SEC Amends Rule 2a-7 to Eliminate References to NRSRO Ratings and to Revise Issuer Diversification Requirements

by Dechert LLP

The U.S. Securities and Exchange Commission (SEC) recently adopted amendments (Amendments) to remove references to credit ratings in Rule 2a-7 under the Investment Company Act of 1940, as amended (1940 Act), the primary rule governing registered money market funds.1 In addition, the Amendments revise the issuer diversification requirements under Rule 2a-7, by removing the exclusion that is currently available for securities subject to a guarantee issued by a non-controlled person. As part of the Amendments, the SEC also revised the forms required to be filed by money market funds and provided certain other clarifications. The compliance date for the Amendments is October 14, 2016, although money market funds can begin complying with some or all of the Amendments prior to that date.

This Dechert OnPoint provides background on the Amendments and discusses the changes adopted by the SEC.


The SEC adopted the Amendments in response to requirements set forth in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). In particular, Section 939A of the Dodd-Frank Act requires federal agencies, including the SEC, to “review any regulation issued by such agency that requires the use of an assessment of the credit-worthiness of a security or money market instrument and any references to or requirements in such regulations regarding credit ratings.” In response to this requirement of the Dodd-Frank Act, the SEC initially proposed the elimination of credit ratings of nationally recognized statistical rating organizations (NRSROs) from Rule 2a-7 in March 2011 and then re-proposed the rule changes in July 2014. On September 16, 2015, the SEC adopted the Amendments.

The Amendments remove the references in Rule 2a-7 to NRSRO ratings, which described the securities eligible to be held by money market funds – replacing those references with an alternative standard that is intended to “retain a similar degree of credit quality.” Under the Amendments, money market funds will be required to apply a four-pronged test, discussed below, to measure the credit quality of securities eligible to be held by the funds. In a departure from the proposing release for the Amendments, the SEC did not adopt the “exceptionally strong” standard described in the Proposing Release.2

In addition, the Amendments: eliminate an exclusion to the issuer diversification requirements under Rule 2a-7; alter the Rule’s treatment of conditional demand features; and amend the Rule’s monitoring and stress testing requirements.

Removal of Credit Ratings from the Definition of “Eligible Security”

Under Rule 2a-7, a money market fund must limit its investments to securities that qualify as an “eligible security” as defined in the Rule, and which have been determined by the fund’s board to pose “minimal credit risks” to the fund. Historically, Rule 2a-7 defined eligible security (and related terms) by reference to NRSRO ratings. Reliance on such ratings, in one form or another, had been part of Rule 2a-7 since it was originally adopted in 1983.3

The Amendments change the definition of an eligible security to eliminate all references to NRSRO ratings, instead defining the term to mean a security that has a remaining maturity of no more than 397 calendar days, and which has been determined by a money market fund’s board of directors (which may delegate to an entity such as the fund’s investment adviser) to present minimal credit risks to the fund.4

The amended definition requires a fund board (or its delegate) to analyze the ability of the issuer or guarantor of the security to meet its financial obligations and mandates consideration of a series of factors that money market funds traditionally have used to evaluate the creditworthiness of a portfolio security.5 Specifically, the analysis of a security will be required to include the consideration of a number of factors, including the issuer’s or guarantor’s:

(i) Financial Condition. This should include an examination of recent financial statements of the issuer or guarantor, including consideration of trends relating to cash flow, revenue, expenses, profitability, short-term and total debt service coverage and leverage (including financial and operating leverage).

(ii) Sources of Liquidity. This should include consideration of bank lines of credit and alternative sources of liquidity that would be available to the issuer or guarantor.

(iii) Ability to React to Market-Wide and Issuer- or Guarantor-Specific Events, including the Ability to Repay Debt in a Highly Adverse Situation. This should include an analysis of risks in various scenarios, including changes to the yield curve or spreads in a changing interest rate environment.

(iv) Position within its Industry, as well as Industry Strength within the Economy and Relative to Economic Trends. This should include consideration of diversification of sources of revenue, if applicable.

