Cash equivalents for EU investors

🇪🇺  discusses investments which have performance similar to cash.

Cash equivalents
In the investment world, we speak of cash as a collection of short-term investment instruments that are highly liquid and easily converted into ready cash. These investments make up the money markets. The short-term nature of all money market instruments means that they rapidly adjust to changes in short term interest rates.

Cash includes familiar bank instruments such as transaction and savings accounts, as well as short term bank certificates of deposit (CDs). Cash also includes a number of marketable liquid securities bought and sold on the money markets. These securities include treasury bills, institutional large bank CDs, commercial paper, bankers acceptances, and repos. Short term municipal securities are held by tax-exempt money funds.

Role of cash in long-term portfolios
Portfolios designed with retirement as their goal go through an accumulation stage, where assets grow because of new contributions and portfolio returns, and then a withdrawal stage. The importance of cash in such long-term portfolios can vary from next to no role at all to an important role, especially during the withdrawal stage.

Cash investments can be held by investors for a number of reasons, ranging from as little as 5% of a portfolio for a younger investor for instance for liquid emergency reserves and for funding obligations due in the short to intermediate term, to inclusion in a portfolio during the withdrawal stage as adequate cash to offset any drawdown so as to avoid selling equities during a protracted market downturn.

EU banking background for the retail investor
There are some differences between the various cash instruments in the different world regions. The US system is probably the most developed and offers the greatest number of options to the retail investor. In non-US regions the picture is quite different and varied. In this section we will look at the options available and their relevance to the retail investor in the EU.

For EU retail investors the situation remains quite fragmented and makes it difficult to apply guidelines for the entire EU. There are still a lot of country specific assets such as bank accounts and for example some assets, that are similar for instance to US savings bonds e.g. UK premium bonds, which have from time to time been a good cash alternative.

The assets available for retail investors in the EU as alternatives to variable interest rate, instant access bank deposit accounts require careful consideration before any decision to invest is made, some of these assets are not widely available for retail investors such as money market funds, and advice from a qualified and certified adviser should be sought. Although generally these investment assets such as money market funds, short term bonds and ultra short term bonds have reduced risk levels over other assets such as equities and long term bonds, they retain capital loss risks.

The purchase of cash equivalents (see note on bank accounts below) such as certificates of deposit or short term bonds can be direct and can also form part of the purchase of a fund, i.e. a short term bond fund etc. The direct purchase of these assets is not considered in detail here with the exception of the examples given below.

The holding of fixed term accounts within qualifying EU based banks is subject to the deposit guarantee rules.

Taxation note
The taxation of shorter term bonds and money market instruments is beyond the scope of this article.

In regards to deposit accounts in banks, the assumption must be that the investor needs to comply with the tax regime in the jurisdiction where the account is domiciled, assuming that accounts can only be opened and maintained by local residents.

The assumption made in this article is that by investing in UCITS ETF's the tax status vis a vis the US should be managed by the asset manager and the tax if any due on the investment fund will be subject to the investors local tax liabilities.

The broad assumption is that publicly traded bonds (of any duration) and CDs (or any money in a bank account) are not considered "US situs property".

Bank accounts
The different jurisdictions (28 nations) and the various banking systems across the EU are too disparate to be described here in full or in any great detail, a separate study will need to be carried out which may best be based upon a country by country approach. While it is not the main purpose of this article to discuss the various bank account solutions that are available to EU investors, there are some examples that are worth citing to demonstrate practical solutions available in some jurisdictions, see below in section on fixed term bank accounts.

In respect to the possibility of opening a bank account that is not in your tax domicile in the EU it should be noted that it is difficult to open and maintain a non resident bank account in Europe. The documentation requirements are ever increasing and banks will ask non residents for credit and background checks in order to comply with KYC requirements. There appears to be some exceptions to this in the case of Raisin, Medirect Bank and others see note below.

It is worth noting that the deposit guarantee system in the EU is not comprehensive and for investors with larger sums held in cash the bank guarantee system isn't accommodative especially where a lower risk level is desired.

The restrictions placed upon EU retail investors are in contrast to what is available to US retail investors in regards to the ability to lodge larger cash amounts in fixed duration accounts or certificates of deposit. The upper threshold for the amount at risk in the EU per bank per individual is €100,000 whereas in the US that amount is $250,000 per depositor per bank per account category. In addition in the US there are facilities available to lodge above this level up to substantially more than $250,000. The result being that using no more than two or three banks an amount of cash c. $1,000,000 can be deposited safely if this was necessary. In the EU this is more difficult and time consuming.

