Given the surprisingly widespread interest in the impact of a U.S. Treasury downgrade or default on money market mutual funds, we decided to reprint several sections of Rule 2a-7 of the Investment Company Act, the regulations governing money funds, below. We review the definitions from the SEC's recently revised version (marked to show changes) of the Rule covering Eligible Securities, First Tier Security, Second Tier Security, and Downgrades, Defaults, and Other Events." We also mention our only previous story (12/08) involving "Univested Cash," a line entry which has been spotted recently on the holdings reports of some Treasury money market funds.
In its initial definitions section, the SEC's Rule 2a-7 says, "Eligible Security means: (i) A Rated Security with a remaining maturity of 397 calendar days or less that has received a rating from the Requisite NRSROs in one of the two highest short-term rating categories (within which there may be sub-categories or gradations indicating relative standing); or (ii) An Unrated Security that is of comparable quality to a security meeting the requirements for a Rated Security ... as determined by the money market fund's board of directors." Note the reliance on short-term ratings "A-1+/P-1/F-1" (the highest levels for S&P/Moody's/Fitch); most of the warnings are in regards to long-term (AAA) ratings.
It also states, "First Tier Security means any Eligible Security that: (i) Is a Rated Security that has received a short-term rating from the Requisite NRSROs in the highest short-term rating category for debt obligations (within which there may be sub-categories or gradations indicating relative standing); (ii) Is an Unrated Security that is of comparable quality to a security meeting the requirements for a Rated Security in paragraph (a)(1214)(i) of this section, as determined by the fund's board of directors; (iii) Is a security issued by a registered investment company that is a money market fund; or (iv) Is a Government Security.... Second Tier Security means any Eligible Security that is not a First Tier Security." Note that any "Government Security" (as defined elsewhere in section 2(a)(16) of the Act (15 U.S.C. 80a-2(a)(16))) that is an "Eliglible Security is automatically "First Tier."
Finally, 2a-7 comments, under "Downgrades, Defaults and Other Events," "(i) Downgrades – (A) General. Upon the occurrence of either of the events specified ... with respect to a portfolio security, the board of directors of the money market fund shall reassess promptly whether such security continues to present minimal credit risks and shall cause the fund to take such action as the board of directors determines is in the best interests of the money market fund and its shareholders: (1) A portfolio security of a money market fund ceases to be a First Tier Security (either because it no longer has the highest rating from the Requisite NRSROs or, in the case of an Unrated Security, the board of directors of the money market fund determines that it is no longer of comparable quality to a First Tier Security)." Note that historically, determining what "is in the best interests of the money market fund and its shareholders" has rarely meant selling downgraded or defaulted securities into an impaired market, so this allows funds to hold impaired securities if need be.
Finally, in other news, we've heard and seen a little bit about some Treasury and Government funds leaving cash uninvested in their fund. This is rare and tough to track (since it's listed outside the fund's normal portfolio holdings), but we have seen some Treasury funds with as much as $1 billion in "Net Other Assets". The only previous mention we show in our Crane Data News is the December 2008 piece, "Uninvested Cash May Be Included in WAM Calcs Says Standard Poors." The piece says, "Standard & Poor's Ratings Services late last week issued a brief "Clarifications For Rated Money-Market Funds Involving Uninvested Cash And Weighted Average Maturity," which addressed several issues which have come up in the unprecedented near-zero yield environment.... Under "Uninvested Cash Held In Noninterest-Bearing Transaction Accounts," S&P says, "Rated funds are permitted to hold more than 5% of total fund assets in uninvested cash with its custodian if the following provision is met: The fund and custodial bank represent to Standard & Poor's that uninvested cash is being held in a non-interest-bearing transaction account with a custodial bank that has elected to participate in the FDIC Temporary Liquidity Guarantee Program (FDIC TLGP) and that those monies are covered without limit under the FDIC TLGP." [Note that this program has continued under Dodd-Frank.]"
