A host of letters were submitted on the SEC's proposal on the "Removal of Certain References to Credit Ratings and Amendment to the Issuer Diversification Requirement in the Money Market Fund Rule" right at the October 14 comment period deadline. Many of these letters have now been posted, and most of the largest managers in the money market space, including Fidelity, Vanguard, BlackRock, Dreyfus, Invesco, and Schwab, expressed some concerns on the proposed changes as part of MMF reforms. Currently, to ensure that these funds are invested in high quality short-term securities, Rule 2a-7 requires that money market funds invest only in securities that have received one of the two highest short-term ratings ("first tier" or "second tier"). The SEC's re-proposed amendments would eliminate the credit ratings requirements for money market funds. Instead, a fund could invest in a security only if the fund's board of directors (or its delegate) determines that it presents minimal credit risks, and that determination would require the board of directors to find that the security's issuer has an exceptionally strong capacity to meet its short-term obligations. (See our Aug. 5 News, "SEC Proposal to Remove Credit Ratings Eliminates First, Second Tier".)
Fidelity supported many of the provisions, but recommended some changes. Writes Scott Goebel, senior vice president, general counsel at Fidelity, "Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act directs the Commission to review and identify any of its regulations that require an assessment of a security's credit-worthiness, to remove any references to credit ratings therein, and to substitute in their place a standard of credit-worthiness that the Commission deems appropriate. The Commission initially proposed amendments related to the removal of references to credit ratings in March 2011 (the "2011 Proposal"). In the Release, the Commission re-proposes such amendments and adds a proposed amendment related to the issuer diversification provision in Rule 2a-7."
Goebel then summarized Fidelity's stance on the proposed rules. "Fidelity supports removing credit rating references and eliminating the two-tier structure to credit-worthiness. We support the section of the Proposed Rules regarding monitoring minimal credit risk of MMF portfolio securities. With respect to credit quality of eligible securities, we believe that minimal credit risk is the appropriate standard and that adding additional words provides no benefit to investors. Regarding the proposed change to issuer diversification requirements, Fidelity urges the SEC not to implement any amendments to tax-exempt MMF diversification requirements."
BlackRock also shared its views in a comment. "BlackRock appreciates the Commission's permitting the continued use of credit ratings in a fund manager's minimum credit risk determination, but we believe that the Commission should explicitly recognize the use of NRSRO credit ratings as a benchmark in a fund manager's minimal credit risk analysis," write Richard Hoerner and Barbara Novick. "BlackRock recognizes the challenges faced by the Commission in removing references to NRSRO ratings in the definition of eligible security under Rule 2a-7 of the Act. BlackRock supports the Commission's proposed definition of eligible security as one that would be a security that, along with meeting certain maturity requirements, the fund's board of directors (or its delegate) "determines presents minimal credit risks, which determination includes a finding that the security's issuer has an exceptionally strong capacity to meet its short-term obligations.""
They add, "Furthermore, BlackRock applauds the Commission for recognizing that "[i]n determining whether a security presents minimal credit risk, a fund adviser could take into account credit quality determinations prepared by outside sources, including NRSRO ratings, that the adviser considers are reliable in assessing credit risk." BlackRock appreciates the Commission's continued acknowledgement of the value of NRSRO credit ratings, but we think that the Commission should go further by including NRSRO credit ratings as a benchmark in its guidance around the minimal credit risk analysis."
In his letter, Gregory Davis, global head of fixed income at Vanguard, said certain aspects of the proposal miss the mark. "As Vanguard has stated previously, we believe that credit ratings provide a valuable, independently established baseline for money market fund investments. The Dodd-Frank Act requires the Commission to replace credit ratings with "to the extent feasible, uniform standards of credit-worthiness." We believe the Commission's proposed credit standard may not adequately replace this baseline and, therefore, fails to achieve the stated goal of Congress. The replacement of the minimum, objective floor for eligibility under Rule 2a-7 with a subjective standard has the potential to create different standards of credit-worthiness."
Vanguard writes, "As a result, we urge the Commission to consider other alternatives, such as the one set forth in this letter, that may more effectively replace the objective standard provided by credit ratings and achieve Congress’s goal of uniformity. Vanguard proposes that the Commission combine the "eligible securities" standard with the "first tier" standard to create one high credit quality standard for all money market securities. The Commission should indicate that only those securities that would currently be assigned ratings in the highest short-term category (allowing for gradations or sub-categories within that category) by a nationally recognized statistical rating organization ("NRSRO") would generally be expected to fall within this band."
Charlie Cardona, president at Dreyfus Corp., comments "[T]he negative impact on money market funds far outweighs any diversification benefits that might arise from adopting this Proposal. Accordingly, we believe the Commission should not adopt this Proposal <b:>." On the definition of "eligible security," he writes, "The Proposal would revise the definition of "Eligible Security" by specifying that the minimal credit risk determination "must include a finding that the security's issuer has an exceptionally strong capacity to meet its short-term financial obligations".... This compares with the Commission's proposals in 2011, which would have defined an Eligible Security by the minimal credit risk determination and substitute subjective standards of credit quality (that sought to correspond with related NRSRO ratings descriptors) for the definitions of "First Tier" and "Second Tier" under the Rule. `We opposed this approach in 2011, mainly because of the subjectivity required.... Our views have evolved to where we believe that the minimal credit risk determination, by itself, should be relied on rather than any substitute standard of creditworthiness that is based on making subjective findings. We believe it is the most appropriate approach to take, providing flexibility and a standard that managers have applied for years, uncluttered with a subjectivity that creates conflict for funds and their boards and managers."
Schwab had some concerns as well. David Lekich, senior vice president and chief counsel, Charles Schwab Investment Management, writes, "Overall, Schwab supports the Proposed Amendments as we generally believe the Commission has struck the proper balance between not requiring entities to rely on ratings from NRSROs while at the same time allowing for their consideration when determining the credit-worthiness of securities being considered for 2a-7 fund portfolios. Furthermore, we generally support provisions of the Proposed Amendments that allow for the disclosure of NRSRO credit ratings in Form N-MFP, as we believe such disclosures will be useful to Commission staff, as well as to certain investors, in monitoring credit risk. Despite Schwab's overall support for the Proposed Amendments, we continue to have some concerns about the proposal, as well as some recommendations for improving it, including: The lack of an independent floor, provided under current law by NRSRO ratings, fails to ensure some uniformity of the evaluation of credit risk across money market funds, which could potentially cause certain funds to present significantly greater risks to investors than others."
Finally, Lu Ann Katz, head of global liquidity at Invesco, backed much of the proposal, with one notable exception. "As a leading MMF sponsor, Invesco is committed to working with the Commission to strengthen money market fund shareholder protections. Invesco values the Commission's efforts to implement the Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd Frank Act") mandate to modify regulations that reference or require reliance on credit ratings and supplant the reference with a creditworthiness standard deemed appropriate by the Commission. We also appreciate the Commission's consideration of comments received on its March 2011 proposal on credit rating references and broader money market reform efforts. After a diligent analysis of the proposal, Invesco generally supports the Commission's July 2014 proposal and offers the following commentary regarding the proposed definition of "eligible security.""
She continues, "We agree with the Commission regarding the revised definition of eligible security and the single standard, thereby combining the first-tier and second-tier categories and requiring minimal credit risk standards that are confirmed by a MMF's board of directors. However, this analysis of whether a security has an exceptionally strong capacity to meet short-term obligations may result in different advisers assessing the same security differently since the standard has embedded ambiguity."
