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The new rating scale from Moody’s –what does it mean for you?9th November 2010

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What is the Moody’s proposal?

• The Aaa rating for money funds disappears

• A money fund can be rated from MF1+ through to MF4

• The rating changes demand amendments to portfolio construction that parallel the revised IMMFA Code of Practice.This means

1. More liquidity2. Higher quality, shorter maturity credits3. Less exposure to interest rate and credit spread changes

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What are the next steps? When does this happen?

• The changed rating criteria are still in draft form

– The consultation period with Moody’s rated funds closed on 5th November

– Implementation is slated for Q1 2011

• Our impression is that Moody’s have been surprised by the level of objections they have received

– We believe that, in all likelihood, the proposals will be amended prior to implementation

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Moody’s proposals – impact for the fund manager• Almost all Prime money market funds (like the RBS Core Global Treasury Fund) are expected to be rated MF1

THIS IS NOT THE HIGHEST RATING

• Money funds with government paper only expected to be rated MF1+

• It will be possible for a Prime fund to be MF1+ BUT THERE WILL BE YIELD IMPACT!

Credit profile

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Aaa Aa1 Aa2 Aa3 A1 A2 A3

GBP GovGBP Core

Liquidity profile

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

- 20 40 60 80 100 120 140 160 180

days to maturity

GBP Gov cumGBP Core cum

1As at 4th November 2010

GTF Sterling Government Fund1 51bp gross

GTF Sterling Core Fund1 71bps gross

Average differential over last 6 months1 14bps

GTF Euro Government Fund1 51bp gross

GTF Euro Core Fund1 71bps gross

Average differential over last 6 months1 18bps

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What does this mean for the RBS product range?

Currently rated AAA (S&P)

Not a money market fund so new Moody’s rating scale doesn’t apply


Expected to be rated MF1(Moody’s)


Expected to be rated MF1+ (Moody’s)

Fixed Return FundsGTF Core FundsGTF Government Funds

Our choices

Maintain existing product range and accept that our Core Fund will not have the highest rating but rather MF1 (in line with the majority of our peer group)

Add an additional prime fund to our product range which attains the MF1+ rating and concomitant drop in yield

Drop the Moody’s rating altogether

Appendices

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Product Characteristics

1 million currency units

AAAm by S&P’s

60 days

1-25 days

Sovereign issuance

Daily dealingT + 0 Distributing

T + 1 Accumulating

Distributing/ Accumulating

N/A

Government Funds Sterling, Euro

DistributingDistributing/ Accumulating Share classes

5 million currency units1 million currency unitsMinimum Investment

AAAf by S&PAAAm by S&P’s /Aaa by Moody’s/AAA/V1+ by Fitch RatingsFund rating

1,3,6,9 month term

1,3,6,9 month term

Reverse repurchase agreements

Daily dealingT+2 settlement

1,3,6,9 month term

N/A

Fixed Return Funds Sterling, Euro, Dollar

Financial institution, sovereign and corporate issuanceMain Investments

Daily dealingT + 0 Distributing

T + 1 AccumulatingLiquidity

60 daysMax. Weighted Average Maturity

Typical Weighted Average Maturity

Benchmark

30-40 days

7 day Libid

Core FundsSterling, Euro, Dollar

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Internal RBS portfolio criteria versus rating agency & regulatory criteria

WAFM of 120 days

WAFM 120 daysFRN AA sovereign:24 monthsAll other securities: 397 days

WAFM: N/A397 days for fixed rate

WAFM: N/AGenerally 397 days

Not to exceed 397 days for deposits

WAFM of 45-50 daysMaturity:• 90% within 3 months• 10% between 3 to 6

months

Final Maturity Restriction

Maximum ongoing group exposure:• F1+ rated:10%, of which

>7 days: 5%• F1 rated:5%• Individual money market

fund (except funds rated AAAmmmf): 10%

• Institutional sponsor/parent company: 5%

• Maximum indirect exposure;

• Per financial group, including all exposure via ABCP conduits and sponsored SPV’s; 15%

• Per Repo counterparty if 102% over-collateralised by govt. or govt. agency securities and daily market-to-market; 25%

• 5% exposure per issuer• A rating committee may

permit up to 10% exposure per issuer for European fund

Max. per non-sovereign issuer• Overnight: 25%• 2-7 days: 10%• >7 days: 5%Maximum per sovereign (national gov’t) issuer• A-1+ rated: no limit• A-1 rated: overnight25%; 2-7 days:10%; >7 days: 5%Credit card ABS FRNs and Auto ABS FRNs are limited to 5% per issuer.

