Do money-market funds need a new credit-rating system? Moody’s believes so. In early fall, the agency proposed a new rating methodology it says would give corporate-cash investors greater insight into a fund’s ability to stay liquid and preserve capital. But some treasury professionals are calling aspects of the plan into question, and say the system could create problems in the short-term cash investment market.
Moody’s proposal comes in light of the turmoil that engulfed money-market funds during the financial crisis. In September 2008, 31 rated funds suspended redemptions and delayed distributions as institutional investors lost confidence in them, according to the agency. Shareholders in two funds had principal losses. Between August 2007 and December 31, 2009, there were 36 cases in the United States and 26 in Europe in which ailing funds received financial and balance-sheet support from their sponsors or parent companies.
The proposed new approach to rating money-market funds is based on the risks exposed by the financial crisis: funds’ vulnerability to market and liquidity risks, the impact of a fund’s investor base on the susceptibility of the fund to redemption risk, and the ability and willingness of sponsors to provide financial support to troubled funds.
Since Moody’s believes neither its current long-term (Aaa to C) nor short-term (Prime-1 to Not Prime) credit-rating scales are suitable, it proposes a new rating scale of MF+1 to MF4 (MF stands for “managed fund”). Money-market funds rated MF1+ and MF1, and some rated MF2, would “exhibit ultimate recoveries consistent with highly rated bonds but with a lower level of certainty regarding the timing of such receipts,” the agency says.
Moody’s would use new metrics to generate the ratings. To evaluate a fund’s stability, for example, the agency would examine its asset profile, liquidity position, and sensitivity to market risk. In the case of asset profiles, a fund’s weighted average maturity and its concentration of investments — whether by obligor, security type, or geography — would be paramount.
On the liquidity side, Moody’s would look at the degree to which the fund is invested in liquid securities, particularly Aaa-rated government securities and securities with maturities of less than seven days. A liquidity assessment would also depend on a fund’s shareholder base. “A diversified investor base would help to reduce the volatility of outflows that could occur for a fund with a concentrated investor base,” says Moody’s. The agency would be particularly interested in evaluating a fund’s top three investors.
To measure a fund’s exposure to market risks, Moody’s plans to stress-test the fund’s mark-to-market value using the following scenarios: a 150 basis-point yield-curve shift across all securities, a 50 basis-point increase in spread, a two-notch downgrade of 10% of the investments in the portfolio, and a 40% overnight redemption rate. The redemption-rate test would “simulate the need to sell at least 40% of a fund’s assets in order to meet investor redemptions,” says Moody’s.
A key aspect of the new ratings would be sponsor support — the ability of a sponsor to support a fund during a crisis, and its willingness to do so. Regarding the former, Moody’s says an MF1+ rating would be achievable when the fund sponsor’s long-term credit profile is at least single-A quality, although the agency would be willing to make exceptions based on other criteria. Regarding willingness to provide support, in the absence of an existing contract that guarantees fund support, Moody’s says it would consider among other things the strategic importance of the asset-management franchise to the sponsor and the sponsor’s track record of supporting its funds.