Standard & Poor's Ratings Services published an updated "Principal Stability Fund Rating Methodology," which includes "new portfolio diversification metrics for investment in banks rated in our highest short-term category ('A-1+'), changes to cure periods for withdrawn and downgraded securities, further differentiation of the methodology at each PSFR level and expansion of credit quality metrics for collateralized repurchase agreements (repo)," according to a spokeswoman. The press release says, "Standard & Poor's Ratings Services has published its updated methodology for its principal stability fund rating (PSFR) criteria in an article titled "Principal Stability Fund Rating Methodology." The criteria apply globally and fully supersede the prior global criteria as well as any region-specific PSFR criteria. The criteria publication follows a request for comment (published March 30, 2015), and the changes from the request for comment are summarized in a separate article, titled "Standard & Poor's Summarizes The Request For Comment Process For The Principal Stability Fund Rating Criteria."
The S&P release explains, "A PSFR, commonly referred to as a money market fund rating, is a forward-looking opinion about a fixed-income fund's ability to maintain principal value. PSFRs are typically assigned to funds that seek to maintain stable or, as is prevalent in non-U.S. funds, accumulating NAVs. PSFRs have an "m" suffix (e.g., 'AAAm') to distinguish the principal stability fund rating from Standard & Poor's issue or issuer credit ratings. We expect that the PSFR criteria may result in downgrades on funds in certain countries. The downgrades would be primarily due to applying the change in diversification metrics to funds. Portfolio amortization and portfolio rebalancing may partly or wholly offset the rating impact. These criteria are effective immediately. We intend to complete our review of all affected ratings within the next three months."
The most popular change among money fund providers will likely be that the new "Rating Methodology" ease the criteria for A-2 rated counterparties. It says about "Repo counterparty risk," "Counterparties (such as broker/dealers) that do not have a rating of 'A-1+', 'A-1', or 'A-2' from Standard & Poor's or do not have a guarantee of all their obligations from an equivalently rated Standard & Poor's-rated entity, are "higher-risk investments." Since we view 'A-2' rated counterparties as sufficiently rated but more likely to force reliance upon the collateral, a repo rated 'A-2' (i.e., whose counterparty is rated 'A-2') is limited to overnight maturities and a fund aggregate and per issuer exposure limit comparable with 'A-1', and more limited than 'A-1+' rated repos (see table 12). This applies to all repo, regardless of the types of collateral backing these transactions."
A document entitled, "Standard & Poor's Summarizes The Request For Comment Process For The Principal Stability Fund Rating Criteria," encapsulates the major changes, explaining, "On March 30, 2015, Standard & Poor's Ratings Services published a request for comment (RFC) on our proposed revisions to the approach we use to rate principal stability funds. Following feedback from the market, we finalized and published our criteria, titled "Principal Stability Fund Rating Methodology," on Feb. 1, 2016.... This RFC Process Summary provides an overview of the changes between the request for comment and the final criteria, and the rationale behind those changes."
On the "Impact on Outstanding Ratings," it says, "We don't expect the rating impact to change as a result of the changes to these criteria from the proposals in the RFC. We currently estimate that the rating impact is consistent with the RFC estimate. We expect that less than 2% of principal stability fund ratings (PSFR) could change. A unique feature of actively managed short-term portfolios such as these funds is that portfolio rebalancing naturally allows for quantitative metrics to align with the updated criteria. Downgrades are less likely than when we published the RFC but are still possible due to the application of global criteria to those funds in Australia and New Zealand that we previously assessed under regional criteria."
A "Summary of Changes for PSFR Criteria" says, "A number of changes made relative to the RFC are editorial in nature or assist in clarifying the analytical approach. Because they are editorial, many of those changes are not detailed in this summary. Criteria changes following the RFC include individual issuer and group concentration limits for investment in highly rated ('A-1+') banks, fund aggregate limits for funds with heavily concentrated investment in banks, diversification limits for investment in overnight bank deposits with 'A-1+' rated banks, credit quality limits for repurchase agreements, application of diversification guidelines, impact of negative yields upon net asset value (NAV) stability, and group issuer limits."
On "Highly Rated Bank Concentration--'A-1+' Bank Limits," "We increased and clarified the amount of concentration that investment funds can hold in highly rated bank (HBC) assets. For example, the individual 'A-1+' rated bank aggregate limit proposed in the RFC for 'AAAm' rated funds was 30%. We increased this limit to 40%. The 40% limit has been clarified with regard to the mix of term and overnight exposure. We also eliminated the maximum maturity limit of 92 days (three months) for HBC assets."