Max. 20% exposure per counterparty for o/ndeposits.Maximum total allocation to “anciliary liquid assets”(deposits and repo) of 49%Max. 10% exposure per issuer. The aggregate value of any holdings representing >5% must not exceed 40%.Increased to 35% if securities are gov’t/supra or gov’t guaranteed.

• 10% limit per parent entity, with a maximum of 5% of that figure with a maturity beyond 1 week

Diversification

60 days 60 days 60 days 60 days30-40 daysWAM

Fund must be AAA-rated by at least one nationally recognised rating agency. Recommended to have in-house credit analysis resource to overlay rating agency process.Securities: in. A1/P1/F1

Fund: AAAmmfSecurities: 100% in F1 or higher, plus matrix based approach using asset maturity and credit quality

Fund:AaaSecurities: P-1/A-2, plus matrix based approach using asset maturity and credit quality

Fund: AAAmSecurities: min. A-1+ & A-1 < = 7 days; 50%Max A-1 > 7 days; 50%

Fund: case by case basis

Securities: restricted to cash or money market instruments

Included:• Sovereign/Supra• Highly rated banksExcluded• ABCP• Call accounts

Credit Quality

IMMFA CriteriaFitchMoody’sStandard & Poor’sUCITS CriteriaRBS Criteria

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Internal RBS portfolio criteria versus rating agency & regulatory criteriacont’d

Marked-to-market weekly. Escalation procedures if Fund value differs more than 10bps (10bps administrator informs fund manager, 20bps informs trustees, 30bps informs directors). Weekly reporting, annual review

Weekly reporting. Case-by-case assessment for variation of frequency or mode

Marked-to-market monthlyMonthly reporting. Expected loss reports. Management review (including compliance and controls). Annual review

Marked-to-market weekly20bps deviation = ratingwatch25bps deviation = rating downgradeWeekly reporting. Management review (including compliance and controls). Annual review

Marked-to-market dailyMonitored on a daily basis by RBS AM’s middle office

Valuation and Monitoring of Fund

5% in overnight20% in one week

Generally targeted atO/N; 10%< 7 days; 25%

No formal rule, but rating committee would consider the funds liquidity position, based on the fund portfolio’s characteristics

No formal minimums, but maximum WAM limit may be adjusted downwards based on high shareholder concentrations

See IMMFA rules, plus considers stress testing and shareholder concentration.

Liquidity

May enter a repo with unrated counterparties where: level of support from rated parent is deemed sufficient; or repo is O/N and at least 102% collateralised with 13-months (fixed) or 24 months (floating) securities

P-1 rated counterparties – up to 7 days: 25% limit; over 7 days: 10% of AUM permitted with P-1 rated counterparties; collateral = or > than 102%Per P-2 rated counterparties: up to 7 days: 10% limit; over 7 days: not permitted

Maximum per repo counterparty for fully collateralised investment• A-1+ rated: O/N: no

explicit limit but general guidance of 40%; 2-7 days: 25%; >7 days: 10%; aggregate exposure: 50%

• A-1 rated: O/N:25%; 2-7 days:10%; >7 days: 10%; aggregate exposure: 25%

The underlying are subject to diversification limits

Minimum 2%haircutMaximum maturity 7 days

Repurchase Agreements (Repos)

IMMFA CriteriaFitchMoody’sStandard & Poor’sUCITS CriteriaRBS Criteria

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IMMFA vs 2a7

Monthly, from Oct 2010 None

GTF publishes daily to investors Portfolio disclosure

Board discretion based on market conditions Monthly

Irish Regulator requires access Stress testing frequency

Max 5% illiquid securities

Max 3% second tier securities

Unrated inc ABS allowed

Please see previous slide for rating criteria Credit

30%20%Liquidity - One week minimum

60 days in arrears via SEC

As from end Nov 2010 data None Shadow NAV

10% 5%Liquidity - Overnight minimum 5% per issuer NoneSingle Investment - Concentration

