Yesterday, Moody's Investors Service published a paper entitled, "Moody's Proposes New Money Market Fund Rating Methodology and Symbols." Its Introduction says, "This Request for Comment describes the framework of a proposed new methodology for rating money market funds (MMFs).... [W]e are proposing the introduction of a new set of rating symbols and definitions we believe will better address the unique risks of money market funds and better distinguish our money market fund ratings from our credit ratings on long-term debt obligations."
A Moody's press release says, "Moody's Investors Service is requesting market participants to comment on a proposed new methodology and rating scale for money market funds. The refined rating methodology, if implemented after a 60-day request-for-comment period, would recalibrate Moody's primary analytical inputs, such as a fund portfolio's underlying asset quality, its liquidity position and susceptibility to market risk, and the likelihood of support from its sponsor." It adds, "Under the proposed rating system, Moody's would also introduce a new five-point rating scale for money market funds ranging from MF1+ (strongest) to MF4 (weakest)."
Yaron Ernst, Managing Director of Moody's Global Managed Investments group, comments, "Our current rating scale uses the traditional Moody's long-term ratings, but has different rating definitions for managed funds. Our new scale, which further differentiates the factors we consider when rating money market funds, will give investors a much better view of how a fund may perform even during times of severe market pressure.... In addition to clarifying the difference between money market fund ratings and Moody's traditional debt ratings, the new methodology will provide investors with more differentiation among money market funds, and more transparency regarding the key factors that affect a fund's ability to meet its objectives."
The release adds, "The new rating scale is being proposed to better capture the risks of money market funds in which investors hold shares, but also expect immediate payment on demand. Accordingly, we plan to rate money market funds based on our opinion on their ability to meet the dual objectives of preserving principal and providing liquidity. The new rating scale would (a) factor in the generally low risk of the underlying money market fund assets,(b) consider a fund's liquidity profile and the potential for a 'run' on the fund, (c) assess a fund's sensitivity to interest rate shifts, and (d) assess the likelihood of sponsor support."
The Request for Comment asks, "Why Are We Proposing Methodology Changes? It answers, "There are a number of reasons why we are proposing a change to our rating methodology and the introduction of a new rating scale for money market funds.... In September 2008, 31 rated funds suspended redemptions, leading to delayed distributions, and in two cases, shareholders in those funds experienced principal losses.... This experience prompted a reconsideration of the approach we use to assign MMF ratings. Moody's initiated a dialog with fund managers, investors, and other market participants to come to a better understanding of the type of information investors in money market funds seek, the role of ratings in their investment decisions, and the particular attributes of our ratings that they find most valuable."
It continues, "Historically, we have rated money market funds using an approach that emphasizes portfolio credit quality and maturity structure, with consideration also given to factors such as portfolio strategy, manager/adviser characteristics, and the likelihood of sponsor support. The performance of money market funds during the financial crisis, particularly after the Lehman Brothers' bankruptcy, heightened investors' focus on the wide range of risks facing these funds.... The proposed methodology is intended to more effectively capture these risks by introducing objective measures to better assess factors such as liquidity risk and market risk, as well as asset quality and obligor concentrations. Greater emphasis is placed on a sponsor’s willingness and ability to support a given fund or group of funds, if need be, as has happened throughout the history of this sector. Extending our analysis of money funds in areas that are increasingly important to investors is expected to result in greater ratings differentiation than under the existing methodology."
The paper adds, "Finally, under Section 938 of the recently passed Dodd-Frank Wall Street and Consumer Protection Act -- the US financial reform bill -- upon rule-making by the Securities and Exchange Commission, nationally recognized statistical rating organizations will be prohibited from having multiple definitions for the same rating symbol. Since the form and nature of money market funds is distinct from bonds rated using our traditional Aaa to C long-term rating scale, and our rating approaches and rating definitions are different, we are proposing a new rating scale that better highlights the distinction between these two types of ratings."
