In wake of OSFI decision, cash alternative ETF products could see evolution in underlying portfolio holdings
While it was the late October decision by Canada’s banking and financial services regulator that ultimately threw the future of high-interest savings (HISA) ETFs into question, one industry leader argues it was just a matter of time before the short-term, high-yielding investment instruments would hit a roadblock.
“I looked at these structures many years ago. At the time and especially when these started growing and offering the yields they were offering, I think I and others clearly found them a little bit peculiar,” says Pat Chiefalo, head of ETFs & Indexed Strategies at Invesco Canada (pictured above). “The world of high interest-rate products that banks offered exists in a certain box, and these ETFs didn't live in that box.”
In the context of the low interest rates that defined the 2010s, the yields offered by HISA ETFs were certainly compelling. But for anyone who understood what needed to happen for banks and deposit-taking institutions to offer those types of yields, Chiefalo said it was clear that cash alternative ETFs couldn’t last in their present and popular form.
After cash ETF inflow tsunami, OSFI ruling breeds dismay
Against the backdrop of steeply rising rates over the past two years, Canada has seen a surge in popularity for HISA ETFs. According to figures compiled by National Bank, the category saw positive inflows every month in 2022, and inflows for the year reached a record $8.8 billion, effectively more than doubling the category’s assets at the end of 2021. In a more recent report, the Big Six bank said Canada-listed cash ETFs – counting both those in CAD and USD – had accumulated a grand total of roughly $21.845 billion in AUM as of September 30, 2023.
But the Office of the Superintendent of Financial Institutions (OSFI) has cast a pall of uncertainty over the sector. On October 31, the federal regulator said it would institute a 100% wholesale liquidity requirement for HISA ETFs, up from the 40% runoff rate banks had largely maintained on HISA assets prior to the ruling. To align with its core liquidity adequacy principles, OSFI said it would require all banks and deposit-taking institutions to maintain “sufficient high-quality liquid assets” to manage the risks around those instruments effective January 31, 2024.
“I think OSFI made the only decision they could … ensuring appropriate risk oversight and making sure the same rules were consistently applied across the banking infrastructure,” Chiefalo said.
OSFI’s decision was met with disappointment from at least two of Canada’s HISA ETF providers, who argued the new liquidity requirements would almost certainly negatively impact the yield these products would be able to provide investors moving forward.
An evolution in HISA ETFs?
Following OSFI’s move, analysts from National Bank suggested investors could see an evolution in the underlying composition of cash alternative ETFs. In the months prior to the OSFI ruling, it noted, all of Canada’s cash ETF providers announced they would allow for the inclusion of money market securities in their underlying portfolios, with three HISA ETFs already seeing such changes.
“Investors might also turn their eyes to money market, floating rate or ultra-short-term fixed-income products,” National Bank said in its September-October ETF flows report. “All of these alternative categories could offer competitive interest rates, but such ETFs may contain a certain level of minimal duration exposure. In addition, floating rate bond and ultra-short term investment-grade bond ETFs may have their own credit profiles different from money market or cash alternative ETFs.”
It also remains to be seen whether investors will see new rates on cash alternative ETFs in their next distributions, or if HISA ETF providers will wait three months before making any changes. Any future yield compression on these ETFs, National Bank’s analysts suggested, would be “a function of the negotiations between deposit-taking bank treasury departments and the ETF providers.”
Whatever lies ahead, it seems clear that the HISA ETF space will never be the same – and from Chiefalo’s perspective, it’s probably for the best.
“It was great that investors looked to ETFs for this type of exposure. However, I was never fully comfortable with the structure and yield level,” he said. “It’s great when you have products that do really well for investors, but they have to also make sense and stay within the existing regulatory regime.”