397397Single Investment - Maximum maturity (days)

120120WAFM/WAL (max days)

6060WAM (max days)

SEC Regulation

Voluntary Code of Practice

CNAV

AAA rating required

Basis

SEC Rule 2a-7IMMFA

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DisclaimerThis material has been prepared by The Royal Bank of Scotland ("RBS") for information purposes only. The investments and investment services referred to herein are available only to persons to whom this material may be lawfully delivered in accordance with applicable securities laws. This material is being distributed only to, and is directed only at, persons who have professional experience in matters relating to investments, falling within Article 19(1) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001 or to other persons to whom this material may lawfully be communicated. This material is not available to private customers within the meaning of the rules of the Financial Services Authority (“FSA”). No securities (nor any related securities or other financial instruments or their related derivatives) (together “Securities") discussed herein may be offered or sold in the United States (“US”) except pursuant to an exception from the registration requirements of the Securities Act of 1933. The material should not be construed as an offer or solicitation to buy or sell any securities or any interest in securities.

The funds are sub-funds of Global Treasury Funds Plc or GTF Managed Funds Plc. Global Treasury Funds Plc is an open-ended investment company domiciled in Dublin.

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GTF Managed Funds Plc is not a recognised collective investment scheme for the purposes of the Financial Services and Markets Act 2000 of the United Kingdom (the FSMA). The promotion of the fund and the distribution of this document in the United Kingdom is accordingly restricted by law. This document is only to and/or is directed only at persons who are of a kind to whom the GTFManaged Funds Plc may lawfully be promoted by a person authorised under the FSMA (an "authorised person") by virtue of Section 238(6) of the FSMA and The Financial Services and Markets Act 2000 (Promotion of Collective Investment Schemes) (Exemptions) Order 2001 (including other authorised persons, certain persons having professional experience of participating in unrecognised collective investment schemes, high net worth companies, high net worth unincorporated associations or partnerships, the trustees of high value trusts and certified sophisticated investors) orSection 4.12 of the FSA’s Conduct of Business Sourcebook (COBS) (including persons who are professional clients or eligible counterparties for the purposes of COBS). The Prospectus of GTF Managed Funds Plc is exempt from the scheme promotion restriction (in Section 238 of the FSMA) on the communication of invitations or inducements to participate in unrecognised collective investment schemes on the grounds that it is being issued to and/or directed at only the types of person referred to above. To the extent that the Prospectus is issued by the Distributor the shares are only available to such persons and the Prospectus must not be relied or acted upon by any other persons.

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Disclaimer cont’dPast performance of the Funds are not necessarily a guide to future performance of the Funds. The value of investments and the income from them can go down as well as up and investors may not get back the amount originally invested. Exchange rates may cause the value of overseas investments and income from them to rise and fall.

The information contained herein is confidential and is intended for use only by the recipient (the “Recipient”). It should not be reproduced or disclosed to any other person without the consent of The Royal Bank of Scotland plc. The material remains the property of The Royal Bank of Scotland plc and / or its affiliates (“RBS”) and must be returned to RBS on request and any copies the Recipient has made must be destroyed.

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Table of Contents:

INTRODUCTION 1 WHY ARE WE PROPOSING METHODOLOGY CHANGES? 1 BACKGROUND 5 PROPOSED NEW RATING SCALE AND RATING DEFINITIONS 6 OVERVIEW OF THE PROPOSED METHODOLOGY 7 APPENDIX I 15 MOODY’S RELATED RESEARCH 17

Analyst Contacts:

PARIS 33.1.5330.1020

Yaron Ernst 33.1.5330.1027 Managing Director [email protected]

LONDON 44.20.7772.5454

Kathryn Kerle 44.20.7772.5403 Senior Vice President [email protected]

NEW YORK 1.212.553.1653

Daniel Serrao 1.212.553.4352 Senior Vice President [email protected]

Henry Shilling 1.212.553.1948 Senior Vice President [email protected]

Ted Collins 1.212.553.7903 Managing Director [email protected]

