GLOBAL LIQUIDITY SOLUTIONS | 2016

Rethinking Your Investment Policy Statement

Cash investing is undergoing a transformation. As the post financial crisis market evolves, new
bank liquidity and capital requirements coupled with money market fund (MMF) reform, are
reshaping the landscape of investment options. In the wake of these new regulations, cash
investors need to adapt to the new complexities of cash investing and it is critical that your
investment policies are prepared for a new paradigm. In the following pages we propose an
investment policy statement framework that can be used as a path to develop your own
document. The aim of this document is to provide the necessary clarity and suggest the
parameters that will guide your organization’s cash investment strategy.
The investment policy statement is the investment blueprint for an organization. A well-
designed investment policy statement identifies the key risks and concerns that could affect
a business and will establish controls to mitigate those risks. It considers factors such as the
liquidity of an organization, the reliability of cash flow forecasting, corporate investment
philosophy and risk tolerance, the breadth of resources available and the experience of
those resources. The document will likely be shaped by the entity’s current liquidity
situation, but
should be flexible enough to respond to changing events. Also, the investment policy should be
written such that everyone has a clear view of the goals and objectives, yet should be specific to
avoid ambiguity and misunderstanding.

OVERALL CASH SEGMENTATION STRATEGY

The liquidity forecast is an integral component to the investment policy and likely shapes the risk appetite and
investment objectives of your investment policy. The ability to forecast cash with a reasonable degree of success
has long-term benefits and may provide opportunities to adopt certain strategies while also mitigating funding and
liquidity risks.

Overall Cash Segmentation Strategy Model Cash Flow

Daily Operating Cash

(Typical Investment
Horizon: 0-30 days)
Overall Cash Balance

Reserve Operating Cash

(Typical Investment
Horizon: 31-180 days)
Strategic Cash
(Typical Investment
Horizon: 181 days-1 year)
Longer Term Investments
0
(Typical Investment
Horizon: 1-3 years) Time
The information shown is provided for illustrative purposes only.
 GLOBAL LIQUIDITY

As investors adapt their investment strategy to the new market paradigm, we believe an important aspect will be the ability to stratify
liquidity. Investors who can reasonably forecast their cash flows are better equipped to segment their liquidity into distinct pools, each
with its own purpose and investment opportunity set. More specifically, investors will likely need to segment their liquidity into balances
needed immediately and those that are more stable. The cash stratification process can clearly offer advantages. Because liquidity can
come at a steep cost, bifurcating your cash may enhance the investment return and provide improved portfolio diversification. Today,
many clients follow this approach where excess cash is invested in securities with varied maturities and credit quality to earn incremental
returns. As you contemplate changes to your investment policy statement, we believe optimizing cash flow forecasting and liquidity
management will help better manage the high cost of liquidity.

Cash Segmentation Detail

DAILY OPERATING CASH RESERVE OPERATING CASH STRATEGIC CASH LONGER-TERM INVESTMENTS
Investment Horizon 0-30 Days 31-180 Days 181 Days-1 Year 1-3 Years
Objective (in order • High liquidity • Liquidity • Capital preservation • Potential for enhanced
of priority) • Late-day access • Capital preservation • Potential for enhanced liquidity returns
• Capital preservation • Potential for higher yield liquidity returns • Capital preservation
How cash is used • Daily operating needs • Known periodic payments • Dividend payments • Acquisitions
(payroll, supplier payments, • Debt repayment • Capital expenditures
accounts payable, tax • Bond proceeds • Other strategic uses
payments, etc.)
• Share buybacks • Unforeseen needs
• Capital expenditures
Cash flow volatility High High to medium Medium to low Low
Commentary • This cash is needed to be • Where immediate liquidity • This segment focuses • Excess cash with no planned
used immediately, but this is not needed, more options on cash not needed need (barring a major business
high liquidity comes with a are available to investors in the short-term, but change) offers investors with
sacrifice of lower yields • These additional options designated for a the ultimate flexibility and
• Deposit supply could be cut can help diversification specific use in the potential to enhance returns
back by banks, especially for and slightly enhance future • This segment is a sweet-spot
non-operating cash, due to potential returns • Recent regulatory and for strategies that focus
Basel III banking reforms. U.S. • Prime and Municipal market changes had less on purchasing securities
Government and Treasury MMFs need to be impact on this segment that are outside of the
MMFs could see pressure reviewed for their level than the first two more normal parameters
on yields as MMF reform of appropriateness liquid operating cash permitted by MMFs
pushes more investors to between the first two classifications. With that
these products. Despite operating cash segments being said, the pressures
these pressures weighing on due to on the most liquid cash
yields, this might not be a the possible imposition will provide even more
concern for this ultra-liquid of liquidity fees and opportunities for yield
short-term cash segment redemption gates advantages going farther
out the curve