See note below on deposit guarantee system for EU which will lead investors to seek alternatives.

Fixed term bank accounts
In order to provide some practical colour to the available shorter fixed term bank account options available in Europe examples of local banks and their current fixed term offerings are given here below. As more information becomes available further examples can be included. These examples are not intended to be comprehensive or to give any indication of the ratings and security of the banks or the competitiveness of their offerings. The rates and terms on offer may change and details should be carefully reviewed prior to any commitment. These accounts are covered in the same way as any other bank account in respect to the EU deposit protection system.

On line banks
The following banks operate across borders at least within the EU region. Access to these banks has not been checked comprehensively and each individual considering using any of the banks for fixed term deposit accounts should satisfy themselves of the banks requirements for account opening, the fees and charges if any, the pedigree of the bank and its participation in the EU deposit guarantee system which it should be remembered is country specific.

Raisin provides a pan Europe bank account access facility. Residents of an EU/EEA country or Switzerland (with the exception of Belgium and Ireland) who are at least 18 years of age and acting on their own behalf, will be able to open a Raisin account. This account then gives access to a range of banks across Europe that offer different deposit accounts. Raisin state that each of the banks has been vetted by them and that they are members of their respective countries deposit guarantee scheme.

Medirect Bank provides online fixed term savings accounts. Accounts are available to both EU citizens and expat EU citizen and are subject to Bank’s review and acceptance. According to Medirect Bank's website; all MeDirect accounts are guaranteed up to €100,000 by the Malta Financial Services Authority (MFSA) under the Depositor Compensation Scheme. In addition it states that interest income earned on Investment Cash Accounts, Savings Accounts, Me1 Savings Accounts, Me6 Savings Accounts, ME3 Savings Accounts, Me12 Savings Accounts, Fixed Term Deposits and NOW Accounts is not subject to foreign withholding tax. The main ownership of Medirect Bank is with AnaCap Financial Partners LLP, a UK private equity firm.

Fimbank Direct provides online fixed term savings accounts and is primarily designed for use by mobile phone users. According to FIMBank's website, FIMBank is based from Malta and provides online fixed term deposit accounts. FIMBank p.l.c. is a participant of the Depositor Compensation Scheme in Malta, established under the Depositor Compensation Scheme regulations, 2015 (‘the Regulations’). The Malta Depositor Compensation Scheme covers deposits in any currency up to EUR 100,000 or equivalent. The main ownership entities of FIMBank consist of United Gulf Holding 78.66%, Burgan Bank K.P.S.C. 8.5%, and Tunis International Bank 1.76%.

Germany
Banks - Germany provides an overview of the account types available in Germany and also provides a comparison of various rates and terms on offer for different competing banks' fixed term deposit accounts.

Netherlands
The Netherlands bank LeasePlan has an online only savings account with an interest rate starting at 0.35%. Once you've opened a "standard" savings account this allows you to move the money in and out and then you can open deposit accounts with different durations and interest rates.

There are the following durations and rates available (rates current as of March 2019):


 * 3 month: 0.30%
 * 6 month: 0.45%
 * 9 month: 0.55%
 * 1 year: 0.65%
 * 2 years: 0.75%
 * 3 years: 0.85%
 * 4 years: 0.95%
 * 5 years: 1.05%

Minimum investment in these deposit accounts is €1,000 which allows quite some flexibility to build the ladder required. For example you can buy 7 deposits of €1,000 each from 6 month to 5 years. At this time the 3 month is lower then the normal savings account and is therefore unattractive.

United Kingdom
The UK bank Metro Bank PLC offers a suite of deposit accounts / bonds which follow an ascending interest rate and increasing duration that could act as a ladder. An instant access savings account will need to be opened prior to the fixed term deposit accounts, (rates current at March 2019).


 * 3 months: 1.00%
 * 6 months: 1.25%
 * 12 months: 1.70%
 * 18 months: 1.95%
 * 36 months: 2.05%

Compare the Market provides an overview of the account types available in the UK and also provides a comparison of various rates and terms on offer for different competing banks' fixed rate deposit / bond accounts.

