Australia

Concise compendium of the key fundamentals impacting investment decision-making for corporate treasurers in Australia, along with the specifics of the various investment instruments.

Liquidity spotlight: Australia

Concise guide for corporate treasurers investing in Australia

Market scale and scope

  • At the end of 2021, Australia’s market for managed funds stood at A$4.48 trillion funds under management. Cash funds, which can broadly be broken down into two types – money market funds (MMFs) and enhanced cash funds – amounted to A$33.6bn.
  • The use of MMFs for liquidity management remains at a nascent stage by comparison to other developed markets.
  • The role of MMFs in the Australian short-term funding market is significantly smaller compared to overseas markets.
  • Australia’s MMF investor base is heavily weighted towards the institutional and superannuation segments.

Key stakeholders

  • The Reserve Bank of Australia (RBA), the central bank.
  • The Australian Prudential Regulation Authority (APRA), an independent statutory authority that supervises banking, insurance and superannuation institutions.
  • The Australian Securities and Investment Commission (ASIC), the principal regulator of fund managers, responsible for registering Australian management investment schemes, licensing fund managers and monitoring their compliance with financial services laws.

Synopsis

Driven by a domestic investor base dominated by institutional investors and superannuation funds and the relatively minor role MMFs have in Australian short-term funding markets, regulators’ emphasis has remained on industry guidance rather than prescriptive MMF regulation seen in other markets such as the US or Europe.

Further distinguishing domestic Australian MMFs from international alternatives is the market convention for fund valuations, which is fully mark-to-market or variable net asset value (VNAV). Australian domestic funds are also less likely to carry an external credit rating, which is the standard for international funds.

However, while the Australian market for MMFs is relatively small – representing less than 1% of the market for managed funds – it nonetheless provides cash-investment solutions to investors seeking credit diversification while maintaining liquidity.

Market overview

Investment in Australia’s managed funds market is dominated by institutional investors and superannuation funds. In 2021, the market was split between retail investors (13%), institutional investors (40%) and superannuation funds (47%). The high proportion of institutional and superannuation fund investors has influenced the evolution of the Australian domestic MMF segment of the industry as risk profiles, valuation methodologies and fund features required by these investor types may be different to those typically required by corporate treasury or retail investors.

Most MMFs use the VNAV methodology with funds being mark-to-market on a daily basis. By comparison, the norm for international prime MMFs is to use a methodology known as low volatility net asset value (LVNAV), in which securities out to 75 days can be valued using amortised cost accounting. As a result of using VNAV and running typically longer-duration portfolios, following recent aggressive tightening by the RBA, a number of Australian domestic funds are showing negative returns. However, as most investors are institutions or superannuation funds that invest over a medium-term horizon, short-term instances of negative rates are not considered critical.

“This is probably the most significant difference between Australia and other important MMF jurisdictions. As funds use mark-to-market valuations – and therefore VNAV – MMFs in Australia can show negative returns”
Gordon Rodrigues
CIO – liquidity, Asia-Pacific, HSBC Global Asset Management (Hong Kong) Ltd
 Other key features of Australian MMFs include:
  • A light-touch regulatory framework;
  • Breakdown of instruments held and their credit rating;
  • No requirement for MMFs to hold solely credit-rated instruments; and
  • Low diversification within funds themselves.

The regulatory environment

With retail investors only a small part of the investment landscape in Australia, there is only a very small amount of regulation aimed specifically at MMFs – apart from a stipulation under the Corporations Act of 2001, that the name of the fund must not be misleading or deceptive. The regulators have clear rules for the standardisation of naming conventions of MMFs to distinguish between ‘money market funds’ and ‘enhanced’ money market funds, which may have very different risk profiles and to reduce the risk of mis-selling.

When ASIC looked at MMF regulation in the wake of the 2008 global financial crisis, it concluded that exposure to systemic risks such as fund redemption was low given the main characteristics of the market, including:

  • Most MMFs have short-term maturity profiles and therefore low levels of volatility;
  • A lack of significant mismatch between liquidity and redemption terms, with the majority of MMFs being able to divest their holdings relatively efficiently; and
  • Only a limited exposure of retail and wholesale investors to MMFs.[i]
As a result – and given existing provisions (such as the existing Corporations Act, which allows funds to freeze redemptions) – there has been no new legislation or regulation, unlike other major jurisdictions. Overall, regulation is light touch, but with a strong expectation that guidance is adhered to by fund managers.

Fund holdings and strategy

Australian domestic MMFs are highly concentrated around bank instruments with certificates of deposit (CDs) issued by the main four banks typically representing 65–80% of most funds, with only limited diversification into smaller banks. As a result, investors achieve only limited diversification of counterparty risk – especially as all funds would tend to have similar exposures to the same issuers. By comparison, international MMFs offer greater diversification through issuers in markets beyond Australia, including Japan, South Korea, New Zealand, Hong Kong, China, Europe and the US, and so offer greater issuer and geographical diversity.

While there is no requirement for Australian domestic MMFs to hold rated instruments, in practice they hold highly rated ones, with very limited exposure to assets that are slightly less liquid, such as term repurchase agreements, securitised debt or lower ST rated A-2 assets. The market is therefore narrow, but of a reasonable high quality.

In 2017, Australia’s Financial Services Council (FSC) issued a guidance note setting out expectations in terms of investment objectives and vehicles.[ii] The FSC categorised MMFs as either short term or standard (otherwise known as enhanced cash funds) and expected funds:

  • Should include high-quality money market instruments and other low-duration money market instruments;
  • Should not take on exposure to equities or commodities;
  • Should only use derivatives in line with the fund’s investment strategy; and
  • Should prohibit or limit investment in securitised products (with some exceptions).

