BankingCash InvestmentsTalking Shop

Talking Shop: Investment Policies and Counterparty Risk on Cash

By April 13, 2023No Comments

Editor’s note: NeuGroup’s online communities provide members a forum to pose questions and give answers. Talking Shop shares valuable insights from these exchanges, anonymously. Send us your responses: [email protected].

Context: The failures of Silicon Valley Bank, Signature Bank and Credit Suisse dramatically drove home the critical need of corporations to keep close tabs on the credit worthiness of their banking partners. In response to the crisis of confidence, some companies moved money out of smaller, regional institutions into large, global systemically important banks. The tumult also sparked questions for treasury from audit committees and the C-Suite about counterparty risk and investment policies.

Sharing investment policies. In response to the inquiry posted below, two NeuGroup members shared edited versions of their investment policies with the peer who asked the question. Excerpts from those two policies, also provided to NeuGroup, follow a response from another peer.

Don’t change the policy? When asked by NeuGroup Insights, the treasurer of one company that provided its policy said he did not change it in the wake of events in the banking world. “We believe a good investment policy should not need to be changed for every crisis. If it is a good policy, it covers all the potential risks,” he wrote.

  • “We do and have given our investment managers tactical guidelines that are more conservative than the investment guidelines,” he added. “In this case, for financials since 2009, we only allow the purchase of specific bank names from a list we provide. We review and edit it from time to time.
  • “One example why we do that is our primary operational bank. Worldwide, we have plenty of exposure to that specific bank via balances in our bank accounts; therefore, we do not allow our asset manager to buy their bonds even though they meet the ratings threshold.”

Question: “I’m looking to see if anyone has a framework in their investment policy around counterparty risk on cash? The news about SVB, Signature and CS prompted an audit committee inquiry about our investment policy. I would appreciate it if anyone is willing to share their investment policy.”

Peer answer 1: “While I cannot share our investment policy itself, we employ best practices and place limits on counterparties. Limits are a combination of hard dollar limits and percentage limits, which allow for flexibility during cash peaks.

  • “We also employ minimum credit ratings and duration limits. Any exceptions (which are few) require advance written approval by the treasurer.”

Peer 2 investment policy excerpts:

“Counterparty credit risk management rules/guidelines:

  • “Asset size-based limits: The company limits counterparty exposure for certain assets to institutions with assets above a specific threshold, as defined by asset type.
  • “Ratings-based limits: The company limits the amount of allowable exposure to a counterparty by the financial condition of the counterparty, as assessed through rating agency (Moody’s, S&P, Fitch) ratings.
  • “Diversification requirements: For certain investment types (e.g., money market funds), the company requires diversification of these investments across multiple funds.
  • Credit Default Swaps (CDS): To the extent the company needs to maintain investments or cash management services at a counterparty and it results in an exposure above the allowable ratings-based limits, a CDS swap may be purchased to mitigate this risk as determined by the CFO and treasurer.”

“Escalation during observed risk events: If a bank’s credit rating falls below BBB- by S&P or Fitch and Baa3 by Moody’s, the corporate treasurer and financial risk committee will be notified.”

“Maximum cash exposure by rating. The following ratings limits exist for cash and cash investments with a maturity of two days or less. All counterparties must be rated by at least one of the three rating agencies (Moody’s, S&P, Fitch), but if rated by multiple agencies, the lowest rating is used.”

Peer 3 investment policy excerpts:

“Cash investments are placed in investment grade financial instruments (excluding BBB) to ensure safety of principal.”

“Diversification. Securities of a single issuer, valued at cost at the time of purchase, should not exceed 3% of the market value of the portfolio. The following specific portfolio holdings limitations are in effect:

  • “Finance corp. securities, including bank notes and bonds: 10%
  • “Industrial/corporate notes and bonds: 40%
  • “Commercial paper: 50%”

“Quality. Individual holdings of commercial paper must be rated A-1, P-1, or better by either S&P, Moody’s or Fitch at the time of purchase.

  • “Securities of issuers with a long-term credit rating must be rated at least A-/A3 by S&P, Moody’s, or Fitch. If a security held in the portfolio does not maintain the minimum rating specified above by one of the rating agencies the investment advisor will notify the treasurer and the security will be sold within 30 days.
  • “Asset-backed securities and mortgage-backed securities must be rated AAA.”
Justin Jones

Author Justin Jones

More posts by Justin Jones