Components of an Investment Policy Statement An example of this would be: The purpose of the Company’s
STATEMENT OF PURPOSE Investment Policy is to establish guidelines and procedures for the
investment and management of Entity XYZ and its subsidiaries’
The statement of purpose identifies the entities covered by the
global cash.
investment policy statement and the policies and procedures
that shall guide those involved.
INVESTMENT OBJECTIVES
Some questions to consider include:
The investment objectives define the purpose of the portfolio and
• Has the policy been adopted by the Board of Directors? profile the broad characteristics. The objectives can generally be
• Is the policy intended to comply with bond covenants and organized into three categories: risk, return, and liquidity. Below
collateral agreements? are objectives that might be found in an investment policy:
• Is the policy specific to the company’s balance sheet assets The principal objectives of the investment policy are to:
or are other activities covered?
1) Preserve principal
• Is the policy global or local? Have all subsidiaries and
2) Maintain appropriate liquidity
entities of the broader organization been considered? Does
the policy cover restricted and unrestricted cash? 3) Generate yield
• Is the policy aligned with the organization’s structure?

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Additional objectives may include: • Is periodically reviewed and reconsidered with reference
• Diversify investments to minimize concentration risk to evolving industry and market conditions
• Deliver returns consistent with benchmark indices for similar • Has been approved by the Board of Directors
investments
Understanding risk tolerance allows you to define the acceptable
• Maximize the risk adjusted return boundaries upon which you can build your investment policy
• Provide fiduciary control of the cash and investments statement. Acceptable boundaries can be designed to limit the
by individuals approved by the entity’s Board of degree to which the investment strategy varies relative to the risk
Directors free rate (cash), to minimize the probability of potential losses,
and to demonstrate consistency with the corporate attitude
RISK TOLERANCE toward risk.
Understanding an organization’s propensity to take risk and
how risk tolerance may change over time is one of the most USING BENCHMARK DATA TO ESTIMATE RISK
important aspects to consider when creating or updating your Assessing risk by using proxies, such as benchmark indices, provides
investment policy statement. Many factors will ultimately insight into the level of risk inherent in different investment
determine the overall level of risk tolerance an organization is strategies. Benchmark indices provide guidance for the trade-offs
willing to take, including: involved and can help communicate to management the probability
• Risk appetite – how much risk are you willing to take with of different events and the likely “worst case scenario” should they
your liquidity? decide to pursue a different strategy for their cash management.
Benchmark indices can be used to explain:
• Time horizon – what is your investment horizon? When will
the funds be needed? If the time horizon is long or excess • The benefits of extending duration and/or adding credit risk
cash is available, opportunities to take on incremental risk to your portfolio.
might be appropriate. • The probabilities of experiencing a negative return
• Corporate philosophy – How do the key stakeholders view over trailing time periods.
risk and what are their expectations? Is the strategy aligned
with your firm’s broader strategic objectives and how might • Historical portfolio drawdowns and subsequent recovery.
a shift in strategy affect the debt rating and growth • Implications for financial statement volatility.
prospects?
• Location of cash – Is your cash readily available for INVESTMENT OPTIONS
corporate purposes or is the cash trapped? Are there plans or Investments options should outline the permissible strategies that
is it possible to repatriate the cash? the entity may consider for investment. There are many factors
• Investment experience – Can the risks be appropriately to consider when evaluating investment options as individually
defined and articulated to management and the Board they have their own advantages and disadvantages.
of Directors?
With money market fund (MMF) regulatory reform changes
• Ability to monitor – can the strategy be integrated into the on the horizon, we believe now is an ideal time to review
reporting and governance structure? What additional controls your investment policy statement. While the U.S. Securities
and procedures need to be developed to monitor risk and and Exchange Commission (SEC) has adopted amended rules
do we have the technology/resources to support the revised to protect MMF investors, improving diversification,
investment framework? disclosure, liquidity and risk management, questions about
According to KPMG,1 a well-defined risk appetite should have the Prime funds will inevitably continue. Investors will need to
following characteristics: decide whether
“gating” options are suitable for daily, on-demand liquidity needs
• Reflective of strategy, including organizational and should consider other aspects as well, including:
objectives, business plans and key stakeholder objectives
• Does your language limit investments solely to
• Reflective of all key aspects of the business stable NAV funds?
• Acknowledges a willingness and capacity to take on risk • What MMF language is appropriate going forward?
• Considers the skills, resources and technology required • Does language that limits MMFs to “Rule 2a-7 funds”
to manage and monitor risk exposures in the context of consider all strategies that might be used as global
risk appetite investment options for your cash?
• Is inclusive of a tolerance for loss or negative events that • What concentration limits should exist for MMFs? Is it an
can be reasonably quantified absolute dollar amount or percentage? Should the fund size
and concentration limit for floating NAV funds be different
1
Source: KPMG, “Understanding and Articulating Risk Appetite,” 2008. from stable NAV funds?

