The Investment Company Institute weighed in on the issue of a U.S. Treasury debt downgrade or default with the publication of a "Viewpoint", entitled, "Debt Ceiling Scenarios: ICI Addresses Key Questions Regarding Possible Impact on Money Market Funds, written by Karrie McMillan and Brian Reid, as well as a more extensive "Frequently Asked Questions About Money Market Funds and Credit Ratings on U.S. Treasury Securities." ICI says, "As Paul Schott Stevens wrote on ICI Viewpoints earlier, a downgrade or default of U.S. Treasury securities would have grave implications for investors, markets, and economies around the world. This prospect raises a number of questions for funds and their shareholders, particularly for money market funds. We've prepared a set of "frequently asked questions," focused on money market funds, to further address the key issues and dispel some of the uncertainty produced by this unprecedented policy situation."
The piece continues, "For example, what would be the impact for U.S. money market funds of a downgrade in the credit rating of U.S. sovereign debt (debt issued by the U.S. Treasury or government agencies)? One of the most important factors is whether any downgrade affects only the U.S. government's long-term credit rating, or applies to both long-term and short-term debt. A money market fund's ability to purchase or hold a rated security depends on the issuer's short-term credit rating. Most of the discussion to date has focused on downgrades to the AAA/Aaa rating on the United States' long-term debt. However, unless the major credit rating agencies also downgrade short-term debt issued by Treasury and other federal agencies, money market funds would not be affected by any change in the AAA/Aaa rating."
The FAQ asks, "Why are news accounts and analysts discussing the impact of the U.S. debt ceiling and deficit debates on money market funds? Failure to increase the U.S. debt ceiling or address the long-term U.S. spending and fiscal imbalance has the potential to adversely affect investors, markets, and economies across the globe -- with severe consequences for interest rates, stock prices, investor confidence, and the day-to-day activities of businesses and consumers. Money market funds own $684 billion in U.S. sovereign debt -- securities issued by the U.S. Treasury and government agencies -- and hold another $491 billion in repurchase agreements, most of which is collateralized by U.S. government debt. Money market funds are required to invest only in short-term, highly liquid securities that present minimal credit risk. Analysts and news reports have focused on the repercussions of any policy or market developments that might affect the liquidity or credit quality of U.S. government securities."
ICI also queries, "Would a downgrade in the short-term credit rating for U.S. sovereign debt force money market funds to dispose of their holdings of U.S. government debt? That's unlikely. Credit rating agencies would have to cut their ratings on short-term U.S. government securities steeply -- by an amount roughly equivalent to eight steps on the long-term rating scale -- to force such an action. None of the major credit rating agencies has discussed a downgrade of U.S. government debt of that severity.... A downgrade ... would not preclude money market funds from purchasing or holding U.S. government securities. Nor would it require money market funds to sell their current holdings of Treasury and other government securities. Downgrading the U.S. government's short-term rating below Second Tier would be the equivalent of taking its long-term credit rating down by approximately eight steps, from AAA/Aaa to BBB+/Baa2."
Questions the ICI also addresses include: "Are there credit factors other than ratings that money market funds must consider when buying or holding securities? Yes. A money market fund must limit its investments to securities that pose a "minimal credit risk," as determined by the fund's board. That determination is made independently of any credit rating. The board of directors normally delegates the power to make that determination to the fund adviser, following policies set by the board. Would money market funds be able to add U.S. government securities to their portfolios if the U.S. government's short-term credit rating falls to Second Tier? Yes. The SEC's Rule 2a-7 -- the rule governing money market funds -- deems government securities to be First Tier securities so long as they are eligible for purchase (i.e., rated in the First or Second Tier by two or more NRSROs).... [The] diversification requirement does not apply to U.S. government securities."
They also ask, "For a money market fund, what would constitute "default" in a U.S. government security? If the U.S. government fails to pay interest or principal when due on a security in a money market fund's portfolio, the fund must dispose of the security in an orderly way, unless the fund's board determines that disposing of the security would not be in the best interests of the fund and its shareholders. The board may consider market conditions, among other factors, in making that decision. If the security accounts for 0.5 percent or more of the fund's portfolio, the fund also must report the default to the SEC. In addition, the U.S. government's failure to pay its obligations could trigger a severe downgrade of its short-term credit rating by NRSROs.
Finally, ICI comments, "Why might a money market fund's board of directors choose not to dispose of a defaulted or severely downgraded security? Rule 2a-7 requires a money market fund to dispose of a security that is no longer eligible (i.e., First Tier or Second Tier) or has defaulted "as soon as practicable consistent with achieving an orderly disposition," unless the board finds that "disposal of the security would not be in the best interests of the money market fund (which determination may take into account, among other factors, market conditions that could affect the orderly disposition of the portfolio security)..." In unsettled markets following a default on U.S. government securities, a board may determine that disposal of its U.S. Treasury securities would not be in the best interests of the fund or its shareholders, particularly if the default promised to be of short duration."
