We had over 700 registrants for the recent webinar on dynamic credit risk analysis and it was not possible to answer all of the questions raised. In this blog, the team at HSBC provides responses to some of the unanswered questions and provides further insights on some of the areas that were discussed in the webinar.
During the webinar, we discussed the critical importance of undertaking credit analysis on counterparties, specifically banks, as a reliance on the headline rating from one of the credit rating agencies is overly simplistic. A credit rating is one useful input to the analysis and can help a treasurer to set minimum thresholds for a counterparty to be eligible for investment, but is not the only consideration for a treasurer who is managing different risks when investing short-term cash. One of the challenges, also discussed during the webinar, is it can be difficult for a treasurer to be able to perform the same level of detailed fundamental credit analysis, and the inherent requirements for ongoing monitoring, that a professional investor such as an asset manager can perform. This is down to the time and resource required to do this effectively on an ongoing basis, as well as the experience of the team, and the availability and quality of data, and is one of the reasons why an investor might consider outsourcing cash investments to a money market fund where this level of analysis and expertise is inherent in the process.
Notwithstanding those challenges, the following are examples of factors that a treasurer can consider when performing high-level analysis of bank credits above and beyond published credit ratings:
As discussed in the webinar, the same focus on undertaking due diligence on bank counterparties should be applied to your MMF providers. In the same way that we have said that not all banks with identical credit ratings operate in the same way or carry the same risks, not all funds with a AAA MMF rating are managed in the same way. HSBC Asset Management will shortly be publishing a paper on the importance of undertaking due diligence on MMFs which we hope will also be a useful tool for treasurers.
Credit analysis and actions taken as a result of a view on creditworthiness should be seen as an entirely real-time, ongoing and dynamic process. Again, one of the challenges for a treasurer is how to deploy this in a resource-constrained environment, whilst being alert to changes and able to act quickly – no further evidence of this is needed than when earlier this CSFB, a ‘GSIB’ or globally systemically important bank in the eye of regulators, defaulted and the default of Silicon Valley Bank rapidly passed through to a wider market dislocation.
Using how HSBC Asset Management operates its Money Market Funds as an example, the large team of credit analysts are monitoring counterparties every day, using a variety of sources such as those provided in the previous section. They do not wait for a downgrade from a credit rating agency as they apply their own internal view and grading of every eligible counterparty. Just as importantly the process is dynamic and flexible – it might not just be a question of “in or out” but there can be a sliding scale that restricts the size of tenor of exposure to a particular counterparty, which could be the first step in taking further action or as a temporary step that then returns to normal as conditions improve.
Investment policies should provide the broader framework that a treasurer can operate under day-to-day but be dynamic enough to allow for prompt action and flexibility in a controlled way.
Bank deposits are the most widely used vehicle for treasurers to place short-term cash, whether that is an excess balance in an operating account or active placement on deposit overnight or for fixed time periods. MMFs are also widely used for short-term cash but are fundamentally different, including in the areas outlined below. Two key differences discussed in the webinar are the ability of the MMF to undertake the ongoing credit analysis of counterparties as well as the level of diversification that an investment in an MMF can achieve (which can often be 50-60 issuers, by way of illustration).
Source: HSBC Asset Management. For illustrative purposes only
MMF ratings are also fundamentally different to bank credit ratings; they do not assess credit risk but rather the ability of an MMF to preserve capital and maintain liquidity. An MMF rating has a suffix of mmf/mf/m depending on the rating agency; the highest rating for an MMF is AAAmmf (Fitch), AAA-mf (Moody’s) or AAAm (S&P) which is therefore not to be confused with a AAA bank credit rating. Treasurers typically look to a AAA MMF rating from at least one rating agency as part of their investment policy.
A question was also asked on the role of IMMFA in terms of how a treasurer can perceive the governance of an MMF. The Institutional Money Market Funds Association is a trade association representing the European MMF industry; it is not a regulator nor does it rate MMFs. It does however operate with a Principles of Best Practice which IMMFA members are bound by, the objective of which is to protect investors by requiring high and consistent standards for IMMFA member funds. These can be seen as additive to existing MMF regulations, requirements from credit ratings agencies for MMF-specific ratings, as well as the members’ own internal investment policies and governance; IMMFA membership does not differentiate the risk between one member fund and another and is not a substitute for a treasurer undertaking their own due diligence on any MMF they use or plan to use. As well as setting principles that members must follow, IMMFA is also an effective body for the MMF industry to engage with regulators and market participants, including on any potential regulatory changes.
