The Securities and Exchange Commission issued its final "Removal of Certain References to Credit Ratings and Amendment to the Issuer Diversification Requirement in the Money Market Fund Rule," one of two remaining supporting rules for its July 2014 Money Fund Reforms (the other final, which involves IRS and Treasury tax issues, is still pending). A press release, entitled "SEC Removes References to Credit Ratings in Money Market Fund Rule and Form," explains, "The Securities and Exchange Commission adopted amendments to remove credit rating references in the principal rule that governs money market funds and the form that money market funds use to report information to the Commission each month about their portfolio holdings. The Commission also adopted amendments that would subject additional securities to issuer diversification provisions in the money market fund rule." Thus, as expected, money funds' old "First Tier" and "Second Tier" credit regime, which required A-1, P-1, F-1 ratings (or A-2, P-2, F-2), will be replaced by a new "minimal credit risk" test that doesn't reference ratings. Note that the new does not prohibit securities ratings and does not involve fund AAA ratings, but just removes rating mandates from the rules. (For more, see our initial July 24, 2014, News, "SEC Adopts MMF Reforms; Chair White on Rule's Fundamental Changes," and the SEC's "Money Market Funds" page.) Finally, thanks to those who participated in our European Money Fund Symposium in Dublin (which concludes today)!

SEC Chair Mary Jo White said of the new rule, "Reducing reliance on credit ratings to determine which securities money market funds can hold is an important part of our efforts related to these funds. These amendments also remove credit ratings from one of the last areas of the Commission's rules where they are referenced."

The release says, "The money market fund rule 2a-7 currently requires money market funds to invest only in securities that have received one of the two highest short-term credit ratings or, if they are not rated, securities that are of comparable quality. The rule also requires a money market fund to invest at least 97 percent of its assets in securities that have received the highest short-term credit rating. The amendments will eliminate these requirements. Instead, a money market fund is limited to investing in a security only if the fund determines that the security presents minimal credit risks after analyzing certain prescribed factors."

It adds, "The amendments will implement section 939A of the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 which requires the Commission to review its rules that use credit ratings as an assessment of credit-worthiness and replace those credit-rating references with other appropriate standards. With today's action, the Commission has removed references to credit ratings from 32 rules and forms. The rules adopted today will be effective 30 days after their publication in the Federal Register and the compliance date will be October 14, 2016."

SEC Commissioner Daniel Gallagher says in a statement, "I am happy to support today's amendments removing references to nationally recognized statistical organizations from our rules and forms governing money market funds. These amendments implement the congressional mandate in Section 939A of the Dodd-Frank Act to eliminate such references from all of our rules. Since the passage of Dodd-Frank, I have been a strong proponent for Commission action to satisfy this mandate given that Section 939A is one of the very few provisions of the statute that directly addresses a cause of the financial crisis. And so, although I lament that it took over five years, I applaud the Commission for adopting these amendments."

Money fund attorney Stephen Keen, Senior Counsel at Perkins Coie, posted commentary about the rule on his firm's Asset Management Advocate. The post, entitled, "It's a Miracle: Rule 2a-7 Gets Shorter." Keen says, "Yesterday, the SEC adopted what I hope will be the final amendments to Rule 2a-7 made during my career. For the first time in the history of Rule 2a-7, the SEC cut more than it added, reducing the length of the rule by over 12%. The amendments relate primary to credit and diversification requirements, but also incorporate some of the staff's FAQs on the 2014 reforms."

Keen provides some background, writing, "The amendments were prompted by Section 939A of the Dodd-Frank Act, which required the SEC to "to remove any reference to or requirement of reliance on credit ratings and to substitute in such regulations such standard of credit-worthiness as each respective agency shall determine." The SEC has complied by removing all references to NRSROs and "rated securities" from Rule 2a-7, which is why the amended rule is shorter."

He writes, "The amended rule retains the minimal credit risk standard that dates back to the original money market fund exemptive orders. Thus, an "eligible security" is now defined as a security that presents minimal credit risk. The amended rule also codifies the following general factors to be considered in assessing credit risk: Financial condition; Sources of liquidity; Ability to react to future market-wide and issuer- or guarantor-specific events, including ability to repay debt in a highly adverse situation; and Strength of the issuer or guarantor's industry within the economy and relative to economic trends, and issuer or guarantor's competitive position within its industry."

Keen continues, "Generally speaking, Rule 2a-7 has two diversification limits: a 5% limit for issuers and a 10% limit for guarantees and demand features. When the limits were added to the rule in 1991, securities subject to third-party guarantees needed to comply with only the 10% limit and did not count towards the 5% limit on the underlying issuer. The amendments remove this exclusion."

He concludes, "The amendments also codify Questions 45 through 48 of the FAQs, which interpreted the revised diversification requirements of the 2014 amendments. The SEC concluded that Section 939A did not prohibit regulations requiring the disclosure of ratings information, and amended Form N-MFP to disclose "each rating assigned by any NRSRO that the fund's board of directors (or its delegate) considered in determining that the security presents minimal credit risks." This is probably the most burdensome change made by the amendments."

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