In early September, Moody's Investors Service caused quite a stir in the money fund industry by proposing to abandon its AAA rating standard and to make major changes to its ratings methodology. (See Crane Data's Sept. 8 News "Moody's Proposes New Money Market Fund Rating Methodology, Symbols".) The NRSRO's Request for Comment, "Moody's Proposes New Money Market Fund Rating Methodology and Symbols", stopped accepting feedback on Nov. 5, but the changes were a major topic of conversation at this week's Association of Financial Professionals conference. The verbal and anecdotal feedback Crane Data's heard has been decidedly negative, but we had yet to see any of the written responses (Moody's keeps them confidential) ... until now.
Treasury Strategies has released its comment letter on Moody's tentative changes. It focuses on the parental support aspects of the changes and urges Moody's to withdraw its proposal. TSI's Anthony Carfang and Jacob Nygren, along with Illinois Institute of Technology's Professor John Bilson, write, "We comment on Moody's proposed new ratings system for money market funds. In particular, we comment on the proposal to award higher ratings to money market funds (MMFs) based on subjective assumptions regarding a fund sponsor's ability and willingness to support a financially stressed fund and the likelihood of its doing so. We believe the proposal will result in serious adverse consequences for MMF investors, sponsors (especially commercial banks), and the financial system as a whole." (See also, Treasury Strategies' press release on its comment letter.)
The letter explains, "Some of the dangers of the proposal include: Inaccurate and misleading ratings, Investor confusion, Damaged integrity and efficiency of money market funds, Moral hazard and systemic risk, Increased risks for investors, Challenges for fiduciary investors, Regulatory and policy issues, and Adverse consequences for bank sponsors. Only money market funds with sponsor support will be able to attain the highest rating under Moody's new rating methodology.... But, as discussed below, a sponsor's creditworthiness is an illusory measure of the likelihood that it will support a distressed fund."
Treasury Strategies says, "An assigned rating would depend not only on a fund sponsor's ability to provide support but also on Moody's qualitative assessment of the sponsor's willingness to provide support.... As Moody's notes, however, most money market fund sponsors have no legal obligation to support their funds, for accounting and other reasons. In the absence of a contractual agreement, Moody's states that it will consider factors such as 'the strategic importance of the sponsor's asset management franchise, in general, and its liquidity franchise, in particular.' Moody's also will consider the sponsor's 'track record for supporting its funds' and the 'extent to which the failure of a money market fund would likely affect the sponsor's brand name or reputation, thereby creating incentive to provide support to its funds. Finally, Moody's will take into account 'any limitations -- legal, regulatory, or accounting -- that could restrict a sponsor's ability to provide support."
The comment letter argues, "These factors will result in unreliable ratings that will mislead investors, undermine the integrity of money market funds, and damage the financial system." It says, "A money market fund rating system that depends on sponsor support as a requirement for attaining the highest rating necessarily will result in inaccurate and unreliable ratings. The likelihood of sponsor support is a highly subjective and speculative conjecture of questionable validity. A recent Federal Reserve staff study (see Crane Data's Sept. 23 News "Fed's McCabe Pens Paper on Cross Section of Money Market Fund Risks") of sponsor-supported money market funds characterizes sponsor support as 'discretionary, unregulated, and opaque' and 'probably most unreliable when systemic risks are most salient.' Absent an express written agreement obligating a sponsor to provide support, Moody's would need to rely on verbal indications of support -- hardly a credible underpinning for a rating. No bank or bank holding company sponsor could make any statement suggesting that it would guarantee an affiliated fund without significant regulatory consequences."
The critique continues, "Moody's methodology depends largely on Moody's assessment of whether an implicit guarantee exists. Moody's proposed methodology will result in invalid and unreliable ratings of money market funds because the ratings will be dependent on assumptions that cannot be proven and in most cases will be denied.... A fund that receives the highest rating from Moody's will be presumed to have an implicit guarantee from its sponsor.... It is unlikely, however, that any sponsor -- particularly a sponsor of a bank affiliated fund -- would be able to acknowledge that any implicit guarantee exists. Accounting and capital consequences would prevent it from doing so.... If a money market fund or its sponsor disavows or fails to confirm an implicit guarantee, Moody's then will be faced with the dilemma of whether to downgrade the fund. If Moody's does not downgrade the fund, the integrity of its MMF rating methodology will be completely undermined. Again, it is reasonable to ask what purpose is served by such a rating system that will produce such illusory and confusing ratings."
Finally, Treasury Strategies' 13-page comment argues, "Money market funds are widely used by a wide range of investors who rely on credit ratings in making their fund selections. If the ratings are inaccurate and unreliable, the integrity of money market funds themselves will be called into question and their important role in the financial markets will be undermined. Money market funds are used by individual investors, retirement plans, pension funds, corporations, bank trust departments, brokerage firms, state and local governments, charitable foundations, and other investors for cash management and investment purposes.... If the ratings system for money market funds is perceived as unreliable and confusing, the investors who rely on these funds may be forced to seek other, less efficient, alternatives for their cash management and short-term investment needs. Money market funds were developed specifically to serve these needs and have done so successfully and efficiently for decades. A flawed ratings system will undermine the efficacy of money market funds in the financial markets and thereby reduce the overall efficiency of the markets.... We urge Moody's to withdraw its proposal."