In addition to the factors described above, which were incorporated into the text of the Rule, the SEC included in the Adopting Release the following asset-specific factors that a board (or its delegate) could evaluate in making determinations regarding minimal credit risk:

  • Municipal Securities: (i) the sources of repayment; (ii) issuer demographics (favorable or unfavorable); (iii) the issuer’s autonomy in raising taxes and revenue; (iv) the issuer’s reliance on outside revenue sources, such as revenue from a state or federal government entity; and (v) the strength and stability of the supporting economy.
  • Conduit Securities: analysis of the underlying obligor for all securities other than asset-backed securities (including asset-backed commercial paper).
  • Asset-Backed Securities (including Asset-Backed Commercial Paper): (i) analysis of the terms of any liquidity or other support provided; and (ii) legal and structural analyses to determine whether the particular asset-backed security presents no more than minimal credit risks for the money market fund.
  • Other Structured Securities (such as Variable Rate Demand Notes, Tender Option Bonds, Extendible Bonds or “Step Up” Securities or Other Structures): in addition to analysis of the issuer or obligor’s financial condition, analysis of the protections for the money market fund provided by the legal structure of the security.
  • Repurchase Agreements: (i) a financial analysis and assessment of the minimal credit risk of the counterparty; (ii) an assessment as to whether the haircut level is appropriate for the particular type of collateral, based upon price volatility in the market for such collateral type; and (iii) a legal analysis of the protections for the money market fund provided by the terms of the repurchase agreements.

The SEC indicated that the “list of the factors in the [Rule] and the additional factors discussed in [the Adopting Release] as guidance are not meant to be exhaustive, and there may be additional factors that could be relevant depending on the type of security analyzed.”6 The SEC also stated in the Adopting Release that, in determining whether a security presents minimal credit risks, a board (or its delegate) should consider not only the individual risks of the security, but also the overall impact of investing in the security in light of the fund’s other portfolio holdings.

Elimination of the Exclusion for Certain Guarantees from the Issuer Diversification Requirement

Rule 2a-7 requires a money market fund to be diversified, both as to the issuers of the securities it acquires and the providers of guarantees (and demand features) regarding those securities. Money market funds must limit their investments in securities of any issuer to no more than five percent of total assets, other than with respect to government securities and securities subject to a guarantee by a non-controlled person. While Rule 2a-7 has not required money market funds to be diversified with respect to issuers of securities that are subject to a guarantee by a non-controlled person, money market funds currently are prohibited from investing more than 10 percent of their total assets in securities subject to a guarantee or demand feature from any one provider.

Under the Amendments, the SEC removed from the issuer diversification requirement the current exclusion for securities that are subject to a guarantee by a non-controlled person. Accordingly, going forward, a money market fund will be required to limit its investments in securities of a non-governmental issuer to no more than five percent of the fund’s total assets, regardless of whether or not the security is subject to a guarantee by a non-controlled person. The SEC stated its expectation that the impact of this change would be minimal and likely affect only “a small number of all money market funds,” particularly tax-exempt or single-state money market funds.

Amendments to Form M-NFP

As part of reforms made to money market funds in 2010, Form N-MFP was created to provide the SEC with a monthly electronic filing of portfolio holdings from each money market fund. The current Form requires money market funds to provide the name of the designated NRSRO for each portfolio security and the rating assigned to the respective security by the designated NRSRO. The Proposing Release would have revised the Form to require money market funds to provide “each rating assigned by any NRSRO if the fund or its adviser subscribes to the NRSRO’s services” and “any other NRSRO rating that the fund’s board of directors (or its delegate)” took into account, when making its credit risk determination, as well as the name of the respective agency that provided the rating.

In response to comments received on the Proposing Release, the SEC did not adopt the requirement for money market funds to report each rating of an NRSRO to which the fund or its adviser subscribes. However, the SEC did adopt as proposed the requirement that money market funds disclose the NRSRO ratings that the fund’s board (or its delegate) considered, if any, in making its minimal credit risk determination for a security, along with the name of the rating agency that provided the rating. Accordingly, if a money market fund’s board (or its delegate) uses NRSRO credit ratings in determining the minimal credit risk of a security, those ratings will need to be disclosed on Form N-MFP.