US deposit guarantee system
In the US the FDIC (Federal Deposit Insurance Corporation) system operates so as to provide a significant protection to ordinary investors for their deposits. The standard insurance amount is $250,000 per depositor, per insured bank, for each account ownership category.

EU deposit guarantee system
In the EU there is a similar system to the US which however is much less generous and is confined to participating banks providing a €100,000 deposit guarantee per depositor per bank. This situation results in significant deposit risks for an EU retail investor who wishes to hold readily accessible and secure "cash" amounts over €100,000. The Deposit Guarantee Schemes (DGS) reimburse a limited amount to compensate depositors whose bank has failed. A fundamental principle underlying DGS is that they are funded entirely by banks, and that no taxpayer funds are used.

Under EU rules, deposit guarantee schemes seek to:


 * protect depositors' savings by guaranteeing deposits of up to €100,000
 * help prevent the mass withdrawal of deposits in the case of bank failure, which can create financial instability

In 2014, the EU adopted Directive 2014/49/EU. It requires EU countries to introduce laws setting up at least 1 DGS that all banks must join. EU countries must


 * ensure a harmonised level of protection for depositors
 * produce lists of the types of deposits that are protected

It must be stressed that the protected funds are limited in Europe, and you need to be careful as the compensation amount is set per financial institution and some financial groups might count as one – for example Lloyds, Halifax and Bank of Scotland count as one institution, as do HSBC and First Direct whereas RBS and NatWest count as two all in the UK.

Cyprus "haircut"
The degree of deposit protection is dependent upon the regulations introduced on a country by country basis within the EU. The threat to investors deposits in EU country banks is not theoretical, in the period of 2012 - 2014 in Cyprus The ‘Troika’ of creditors agreed the final deposit levy on Cypriot accounts was to be 47.5% for shareholders, bondholders, and depositors with more than €100,000 in the two largest Cypriot banks. The "Troika" is the European Commission (EC), the European Central Bank (ECB) and the International Monetary Fund (IMF).

The levies placed on large depositors were used as equity to recapitalize the bank, following a decision reached in March 2013 as part of the bailout package for Cyprus.

As a condition for receiving a $13 billion (€10 billion) bailout package, Cyprus was forced by Troika lenders to sponsor a portion of their bailout, which they raised by levying shareholders, bondholders, and depositors with more than €100,000 in accounts. Therefore for investors wanting to hold substantial cash amounts for whatever reason, it is essential to manage the cash instruments so as to avoid deposit compromise.

Money markets
The money market is where financial instruments with high liquidity and very short maturities are traded. It is used by participants as a means for borrowing and lending in the short term, with maturities that usually range from overnight to just under a year. Among the most common money market instruments are eurodollar deposits, negotiable certificates of deposit (CDs), banker's acceptances, U.S. Treasury bills, commercial paper, municipal notes, federal funds and repurchase agreements (repos).

Money market transactions are wholesale, meaning that they are for large denominations and take place between financial institutions and companies rather than individuals. Money market funds offer individuals the opportunity to invest smaller amounts in these assets.

Money market funds
A Money Market Fund is a type of mutual fund.

MMFs issue shares to investors to finance their activities, offering a high degree of liquidity, diversification and market-based yields.

The value of their shares fluctuates in line with the price of the debt instruments in which they have invested. They have to maintain a high level of asset liquidity to be able to meet daily redemptions by their investors.

There are three types of MMF available in the EU, these are:


 * Treasury bills
 * Commercial papers
 * Certificates of deposit

These MMF's are further categorised by their risk profile into:


 * Public debt constant net asset value
 * Low volatility net asset value
 * Variable net asset value

These funds are managed by asset managers who are either controlled by banks or by independent entities. The expenses associated with these funds can vary widely from asset manager to asset manager. Some funds require entry premia and the expense ratio should be carefully checked in all cases.

The MMF's in the EU are mainly used by institutions and large corporate bodies to place shorter term cash. Individual investors can purchase money market ETF's through online platforms and through financial advisers. A selection of MMF's are shown in the following table:

Certificates of deposit
The term Certificate of Deposit or CD refers to money market instruments of relatively short duration or savings accounts that pay a fixed rate of interest until a given maturity date. Also, funds placed in a Certificate of Deposit usually cannot be withdrawn prior to maturity or they can perhaps only be withdrawn with advanced notice and/or by having a penalty assessed.