On "Credit Quality--Repurchase Agreements--Counterparty Credit Quality," the following change was made. "Minimum counterparty credit quality for investment was 'A-1' short term, across all PSFR categories. We extended credit rating eligibility to 'A-2' counterparties involved in repurchase agreements (repo) when fully or overcollateralized by traditional collateral (as defined within PSFR criteria) and maturing overnight. Investments rated 'A-2' that mature overnight would be added to the maximum 'A-1' category for the purposes of determining overall portfolio credit quality.... This was not proposed in the RFC. Market feedback via the RFC consultation provided valuable information that encouraged us to consider the advances made in the repo markets since 2011."
S&P explains, "Our research into repo market operations resulted in our belief that improved operations and risk management practices has enhanced confidence in the ability of money market funds to close out repurchase agreements with smooth transition of collateral in the event of default involving collateralized repo transactions. In addition, we reviewed updated short-term default data and historical spread movements over short maturities. These confirm a low likelihood of counterparty default over short-time horizons and the low volatility of "traditional" collateral (typically government securities issued by highly rated sovereigns) underlying the repo transaction."
On "Diversification--Application of Criteria," they write, "We better aligned treatment of differing types of exposures to the same rated issuer. Specifically, we aligned the diversification criteria so that we treat investment exposure to an issuer at the same maturity similarly irrespective of the form the exposure takes. Specifically this resolves differing treatment to an issuer whether the fund invests in an overnight deposit or term investment such as commercial paper.... In a similar approach already utilized in the criteria for a repo and commercial paper exposure combination we re-aligned the "per issuer" exposure metrics. For example, a 5% 90-day commercial paper with an 'A-1' rated bank can now be combined with an 'A-1' rated overnight deposit of 5% to form an aggregate 10% exposure to that 'A-1' rated bank."
Furthermore, there were changes made to "Diversification--Group Limits." The document explains, "We added to our approach of the newly introduced group limits by slightly increasing the group limit for HBC.... This change has occurred following the RFC. The group limit thresholds remain as proposed in the RFC for investments from the same group, rated 'A-1' or 'A-1+'. However, we have added an exception for HBC to align the group limit with the HBC limit. In our view, potential price volatility of group members is based upon how strategically important (or connected) they are to the group."
Also, there was a change related to "Negative Yields." It says, "We make a statement on negative yields and management fees and their association to fund losses in the PSFR criteria.... This was not proposed in the RFC. However, on Sept. 17, 2015, we added a section on frequently asked questions to the previous criteria, "Principal Stability Fund Rating Methodology," which was originally published June 8, 2011. The section addressed the topic of stable NAV and variable NAV funds' (inclusive of accumulating NAV funds) investment in securities that generate negative yields. The FAQ information has been embedded in the criteria, and the FAQ has been deleted."
It explains, "PSFRs are an assessment of credit risk in a portfolio and its impact on a fund's principal value. In times when market yields are below zero (0.00%), investors seemingly recognize that they are losing capital by their continued use of money market fund products. Negative yields due to market rates for investments are not addressed by these ratings when (a) they result from strategies consistent with the risk mitigation framework expressed in our criteria, and (b) when the fund disclosure and operating documents explicitly state a loss in principal is possible through share cancellation (or similar mechanisms). In our updated approach, NAV declines due to negative yields would not automatically result in a negative rating action, but NAV declines due to management fees greater than the fund's return result in a loss of principal to investors and can result in lowering a PSFR."
Finally, a second S&P release, entitled "Principal Stability Fund Ratings Placed Under Criteria Observation Due To Revised Criteria," explains, "The funds with ratings placed under observation as a result of the changes to our PSFR criteria are labeled as being "UCO" (under criteria observation).... Fund placed Under Criteria Observation include: "BlackRock Cash Fund (fund sponsor, BlackRock Asset Management Australia Ltd.), Principal stability fund rating AAAm; Colonial First State Wholesale Premium Cash Fund (fund sponsor Colonial First State Investments Ltd.), Principal stability fund rating AAAm; Goldman Sachs A$ Cash Reserves Fund (fund sponsor Goldman Sachs Asset Management Australia Pty Ltd.), Principal stability fund rating AAAm; and, Macquarie Treasury Fund (fund sponsor, Macquarie Investment Management Ltd.), Principal stability fund rating AAAm." (See also our May 22 News, "JP Morgan Streamlines AAA Ratings on Money Funds; Lux Current Yield.")
