Wells Fargo Securities' Garret Sloan recently published a piece entitled, "Tier-2 Holdings Growing in 2a-7 Funds," which says, "In March we noted the relatively cheap market levels in short-term credit markets. The basis between 30-day tier-1 and tier-2 commercial paper had reached levels that started to entice even longer-duration credit investors. Wider spreads and higher yields also attracted a handful of money market funds to acquire tier-2 CP. Until that point, tier-2 CP had been largely absent from 2a-7 fund holdings despite the ability of unrated funds to allocate up to 3 percent of portfolio assets to tier-2 securities. March was a turning point in commercial paper markets not only because of the tier-1/tier-2 basis, but also because it represented a near-term peak in total tier-2 CP outstanding, rising to almost $120 billion. Since the March peak, the tier-1/tier-2 30-day commercial paper basis has tightened, and the total amount of Tier-2 CP outstanding has declined. Additionally, from a regulatory perspective, the SEC has finalized and adopted Dodd-Frank rule 939A for money market funds removing reference to agency credit ratings." Sloan adds, "Regardless of the prime money market fund outflow dynamics over the coming year, tier-2 commercial paper will likely take a more prominent place in 2a-7 portfolios. If that is the case, it will be based on the primary value proposition that many tier-2 issuers provide to the short-term market. These include (1) diversification, (2) yield differential, and (3) a history of ratings stability . Additionally, with the removal of NRSRO language from rule 2a-7, money market funds will no longer need to keep their 3 percent tier-2 buckets empty for fear of quickly filling up on a ratings announcement. In such cases, the determination to place securities in the tier-2 bucket will be largely internal."

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