Credit Policy Contact:

Barbara Havlicek 1.212.553.7259 Senior Vice President [email protected]

REQUEST FOR COMMENT

GLOBAL MANAGED INVESTMENTS SEPTEMBER 7, 2010

Moody’s Proposes New Money Market Fund Rating Methodology and Symbols

Introduction

This Request for Comment describes the framework of a proposed new methodology for rating money market funds (MMFs). If adopted, our new rating methodology will supersede the following principal methodologies as they apply to money market funds: "Moody's Managed Funds Credit Quality Ratings Methodology" and "Money Market and Bond Fund Market Risk Ratings" (both published in July 2004). At the same time, we are proposing the introduction of a new set of rating symbols and definitions we believe will better address the unique risks of money market funds and better distinguish our money market fund ratings from our credit ratings on long-term debt obligations.

Why Are We Proposing Methodology Changes?

There are a number of reasons why we are proposing a change to our rating methodology and the introduction of a new rating scale for money market funds. To summarize:

» In September 2008, 31 rated funds suspended redemptions, leading to delayed distributions, and in two cases, shareholders in those funds experienced principal losses. Further suspensions and additional losses would likely have occurred in the US if the US Treasury had not made principal protection insurance programs available to the money market fund industry. As a result of these developments, we lowered our ratings on the 31 funds to below the investment grade level.

» This experience prompted a reconsideration of the approach we use to assign MMF ratings. Moody’s initiated a dialog with fund managers, investors, and other market participants to come to a better understanding of the type of information investors in money market funds seek, the role of ratings in their investment decisions, and the particular attributes of our ratings that they find most valuable.

mailto:[email protected]�



GLOBAL MANAGED INVESTMENTS

2 SEPTEMBER 7, 2010

REQUEST FOR COMMENT: MOODY'S PROPOSES NEW MONEY MARKET FUND RATING METHODOLOGY AND SYMBOLS

» Historically, we have rated money market funds using an approach that emphasizes portfolio credit quality and maturity structure, with consideration also given to factors such as portfolio strategy, manager/adviser characteristics, and the likelihood of sponsor support.1

» The performance of money market funds during the financial crisis, particularly after the Lehman Brothers’ bankruptcy, heightened investors’ focus on the wide range of risks facing these funds. The risks that were accentuated related to: 1) the vulnerability of money market funds to market and liquidity risks, in addition to credit risk; 2) the impact of the nature of the investor base on the susceptibility of a fund to redemption risk; 3) the vulnerability of a fund to illiquidity, despite owning highly-rated assets and the related investor expectation of high ultimate recoveries; and 4) the ability and willingness of sponsors to provide financial support to troubled funds. In addition, it has become clear that potential “runs” on money market funds pose a systemic risk.

Because of investor expectations and market convention, and in some cases supported by regulation, rated funds generally invest very conservatively (typically, Prime-1 commercial paper of modest weighted average duration) and rating differentiation has been limited.

The proposed methodology is intended to more effectively capture these risks by introducing objective measures to better assess factors such as liquidity risk and market risk, as well as asset quality and obligor concentrations. Greater emphasis is placed on a sponsor’s willingness and ability to support a given fund or group of funds, if need be, as has happened throughout the history of this sector. Extending our analysis of money funds in areas that are increasingly important to investors is expected to result in greater ratings differentiation than under the existing methodology.

Finally, under Section 938 of the recently passed Dodd-Frank Wall Street and Consumer Protection Act – the US financial reform bill – upon rule-making by the Securities and Exchange Commission, nationally recognized statistical rating organizations will be prohibited from having multiple definitions for the same rating symbol. Since the form and nature of money market funds is distinct from bonds rated using our traditional Aaa to C long-term rating scale, and our rating approaches and rating definitions are different, we are proposing a new rating scale that better highlights the distinction between these two types of ratings.

