Published: September 01, 2013
Domestic firms and multinational companies operating in China have accumulated record levels of cash, despite the rate of economic expansion slowing in the world’s second-largest economy. The growth in cash and cash equivalents held by companies has been faster in Asia than in other regions, with levels peaking in China [1]. For renminbi cash investors, the opportunity set has, in the past, been largely confined to bank deposits. However, the Chinese money market fund industry is proving an increasingly attractive alternative.
The trend towards growing cash reserves is unlikely to reverse anytime soon. Although few expect the Chinese economy to return to the double-digit growth rates observed during the last decade, growth rates are likely to settle down to more constant and sustainable levels. With liquidity and efficient cash management concerns at the fore, corporate treasurers face the important decision of how best to achieve the level of security and liquidity they need for cash, while also focusing on yield optimisation.
The options for domestic companies and multinationals with operations in China that have accumulated significant renminbi-denominated reserves, and are looking at ways to generate a return from their cash, have traditionally been limited to bank deposits. The terms for most domestic bank deposits have been set by the People’s Bank of China, forcing companies to accept yields that are lower than market rates.
Furthermore, the environment has been one of tight regulation of cross-border money transactions, with currency controls restricting outflows for many companies to periodic dividend payments. This has effectively meant that surplus cash is ‘trapped’, although this appears to be changing. While some domestic Chinese banks offer structured deposits with more flexible tenors and less compressed rates of return, ways of extracting maximum value from renminbi-denominated cash reserves have been scarce.
The opportunity set is, however, broadening. Although investing directly in fixed income securities in China comes with its own plethora of challenges, the ease of access to short-dated renminbi-denominated securities provided by dedicated money market funds is something treasurers should consider.
Resulting from a wave of innovation in the now well-established and deepening Chinese fixed income market, money market funds typically invest in government-issued securities with maturities of up to one year, as well as other short-dated instruments, including certificates of deposit and repurchase agreements (repos). The pool of investible assets is wide, with more than two-thirds of the Chinese fixed income market comprised of government securities, and over one-third having maturities of less than three years.
For corporate treasurers, using renminbi-denominated money market funds for their cash management needs has several advantages. At the basic level, foremost among corporate treasurers’ concerns are likely to be the safety of their cash (principal protection), the ease of access (liquidity) and the rate of return on their investment (yield). It is useful to look at how money market funds aim to achieve each of these objectives.
There is a growing focus among both domestic companies and multinationals operating in China on the effective management of their renminbi-denominated cash reserves. At the core of these efforts is the need to preserve principal. Corporate treasurers are increasingly turning to money market funds, many of which are AAA-rated and, therefore, represent the highest standards of credit quality.
As the Chinese money market fund industry has matured, it has come to share the characteristics of its developed market counterparts, in terms of providing full transparency about easy-to-understand fund structures. Managed to international standards, a cash allocation to a renminbi-denominated fund can fit in with existing company-wide investment policies. The large size of many of the funds allows treasurers to adhere to formal guidelines, such as constraints on the maximum percentage of the total assets under management that their holding in the fund can represent, or the minimum number of counterparties that a fund must have exposure to. A large and stable client base, in many cases comprising hundreds of institutional investors, provides an underlying layer of support.[[[PAGE]]]
Renminbi-denominated money market funds are also a useful tool for managing reserves over a longer time period, due to the fact that they enjoy greater flexibility than bank deposits in terms of tenor. For most bank deposits, the tenor, or the term of the contract, is set by the People’s Bank of China. To allow treasurers to ensure that operating, reserve and strategic cash requirements can be adequately met, Chinese money market funds offer daily liquidity.
This is achieved through investment in the most liquid assets: in addition to cash and bank deposits, short-dated bonds, repos (the seven-day repo market has in the past been the deepest and the most liquid) and other government securities. Companies stand to benefit from having a diverse range of instruments for cash management at their disposal.
With the opportunities for extracting value from cash reserves remaining scarce, the appeal of money market funds to corporate treasurers looking for a modest yield advantage is clear. Fixed income investment in China remains constrained by the authorities, with many foreign companies with Chinese-domiciled operations prevented from investing directly in fixed income securities. Furthermore, the rate of interest that can be earned on bank deposits remains capped at an annualised 1.35%.
Money market funds, which can invest in fixed income securities in addition to cash, have the potential to provide investors with a modest pickup in yield. Based on long-term averages, the seven-day repo market, a big part of the universe in which money market funds invest, has provided a 3% yield.
June 2013 saw a spike in volatility in Chinese money markets. This served to highlight the potential adverse effects of an environment of constrained liquidity, and to emphasise the need for companies to be able to flexibly manage their cash holdings.
Intermittent fluctuations, however, have little bearing on the capacity of money market funds to adequately meet the principal preservation and liquidity needs of corporate treasurers. Among the main duties of corporate treasurers investing surplus cash is, of course, ensuring that the company’s assets are not jeopardised. In China, AAA-rated money market funds can help them achieve their objective of a high level of security and liquidity for their cash investments, while also having the potential to generate excess returns. They also provide a first step towards benefiting from the wealth of untapped opportunity waiting to be accessed by investors as the Chinese fixed income market continues to deepen.
Note
[1] Source: Bloomberg, as at 15 December 2012. Analysis done by looking at the cash and cash equivalents of the top 100 listed companies in each country.
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