Part 1 of 3: Regulatory Overview for Short-Term Investments, including M&A Escrow Deposits

As anyone who has flown since 9/11 can attest, the price of safety is the diminishment of convenience. The same holds true when it comes to the investment landscape in a post-credit crisis marketplace. Liquidity is becoming increasingly challenging and this will continue. Understanding the changes that are quickly accelerating is important in order to mitigate the inconveniences and potential negative impacts for short term investments, including corporate cash and M&A escrow deposits.

A wide array of banking and money market reforms have been introduced since the credit crisis, all with the intent of strengthening the financial system. Many of these changes have had significant consequences, including the reduction in the number of short-term investment options and a decline in the potential returns connected to the investment opportunities that remain.

Basel III and the SEC’s money market fund reform compliance metrics may have been tailored to different markets, but their shared goals of increasing transparency and mitigating the tension between short-term funding and longer term investing have had a direct impact on the investment landscape.

In the money market fund arena, the recently released enhanced liquidity stipulations and floating net asset value (floating NAV) pricing methodology attempt to mitigate the mismatch between fund investors’ daily liquidity requirements and the long-term holdings within the fund portfolios. Interestingly, however, although these reforms have arguably improved the integrity of the funds in scope, the new regulations have also served to crystalize the difference between principal protection and market risk –prompting investor reviews of the appropriateness of money market funds as cash equivalents.

Similarly, in the commercial banking arena, Basel III’s Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) require certain financial institutions to significantly reduce the mismatch between their balance sheet assets and liabilities. Organizations governed by these new rules are now required to regularly report against these metrics, providing a means for investors and depositors to more easily evaluate the stability of their banking and financial partners. However, as the cost of holding short-term deposits increases, providers are passing those costs along in the form of lower returns. In some situations, certain deposit offerings have even been eliminated or trimmed to align product suites with the elevated cost of maintaining them. For example, many of the banking industry’s biggest players have begun informing large depositors in accounts that have traditionally been free that their institutions will soon be forced to start levying fees to offset the cost of complying with new regulations.

“Banks are urging some of their largest customers in the U.S. to take their cash elsewhere or be slapped with fees, citing new regulations that make it onerous for them to hold certain deposits. The banks, including J.P. Morgan Chase & Co., Citigroup Inc., HSBC Holdings PLC, Deutsche Bank AG and Bank of America Corp., have spoken privately with clients in recent months to tell them that the new regulations are making some deposits less profitable.” The Wall Street Journal, December 7, 2014

 

The impact is particularly visible in the market for certain deposit product categories, such as money market deposit accounts (MMDAs), time deposits and escrows –all of which are either defined as non-operating under Basel III, or which attract incremental capital costs because they provide funding that cannot be employed to support existing bank assets.

In summary, the increased regulatory burden imposed on providers of short-term investments and the corresponding increased delivery costs are likely to result in continued downward pressure on yields, a reevaluation of investment products both by providers and investors and, in some cases, fewer investment options as the infrastructure and costs of maintaining such products becomes prohibitive.

Greater protections do not come without a price. In the case of the financial markets, the cost of improved transparency and enhanced financial strength may be fewer short-term investment options and lower rates of return. Keep in mind, good information and careful planning can help you navigate this turbulent environment.

Contact your escrow administrator or SRS Acquiom at 646.503.4253, to discuss alternative options and to learn how your escrow investment choice may be affected by these changes over the life of the escrow.

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