Implementing the Dodd-Frank Act’s Prohibition Against References to Credit Ratings: The Investment Company Act Rules and Forms
As required by the Dodd-Frank Act, the SEC is proposing the removal of references to credit ratings in certain rules and forms under the Investment Company Act of 1940. Three Investment Company Act rules: Rules 2a-7, 3a-7 and 5b-3, and four forms: Forms N-1A, N-2, N-3 and N-MFP, are affected. The proposed amendments remove the references to credit ratings in Rules 2a-7 and 5b-3 and replace them with alternative standards of credit-worthiness designed to achieve the same purposes.
In addition, the Commission proposes new Rule 6a-5 under the Investment Company Act to establish a credit-worthiness standard to replace the credit rating reference the Dodd-Frank Act eliminated from the Investment Company Act. Finally, the SEC proposes elimination of required disclosures of credit ratings in Form N-MFP, and removal from Forms N-1A, N-2 and N-3 the requirement that credit ratings be used when portraying credit quality in shareholder reports.
Under the proposal, a rating would no longer be a required element in determining which securities are permissible investments for a money market fund. A security would instead be an eligible investment for a money market fund if the fund’s board or its delegate determines that the security presents minimal credit risks. The fund’s board may continue to consider credit in making those determinations.
As under the current rule, funds would have to invest at least 97 percent of their assets in securities that the board has determined are issued by an issuer that has the highest capacity to meet its short-term financial obligations. This standard is intended to be consistent with the highest credit rating category. To satisfy the proposed standard, an investment adviser would be required to exercise “reasonable diligence” in keeping abreast of new information about a portfolio security that the adviser believes to be credible.
Similarly, the proposed amendments to Rule 5b-3 would eliminate the requirement that securities collateralizing repurchase agreements, other than cash or government securities, be rated in the highest credit rating category or be of comparable quality. In place of this requirement, the proposal would put certain restrictions on collateral other than cash or government securities. Such collateral would have to consist of securities that the fund’s board of directors determines are issued by an issuer that has the highest capacity to meet its financial obligations, and be sufficiently liquid that they can be sold at approximately their carrying value in the ordinary course of business within seven calendar days.
Proposed rule 6a-5 would deem a business and industrial development company to have met the requirements for credit-worthiness of certain debt securities if the board of directors determines that the debt security is subject to no greater than moderate credit risk, and is sufficiently liquid that the security can be sold at or near its carrying value within a reasonably short period of time.
Comments should be submitted on or before April 25, 2011. View the proposing release and text here.