On Friday, we featured the major comment letters from money fund managers written in response to 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." (See Crane Data's Oct. 17 News, "Fund Cos. Have Concerns on SEC's Removal of Credit Ratings Proposal.") Today, we focus on comments from industry organizations like the Investment Company Institute and the Securities Industry and Financial Markets Association. The proposal, which is part of the SEC's money market reform package, would remove references to credit ratings of nationally recognized statistical rating organizations (NRSROs) from Rule 2a-7. Below are some excerpts with links to the full comment letters.
ICI Counsel Dorothy Donahue writes, "ICI shares the SEC's goal of "preserv[ing] a similar degree of risk limitation as in the current rule," while "allowing for gradations in credit quality among securities that meet a very high standard of credit quality ...." The SEC's reference to an "exceptionally strong" capacity to pay financial obligations, however, may not be the clearest means of conveying this intent. We understand that the SEC does not propose to refer to a "strong" capacity to repay obligations (as suggested in our previous comment letter) because at least one NRSRO uses "strong" to describe its second highest short-term rating category. Nevertheless, we believe that there are better modifiers than "exceptionally" to use in this context. "Exceptional" implies something unusual that might be read as not including a large number of money market securities of very high credit quality. Exceptional also is not commonly used with gradations; we do not frequently say something is more exceptional than another exceptional thing."
She explains, "The SEC requests comment on whether a finding that a security's issuer has a "very strong" capacity to meet its short-term financial obligations better reflects the current limitation in Rule 2a-7. We believe it does. Indeed, we believe that use of the terminology "very strong" might better convey a very high standard of credit quality, which may nevertheless be subject to gradations. Use of "very," rather than "exceptional," also would be consistent with the re-proposed credit standard for a security underlying a conditional demand feature. This would have the benefit of making clear that the risk of default for such an underlying security should be as low as the risk of default for eligible securities generally."
ICI's letter adds, "Indeed, we urge the SEC to use consistent terms to describe credit requirements throughout Rule 2a-7. The definition of "eligible security," for example, should refer to guarantors as well as issuers (as the case may be) and the "capacity for payment of" rather than "capacity to meet" financial obligations. Similarly, it would be better for paragraph (d)(2)(iv)(C) to refer to "financial obligations" rather than "financial commitments." Using consistent terms to describe the credit risks permitted by Rule 2a-7 will help to achieve a more consistent degree of risk in money market fund portfolios."
It tells us, "Finally, regardless of what modifier is used, we recommend that Rule 2a-7 expressly include a phrase that assessments of the credit quality of eligible securities may include sub-categories or gradations indicating relative standing. Rule 2a-7 currently uses this phrase in the definition of an NRSRO's rating category, which helps facilitate an understanding that grading the relative risks of two securities does not necessarily imply that they are not both of very high credit quality."
SIFMA, which represents banks, securities firms, and asset managers, had six main comments on the proposal. Timothy Cameron, managing director, SIFMA Asset Management Group, and John Maurello, managing director, SIFMA Private Client Group write, "The Commission should revise the proposed definition of "Eligible security" to eliminate the new phrase "which determination [of minimal credit risks] must include a finding that the security's issuer has an exceptionally strong capacity to meet its short-term financial obligations." The Commission should eliminate its cross-reference in the proposed Rule to commentary in the Release on the definition of "Eligible security" which conflicts with Section 939A of the Dodd-Frank Act."
The letter continues, "The Commission should clarify the expected frequency of review under the proposed requirement that the adviser provide ongoing review of whether each security (other than a government security) continues to present minimal credit risks. The Commission should reiterate in the adopting release that its commentary on minimal credit risk analysis provides a permissive, not mandatory, list of factors, and is not intended as an exhaustive list of factors required in a minimal credit risk determination. The Commission should eliminate the requirement to report on Form N-MFP ratings assigned to each security. The Commission should retain in Rule 2a-7 the exception from issuer diversification testing for securities with a guarantee from a non-controlled person of the issuer."
James Allen and Matt Orsagh of the CFA Institute, write, "We recognize that breaking money market funds' ties to a $1 NAV may lead some to seek competitive advantage by boosting yields through the acquisition of higher-risk instruments. However, such strategies are not strictly limited to variable NAV funds, as stable NAV funds adopted strategies to boost their yields prior to 2008, both by buying instruments with higher-risk characteristics and by extending average portfolio maturities with longer-dated instruments. Statutory and regulatory mandates to rely upon credit ratings enabled money market and other funds to look to those ratings as a proxy for credit quality without having to conduct their own due diligence. Removing the mandated use of these ratings will make funds and their directors more accountable for poor due diligence."
Micah Hauptman of the Consumer Federation of America laid out "the most glaring deficiencies" of the rule. "The removal of references to credit ratings without replacing those ratings with any concrete criteria limiting the securities that funds can invest in makes it more likely that funds will continue to rely excessively on credit ratings; The subjective standard and expansive discretion that is provided to money fund directors and advisers to decide what constitutes an eligible security for investment makes it more likely that funds will invest in riskier securities; The provision of optional, rather than mandatory, factors for money fund directors and advisers to consider makes it more likely that there will be a wide range in the quality and breadth of credit analyses among money funds."
Kathryn Quirk, chair of the Committee on Investment Management Regulation for the New York City Bar, states, "We express our hope for further clarity through the inclusion of an objective legal standard in the Proposed Amendments to Rule 2a-7 with respect to the assignment of responsibilities for "ongoing monitoring" or "ongoing review" of a money market fund's portfolio securities to determine that such securities continue to present "minimal credit risk," including the proposed requirements with respect to the maintenance of written records of such determinations."
Finally, Richard Johns with the Structured Finance Industry Group comments that the proposal would particularly affect asset-backed commercial paper. "We therefore respectfully suggest that an obligor of an asset-backed security only be treated as an issuer of that security if its obligations constitute 20 percent of the obligations of that security rather than applying the "10 percent obligor" provisions under Section (d)(3)(B) of the Rule."
