Fitch anticipates minimal impact from the diversification portion of Rule 2a-7 changes proposed by the SEC in June 2013 on Fitch-rated funds, according to a report released by Fitch Ratings. The study, "Little Impact on Fitch-Rated Money Funds From SEC Proposed Diversification Rules," explains that the proposed changes are intended to foster greater levels of money market fund (MMF) portfolio diversification. But, the Issuer and guarantor diversification requirements in the SEC proposals already feature prominently in Fitch's MMF criteria and analysis. "Based on Fitch's review of March 31, 2014 portfolio data for 121 Fitch and non-Fitch rated prime MMFs (using data provided by Crane Data LLC), it appears that most funds currently manage to standards that meet or exceed the recently proposed SEC diversification guidelines; consequently, it appears that if these guidelines were adopted, there would be only modest impact on non-Fitch-rated MMFs," the report asserts.
"Among funds not rated by Fitch, single state money market funds would be the most directly impacted by the adoption of the proposed guidelines, as these funds make the heaviest use of the current 25% guarantor exemption," says the report. Less than 2% of tax-exempt retail and state money fund assets are triple-A rated by Fitch; Institutional money funds tend to be triple-A rated while Retail investors normally don't insist on a third-party rating.
Current Rules Fitch writes, "Rule 2a-7 currently limits prime and national tax exempt MMFs to investing no more than 5% of total assets at acquisition in the first tier securities of any single issuer, although they can invest 25% of total assets in the first tier securities of a single issuer for a period of up to three business days, provided this exception is used only for a single issuer at any one time. Bonds issued or guaranteed by the U.S. government are exempt from the 5% limit. For single state tax exempt funds, Rule 2a-7 currently imposes less stringent diversification requirements, largely in recognition of the potentially limited supply of strong issuers in which a state fund can invest. Single state tax exempt funds cannot invest more than 5% of total assets in securities issued by any single issuer with respect to 75% of the portfolio. The remaining 25% of a state fund portfolio is not subject to single issuer diversification requirements. This contrasts with taxable and national tax exempt funds, which cannot make use of the 25% bucket exemption."
They explain, "In addition, Rule 2a-7 currently applies a 10% concentration limit on providers of guarantees or demand features from a single institution. However, this limit applies to only 75% of the portfolio. This creates a 25% basket for guarantees and demand features from a single first tier provider. Fitch notes that under current 2a-7 rules, each sponsor of an ABS special purpose entity (SPE) is considered a discrete issuer instead of a guarantor and hence not subject to the 10% guarantor limitation."
On the "SEC's Diversification Proposals," Fitch writes, "To further limit single risk concentration levels, the SEC proposes requiring MMFs to consolidate affiliated entities into single issuers when applying the 5% issuer concentration limit. The proposal deems entities to be affiliated if one controls another or both are under common control, with control defined as ownership of more than 50% of an entity’s voting securities. To limit indirect risk to a guarantor, the SEC has proposed removing the 25% basket and applying the 10% concentration limit on providers of guarantees and demand features to the fund's entire portfolio."
They continue, "Furthermore, the SEC proposes requiring funds to treat ABS sponsors as guarantors subject to rule 2a-7's 10% guarantor diversification requirements. This includes exposures to asset- backed commercial paper (ABCP), which are commonly owned by MMFs because their short maturities (typically three months) are consistent with a MMF's maturity and liquidity profile. However, an ABS sponsor would not be subject to the guarantor diversification requirements if the fund’s board of directors determines that the fund is not relying on the sponsor to support the ABS trust."
On the "Impact of Proposed Diversification Changes," the report says, "Fitch's criteria for 'AAA' rated MMFs provide for a concentration guideline of 10% to any direct first tier issuer, which is higher than the 5% guideline proposed by the SEC. However, this differential is mitigated by the Fitch criteria stipulation that within the 10% guideline, only 5% can exceed seven days. As of March 31, 2014, large direct concentrations in Fitch-rated U.S. funds were well within the 10% guideline, with no large direct concentrations exceeding 5.5% of assets. Fitch's guideline for total direct (issuer) and indirect (guarantor) exposure to the same institution is 15%. By contrast, the SEC proposal calls for a 5% direct exposure limit and a 10% indirect exposure limit. Theoretically, a Fitch-rated MMF that had no direct exposure to an institution but had a 15% exposure to that institution as a guarantor would have to reduce this exposure by 5% if the SEC proposals are adopted."
"Fitch continually monitors the exposure concentrations of its rated MMFs on a weekly basis," states the report. "Fitch noted only a small number of funds with issuer concentrations exceeding 5%. In general, any variances in the underlying exposure concentration were short, generally coming due in the three−six month range. Therefore, adoption of proposed issuer concentrations shouldn't be difficult for these funds to implement."
Finally, Fitch writes, "Also, adopting the removal of the 25% basket proposal, as well as the ABS sponsor proposal, would have only a limited impact on prime and government MMFs not rated by Fitch. Fitch noted a small number of funds with concentrations slightly in excess of the 10% proposed SEC guideline to ABCP programs whose sponsors would be deemed guarantors under the proposed change. Given the short remaining tenor of the exposures (one month or less) and the moderate level of variance to the 10% guideline, Fitch would anticipate the funds would be able to meet the 10% limit if the proposal to remove the 25% basket were to be adopted. However, among funds not rated by Fitch, single state money market funds would be the most directly impacted by the adoption of the proposed guidelines, as these funds make the heaviest use of the 25% basket."
