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SEC Eliminates Credit Ratings from Money Market Fund Rules

Earlier this week, the SEC voted to adopt rule amendments eliminating references to credit ratings from Rule 2a-7, the rule governing money market funds.  The amendments were adopted pursuant to one of the SEC’s mandates under the Dodd-Frank Act which generally required all federal agencies to remove references to and reliance on credit ratings from their rules. The SEC proposed the changes at the same time that it adopted final rules relating to major money market fund reforms last year.

The revised rule creates a “single, uniform minimal credit risk finding based on the capacity of the issuer or guarantor of a security to meet its financial obligations.”  The uniform requirement eliminates the tier 1 and tier 2 distinction for eligible securities as advocated by the Forum in its comment letter on the rule proposal.

The revised rule codifies general factors that should be considered in analyzing whether a particular issuer or guarantor has the capacity to meet its financial obligations.  The Commission elected to include the factors in order to “further promote effective and uniform application of the risk standard” as well as provide an objective standards that can be verified by the Commission’s examiners.  The board or its delegate must consider, to the extent appropriate: the issuer’s or guarantor’s financial condition; its sources of liquidity; its ability to react to future events; and the strength of the issuer’s industry as well as the issuer’s competitive position within its industry.

The rule also requires that money market funds adopt written procedures that require the adviser to “provide an ongoing review of the credit quality of each portfolio security to determine that the security continues to present minimal credit risks.”  The Commission noted that this review would typically update the information used to make the initial determination.  While the Commission declined to adopt a specific interval for the review, the release states that the SEC expects the review to be conducted on a “regular and frequent basis.”  Funds will not be required to keep records of the adviser’s ongoing review–documentation only will be required for the initial determination and other times as specified by the fund’s board.

The Commission also amended the stress testing requirements to require testing against a hypothetical “event indicating or evidencing credit deterioration of particular portfolio security positions” rather than against a credit downgrade.

In a departure from the rest of the rule amendment, Form N-MFP will still require credit rating disclosures.  A money market fund will have to disclose the credit ratings for each portfolio security if such ratings are used by the fund board or its delegate in making minimal credit risk determinations.  The rule amendments also eliminate the current exclusion to the issuer diversification requirement of securities subject to guarantees issued by non-control persons.

The compliance date for the rule amendments is October 14, 2016–chosen to coordinate with the compliance date for the 2014 money market fund rule amendments regarding floating NAV, liquidity fees, and redemption gates.