Published April 27, 2011
When an 849-page Act of Congress was dropped in the country’s lap last July, a brief section buried on Page 513--telling the SEC to further tighten credit quality regulations limiting how taxable money market mutual funds invest your money-- may not have gotten your attention.
When the SEC complied last month by adopting a 21-page release that proposed additional changes and invited the fund industry, shareholders and others to submit comments by next Monday, it may not have gotten your attention either.
It’s, therefore, not yet too late to know what’s involved and to comment, if you wish. (E-mail email@example.com, including File Number S7-07-11 on the subject line.)
The steps leading to this point began when, after months of drafting and redrafting, Congress shoehorned Section 939A, “Review of Reliance on Ratings,” into the Dodd-Frank Act.
It was a reaction to concerns that reliance on credit ratings agencies had become excessive--and costly when agencies’ assessments of some securities’ credit-worthiness were too optimistic-and that this contributed to the financial crisis of 2008.
Aimed at all federal agencies--not only at the SEC-- the section:
Ordered them to remove from their regulations “any reference to, or requirement of, reliance on credit ratings” when discussing “the credit-worthiness of a security or money market instrument…”
Asked them to substitute “such standard of credit-worthiness as…appropriate.”
As owner of one of 27.3 million accounts, invested in 450 taxable money market funds, you may not have become aware of those paragraphs because of the hubbub accompanying Dodd-Frank’s becoming the law of the land.
Moreover, you may have become less sensitive to money market problems, as the funds had essentially recovered from the crisis by then.
In normal times, when interest rates were high enough, you probably thought little about your money market fund. It provided you a place to park cash reserves while earning income from high-quality, not volatile, short-term government and/or corporate money market instruments, which the fund could quickly turn into cash.
Owing to the industry’s nearly trouble-free record, you probably didn’t lose sleep because it depended on highly regulated, prudent portfolio management to maintain a share price of $1.
Your feeling of contentment was probably rattled in September 2008, however, when many investors withdrew their money following the defaults of Lehman Brothers’ debt securities held by funds. The $1 share prices were at risk until funds got cash from sponsors or affiliates and temporary support from the Federal Reserve and Treasury. Only one “broke the buck,” falling to 97 cents.
The crisis having ended — and the SEC having adopted relevant rule changes as Dodd-Frank was moving through Congress — the agency took its mandated look at several regulations, including Rule 2a-7, which governs the operations of taxable money market funds.
(The rule was adopted in 1983, a dozen years after money market funds were introduced and soon after they saved the mutual fund industry during an awful period of recession, high inflation, and high interest rates. By year-end 1981, they accounted for 77% of all mutual fund assets, the highest year-end share ever, according to the Investment Company Institute.)
Among the additional proposed changes, on which you can comment:
Remove Rule 2a-7’s credit ratings requirements for securities which money market funds may own. Adopted 14 months ago, they stipulate that an “eligible” security (a) have a rating from “requisite NRSROs,” or Nationally Recognized Statistical Rating Organizations, in one of the two highest short-term rating categories or (b) be “an unrated security of comparable quality,” as determined by a fund’s directors. (Ten NRSROs--led by Fitch, Moody’s, and Standard & Poor’s-- are registered with the SEC.)
Continue to limit money market funds to short-term securities that (a) present “minimal credit risks,” as determined by their boards of directors (or their delegates), and (b) are in the first or second “tier” for credit quality--with at least 97% in the first.
Fund boards, with the aid of investment advisers, “would still be able to consider quality determinations prepared by outside sources, including NRSRO ratings, that fund advisers conclude are credible and reliable, in making credit risk determinations.”
Stop requiring--but don’t prohibit-- the use of credit ratings when portraying credit quality in shareholder reports such as tables, charts, graphs and management discussions of fund performance.
“Money funds can live with the proposed 2a-7 changes,” one prominent fund executive told me, requesting anonymity. Does he represent a majority? How will SEC rulemaking reflect comments advocating retention of 2a-7’s ratings provisions?
Whatever happens, it may be worth knowing that advisers which could afford it have been enhancing their credit research capabilities — long before before Dodd-Frank became a gleam in the eyes of policymakers.