Introduction of New Rating Symbols and Definitions

We have historically used a slightly modified version of our traditional long-term rating scale (Aaa to C) in rating money market funds,2

Given the unique nature of money market funds – that is, investors own shares in the fund yet expect to be able to withdraw their funds on demand – we are proposing that long-term rating symbols be discontinued. Instead, we would rate money market funds based on our opinion of their ability to meet the dual objectives of preserving principal and providing liquidity to holders. To clearly distinguish these ratings from our long-term bond ratings, a distinct symbol set with its own definitions would be introduced following the form MF[n], on a rating scale from MF1+ to MF4.

where the preponderance of ratings is concentrated at the Aaa level. Indeed, money market funds are distinct from long-term fixed income instruments in that while they are generally undated, they are typically viewed as short-term investments and investors expect to be able to withdraw their funds on demand. Nonetheless, from a strictly legal perspective, money market fund investors own shares that represent an interest in a portfolio of securities.

1 See “Parental Support in Money Market Funds: Moody’s Perspective” dated November 2008. 2 Moody’s Money Market Fund ratings today are expressed by using symbols at the broad rating category level without the use of modifiers (e.g., -1, -2, -3). European

Constant Net Asset Value (CNAV) funds are currently rated on the same scale and are also assigned an MR1+ symbol to denote their CNAV status.

http://v3.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_112003�


3 SEPTEMBER 7, 2010


Contrasting the Proposed New Rating Scale With Moody’s Traditional Credit Ratings

Although money market funds are not credit instruments, they do compete for investor funds with short-term credit investments such as commercial paper, short-dated bonds, and bank deposits. Accordingly, investors may be interested in how the proposed money market fund ratings would compare with Moody’s rating opinions expressed using our traditional long-term and short-term rating symbols. Due to the unique character of money market funds, a direct mapping of the proposed MF ratings to either Moody’s long-term or short-term ratings is not appropriate, but comparisons can nevertheless be made.

Money market funds have no repayment date, yet investors expect their money on demand as they would for any short-term obligation or bank deposit. This means that a long-term fixed income rating is not necessarily the best expression of money market risks to investors. On the other hand, Moody’s prime rating scale (Prime-1, Prime-2, Prime 3, and Not Prime) is not the best alternative either. Although a money market fund may have an expected loss profile consistent with its underlying (normally Prime-1) rated assets, its ultimate loss severity in case of fund liquidation or a redemption suspension event would typically be much lower than in the case of an individual defaulted Prime-1 rated obligation. In addition, money market funds are more sensitive to systemic risk and investor “runs” than Prime-1 rated obligations. Thus, neither the long-term nor short-term credit rating scale provides a basis for expressing the risk of money market funds that is consistent with other obligations rated on those scales.

We believe most money market funds rated MF1+ and MF1, and many of those rated MF2, by virtue of design and regulation, would exhibit expected ultimate recoveries consistent with highly-rated bonds (i.e., at least A-rated), but with a lower level of certainty regarding the timing of such receipts. In comparison to short-term debt obligations rated on the prime scale, we believe money market funds rated MF1 or MF1+ would exhibit a risk profile broadly consistent with Prime-1 rated investments. However, there is a higher expected frequency of payment interruption offset by higher expected recoveries in the event of payment interruption. Similarly, money market funds rated MF2 and MF3 might be compared to Prime-2 and Prime-3 rated investments, respectively, while recognizing distinctions in the meaning of the rating scales. Were we to express opinions on money market funds using the prime scale, which places a much greater weight on default probability than on loss-given-default, even conservatively invested funds may not receive Prime-1 ratings and many could be rated Prime-3 or even Not-Prime.

While we believe that the distinct MF scale provides investors with useful information and differentiation among funds, we recognize it may raise issues for some investors whose investment guidelines reference Moody’s traditional credit rating scale. Indeed, for certain types of fixed income securities (e.g., some municipal bonds and structured financings), we expect to update our own rating criteria in these areas to accommodate the new rating scale. We plan to communicate more specifically about how the proposed MF ratings will be interpreted in the context of other Moody’s rating methodologies once our methodology is finalized.


4 SEPTEMBER 7, 2010


Enhanced Analysis and Improved Transparency

The proposed new methodology would use specific metrics to measure several factors that we consider indicative of a fund’s ability to preserve principal and provide liquidity. The proposed new metrics address the following factors: (1) asset profile, including weighted average maturity (WAM) and obligor concentration; (2) portfolio liquidity, measuring different liquidity “buckets” (daily or weekly) relative to investor concentration and fund assets under management (AUM); and (3) market risk where the impact of specified market shocks on a fund’s net asset value (NAV) is estimated. We believe the above factors would provide relevant differentiation among funds and investors would benefit from more transparency with respect to various fund characteristics.

