Groups Protest Money Market Fund Ratings Proposal

Asset managers, a state pension fund, investment advisers, and a consumer group are urging the Securities and Exchange Commission not to eliminate references to credit ratings from its Rule 2a-7 on money market funds, warning that funds and investors would be harmed as a result.

They made their pleas in comment letters sent to the SEC over rule changes it proposed in March to comply with a mandate imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Reflecting lawmakers’ concerns that credit agency ratings proved unreliable in the recent financial crisis, the act requires the SEC to review its rules that use ratings to assess the creditworthiness of a security or money market instrument, and replace those references with other standards that are more appropriate.

The asset management group of the Securities Industry and Financial Markets Association was one of the strongest opponents of the SEC proposal.

The group — whose members manage over $20 trillion of assets for state and local pension funds, universities, mutual funds, and private funds — claimed the Dodd-Frank directive does not apply to Rule 2a-7.

Rule 2a-7 seeks to protect investors in money market funds by imposing risk-limiting conditions on the investments the funds can make.

Under the rule, if a money market fund invests in a security that is rated, then the rating must be in one of the two highest rating categories. And no more than 3% of the fund’s assets may be invested in securities in the second-highest rating category. 

In addition, the fund’s board of directors or its delegate, such as the fund’s manager, must determine that every security a money market fund purchases presents minimal credit risks, regardless of the rating.

The SIFMA group said that Dodd-Frank does not apply to Rule 2a-7 because the rule “does not require reliance on ratings as an assessment of creditworthiness. Indeed, Rule 2a-7 forbids such reliance.”

“Ratings are only a floor, providing an additional layer of protection for shareholders beyond the minimal credit risks standard,” the group said in a seven-page letter signed by managing director Timothy Cameron.

“It appears that Rule 2a-7 was inadvertently swept up in the push to prevent overreliance on credit rating agencies because Section 939A [of Dodd-Frank] is being interpreted over-broadly, to eliminate use of ratings where they provide an additional safeguard to fund shareholders.”

BlackRock, which managed $3.561 trillion for institutional and individual clients as of Dec. 31, agreed with the SIFMA group.

“We believe that a [nationally recognized statistical rating organization] rating provides a useful first-level filter for an independent credit assessment,” BlackRock managing directors Simon Mendelson and Richard Hoerner wrote in a three-page letter.

“Removal of the NRSRO requirement could have the opposite of the intended effect, as it could permit a money fund to purchase a security that today would not meet the minimum threshold created by the current NRSRO rating requirements.”

The Dodd-Frank act “was not intended to require the wholesale elimination of references to ratings,” they said.

The Consumer Federation of America also said the elimination of rating references would weaken 2a-7.

“Because the commission proposal eliminates references to ratings without putting anything in their place, and because it continues to allow fund directors and managers to rely heavily on ratings in conducting their own evaluation of creditworthiness, we do not believe it would result in the significantly reduced reliance on ratings that Congress intended. Nor wold it make money market mutual funds safer,” Barbara Roper, the group’s director of investor protection, wrote in a four-page letter.

“On the contrary, the rule proposal would throw open the door to even riskier investment practices by money market mutual funds.”

“We urge you to table this proposal until the commission is prepared to offer a meaningful alternative that satisfies the congressional mandate and, at the very least, does not expose investors to greater risks than they currently face when they invest in money market mutual funds,” Roper wrote.

Colorado Public Employees’ Retirement Association officials also said they “strongly oppose … the removal of any such [rating] references until a robust alternative to NRSRO ratings is identified.”

In a three-page letter, Gregory Smith, COPERA’s chief operating officer and general counsel, and Jennifer Paquette, its chief investment officer, said that “COPERA also has concerns regarding proposed rules which seek to allow credit risk to be determined by investment company boards which oversee money market funds” and believes “this may increase the risk in money market portfolios.”

David Lekich, vice president and acting chief counsel of Charles Schwab Investment Management Inc., which serves as investment adviser to 17 money market funds with more than $150 billion in total assets, and 86 mutual funds with more than $200 billion in assets as of Dec. 31, echoed BlackRock and Roper in an eight-page letter.

“The current ratings requirement is only the beginning of CSIM’s investment analysis,” he wrote. “If a security does not meet the ratings requirements … the investment review process ends. However, if the ratings requirements are met, then an internal review is commenced to determine whether the security also presents minimal credit risk.”

“Removing the reference to credit ratings … converts a two-prong test into a single test, whereby determination of what constitutes an eligible security will be based solely on whether the investment adviser concludes that the security presents 'minimal credit risks,’ ” he said.

Karrie McMillian, general counsel of the Investment Company Institute, worried that the SEC proposal could “have the unintended consequence of raising some credit standards and lowering others.”

In a 13-page letter, she recommended some “different approaches” that would keep 2a-7 “in line with [its] current standards.” Rule 2a-7 could define an eligible security as one “with a remaining maturity of 397 days or less that the fund’s board of directors determines presents minimal credit risk.”

The board also would determine that the issuer “has a strong capacity to meet its short-term obligations,” she said.

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Washington
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