Certificates of deposit are typically known as term deposits in countries like Australia, Canada and New Zealand, as time deposits in Asia, CDs in the United States, as fixed rate bonds in Great Britain, and as fixed deposits in some other countries.

Cash on deposit in trading platforms
It is worth noting that cash amounts held in dealing platforms are likely to be kept by the platform in a money market account or similar, this should be checked where larger sums are being held for whatever reason. This will enable the investor to understand the risks to their cash in investing platforms.

EU money market regulation changes
The regulatory regime for MMFs is currently undergoing signiﬁcant change due to the implementation of the EU Money Market Fund Regulation (MMFR) which applies from 21 July 2018. Existing MMFs benefit from an 18-month transitional period and are required to comply by 21 January 2019. Under the MMFR, an MMF may be established as:


 * a Public Debt CNAV MMF;


 * a Low Volatility NAV (LVNAV) MMF; or


 * a variable NAV (VNAV) MMF.

The Public Debt CNAV MMF will value assets under the amortised cost accounting methodology and must invest 99.5% of its assets in government backed securities.

The LVNAV is permitted to use amortised cost accounting to value assets that have a residual maturity up to 75 days, while other assets must be valued at mark-to-market/mark-to-model. The LVNAV may display a stable share price per unit/share as long as this does not deviate by more than 20 bps from the price per unit/share as calculated under the mark-to-market/mark-to-model methodology.

Alternatives to money market funds for EU investors
For those EU investors looking for alternative assets with reduced levels of risk to hold cash, there are alternatives that may be appropriate other than bank deposit accounts and money market funds. This approach may be salient for retail investors who may wish to maintain or reduce their lower risk exposure and at the same time to avoid any possibility of capital loss through bank haircuts. In addition the use of these assets can be part of an investors process of holding capital prior to investing. Short term bonds and ultra short term bonds may be worthwhile evaluating albeit there are risks attached to holding these assets which could lead to loss of capital. There are a number of considerations when contemplating investing in short term or ultra short term bonds:


 * Home currency and hedging
 * TER
 * Sterling investors may consider gilts preferable
 * Tax status of home country may affect the choice of accumulating or distributing versions if they exist
 * Low return rates of some bonds including negative returns
 * The risk profile of government bonds and corporate bonds
 * Alternative local fund options that may be available in some individual countries
 * Pension fund options where they exist may offer simplicity and tax efficiency

Short term bonds
Investors looking for capital preservation may try to focus some part of their portfolio allocations on minimal-risk investment options, including cash, money markets, certificates of deposit (CDs) and bonds. Short-term bonds fall on the safer end of the debt risk spectrum due to their short duration and near-cash status. A shorter duration or maturity date leads to less credit risk and less interest rate risk. The choice of bond will affect the risk level, with government treasuries presenting less risk than corporate bonds. Some short term bond funds that are available to retail investors are listed in the table below:

Note: In any choice of an ETF check that the currency, accumulation / distributing status, hedging, exchange are compatible with your needs and provides the most cost effective solution.

Ultra short term bonds
Ultra-short term bond funds are bond funds that invest only in fixed-income instruments with very short-term maturities. An ultra-short bond fund will ideally invest in instruments with maturities up to around one year. This investing strategy tends to offer higher yields than money market instruments, with fewer price fluctuations than a typical short-term fund. It is important to note that ultra short term bonds are not money market funds and are not subject to the special regulatory requirements (including maturity and credit quality constraints) designed to enable money market funds to maintain a stable share price.

Ultra-short term bond funds give investors more significant protection against interest rate risk than longer-term bond investments. As noted above ultra short term bonds are normally more risky than money market instruments, this is in part due to the fact that money market funds generally are required to invest in specific assets including government debt, corporate debt, while ultra short term bond managers have a wider remit and are not subject to the same regulations as money market funds.

Suggested suite of cash equivalent funds for EU retail investors
An EU investor looking to hold a cash equivalent might consider using one or a combination of funds from the above asset categories. The following table shows a short list of possible candidates for a range of cash equivalent funds. Considerations include:


 * Expenses
 * Hedging to home currency
 * Sterling investors may prefer gilts
 * Check for "hidden" charges such as exit premia
 * The funds may be negative

These funds are provided by reputable managers and have reasonable expenses without entry or exit premia: