Fitch today released updated rating criteria for money market funds, with particular emphasis on funds that invest in short term debt instruments issued by financial institutions, non-financial corporations and asset backed commercial paper programmes (often referred to as ‘prime’ funds).
Prime money market funds were central to the financial crisis last year following the failure of the Reserve Primary Fund, which in turn led to unprecedented redemption activity at a number of other prime funds. The updated criteria apply globally to both constant as well as variable net asset value money market funds (CNAV and VNAV, respectively).
The publication of Fitch’s revised criteria coincides with recent proposals to enhance the regulatory framework for money market funds put forth by various regulators, notably the US Securities and Exchange Commission (SEC), and certain industry trade associations. In several important areas, the changes under consideration by the SEC and the industry closely mirror Fitch’s criteria, which were initially proposed earlier this year.
The objectives underpinning the proposals from the SEC and the industry serve to strengthen the money market fund industry and, when adopted, will provide a common framework for managing money market funds in the US. Moreover, certain non-US domiciled funds also are expected to substantially mirror these new rules in support of a global standard for CNAV money market funds.
Key proposed regulatory enhancements to the way money market funds will operate include: more conservative credit quality and liquidity guidelines; introduction of a weighted average final maturity of 120 days to better capture spread risk and bolster overall portfolio liquidity (termed WAMF by Fitch); minimum daily and weekly portfolio liquidity, as a percent of assets, to protect against stressed redemption levels; recognition of counterparty risk in repurchase agreements; and streamlined process of sponsor support, if needed.
In order to for funds to be assigned ‘AAA-mmf’ ratings there are a number of elements of Fitch’s criteria that are above and beyond those proposed by regulators and the industry.
Key elements of Fitch’s new criteria include: a new rating scale (AAAmmf) and definitions that are intended to provide improved transparency and differentiation; the measurement of overall portfolio risk along two dimensions – credit quality and maturity (termed the Portfolio Credit Factor or PCF matrix); an analysis of fund diversification that considers direct and indirect credit risk exposures; overnight and weekly portfolio liquidity analysis to determine a fund’s shareholder profile and concentrations in addition to fixed percentages; a review of guidelines designed to reduce the risk from securities lending, reverse repurchase agreements and other leveraged activities; an evaluation of the fund sponsor’s multi-faceted role, including: investment management; risk oversight; governance; administration; and financial support, if needed, in times of extreme stress.
The minimum standards established under the enhanced regulatory framework are viewed as being consistent with risk in the ‘Ammf’ to ‘AAmmf’ range on Fitch’s new scale. In reality, however, most funds operate with tighter guidelines than those allowed under regulatory and industry proposals and are also sponsored by larger, financially-sound entities. As a result, Fitch expects that the majority of funds it currently rates will qualify for ‘AAAmmf’ ratings under Fitch’s new criteria.
Some funds, however, may elect to operate with guidelines that are outside of the ‘AAAmmf’ criteria or may be sponsored by entities that are viewed by Fitch as lacking sufficient resources and/or an established track record in the investment management industry. Such funds may no longer fall within Fitch’s ‘AAAmmf’ ratings guidelines. Fitch will provide a 90-day implementation window in order for funds to adapt to the changes in Fitch’s new criteria and allow for conversion to the new scale.
Fitch notes that the structure of money market funds and the degree of systemic risk that the industry poses continues to be debated. In the US, the President’s Working Group on Financial Markets is studying the issue and is expected to publish its recommendations in December.
Similarly, the Committee of European Securities Regulators (CESR) recently began a work programme with the goal of establishing Europe-wide criteria for collective investment schemes wishing to be classified as “euro money market” funds. Industry groups also continue to consider whether additional, longer term changes are warranted. Fitch will monitor these developments, providing commentary and adjusting its ratings methodology as appropriate.