Fitch Ratings published a document yesterday entitled, "U.S. Money Market Funds: A Year of Changes and Challenges - and More to Come?. Fitch briefly discusses the PWG Money Market Reform Options report and reviews its revisions to the ratings agency's criteria for rating AAA money funds. It says, "Last week, the President's Working Group on Financial Markets released a report titled 'Money Market Reform Options,' which called for a study of various proposed options for further reform of money market funds. The PWG report discussed policy options that may help further reduce systemic risk of MMFs, outlining benefits and limitations of each option. Fitch Ratings is closely monitoring the developments surrounding this report."
Fitch continues, "These policy options will be further studied by the newly established Financial Stability Oversight Council (FSOC), and the FSOC, and the SEC, as part of these deliberations, will solicit public comments and conduct a series of meetings with various money market fund stakeholders. The report from the PWG is latest development for the money market fund industry in a year of many changes and challenges. As market participants consider these developments and the effects they may have going forward, Fitch believes it is worth reviewing the changes and challenges of the past 12 months and the implications for the ratings of money market funds."
The NRSRO says, "In October 2009, Fitch published substantially revised rating criteria and ratings scales for money market funds (Global Money Market Fund Rating Criteria, Oct. 5, 2009). Following an exposure draft published in early 2009 and in-depth feedback from market participants, the criteria changes were designed to address some of the more pressing structural weaknesses in money market funds that surfaced during the credit/liquidity crisis in late 2008. Changes to Fitch's ratings definitions and scale for money market funds brought greater transparency and differentiation versus other rated funds and securities. Since then, Fitch has fully reviewed all of its rated money market funds globally under the new criteria, while also focusing on providing funds and their investors with enhanced analytical tools and transparency."
It continues, "Fitch's revised ratings criteria included several notable changes that were intended to provide investors with greater liquidity protection and capital preservation. These revisions included minimum liquidity guidelines and an assessment of shareholder concentrations vis-a-vis these liquidity guidelines to address redemption risk, adoption of maximum and average final maturity guidelines for portfolio holdings, an enhanced framework for measuring direct and indirect credit risk arising from repurchase agreements and other forms of counterparty risk and, finally, consideration of the sponsor's ability and willingness to provide support to the fund, if needed."
They add, "Since Fitch's criteria update, the industry has continued to evolve and adapt in the face of regulatory changes and a challenging operating environment. In 2010, the SEC enacted several notable changes to Rule 2a-7 of the 1940 Investment Act that governs U.S. money market funds. Under the revised Rule 2a-7, all registered money market funds are required to maintain minimum levels of overnight and one-week liquidity, operate with tighter limits on interest rate risk, keep the weighted average final portfolio maturity to 120 days, and hold smaller exposures to higher credit risk (Tier 2) securities. Funds also are required to have an understanding of their shareholders and their potential funding needs in order to manage redemption risk accordingly. Additionally, the SEC adopted portfolio and 'shadow NAV' reporting requirements and made it administratively easier for fund sponsors to take measures to support the fund's $1 NAV and provide liquidity."
Fitch says, "At the same time, fund sponsors generally have adopted a more risk-averse profile, operating well inside the SEC's regulatory limits and Fitch's new ratings parameters.... The many regulatory changes that have taken place over the last year are undoubtedly positive in terms of strengthening the safety (and lowering the systemic risk) of money market funds. They provide an important baseline level of credit quality and liquidity and can be viewed as a welcome convergence toward global standards and more uniform definitions of what constitutes a 'money market fund.' That said, AAAmmf-rated money market funds continue to be held to a higher standard of conservatism, relative to current regulatory minimums, consistent with investors expectations."
Finally, they comment, "Money market funds and their sponsors continue to face challenges, including an uncertain regulatory environment and a more difficult, less profitable operating environment constrained by low interest rates and less portfolio flexibility. On the regulatory front, the PWG's options for further regulatory reform encompass a range of proposals, including: Floating or variable NAV for all money market funds; Privately-funded emergency liquidity facilities for MMFs; Mandatory redemptions in kind; Insurance for MMFs; A two-tier system of MMFs, with more conservative investment and operating guidelines for stable NAV funds; A two-tier system of MMFs, with stable NAV funds offered to retail investors and floating NAV funds offered to institutional investors; Regulating stable NAV MMFs as special purpose banks."
They add, "Some of these proposals could be far-reaching in their impact. However, it is not at all clear which, if any, of these potential options may be adopted. To date, the industry has proven itself to be resilient and adaptive in the face of these challenges. In fact, many of the larger sponsors continue to show an interest in expanding the depth and breadth of their 'liquidity franchises' for the longer-term. Nonetheless, the outlook for the industry in 2011 is less than certain against this backdrop of unresolved regulatory debates, a challenging operating environment and heightened market risk."
