Sunday, January 31, 2010

Short-Term Fixed Income Research Note

• The SEC’s amendments to Rule 2a-7 will require money market funds to hold more liquid assets, marginally reduce credit risk, and increase transparency through operational enhancements

• As outlined, these amendments could adversely impact retail funds who tend to hold less liquidity due to the redemptive characteristics of their investor base

• Changes to repo treatment could limit money fund participation in non-Treasury repo, but an interpretation of the rule could be at odds with the Fed’s tri-party task force initiatives

• The rule would require funds to disclose fluctuations around the $1 NAV figure on a monthly basis, but taken in conjunction with the amendment that allows for electronic redemptions at a price other than $1, could be a harbinger for floating NAV money funds

• Structural changes to money market funds will be addressed at some future date and will include floating NAV and private sources of liquidity

SEC debuts new money fund rules

Today, the Securities and Exchange Commission revealed its proposed changes to Rule 2a-7, the section of the Investment Company Act that governs money market
funds. The SEC staff outlined proposed changes at today’s meeting, and their comments were at a fairly high level, making it challenging to answer some important questions.

We suspect it may take several days before a final document detailing the new rules will be released by the agency. Moreover, Chairman Mary Shapiro indicated in her opening remarks that more regulatory changes for money funds may be forthcoming.

The amendments released today can be characterized in three sections: money market fund liquidity, portfolio credit, and fund operational enhancements. Based on information released today, money funds will be required to hold more liquid assets, marginally reduce credit risk and will be subject to an increased administrative and operational burden.

These are the highlights of the rule changes as outlined so far by the SEC:


• Daily requirement: 10% of the portfolio must be in cash, U.S. Treasuries, or other securities that mature within 1 day

• Weekly requirement: 30% of the portfolio must be in cash, U.S. Treasuries, other government securities (possibly agencies) that mature in 60 days or less, or other securities that mature within 7 days

• Weighted average life: Spread WAM of portfolio set to a limit of 120 days
• Weighted average maturity: Maximum WAM reduced to 60 days from 90 days


• Tier 2 securities: Restricts investment to 3% of portfolio from 5%. Restricts concentration to 0.5% of securities issued by a single issuer from the current limit of the greater of 1% or $1 million.

• Illiquid securities: Restricts investment to 5% of portfolio from 10%. Redefines illiquid securities as any security that cannot be sold at carrying value within 7 days.

• Credit ratings: Requires funds to designate 4 Nationally Recognized Statistical Ratings Organizations who the fund board deems as reliable. Eliminates current requirement that funds invest only in rated ABS securities.

• Repurchase agreements: If money fund “looks through” the repo issuers for purposes of diversification, the SEC will restrict collateral to cash or government securities only (GC repo), rather than current rule of highly rated securities. The funds are also required to evaluate the counterparty credit worthiness.


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