Speech by SEC Commissioner:
Statement at SEC Open Meeting Regarding Money Market Fund Reform
Commissioner Kathleen L. Casey
U.S. Securities and Exchange Commission
June 24, 2009
Good morning. I want to join Chairman Schapiro in recognizing the Division of Investment Management and the offices of General Counsel and Economic Analysis for their contributions to this proposing release. And I want to commend the Chairman for taking up this critical rulemaking in such a timely way.
As the Chairman has already noted, since their inception in the 1970s, money market funds have become one of the most widely held financial products in our markets. Investors, both retail and institutional, look to these funds as a cost-effective tool to manage cash. They have served as a significant source of financing for governments, businesses, and financial institutions, and, historically, they have been prized for their liquidity and reliability.
In the past year, however, the onset of the financial crisis, the collapse of the Reserve Fund, and subsequent actions taken by Treasury and the Federal Reserve with respect to money market funds have led to questions about the safety and reliability of these funds and the regulatory requirements under which they operate. Suggestions for regulatory changes have been offered by a wide range of respected experts, including the President’s Working Group on Financial Markets, the Group of 30, the Investment Company Institute, and (most recently) the Administration in its White Paper on Financial Regulatory Reform. Importantly, each of these recommendations has helped the Commission to develop the reform proposal before us today.
I am quite pleased with the overall approach of the release. Once again, the Division staff has done a wonderful job. In particular, I should highlight their recommendations with respect to the rule’s liquidity and maturity requirements, as well as those relating to the processing of transactions, exemption for certain affiliate purchases, and liquidation mechanisms. I also would like to credit the staff for suggesting robust questions about the use of tier two securities, an issue that deserves close scrutiny as we move forward.
One area of rule 2a-7 that gives me grave concern, however, is the continued reliance on NRSRO ratings. Although we pose questions relating to the removal of the Rule’s ratings requirements, consistent with last year’s proposals to remove ratings from a number of our rules, this release also contemplates the idea of further embedding the discredited large rating agencies in the money market space — if that is at all possible, given their 99 percent market share. Specifically, we are posing questions on the idea of giving fund boards authority to designate a certain number of NRSROs that they must look to in evaluating the eligibility of portfolio securities under the rule and that they must determine annually issue ratings sufficiently reliable for that use.
If the Commission were to adopt this approach, we would be going absolutely in the wrong direction. If the lessons of the current crisis are to guide us, we should be acting to reduce investor and regulatory reliance on credit ratings. This is not only my view, it also is the view of the Administration, key members of Congress, the PWG, the Financial Stability Forum (now the FSB), the International Organization of Securities Commissions, the G-30, and others.
The Commission first adopted the NRSRO concept in 1975, incorporating it into the Net Capital Rule and thereby outsourcing credit judgments to the original three NRSROs. References to NRSRO ratings were subsequently added to dozens of other Commission rules and forms, including rule 2a-7 in 1991, eight years after that rule was adopted. Unfortunately, it has become increasingly evident over time that there are considerable unintended and sometimes harmful consequences to the regulatory use of ratings.
Commission reliance on NRSRO ratings amounts to a government-sanctioned oligopoly for the dominant three rating agencies and serves as a formidable barrier to competitors who might provide a useful check on their performance. Further, these references have acted as a crutch rather than a safeguard for many investors, creating a false sense of comfort and protection and effectively encouraging their use as a substitute for actual due diligence.
There is perhaps no better illustration of this than the experience of the Primary Fund. On September 15, 2008, Lehman Brothers Inc. filed for bankruptcy, an event that precipitated the Reserve Primary Fund’s breaking the buck. On that same day, Lehman was still rated investment grade by the Big Three credit rating agencies. There must be a better way.
More pervasively, in the several years leading up to last September’s events, a number of money market funds held positions that were issued by structured investment vehicles, or SIVs. For example, in October 2007, one large money market fund held $640 million of securities issued by a SIV that had gone into liquidation despite original ratings of AAA by the two largest rating agencies. There were fears throughout this period about the SIV holdings in the portfolios of other several leading fund companies. We know, too, that it took a long time for many of these funds to liquidate their exposure to these assets and, often, the fund sponsors had to come to their aid. These events demonstrate that the highest credit ratings held by many SIV securities were in many cases wholly undeserved. More importantly, they provide a cautionary tale for regulators about the dangers of reliance on ratings, particularly for money funds.
Therefore, I welcome the fact that we are seeking further comment on removing NRSRO references and asking whether, in light of more recent events, this is the better course. Although the mutual fund industry and affiliated interests have previously opposed this reform, I note that these comments came to us before the events of last September — including the numerous instances where distressed securities threatened the soundness of a number of funds that ultimately (and fortunately) did not break the buck.
I hope that through today’s release that we will hear from a broader range of commenters who have had a chance to think further about the central role of ratings in the credit crisis and to see if there are additional lessons we can take away from these experiences. Thank you, again, to the staff for bringing us this proposal.