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 GLOBAL LIQUIDITY

• Does your language reference ratings? Will all 2a-7 funds PERMISSIBLE INVESTMENTS
carry ratings going forward? Will AAA ratings continue to The permissible investments section of your organization’s
be used in Europe if the funds are no longer able to meet investment policy statement takes the process one step further
their dual objectives of principal stability and liquidity? and outlines the specific securities which have been authorized
• How does a floating NAV affect your reporting infrastructure for investment as well as additional restrictions as to credit
including pricing, accounting, compliance, and tax? quality, maturities, and concentration limits. The list of
permissible investment types should be transparent and within
Answering these questions and preparing for changes driven by sectors, and any limitations should be identified within each
the yield environment and regulatory reforms are critical steps sector. For example, if you permit securitized investments you
and may allow your organization to better optimize liquidity. may limit the collateral type, the collateral guarantee, and the
The examples below suggest appropriate language as well as quality of the collateral allowed. The table below illustrates
investment options typically used for liquidity management: how different security types should fit into each tier of your
cash segmentation strategy.
• Bank deposits
• Direct securities PROHIBITED SECURITIES
• Money Market Funds The investment policy statement should be explicit to prevent
– Government MMFs users from “reading between the lines” and making assumptions
– Prime and Municipal MMFs on permitted risks. The policy statement should include a section
• Other Structures of prohibited securities which likely is shaped by risk tolerance.
– Ultra-short bond funds Some examples of securities, security types, and strategies
– Short Duration bond funds which may be prohibited include derivatives, securities with
– Separately Managed Accounts embedded options, short selling, and margin transactions. We
– Private Funds suggest adding language that states unless a specific security
type is permitted by this policy, it should be viewed as
prohibited.

Permissible Investments
DAILY RESERVE STRATEGIC LONGER TERM
OPERATING CASH OPERATING CASH CASH INVESTMENTS
MONEY MARKET FUNDS
Government MMFs • • • •
Prime and Municipal MMFs • • • •
DIRECT SECURITIES
Government Securities • • • •
Sovereign, Sovereign Guaranteed, Supranationals and • • • •
Foreign Agency Securities
Bank Obligations (CDs, TDs, Bank Accounts) • • • •
Overnight Repo •
Term Repo • • •
Commercial Paper • • • •
Asset Backed Commercial Paper • • • •
Corporate Bonds • • •
Asset Backed Securities • • •
Covered Bonds • • •
Mortgage Backed Securities • •
Municipal Securities • • • •
OTHER STRUCTURES
Ultra-short Bond Funds • • •
Short Duration Bond Funds • •
Liquidity Separate Accounts • • •
Separate Accounts • •

