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SEC Proposes Rules Affecting Money Market Funds

On Wednesday, March 2, the Commission considered a proposal to remove credit rating references from the Investment Company Rules, including Rule 2a-7 (the rule governing money market funds).  This rule proposal was precipitated by the Dodd-Frank bill, which requires all agencies to "to remove any reference to or requirement of reliance on credit ratings and to substitute in such regulations such standard of credit-worthiness as each respective agency shall determine as appropriate for such regulations." (Dodd-Frank Wall Street Reform and Consumer Protection Act, § 939A, "Review of Reliance On Ratings")  The Commission voted unanimously to issue the proposed rule for comments, but two Commissioners expressed concerns about how the rule proposal will impact fund boards.  While the text of the proposal is not yet public, comments by staff and the Commissioners appear to indicate that the rule proposal will require fund boards and their delegates to determine that particular investments pose "minimal credit risks" and that the issuer has the "highest capacity" to meet its financial obligations.  Chairman Schapiro explained the rule proposal as follows: 

Under the proposal we are considering today, a rating would no longer be a required element in determining which securities are permissible investments for a money market fund.  Instead, a security would be an eligible investment for a money market fund if the fund's board or its delegate determines that the issuer has the "highest capacity to meet its short-term financial obligations." This is a standard that is intended to be consistent with the highest credit rating category.

Alternatively, a security would be an eligible investment if the board or its delegate determines that it presents minimal credit risks, but does not meet the criteria for a first tier security. As with the current rule, such second tier investments cannot make up more than 3 percent of the fund's assets.

While other comments indicated that under the proposal, fund boards might take into consideration credit ratings, it is unclear precisely the role such ratings might play in the analysis.

Commissioner Aguilar, in a written statement, noted the Dodd-Frank requirement to remove references to credit ratings, but questioned "what do regulators do when no appropriate substitute exists?"  Both he and Commissioner Paredes expressed concern about removing credit ratings in Rule 2a-7, which serve as a backstop to eliminate certain potential investments.

Chairman Schapiro's opening statement is here:  http://www.sec.gov/news/speech/2011/spch030211mls-ratings.htm

Commissioner Aguilar's written remarks are here:  http://www.sec.gov/news/speech/2011/spch030211laa-ratings.htm