Treasury is responsible for and owns cash. To effectively safeguard and manage the organization’s funds, treasury takes charge of corporate cash.

Ensuring that there is adequate cash to meet its ongoing obligations, as well as to finance working capital for business operations and varied requirements, are key responsibilities of corporate treasurers.

At a time when cash and liquidity management are paramount concerns for corporate treasury, the significance of effective cash segmentation as a vital tool for treasurers in managing cash across different environments cannot be overstated.

“At the heart of cash segmentation is the classification of cash according to the likely future needs of the business. This is done by using a cash forecast to categorize cash into virtual ‘buckets,’ with each bucket representing a different time horizon and tolerance for risk. Each bucket can then be invested in instruments that reflect that tolerance”, as per the Association for Financial Professionals® (AFP) Executive Guide: The Future of Corporate Investing, underwritten by Allspring.

Typically, organizations categorize or divide cash balances into three buckets or segments - operating cash, working capital (medium-term cash), and strategic cash (long-term cash). This practice is integral to effective investment management, contributing to improved returns on the overall cash portfolio.

In light of shifting interest rates, managing and investing corporate cash is a challenge for treasurers, yet even with a strong focus on the future movement of interest rates, the foremost objectives of investing corporate cash are protecting principal value and maintaining sufficient liquidity while also identifying opportunities to generate yield “without altering the segmentation process or investment policy”, according to the AFP Executive Guide.

To achieve this, the AFP guide recommends five cash segmentation changes:

Maturity changes

“Adjusting the maturity of instruments within the portfolio can enable treasurers to achieve an improved return by identifying value opportunities along the yield curve, especially when investing medium- and long-term cash. For these cash segments, investment policies will typically set two parameters for maturity: a maximum date to final maturity for each instrument and a maximum average maturity for the segment as a whole,” stated the AFP guide.

Furthermore, these parameters vary across organizations, influenced by regulatory restrictions and the corporation’s risk appetite. However, in accordance with the AFP guide, for companies investing primarily in operating cash, changes are limited due to stringent policies requiring placement of funds in overnight (or short-term deposits) or money market funds.

Duration changes

In keeping with the AFP guide, duration assesses the sensitivity of an instrument or portfolio to changes in interest rates. As interest rates decline, bond prices usually rise. Consequently, a portfolio with a higher duration stands to gain more when interest rates begin to fall, assuming other factors or variables remain unchanged.  

Credit quality changes

As indicated by the AFP guide, one approach to achieving higher returns is by accepting lower levels of credit quality, thereby taking on additional risk.

“For operating cash, the policy will generally be tight, restricting the placement of cash to highly rated instruments (e.g., T-bills), counterparties (e.g., cash management banks) and money market funds”, as advised by the AFP guide.

While prime money market funds offer higher returns than government or treasury funds due to perceived credit quality differences, many organizations limit operating cash investments to government funds. The AFP guide goes on to suggest that investment policies commonly establish limits or restrictions on the proportion of each segment or bucket that can be invested based on credit quality, including specific or designated minimum credit ratings.

Concentration risk changes

The AFP guide reckons that treasurers are unlikely to take on more risk by increasing concentration risk. The diversification offered by prime money market funds is a significant advantage. Similarly, the guide advocates outsourcing to a third-party manager through a separately managed account, allowing corporations to design their portfolios without the burden of implementation.

Allocation changes by asset type

Besides adjusting maturity and duration, the AFP guide counsels that investment managers can also alter other elements of a portfolio by modifying its asset allocation.

Future-proof your cash segmentation

The SEC’s latest round of money market fund (Rule 2a-7) reforms was published in July 2023. “While the precise impact of the reforms is unknown, treasury practitioners should try to understand the potential implications for their organizations”, advises the AFP guide.

The proposed reforms encompass four key measures:

1. The elimination of redemption gates.

2. An increase in daily and weekly liquidity requirements (the minimum daily liquid asset requirement has been raised from 10% to 25%, and the minimum weekly liquid asset requirements from 30% to 50%).

3. Adoption of a liquidity fee requirement. The AFP guide says, “Institutional prime and tax-exempt money market funds may have to impose a liquidity fee if they have daily redemptions of greater than 5% in net assets and if prices have moved more than a “de minimis” amount. This rule does not apply to government or retail funds.”

4. Additional provisions to address the effect of potential negative interest rates. Guidance is provided for any stable NAV fund (such as government and retail money market funds) on how to respond if the fund encounters a negative return in the future. Possible responses include converting to a floating NAV fund or employing a "reverse distribution mechanism” (share cancellation to cover negative yield).

The money market fund reforms are likely to impact treasury and government markets.

As suggested by the AFP guide, “There is likely to be a shift from prime to Treasury and government funds, albeit not on the scale seen in 2016. Other reforms also have implications for these funds. A key change is the increase in minimum daily and weekly liquidity requirements, which will have an impact on fund yields as investments are focused on shorter maturities.”

The reforms are also likely to lead to changes in investment policy and strategy. According to the AFP guide, market movement is expected as managers of prime funds consider converting to government funds to sidestep certain regulations. This may initially reduce the choices available to investors who prefer to remain in prime funds.

Additionally, the reforms mandate that all funds report or disclose investors holding over 5% of the fund by investor type. This measure may potentially help treasurers address concerns over “The risk of mandatory liquidity fees”, the AFP guide added.

To conclude, with interest rates predicted to drop, the AFP Executive Guide recommends that corporate treasurers revisit their investment approaches for each cash segment, realign their expectations considering market benchmark shifts, and report any forecasted changes in investment income to the CFO.

In this regard, the immediate next step for corporate treasurers would be to engage with their trusted advisors and fund managers to comprehend the likely impact or effects of money market fund reforms, particularly in uncertain times.