After the 2008 financial meltdown proceeded from a credit to a liquidity crisis, the 27 countries that comprise the Basel Committee on Banking Supervision sought a solution to mitigate catastrophic losses should such an event happen in the future. The new measures, which build upon the Basil I and II agreements passed in 1992 and 2004, introduce two new liquidity ratios to ensure banks maintain 30 days of cash reserves in the event of crisis situations. The implications will be felt outside the banking industry. As banks seek to comply with the regulations and increase their equity ratios, they may have less of a desire to issue debt. Further, they will seek longer-term, retail funding over that of institutions or short-term funds.
While Basel III will affect money market products, the money market industry itself is facing reform. Over the last several years, the SEC has implemented changes to money market funds in order to achieve the same ends as Basel III – to protect liquidity in times of market stress. The most recent regulations, passed in 2014, change the definition of what constitutes a government money market fund. They also require that money market funds be priced at a “floating” Net Asset Value (NAV). Additionally, the new rules allow managers to charge liquidity fees, paid to the fund on redemption, and provide “redemption gates” that would suspend withdrawals. These allowances are stipulated to be used in times of extreme market stress, such as the crisis of 2008. Government and US Treasury money market funds will not be required to comply with the new rules.
In light of these recent changes affecting cash investors, a careful and strategic approach to cash management may mitigate the downside. Some approach cash management through a “bucketing” or segmented approach: determine the different needs of cash, for example, operational or core cash, and separating those assets and placing them in their own portfolios with their own specific criteria. Investors can invest short term for an operational cash portfolio and then take a longer-term approach to another portfolio type, thereby increasing the performance of the portfolio as a whole.
The implications for investors are clear. Non-government money market funds may not be the stable investment vehicle they once were. They will be subject to market movements like all other securities and will additionally require redemption fees. In the past, a passive approach to cash management was sufficient. But in the new environment, taking an active role will be imperative to preserve capital and generate yield.
