In a "no-action" letter released late last week ("No-Action Request Concerning the Eligibility for Acquisition by Money Market Funds of Window Variable Rate Demand Bonds," the Securities & Exchange Commission gave the okay for a new type of security for money funds. The SEC said it, "would not recommend that the Commission take any enforcement action under Section 34(b) or 35(d) of the Act or Rule 22c-1 thereunder against a Money Market Fund if it acquires and treats a WVRDB, as described in your letter, as a 'Long Term Variable Rate Security' for the purposes of paragraph (d)(3) of Rule 2a-7 under the Act, provided the Money Market Fund otherwise complies with Rule 2a-7."
The original exemption request (which is not yet available online) said, "Citigroup Global Markets Inc. wishes to offer registered open-end management companies operating as money market funds in reliance on Rule 2a-7 of the Investment Company Act the opportunity to invest in Window Variable Rate Demand Bonds (WVRDBs), as described more fully below. A WVRDB is designed to provide money market funds with an investment that provides minimal credit risk as well as liquidity. The liquidity offered to investors will be 'unconditional' and will be provided by the issuer rather than a third-party financial institution."
Citi's letter explains, under "Current Market Conditions for Variable Rate Bonds and Benefits of WVRDBs," "Due to the ongoing financial crisis, the market for traditional variable rate bonds has been significantly disrupted. Traditional variable rate bonds generally require bond insurance or credit support from a bank and external bank support to support payment of purchase price. However, Citigroup has found that with the 'freezing' of the credit markets that bank support has been exceedingly difficult to obtain and that with the significant drops to their credit ratings, most bond insurers are not viable for money market fund eligibility (with regard to both existing and new programs). As a result, it has become substantially more difficult for municipal issuers in particular to issue and maintain existing variable rate bond programs."
It continues, "Citigroup believes that the current disruption in the variable rate bond market imposes significant hardship on both public sector issuers and money market funds. Citigroup has found that this hardship affects not only new issuances but also existing issuances, where the existing credit providers present greater credit risks than are appropriate for money market funds. Variable rate bonds have historically provided municipal borrowers the lowest cost of funds. The difficulty in obtaining financing through the variable rate bond market has increased financing costs to these issuers at a particularly difficult time since declining tax revenues have put a great strain on operating budgets. This has come at a time when many of these issuers will require financing in order to fulfill their role in the economic recovery through the development of infrastructure projects."
They state, "WVRDBs provide critical assistance to public sector issuers by creating greater access to the variable rate markets. First, for qualifying highly rated issuers, they do not required bond insurer support, credit support or external bank support. In addition, WVRDBs eliminate the daily/weekly put risk for issuers.... Furthermore, the developments in the financial sector have also dramatically curtailed the number of appropriate investments available for money market funds (while the amount of money held in money market funds has considerably increased as investors have allocated more of their portfolios away from the equity markets).... [M]any traditional purchasers of variable rate bonds, including money market funds, have been seeking to be less dependent on financial institutions (both banks and insurers) as a source of credit support, even if provided by the most credit-worthy institutions. For example, in Citigroup's recent experience, money market funds would prefer that a 'demand feature' be provided by the issuer rather than a third-party financial institution."
Citi says, "WVRDBs address these concerns. First, WVRDBs reduce the exposure of money market funds to banks and other financial institutions, due to the WVRDBs' 'self tender' feature described below (i.e., the ability of the holder to sell the WVRDB back to the issuer). Furthermore, WVRDBs, as an alternative to traditional variable rate bonds, offer diversification benefits including the diversification of event and put risk as well as portfolio diversification. Citigroup believes that a WVRDB should be viewed as a Long Term Variable Rate Security for purposes of paragraph (d)(3) of Rule 2a-7. Citigroup seeks the requested no-enforcement position, however, to clarify this issue for money market funds that have expressed an interest in acquiring WVRDBs."
Finally, they explain, "A WVRDB is a variable rate security with a nominal long-term maturity (e.g., 30 years). An issuer may offer one or more series of WVRDBs. A WVRDB will be subject to a 'dual put' feature, which will allow an investor, at its sole option, to tender a WVRDB for purchase within a fixed period of time not to exceed 397 calendar days (i.e., 13 months) in any case. In addition, upon notice of not less than 30 days (and not more than 60 days), a WVRDB is subject to redemption prior to its stated maturity, at the option of the issuer, in whole or in part, at a price equal to the amount of bonds called for redemption, plus accrued interest to the date of redemption, without premium."