In addition, the proposed methodology would expand our assessment of the ability and willingness of a third party (usually the fund sponsor) to provide support to a fund. We expect that only funds with creditworthy sponsors would receive ratings at the higher end of the scale under this revised approach. We also anticipate that funds with highly creditworthy sponsors that are deemed likely to support their funds may achieve a rating that is higher than would be implied based solely on the fund’s invested portfolio, although uncertainty about support would temper the degree of benefit.

Scope of Application – Constant and Variable NAV Funds

We propose applying the same methodology to rate both constant and variable NAV funds, both in the US and Europe, as long as both fund types pursue the primary objectives of the preservation of principal and the provision of liquidity on demand.

Request for Comment

Market participants are encouraged to send their comments to [email protected] no later than 5 November. Respondents are requested to note their role in the MMF sector, such as fund manager, investor, trustee, regulator, or other third party. Moody’s will consider comments received during this time and potentially make changes to our proposed methodology, after which we will publish a final methodology and begin the process of implementing any associated rating changes. In addition to requesting feedback on any aspect of the proposal and new rating scale, we request feedback on the following questions:

1. Would money markets benefit from fund ratings that provide enhanced information and greater differentiation as we are proposing?

2. Would the approaches proposed and the factors considered, including the relative emphasis on – and calibration of – the different factors, provide a reasonable basis for differentiation among money market funds?

3. Would the use of distinct rating symbols, along with added disclosure about rating drivers, be helpful in highlighting the distinct character of money market funds relative to other competing investments?

4. Can investment managers and other fiduciaries accommodate the proposed ratings within their existing investment guidelines? If not, would the anticipated utility of the ratings lead managers to seek revisions to those investment guidelines to better accommodate the ratings?



5 SEPTEMBER 7, 2010


Background

During the recent financial crisis, money market funds were impacted in a manner not seen in their previous almost 36 years of operation. There were an unprecedented number of rating downgrades starting in August 2007, with market volatility, illiquidity, and spread-widening affecting highly rated short-term instruments. In some instances, these factors were compounded by the financial stresses, which peaked during a pivotal two-week period preceding and following the Chapter 11 bankruptcy filing of Lehman Brothers on September 15, 2008. These events contributed to the collapse of the Reserve’s Primary Fund and the follow-on imposition of redemption restrictions on 31 money funds in the US and Europe, including 25 funds managed by the Reserve, in light of the rapid and overwhelming redemptions initiated mainly by institutional investors who lost confidence in primary money market funds (see Figure 1).

As a result, money market funds were forced to sell their short-dated securities (which were issued primarily by financial institutions), reallocate portfolio assets, and shorten portfolio durations, thus exacerbating inter-bank funding pressures, increasing rollover risks, and reducing the already diminished appetite for non-financial commercial paper. In response to this spiral, US government authorities introduced in rapid succession three programs specifically geared to stabilize money market funds and restore institutional investor confidence.

According to our research, 62 funds – including 36 funds in the US and an estimated 26 funds in Europe – received financial and balance sheet support from their sponsor or parent company during the financial crisis between August 2007 and December 31, 2009.3

FIGURE 1

Money Market Fund Cash Flows

-300-250-200-150-100

-500

50100150200250

9-N

ov-0

7

9-D

ec-0

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9-Ja

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9-Fe

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In $Billion Euro Pound Sterling US Dollar US Prime funds

Source : iMoneyNet

In addition, the number of funds that “broke the buck” and/or suspended redemptions might have been higher without the benefit of sponsor support and government initiatives. This is consistent with data we reviewed in connection with historical events prior to 2007, where losses of value in funds caused them to risk “breaking the buck” or suspend redemptions had it not been for sponsor support.4

3 The numbers are largely based on data compiled for the 100 largest prime money market funds only, out of 239 funds, and accounted for 92% of the assets in this

segment. Some funds received parental support on more than one occasion, but they are still reported as a single event in this report.

