Wells Fargo Advantage Funds' latest "Portfolio Manager Commentary recaps the SEC's recent removal of ratings references from its rules. It says, "On September 16, 2015, the Securities and Exchange Commission (SEC) approved amendments to Rule 2a-7 to remove references to credit ratings issued by Nationally Recognized Statistical Rating Organizations (NRSROs) and replace such references with a new standard of creditworthiness. Money market funds will be required to comply by October 14, 2016 -- the same date that institutional prime money market funds will convert to a floating net asset value (NAV). Money market funds are allowed to invest only in securities that present minimal credit risks to the fund. These so-called eligible securities historically have been defined in Rule 2a-7 largely by reference to NRSRO ratings, being designated first tier (in the highest ratings category, such as A-1/P-1) and second tier (in the second-highest ratings category, typically A-2/P-2). However, the Dodd-Frank Wall Street Reform and Consumer Protection Act required the SEC to end reliance on NRSRO ratings in its rules. And, thus, the SEC now has amended Rule 2a-7 to remove references to NRSRO ratings and to require a fund board to make a determination, without reliance on NRSRO ratings, that a security presents minimal credit risks based on analysis of the capacity of the security's issuer or guarantor to meet its financial obligations. Under the amended rule, such analysis must consider specific factors as appropriate, including an issuer's or guarantor's financial condition, sources of liquidity, competitive position, industry strength, and likely adaptability in response to adverse events." Wells explains, "What does this mean to investors in prime and municipal instruments? Changes are likely to be cosmetic -- for example, credit rating information will no longer be included on required filings. The SEC has stated that the removal of credit ratings from Rule 2a-7 is not intended to change the current risk profile of money market funds, a point they make on the third page of the discussion prior to the rule. Whether one considers this guidance or not, it is illustrative of the spirit of the rule and what the regulator expects to see. Currently, Rule 2a-7 permits funds to invest up to 3% of their assets in second tier securities. However, in spite of this, the use of second tier securities in prime money market funds is extremely low. August 31 data from Crane Data reveal that prime money market funds total $1.6 trillion, but holdings of nonrepo tier 2 securities total only $1.5 billion, or less than 0.1% of total holdings. Finally, these amendments do not prohibit money market funds from seeking an NRSRO rating on the overall money market fund itself, which is likely to be the most binding constraint against a wholesale migration to tier two instruments. Standard & Poor's, which rates 72% of institutional prime money market funds, prohibits the use of tier two securities in funds it rates as AAA. As long as customers demand rated funds, funds are likely to continue to be rated after conversion to floating NAV and removal of NRSRO references in the regulations."
