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Muni Groups Weigh In On Ratings

WASHINGTON - Nine municipal issuer groups are urging the Securities and Exchange Commission to only designate rating agencies as nationally recognized statistical rating organizations if they have uniform scales for rating muni and corporate securities.

The groups include the Government Finance Officers Association, the National League of Cities, the American Public Power Association, and the Council of Infrastructure Financing Authorities.

They made the request in a two-page comment letter on the SEC's proposals to tighten regulation of money market funds so that they will be less susceptible to market turmoil. Investors have invested more than $3.6 trillion in the funds, Fidelity Investments told the SEC in its comments.

The rule changes, which the SEC proposed earlier this summer, would restrict money market funds from investing in so-called second-tier securities, shorten the weighted average maturity of fund holdings to 60 from 90 days, require fund managers to conduct periodic stress tests to make sure they can maintain stable net asset values, and require monthly disclosures of holdings to both the SEC and investors.

The commission also asked for comments on whether it should require funds to maintain floating rather than stable net-asset values or eliminate the NRSRO rating benchmarks from its Rule 2a-7 on money market funds. The benchmarks help funds comply with the rule's requirements.

In their letter, the nine muni market groups cited Investment Company Institute figures showing that money market funds are the largest investor in short-term municipal bonds, holding 65% of $500 billion of such bonds that are outstanding.

But the groups noted that money market funds "can invest only in securities in the highest two short-term rating categories, which leaves some high-quality municipal bonds ineligible for purchase." At the same time, the rating agencies "use different criteria and scales for municipal and corporate securities, which do not always reflect the high-quality of municipal bonds," they said.

"Despite the fact that the default rate for single-A rated municipal bonds is far lower than triple-A corporate bonds and the ratings criteria is far steeper for municipal rather than corporate bonds, the SEC rules do not differentiate [between the two for] the bond rating purchasing criteria for mutual funds."

The groups said that because they are concerned about the dual ratings system "and the likelihood that many municipal securities ratings have been unduly suppressed over the years," the SEC should only give NRSRO accreditation "to entities that use a comparable or uniform rating scale for all securities."

The GFOA made a similar request to the SEC a year ago, after House Financial Services Committee chairman Rep. Barney Frank, D-Mass., proposed legislation that would require the commission to only grant NRSRO status to rating agencies with uniform rating scales.

The nine groups also agreed with the Investment Company Institute, Vanguard Group Inc., Fidelity Investments, and Charles Schwab Investment Management Inc. in opposing any SEC action that would require money market funds to adopt floating rather than stable net-asset values.

"We believe that such a move would be harmful to state and local governments and the entire [money market fund] market," the muni market groups said. "The fixed NAV is the trademark of money market funds and changing its structure likely would eliminate the market for these products, leading to fewer investors in municipal bonds, and forcing state and local governments to divest their [money market fund] holdings."

ICI said the stable $1.00 NAV "provides shareholders convenience and simplicity in terms of tax, accounting, and recordkeeping" and that moving to a floating NAV "could lead to substantial and far-reaching negative consequences for the money market" without reducing systemic risk.

The muni market groups, ICI, and other three other firms also opposed the SEC's proposal to reduce the weighted average maturity of portfolio holdings to 60 from 90 days. Vanguard said a 60-day WAM "could stifle innovation in the short end of the market." It cited tender option bonds as one of many new security structures that are illiquid when first introduced until a market develops for them.

ICI, Vanguard, and Schwab also said they would oppose any attempt by the SEC to remove NRSRO benchmarks from Rule 2a-7. ICI proposed instead that fund advisers be required to designate and disclose three or more NRSROs that funds would look to for all purposes under the rule.

Fidelity noted that the SEC estimated its proposed rule changes would decrease from two to four basis points the yield that could be achieved by a money market fund. But it said its own research showed that the potential yield reduction could be as high as 25 to 43 basis points for institutional nonrated funds, 19 to 32 basis points for rated institutional funds, and 14 to 31 basis points for retail funds.

Meanwhile, the American Securitization Forum, an independent affiliate of the Securities Industry and Financial Markets Association, warned that the SEC proposed rule changes "could, if adopted, unintentionally curtail the availability of commercial and consumer credit and increase systemic risk."

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