The Cash Management Programme
There are a number of banks and specialist cash management companies ("Cash Managers") that offer a cash management programme (the "Cash Management Programme") to asset managers and funds. Often the Cash Management Programme is combined with the security of a trust status bank account. In simple terms, the Cash Manager will open one or more trust accounts with a money centre US bank, in the name of the fund, through which they operate the Cash Management Programme. The investment objective of the Cash Management Programme is to achieve a small but positive yield enhancement over and above TBills, or some other predetermined benchmark. It is important to be clear that the Cash Manager does not set out to achieve dramatically enhanced yields, but rather aims to provide a consistent, marginally improved return.
But what is the added value of the Cash Management Programme to a fund and its shareholders?
Custody of Assets
When establishing an offshore fund it is important to clearly demonstrate to potential investors that the fund has been organised so that the custodial arrangements ensure that the assets are as secure as possible and protected from any third party risk, except, of course, the inherent market risk.
In order to provide this comfort to investors it is common practice to appoint a custodian bank as the "Custodian" of the fund. The Custodian normally receives all subscriptions, which are paid into an account held with the Custodian on behalf of the fund. Out of this account, the Custodian pays monies to the fund's Prime or Clearing Broker. It would also pay the proceeds of redemptions to shareholders, as well as all the operating expenses of the fund, subject to receipt of proper invoices, which would be provided by the Administrator.
It should be noted, however, that a Custodian will not normally accept responsibility for any assets held outside of its control. This applies particularly with regard to any assets held in the account of the fund with the broker.
Custodial Fees for Futures and Commodity Funds
Custodians, as a general rule, are paid an annual fee, which is usually calculated as an annual percentage of the average total Net Asset Value of the fund, often subject to a minimum monthly fee.
With a more traditional securities fund, such fees are equitable. However, with a futures, or commodity fund, where it is normal practice for the majority of the assets to be held with the Clearing Broker, such fees are more difficult to justify - particularly, if the Custodian will not accept any responsibility for the assets of the fund held by the Clearing Broker.
Although the Cash Management programme described below was originally created for the managed futures industry, it is also highly beneficial to other alternative investment and hedge funds that, from time to time, maintain high cash balances - as described under "The CMP Trust Account" below.
Customers' Pooled Segregated Accounts
Most major Clearing Brokers, are Futures Commodities Merchants ("FCMs") and operate under CFTC regulations, which require that customers' monies are segregated into a "Customers' Pooled Segregated Account" (the "Pooled Account"). This is a separate account from the FCM's everyday operating account. Thus the FCM is not able to utilise customer's monies for its own purposes. However, the segregated account, into which an individual customer's money is paid, is not an individually segregated account - it is a pooled segregated account, into which monies belonging to many, if not all of the FCM's customers, are paid.
What many, often sophisticated and experienced investors (and even some CTAs), fail to appreciate is that, if the FCM was to suffer a major client loss, (relating to a client who was a participant in the Pooled Account), which resulted in a deficit, after applying the sum of all of the assets held for the defaulting client and all of the FCM's liquid assets, then the Pooled Account could suffer net losses. In such a case those net losses would be passed on, on a pro-rated basis, to the remaining individual participants in the Pooled Account.
The CMP Trust Account
An account providing custodial and cost efficiency for futures and commodity funds and other funds that have substantial cash balances.
Custom House has identified Specialist Cash Managers, including banks who will offer the Cash Management Programme. Programme. This can be using a managed account or a custodian bank, although it is offen operated through two trust accounts held with a leading US bank (the "CMP Trust Accounts"). The first account will be the "Operating" or "Subscription Trust Account", into which the initial subscriptions would be paid. The net subscriptions (i.e. after deduction of initial charges or sales commissions) are then paid into the second account - the "Investment" or "Trading Trust Account" - and invested in the money markets, by the Cash Manager, on behalf of the fund. The Cash Manager will comply with the investment risk profile set by the Investment Manager or The Directors of the fund.
Utilising this Investment Trust Account, the Cash Manager would, on a daily basis, not only pay any margins due to and called for by the FCM, but also draw down, from the FCM, any balances in the fund's account at the FCM which are surplus to the FCM's margin requirements.
Each month Custom House, as the Administrator of the fund, would give instructions to the Cash Manager to transfer money out of the Investment Trust Account into the Operating Trust Account, to meet monthly operating expenses. In addition all other payments to third parties, including service providers fees and Shareholder redemptions, would be made out of the Operating Trust Account after taking into account any subscription received.
Both accounts would be held under a trust structure with the named US money center bank. This means that the monies held in these accounts are truly segregated, in fact and law, in the name of the fund and thus fully protected in the event that the FCM, the Cash Manager, or, indeed, the bank holding the fund's trust accounts, were to fail.
CMP Trust Account - Advantages
(1) Advantage - Asset Protection
The main attraction of the CMP Trust Account is that the fund's assets are not vulnerable to losses from third party credit risk, because they are held in an individually segregated trust account.
The experiences of recent years, such as the Refco debacle, epitomised by the "Barings Syndrome" have raised concerns as to which FCMs have sufficient capital to survive such a major client collapse. What is worrying is that the next major collapse may be larger than any FCM. Therefore we believe that it can only be prudent for all cash liquid funds to incorporate a secure custodial structure.
We believe that the CMP Trust Account provides maximum security (with additional cost efficiencies) and should be considered in preference to holding surplus cash assets with an FCM, however well known and however well capitalised that FCM may be.
Hedge Funds also have a counter-party risk in their relationship with their Prime Broker. Therefore any Hedge Fund that holds meaningful cash balances should consider the Cash Management Programme.
(2) Advantage - Professional Cash Management
The CMP Trust Account ensures that the fund's reserves will receive daily attention from professional cash managers. Professional management - knowing which securities to buy in a given class - can help ensure the highest return commensurate with the risk parameters and liquidity requirements of each fund. Cash managers add value as a result of the economies of scale they achieve on behalf of all their clients, their knowledge of the specific issues within each risk / return category, and their continuous monitoring of market conditions.
(3) Advantage- Cost Savings = Performance Enhancement
The CMP Trust Account is a truly cost efficient (and therefore performance enhancing) alternative to the classic custodial bank arrangements. The cost of custody under the CMP Trust Account is usually less than 0.01% of the NAV p.a. Minimum custodial fees can equate to as much as 0.5% of the NAV, or substantially higher, for a small or medium sized fund using a Custodian Bank, whereas the yield on a cash management programme is usually paid net of cash management fees. Furthermore, Prime and Clearing Brokers and FCMs will not usually accept, indeed, are often legally prohibited from accepting, subscriptions for offshore funds and therefore a payment bank has to be appointed. The trust bank utilised by the Cash Manager will fulfill this function.
Thus the CMP Trust Account can, not only enhance the return to the fund by efficient cash management, but also introduce a 'hidden' profit, reflecting the savings obtained by virtually eliminating the custodial fees.