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EVALUATING CREDIT QUALITY RISK CONCENTRATIONS

• For each eligible security type, minimum credit quality,
The investment policy should adequately define sources of credit maximum maturity, and maximum exposure per security
risk, the overall credit risk tolerance, permitted exposures, and type and per issuer for each sector should be defined. Pay
the procedures for monitoring credit risk. Lending arrangements, particular attention to the percentages as these bands
counterparties, and investments should be evaluated in aggregate should anticipate changes in supply that result from
for significant concentrations and strategies that offer balance regulatory reform.
sheet diversification should be considered. Key considerations
should include: • What is the policy for reporting issuers who are downgraded?
Should you maintain a “downgrade basket” so that
• What is the minimum credit quality acceptable to forced sales are not required? How do you
your organization? communicate downgraded securities across the
• How do you evaluate credit today? Do you have the breadth organization?
of credit resources internally to assess credit risk or should • How should you evaluate split rated securities? Should the
it be outsourced? same ratings methodologies as the benchmark providers or
• How does your organization monitor and measure credit risk should you follow a different approach which may be
and changes in credit risk? more closely aligned with your risk appetite?
• If you limit credit quality, what does it mean for • What are the current credit trends and how do they impact
available supply? your organization? For example, post-2008 public
• Does the minimum credit quality potentially leave you with resistance to the use of taxpayer support has led to a shift in
concentrated risk exposures? Historically, having a high the credit quality of many financials as the likelihood of
credit quality bias has left balance sheets with significant extending government support has been lowered. Sovereign
exposures to financials. Policies to ensure prudent ratings volatility can also influence the credit ratings of
diversification of credit risks should be evaluated and national banks and investment policies should anticipate
considered. the consequences of sovereign credit downgrades.

Credit and Maturity Guidelines

MAXIMUM MAXIMUM % SINGLE ISSUER MAXIMUM MINIMUM
MATURITY OF PORTFOLIO % OF PORTFOLIO CREDIT RATING*
MONEY MARKET FUNDS
Government MMFs NA 100% N/A AAAm/Aaa-mf
Prime and Municipal MMFs NA 100% N/A AAAm/Aaa-mf
DIRECT SECURITIES
Government Securities 5 years 100% NA NA
Sovereign, Sovereign Guaranteed, Supranationals 5 years 50% 10% AA-/Aa3
and Foreign Agency Securities
Bank Obligations (CDs, TDs, Bank Accounts) 1 year 50% 5% A-1/P-1
Overnight Repo 1 Day 25% 5% A-1/P-1
Term Repo 90 Days 10% 5% A-1/P-1
Commercial Paper 270 days 50% 5% A-1/P-1
Asset Backed Commercial Paper 270 days 50% 5% A-1/P-1
Corporate Bonds 5 years 50% 5% A-/A3
Asset Backed Securities 5 year WAL 20% 5% AAA/Aaa
Covered Bonds 5 years 20% 5% AAA/Aaa
Mortgage Backed Securities 5 year WAL 20% 5% AAA/Aaa
Municipal Securities 5 years 25% 5% A-/A3
OTHER STRUCTURES
Ultra-short Bond Funds NA 50% 10% NA
Short Duration Bond Funds NA 50% 10% NA
Liquidity Separate Accounts NA 50% NA NA
Separate Accounts NA 50% NA NA

*Credit Rating refers to the rating given by a Nationally Recognized Statistical Rating Organization (“NRSRO”) such as Standard & Poor’s Ratings Group (“S&P”),
Moody’s Investors Services, Inc. (“Moody’s”) or Fitch Ratings (“Fitch”) and is the rating firms’ subjective opinion concerning the ability and willingness of an issuer
to meet its financial obligations in full and on time. Ratings apply only to the underlying holdings of the portfolio and do not remove the Fund’s market risk. If
two or more NRSROs have assigned a rating, the highest rating is used. Ratings other than S&P ratings are converted into their equivalent S&P rating.
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 GLOBAL LIQUIDITY

