As part of its July 23rd Money Market Fund Reform package, the SEC re-proposed amendments for the "Removal of Certain References to Credit Ratings" which would eliminate the credit ratings requirements for money market funds. The biggest change is the SEC eliminating its "First Tier" and "Second Tier" definitions and replacing these with a single but more amorphous "minimal credit risk" standard. The proposals are open to a 60-day comment period (once they're published in the Federal Register), and comments may be submitted to rule-comments@sec.gov (include File Number S7-07-11 on the subject line). Below, we take a deeper dive into the proposal, which is posted on the SEC's web site. We believe these proposed changes should have little impact on fund's current investment policies (once finalized and implemented), but we believe they will reduce even further the already mimimal amount of "Second Tier" securities purchased by money funds. Note that the SEC's proposal only involved mandates for the ratings of money market securities, and does not involve or impact triple-A ratings on money market funds (which will still be permitted).
According to the proposed new rules, a money market fund could invest in a security "only if the fund's board of directors (or its delegate) determines that it presents minimal credit risks, and that determination would require the board of directors to find that the security's issuer has an exceptionally strong capacity to meet its short-term obligations," states the SEC's money market reform press release. They also proposed amendments to Form N-MFP. "Currently money market funds report their portfolio holdings and other information to the Commission each month on Form N-MFP, including certain credit ratings assigned to each portfolio security. The re-proposed amendments to Form N-MFP would require that a money market fund disclose any credit rating that the fund's board considered in determining that a portfolio security presents minimal credit risk," says the release.
The Proposal's summary says: "The Securities and Exchange Commission is re-proposing certain amendments, initially proposed in March 2011, related to the removal of credit rating references in rule 2a-7, the principal rule that governs money market funds, and Form N-MFP, the form that money market funds use to report information to the Commission each month about their portfolio holdings, under the Investment Company Act of 1940. The re-proposed amendments would implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. We are issuing this re-proposal in consideration of comments received on our March 2011 proposal. In addition, we are proposing to amend rule 2a-7's issuer diversification provisions to eliminate an exclusion from these provisions that is currently available for securities subject to a guarantee issued by a non-controlled person."
Here's some background on the amendments. The SEC writes, "Section 939A of the Dodd-Frank Act requires each federal agency, including the Commission, to "review any regulation issued by such agency that requires the use of an assessment of the credit-worthiness of a security or money market instrument and any references to or requirements in such regulations regarding credit ratings." That section further provides that each such agency shall "modify any such regulations identified by the review ... to remove any reference to or requirement of reliance on credit ratings and to substitute in such regulations such standard of credit-worthiness as each respective agency shall determine as appropriate for such regulations.""
The proposal explains, "As a step toward implementing these mandates, in March 2011 we proposed to replace references to credit ratings issued by nationally recognized statistical rating agencies ("NRSROs") in two rules and four forms under the Securities Act of 1933 and the Investment Company Act, including rule 2a-7 and Form N-MFP under the Investment Company Act The 2011 proposal preceded other amendments to rule 2a-7 and Form N-MFP that we proposed last year as part of our broader efforts to reform money market funds. At that time, we noted that we were not rescinding our 2011 proposal to remove ratings references from certain rules and forms under the Investment Company Act, but that we intended to address the matter at another time."
The Proposal adds, "We received several comments on the 2013 Money Market Fund Proposing Release suggesting that we act on credit ratings as part of our broader money market fund reforms. And today in another release, we have adopted certain amendments to rule 2a-7 and Form N-MFP that we proposed last year. We also received comments on the 2011 Proposing Release that raised a number of concerns with respect to the proposed amendments and suggested alternative rule text for some provisions. We have determined to re-propose amendments to replace references to credit ratings in rule 2a-7 and to modify provisions in Form N-MFP that reference credit ratings, in consideration of the mandate of Dodd-Frank Act section 939A, the comments on the 2011 Proposing Release, and the broader money market fund reforms we have adopted today."
