In our April issue, Money Fund Intelligence interviews Standard & Poor's Financial Services' Peter Rizzo, Managing Director and Joel Friedman, Senior Director in S&P's Funds Ratings Group. Each of them have been involved in rating money funds for over 20 years, and S&P's funds rating business is preparing to mark its 30th anniversary later this year. S&P currently rates about 450 funds 'AAAm' for principal stability which account for $2.48 trillion globally. We excerpt from our Q&A below.
Q: What made fund ratings important? Rizzo: I believe it was originally due to institutional investors and regulatory requirements. For instance, insurance companies under the NAIC had a potential benefit of reduced capital reserves to be set aside if it was rated versus unrated. It was 0% [capital] if you invested in AAAm rated money market funds versus about 30% if they were not rated. Friedman: And the capital reserve requirements would be reduced to 1% if they invested in AAm or Am rated MMFs. Rizzo: Some corporate treasurers had internal guidelines that said they wanted it to be in a rated fund to put some checks and balances on their investments. These kinds of factors drove the initial impetus to get ratings.
Q: What is the biggest recent change in rating funds? Rizzo: Our criteria, which were updated in 2011, is a lot more granular. So just walking through the nuances of the criteria and details to make sure everyone is on the same page and understands why it is the way it is and [explaining] how we go about monitoring, implementing, and applying it can be a challenge. Prior to the 2011 update, it was more open-ended and any breeches in the criteria were handled case by case. Now there are pre-defined cure periods; it is black and white. That is a plus to the new criteria; the transparency is enormous. The one drawback you might hear from fund managers is because it is so detailed and black and white, there is no flexibility. Friedman: There are definitely more metrics that portfolio managers now have to follow, both in terms of regulations and also in the different rating agency criteria. So I think that makes it challenging for them as well.
Q: What is your biggest concern today? Rizzo: Obviously, regulatory changes and the impact they have is a concern to the market. Also, headline risk that could send a shockwave through the markets and cause a run on the industry [is a concern]. However, given the amendments to 2a-7, there is a lot more liquidity. Funds are in a better position to deal with any sort of market event these days. Friedman: My concern would be if interest rates actually start rising for the first time in so long and rise faster than anticipated. This is where you could have some big issues like we did in 1994. The good news now is that funds are all doing their own stress testing, so they will understand the potential impact of those rate rises. Still, it's definitely something managers will have to watch.
Q: How else have ratings requirements and fund management changed? Rizzo: There is much more transparency and we've come up with additional metrics. Like 2a-7, there was no weighted average life requirement in the prior criteria. Now we have introduced the WAM-to-final, which is, effectively, the WAL criteria. There are others including stress testing, increased credit quality restrictions, and liquidity. We don't set liquidity guidelines, but we are much more focused on fund managers being able to manage their own liquidity. Those are the main areas. Friedman: We have noticed though that funds have been managing more conservatively. They have been focused really on liquidity, and that is the number one thing that we believe managers saw in '07 and '08, that liquidity was at a premium. So they have certainly enhanced their liquidity buckets, and likely would have even without the 2a-7 changes.
Q: How might regulatory changes impact ratings? Rizzo: Like everyone else, we are still waiting to see which regulatory changes could occur. Clearly, one of them is floating the NAV. From our perspective, while the methodology does reference the one dollar anchor point, that is only a reference point. Effectively, if they say 'float the NAV' and fund managers, as we would expect, would continue to manage in the same manner, we wouldn't need to adjust the methodology.... Other regulatory considerations include capital, on which we published a piece in the fall of last year that walked through different scenarios. Along those lines, if you have a pool of assets that can support a problem, then that would be a ratings positive.
Q: Any thoughts on future of the money funds and ratings? Rizzo: Obviously, regulatory changes and what they may mean are a concern. However, we rate a lot of non 2a-7 registered funds or pools, and separate accounts. There are probably 65 to 75 'm'-rated pools that are not 2a-7 registered. Outside the U.S., there is a large demand for principle stability fund ratings. Obviously, it would be a big challenge to us if the industry changes in a negative way. But as always, we will evaluate the changes, and make any necessary adjustments to our criteria we feel are needed to issue ratings that reflect the relative risk. Friedman: I think that the good news for the industry thus far is that, even during this prolonged period of extremely low interest rates, investors have stuck with money funds. Why? Because they like the product. So barring any very significant change to that product, I think they will maintain a good amount of their assets [there].... We'll see.
