The SEC proposes that money market funds no longer be required to rely on credit ratings for determining which securities are permissible investments for that fund.  The SEC’s proposal also would remove credit ratings in 3 other areas:  repos, certain business and industrial development company (BIDCO) investments, and shareholder reports.  The public comment on the rule proposal ends 4/25/11.

"The focus of these efforts is to eliminate over-reliance on credit ratings by both regulators and investors, and encourage an independent assessment of creditworthiness." --  SEC Chairman Mary Schapiro.

As amended, Rule 2a-7 (Investment Company Act of 1940) - which governs the operations of money market funds - would no longer require that ratings be a determining factor for which securities are eligible investments.  Instead, a security would be an eligible investment for a money market fund if that fund’s board or its delegate determines that the security presents minimal credit risks.  Currently, a fund is must invest at least 97% of its assets in securities that the board has determined are issued by issuers that have the highest capacity to meet its short-term financial obligations - i.e., "investment grade."

SEC Fact Sheet.   Rule 2a-7 currently sets these requirements for money market funds ("MMF's"): 

• MMF's can only invest in securities that are first or second tier - i.e., they have received the highest or second highest short-term rating. 
• At least 97% of a MMF's portfolio must be invested in “first tier” securities. 
• If a security isn't rated, the funds must evaluate the credit quality of the security and deem it to be of comparable quality to a security receiving one of the two highest short-term ratings.
• A fund's board of directors (or its delegate) must determine that the security presents minimal credit risks, based on factors relating to credit quality, in addition to any rating the security may have received.

As proposed, the credit ratings requirements for MMF investments would be eliminated and replaced by the following:

• MMF's would have to assess the credit quality of the security and determine that each portfolio security presents minimal credit risks.
• MMF's would have to determine whether the portfolio security is a “first tier” or “second tier” security, using new definitions for those terms.

    Removing References to Credit Ratings Re: Securities Collateralizing Repo Agreements.   Some funds invest in repo agreements, under which a party sells securities to the fund and agrees to repurchase the securities at a later date for a price higher than the original sales price.  In some circumstances, funds entering into repos don't look to the credit-worthiness of the issuer of the repo (the counterparty), but instead “look through” to the value and liquidity of the securities that collateralize the agreement for satisfaction of payment.

As proposed, the board of directors of a fund (or its delegate) would be required to determine that non-governmental collateral securities are issued by an issuer that has the highest capacity to meet its financial obligations and are highly liquid.

For further details, go to:   [SEC PR 11-59, 3/2, 'Credit Rating References']