Other Amendments

Treatment of Conditional Demand Features

Currently, Rule 2a-7 provides that a security subject to a conditional demand feature may be considered an “eligible security” if the conditional demand feature itself is an “eligible security” and the underlying security (or guarantee) received a credit rating within the highest two categories from a NRSRO. Under the Proposing Release, the references to credit ratings would have been eliminated from this requirement and a money market fund’s board (or its delegate) would have been required to determine that the underlying security or its guarantee “[had] a very strong capacity for payment of its financial commitment.”

As a result of comments received on the Proposing Release, the SEC did not adopt this “very strong capacity” standard, instead adopting a “uniform minimal credit risk standard.” Therefore, under the Amendments, a money market fund’s board (or its delegate) must determine that both the conditional demand feature and the underlying security (or guarantee) are eligible securities as defined in the Rule.


Under Rule 2a-7, currently a money market fund’s board (or its delegate) has to promptly reassess whether a security that has been downgraded by an NRSRO continues to present minimal credit risks, and take such action as it determines is in the best interests of the fund and its shareholders. Under the Amendments, as proposed, this requirement has been changed to require the adoption of written procedures that require the money market fund’s adviser to “provide an ongoing review of the credit quality of each portfolio security to determine that the security continues to present minimal credit risks.”7 Although the SEC did not provide a specific requirement with respect to the frequency for the monitoring, it stated that “monitoring efforts should occur on a regular and frequent basis.” The SEC noted that most money market funds engage in daily monitoring of changes in credit quality, and that some even do so on an hourly basis in certain situations, which is in the SEC’s view “consistent with the ongoing monitoring requirement adopted.”

Stress Testing

Rule 2a-7 currently requires a money market fund to adopt procedures to conduct periodic stress testing of the fund’s portfolio. These stress tests must assess specific hypothetical events, including a downgrade in the credit rating of a portfolio security or its guarantee. As part of the Amendments, the SEC adopted changes to Rule 2a-7 to replace references to credit rating downgrades in the stress testing provisions with references to an event indicating or evidencing credit deterioration of a particular portfolio security or its guarantee. Accordingly, although money market funds may continue to test their portfolios against possible credit rating downgrades, such Funds must also test securities against “any other indication or evidence of credit deterioration they determine appropriate.”


The Amendments will require revisions and additions to money market fund procedures and will require increased oversight of the process for determining the credit quality of portfolio securities. The Amendments also will impact the diversification requirements under Rule 2a-7. A money market fund will need to be in compliance with the Amendments on or before October 14, 2016, but it can begin complying with the Amendments before such time.


1) Removal of Certain References to Credit Ratings and Amendment to the Issuer Diversification Requirement in Money Market Fund Rule, Investment Company Act Release No. 31828 (Sep. 16, 2015) (Adopting Release).

2) Removal of Certain References to Credit Ratings and Amendment to the Issuer Diversification Requirement in the Money Market Fund Rule, Investment Company Act Release No. 31184 (July 23, 2014) (Proposing Release).

3) See Valuation of Debt Instruments and Computation of Current Price Per Share by Certain Open-End Investment Companies (Money Market Funds), Investment Company Act Release No. 13380 (July 11, 1983).

4) The Proposing Release would have required a money market fund’s board or its designate to include “a finding that the security’s issuer has an exceptionally strong capacity to meet its short-term financial obligations” when determining whether a security presented minimal credit risks. However, commenters generally raised concerns with the “exceptionally strong” standard. See Proposing Release (emphasis added); See also Adopting Release.

5) The SEC recognized in the Proposing Release that a fund board (or its delegate) could continue to consider external factors, including NRSRO ratings, as part of its minimal credit risk and monitoring processes, and that the Amendments did not change this. See Proposing Release.

6) The SEC recognized “that the range and type of specific factors appropriate for consideration could vary depending on the category of issuer and particular security or credit enhancement under consideration, and that the board (or its delegate) therefore may determine to include other factors in its credit assessment.” See Adopting Release.

7) Specifically, in the Adopting Release, the SEC noted that “as a practical matter,” a fund board (or its delegate) will have “to monitor for downgrades by relevant credit rating agencies because such a downgrade would likely affect the security’s market value.” See Adopting Release.


Written by:

Dechert LLP

Dechert LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.