MMFs must impose concentration limits and/or diversification ratios to reduce a fund’s exposure to a single entity, the FSC guidance states. However, exposure to money market instruments issued by major Australian banks should be capped at 70% of the MMF portfolio and exposure to non-major, non-government money market instruments to be capped at 15% of the portfolio. The regulators are mindful of international standards and apply liquidity limits that are similar to those in Europe (see below). Thus, guidance suggests that a 10% minimum should be invested in daily liquid assets and 30% in weekly liquid assets.

Overall, the landscape for Australian MMFs can be characterised as rigorous in terms of its guidance – fund managers can largely be expected to hold to ASIC and FSC guidance – but low in statutory regulation, in part due to the concentration around high-quality assets and instruments.

Credit ratings – In contrast to international MMFs, Australian onshore MMFs are typically unrated, although there are instances of both international and domestic investment managers obtaining ratings for Australian domestic MMFs.

In line with corporate treasury expectations, the market convention for international MMFs is that they are typically rated by one or more credit rating agencies.

Country specifics

Portfolio characteristics
  • Settlement –Settlement cycles for AUD MMFs vary and are typically longer than those of international funds for which the market convention is T+0.
  • Weighted Average Maturity (WAM) – 60 days, in line with international norms (for enhanced cash funds, WAM is 365 days or less)
  • Weighted average life (WAL) – 120 days, slightly longer than the 90-day international norm.
  • Management fees – Fees vary between client segments as well as for factors such as the stability of cash being invested, but typically within a range of 10–20 bps for institutional investors.
  • Credit risk – more than 50% of fund must be invested in major banks or A1+ rated instruments; this is in the nature of guidance.
  • Leverage – Only permitted for short-term borrowing to manage redemption requests and limited to 10% of AUM.

Identifying the right fund manager

Corporate treasurers typically operate within a range of well-defined risk parameters from counterparty risk tolerance to diversification constraints. Identifying a MMF that sits within these parameters requires careful consideration of the manager’s investment philosophy, the regulatory regime under which they operate, as well as constraints a manager must adhere to, to maintain a fund credit rating.

  • Diversification – A key benefit to investing in MMFs is to achieve greater diversification via pooled investment vehicle. However, as highlighted earlier in the paper, domestic Australian MMFs are typically less diversified both from an issuer and geographical perspective than international alternatives.
  • Duration – Onshore funds tend to be benchmarked against the Bloomberg AusBond Bank Bill Index and therefore tend to have portfolios with higher WAMs to achieve yields in line with benchmark. By contrast, offshore funds are not managed to a benchmark; instead, they have a reference benchmark for comparison, typically the RBA cash overnight rate. This could be a strong consideration for corporate treasurers sensitive to negative returns in a rapidly rising rate environment where a fund with a longer WAM will be slower to reflect the rate hikes.
  • Credit risk – Treasurers need to make sure onshore funds selected would invest only in the highest short-term rates instruments or only liquid asset types, if that is their global investment policy, given the absence of a prescriptive regime.
  • Liquidity risk – Liquidity risk management should consider both asset and liability factors. In jurisdictions where minimum daily and weekly liquidity buckets are not mandated by regulation, it’s important to understand a manager’s internal liquidity policy, in particular how they define the type of assets that can be used and the maximum tenor and percentage weight for each asset type. Liability factors should include individual client concentration limits and client sector limits for those sectors that exhibit herding behaviour during periods of market stress.
  • ESG risk – As a minimum, managers should be able to demonstrate how risks arising from environmental, social and governance (ESG) factors are managed within their credit process and internal credit scoring, a process known as ESG integration. Where designated ESG MMFs are being considered, a manager must be able to evidence a material impact on the MMF investment universe achieved using the ESG investment methodologies they have adopted.

Market and regulatory developments

  • Notwithstanding the limited diversification benefits due to the high concentration around domestic bank CDs, Australia’s onshore MMFs operate in a relatively low-risk, high-quality investment space.
  • There are no current plans to change the regulatory framework governing Australia’s onshore MMFs and therefore there is greater emphasis on investors to understand the risk profile of a MMF solution.
  • Sustainability – Given the highly constrained investment universe for onshore funds, the scope to develop an onshore ESG MMF is limited. As treasurers move to adopt more sustainable treasury practices, the demand for ESG MMFs is most likely to be met through international alternatives given the much broader investment universe available to them.
  • [i] Report 324 Money Market Funds, Australian Securities & Investments Commission, 2012, p5

    [ii] FSC Guidance Note No 35: Money Market Funds Naming Convention, 2017, p7

    Gordon Rodrigues

    CIO – liquidity, Asia-Pacific | HSBC Asset Management (Hong Kong) Ltd

    Gordon Rodrigues is the Chief Investment Officer for the Liquidity Business in A-Pac. Prior to that he was the Head of Asian Rates, FX and Liquidity in the Asian Fixed Income team within HSBC Asset Management in Hong Kong. He has been working in the financial industry since 1992. Rodrigues joined HSBC Global Markets, India, in 1994 as a Treasury Sales Specialist covering Corporate and Institutional Clients and traded Credit Products on the Fixed Income Trading Desk from 1998-2002. Gordon moved to HSBC Asset Management India in 2002 to set up the Fixed Income Investment Team and headed the team till 2007 before relocating to Hong Kong.

    Prior to joining HSBC, Rodrigues worked as a Foreign Exchange & Fixed Income Dealer at Merwanjee Securities in Mumbai. Rodrigues holds a Master’s degree in Finance and a Bachelor’s degree in Electronics Engineering, both from the University of Mumbai (India).