicles to companies.

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