BENCHMARK
ACCOUNTING AND RATING AGENCY CONSIDERATIONS
Benchmarking is the process of using data to identify, Included in your investment blueprint should be input from
understand, and evaluate the practice or performance of one’s key stakeholders, including your accounting and tax colleagues.
organization versus others. A benchmarking exercise enables As investors evaluate the opportunities for diversification and
entities to assess how well they measure up to a standard as well incremental yield, the accounting implications should be well
as whether or not that standard is best in class. Benchmarks are understood. Significant shifts in strategy may influence your
also used in investment portfolios for similar reasons; however, organization’s financial metrics which may have implications for
their limitations should be well understood. credit ratings and funding levels. While the rating agencies
• Benchmark data can be used to help identify an likely have adjusted how they view liquidity, reflective of the
appropriate strategy for your liquidity. Evaluating way many organizations now manage their cash, articulating the
benchmark returns, whose risks are similar to those you may strategy and the risk profile of the portfolio will be critical.
consider, can assist management in identifying how a change Additionally, understanding the differences between how
in investment strategy may influence their liquidity portfolio. investments can
Benchmark data with varied duration, credit, and volatility be classified and reported can influence the ultimate strategy
characteristics can be analyzed to understand how a shift selected. Questions we believe are appropriate include:
in strategy may influence the expected return/net income • How will the rating agencies view the investment
characteristics, the distribution of possible outcomes and strategy shift and what are the implications for the
impact to corporate financials. leverage calculations and credit ratings?
• Benchmarks can be used for evaluation purposes provided
it is representative of the intended risks an investor is • Will this strategy change the accounting for the
seeking. In order for the benchmark to be considered investment portfolio?
acceptable, it should be transparent, consistent, measurable, • Which accounting category (Held to Maturity, Available for
investable, and known in advance. Often, simple market Sale, or Trading) is most important to your organization?
indices do • What changes to accounting are FASB/IFRS contemplating
not reflect the permitted risks an investor may desire and in the future and do those changes have any effect on
constructing a customized benchmark with the desired your strategy?
duration and credit characteristics is the path investors will • Do you have an impairment policy? Will you need to develop
need to pursue. an impairment framework and how do you go about doing it?
• Benchmarks also have limitations. While benchmarks • What are your peers doing?
may also serve as tools to assess your strategy, the choice of
benchmark and the limitations of benchmark construction • What financial statement disclosures will you need to
should be well understood. Often, benchmarks are used make regarding portfolio liquidity, fair value pricing, and
to assess performance; however, the comparison may be investment risk?
more difficult due to limitations in portfolio strategy
RISK ORGANIZATION AND GOVERNANCE
or benchmark construction. For example a benchmark
should be investable and reflect all assets available to Risk management begins with a strong and visible commitment
investors. Often the benchmark may not be replicable or from the entire organization to understand risk and develop
investable because the index choice may include exposures the appropriate controls, including oversight, monitoring, and
not permitted in a client’s investment policy including reporting. Critical to the success is establishing an organizational
debt issued by companies domiciled in emerging markets, structure and policies that seek to mitigate risks. The following
subordinated debt, or of issuers whose credit quality is topics, we believe, should have a place in your investment
not permitted by policy. Investors should be aware of how policy:
benchmarks are constructed, the underlying risk inherent
in the benchmark, and whether the design and mechanics Custody
of the benchmark are consistent with the strategy being The custodian plays a key role in managing your assets as
pursued. Additionally, benchmarks are rebalanced monthly they are responsible for settlement, safekeeping, and reporting
with new constituents being added and removed from the of the investment portfolio. Often, clients hire an
index and the portfolio similarly should be rebalanced with independent custodian to segregate investment management
the same frequency. from the safekeeping of assets. The basic premise behind
segregation is that by separating responsibilities the ability to
perpetrate and conceal fraud is greatly reduced. Custodians
also can provide standardized pricing, investment guideline
compliance and reporting across multiple portfolios, which
may also be sought be clients.