It continues, "Rule 2a-7 contains "risk limiting" provisions designed to minimize the amount of risk a money market fund may assume.... Among these conditions, rule 2a-7 limits a money market fund's portfolio investments to "eligible securities," or securities that have received credit ratings from the "requisite NRSROs" in one of the two highest short-term rating categories or comparable unrated securities.... Rule 2a-7 further restricts money market funds to securities that the fund's board of directors (or the board's delegate) determines present minimal credit risks, and specifically requires that determination "be based on factors pertaining to credit quality in addition to any ratings assigned to such securities by an NRSRO." A money market fund is required to invest at least 97 percent of its total assets in eligible securities that have received a rating from the requisite NRSROs in the highest short-term rating category for debt securities ("first tier securities") or unrated securities of comparable quality."
It outlines the details of the proposal. "To implement the mandate of Dodd-Frank Act section 939A, we are re-proposing amendments to remove references to credit ratings in rule 2a-7. The re-proposed amendments would affect five elements of the rule: (i) determination of whether a security is an eligible security; (ii) determination of whether a security is a first tier security; (iii) credit quality. The re-proposed amendments to rule 2a-7 reflect our consideration of commenters' concerns and suggested modifications to our 2011 proposal, as well as the broader money market fund reforms we have adopted today. These re-proposed amendments are designed to remove references to, or requirement of reliance on, credit ratings in rule 2a-7 and to substitute standards of creditworthiness that we believe are appropriate."
Further, it states: "After consideration of the comments and the statutory directive to eliminate references to ratings in our rules, and to seek consistent standards of creditworthiness to the extent feasible, we are re-proposing amendments to rule 2a-7. The re-proposal would combine the two risk criteria into a single standard, which would be included as part of rule 2a-7's definition of eligible security. As re-proposed, an eligible security would be a security with a remaining maturity of 397 calendar days or less that the fund's board of directors (or its delegate) determines presents minimal credit risks, which determination includes a finding that the security's issuer has an exceptionally strong capacity to meet its short-term obligations."
"Thus, under our re-proposal, a money market fund would be limited to investing in securities that the fund's board (or its delegate) has determined present minimal credit risks, notwithstanding any rating the security may have received. In addition, fund boards would no longer be required to designate NRSROs. The re-proposed determination is designed to retain a degree of credit risk similar to that in the current rule by allowing for gradations in credit quality among securities that meet a very high standard of credit quality, while limiting a money market fund's investments in second tier securities to those the fund determines do not diminish the overall high quality of the fund's portfolio. As a result of the single standard and elimination of the distinction between first and second tier securities we are re-proposing, we also are re-proposing to remove the current prohibition on funds investing more than 3 percent of their portfolios in second tier securities."
On second tier securities, it states, "By eliminating the rule's current limitations on investments in second tier securities, funds theoretically could invest in second tier securities to a greater extent than permitted today. The re-proposed standard, however, is designed to preserve the current degree of risk limitation in rule 2a-7 without reference to credit ratings by requiring a fund's board (or its delegate) to determine that the issuer of a portfolio security has an exceptionally strong capacity to meet its short-term obligations, a finding that some boards or fund advisers may determine can be met by second tier rated securities (but only of the highest quality).... We request comment on consolidating the credit quality standard and eliminating the distinction between first and second tier securities. Do commenters believe that the re-proposed standard is an appropriate standard of creditworthiness for rule 2a-7?"
On stress testing it says, "Our re-proposed stress testing amendments would require that money market funds stress test for an event indicating or evidencing credit deterioration of particular portfolio security positions, each representing various exposures in a fund's portfolio." Finally, regarding Form N-MFP it proposes, "We have carefully considered these comments and are re-proposing instead to require that each money market fund disclose, for each portfolio security, (i) each rating assigned by any NRSRO if the fund or its adviser subscribes to that NRSRO's services, as well as the name of the agency providing the rating, and (ii) any other NRSRO rating that the fund's board of directors (or its delegate) considered in making its minimal credit risk determination, as well as the name of the agency providing the rating." The anticipated compliance date for these new rules is 18 months after the reforms are effective.