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Reporting
Summary
Taking stock of the reporting needs across your organization
The investment policy statement serves as a blueprint for
and including it in the investment policy statement is also
your organization and guides the planning and
important. Reports may be designed to identify investment
implementation of a liquidity program. The examples
holdings, performance, key risks, and should be calibrated
provided in the template should serve as a roadmap to build
to meet the needs and objectives of senior management
your policy. However, one
and/or the investment committee. To ensure that the key
should recognize that entities are idiosyncratic and that the final
risks are identified, monitored, and reported an organization
blueprint you build should reflect the objectives, restrictions,
might need to identify infrastructure that can be leveraged
risk tolerances, and preferences that are important to your
or deployed and your organization should be willing to
organization. At Morgan Stanley, we are committed to working
allocate resources to ensure the right governance structure is
with our clients and assisting you in designing your investment
designed. Lastly, policies around record retention and business
policy statement to best suit your needs.
continuity should be highlighted.

Roles and Responsibilities

An investment policy should also identify who is responsible About Morgan Stanley
for the implementation, oversight, management of the Investment Management
strategy, and the roles and responsibilities of the Board of
Morgan Stanley Investment Management has managed money
Directors, senior management and the treasury staff. The
market assets since 1975 and is dedicated to offering clients
investment policy should clearly define:
unique investment solutions through institutional money market
• Duties and responsibilities of all parties involved. funds and highly customized solutions. The Global Liquidity
• Procedures for periodic review and policies Solutions team, which has over $153 billion in assets under
for implementing change. management,* is comprised of highly experienced professionals
across the U.S. and Europe and welcomes the opportunity to
• Procedures for approving policy exceptions if permitted.
advise on the issues impacting short-term markets both broadly
• Criteria for outsourcing or insourcing management of the and with respect to your investment policy statement. If you have
corporate liquidity. The segregation of responsibilities further questions or require additional assistance, please contact
with escalating approval depending on risk. your Morgan Stanley Relationship Manager.
• The authority to implement investment strategy
decisions, wire transfers, and other critical tasks. *
As of December 31, 2015.

Compliance
Compliance reporting to satisfy internal auditors and
management will be required. The source of that information,
the frequency, and requirements should also be determined.
Independent compliance monitoring is generally preferred as
the separation of duties is critical to effective risk
management. The policy should be written in a way such that
testing can be appropriately conducted and that reference data
is available from independent sources to validate compliance
rules.

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Privately offered unregistered funds whose interests are offered only to
a limited number of sophisticated investors pursuant to a confidential This document represents the views of the portfolio management team. It
offering memorandum. does not reflect the opinions of all portfolio managers at Morgan Stanley
Investment Management and may not be reflected in other strategies
There is no assurance that a money market portfolio will achieve its
and products that the Firm offers. The document has been prepared as
investment objective.
information for investors and it is not a recommendation to buy or sell
An investment in a money market portfolio is not insured or any particular security or to adopt any investment strategy. Current and
guaranteed by the Federal Deposit Insurance Corporation or future portfolio holdings are subject to risk. The authors’ views are subject
any other government agency. Although the portfolios seek to to change without notice to the recipients of this document. The forecasts
preserve the value of your investment at $1.00 per share, it is in this piece are not necessarily those of Morgan Stanley, and may not
possible to lose money by investing in the portfolios. actually come to pass.
Shareholders should consult their individual tax advisor to Please consider the investment objectives, risks and fees of the strategy
determine whether the portfolios’ distributions derived from carefully before investing. A minimum asset level is required. For important
interest on the U.S. Treasury obligations and U.S. Government information about the investment manager, please refer to Form ADV Part 2.
securities are exempt from state taxation in their own state. There is no guarantee that any investment strategy will work under all
market conditions, and each investor should evaluate their ability to invest
Past performance is no guarantee of future results. for the long-term, especially during periods of downturn in the market.
This material has been prepared using sources of information generally
Morgan Stanley Distribution, Inc. serves as distributor for the Morgan
believed to be reliable but no representation can be made as to its accuracy.
Stanley Institutional Liquidity Funds.
Please consider the investment objectives, risks, charges and Morgan Stanley Investment Management is the asset management division
expenses of the portfolios carefully before investing. The of Morgan Stanley.
prospectus contains this and other information about the
portfolios. To obtain a prospectus, download one at
www.morganstanley.com/im or call 1.800.236.0992. Please
read the prospectus carefully before investing.

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