4 See “Sponsor Support Key to Money Market Funds,” dated August 9, 2010.

http://v3.moodys.com/viewresearchdoc.aspx?docid=PBC_126231�


6 SEPTEMBER 7, 2010


The September 2008 crisis had a significant impact on investors in money market funds. Some, particularly those invested in Reserve Management Funds, suffered payment delays and principal losses. As a result, investors generally have become more sensitive to the differences among money market funds, not just in terms of their asset credit quality and market risk, but also in the degree of exposure to, or insulation from, stress events that could render a fund unable to pay unexpected levels of redemptions. The importance of sponsor support has further been highlighted as a key consideration.

As part of the process of reconsidering our methodology for rating money market funds, we studied those funds that had difficulty meeting their redemption obligations in 2007 and 2008, as well as the effect of previous stress events on money market funds. We analyzed the funds’ assets at the time of stress, as well as their liquidity positions, sensitivity to market risk, manager attributes, and their sponsor’s ability and willingness to provide support. We also conducted interviews with investors in both the US and Europe and discussed their concerns following the financial crisis, including the type of information and differentiation they would find useful with respect to money market funds. Our research of these historical events and the feedback provided by investors have informed our proposed new methodology.

Proposed New Rating Scale and Rating Definitions

Our proposed ratings would be expressed on a new “MF” (managed fund) rating scale, to differentiate between money market fund ratings and our traditional long-term and short-term credit ratings. We believe that neither our (Aaa-C) long-term credit rating scale nor our short-term (Prime) rating scale would be optimal for rating money market funds for the following reasons: (1) money market funds do not issue debt and investors own shares in the funds; (2) while there is a general expectation by investors of immediate redemption at par, the legal promise is very different, given the qualifications that are included in most money market fund prospectuses and other provisions;5

The proposed money market fund ratings, applied globally, would be defined as representing Moody’s assessment of the ability of money market funds to meet the dual objectives of providing liquidity and preserving capital as detailed below:

(3) the inherent nature of money market funds, which seek to provide reasonable short-term returns, while also seeking to provide liquidity on demand, yet are exposed to credit, interest rate and liquidity risks with very limited tolerance for mark-to-market deviations; and (4) money market funds’ significant susceptibility to systemic risk, as evidenced during the financial crisis. Such differences in investor expectations, in instrument characteristics, and in the influence of systemic factors suggest that a unique rating definition and scale is appropriate.

5 For example, U.S. Securities and Exchange Commission (SEC) rule 2a-7 allows funds’ boards of directors to suspend redemptions in certain cases.


7 SEPTEMBER 7, 2010


FIGURE 2

Managed Fund (MF) Rating Definitions

MANAGED FUND RATING DEFINITION

MF1+ Money market funds rated MF1+ have excellent ability to meet the objectives of providing liquidity and preserving capital.

MF1 Money market funds rated MF1 have very good ability to meet the objectives of providing liquidity and preserving capital.

MF2 Money market funds rated MF2 have good ability to meet the objectives of providing liquidity and preserving capital.

MF3 Money market funds rated MF3 have marginal ability to meet the objectives of providing liquidity and preserving capital.

MF4 Money market funds rated MF4 have weak ability or have failed to meet the objectives of providing liquidity and preserving capital.

Overview of the Proposed Methodology

The proposed methodology would combine an assessment of a fund’s portfolio credit profile with an evaluation of its portfolio stability profile and reflect consideration of other factors relating to potential sponsor support and the fund’s management, as outlined below.

Portfolio Credit Profile

When benchmarking a fund’s portfolio credit quality, we consider the quality of individual securities in the fund as well as the maturity of those investments, reflecting the view that shorter-dated instruments represent less absolute quantum of risk, all else being equal, than longer-dated instruments (i.e., the cumulative expected credit loss curve is upwardly sloping over time). This analysis is accomplished using Moody’s Credit Matrix, which is a tool that attributes to each security in the portfolio a specified amount of loss that is derived from: 1) its actual, estimated or derived long-term rating; 2) the expected loss associated with that rating over a one-year timeframe using Moody’s long-term idealized loss table; and 3) an adjustment for the security’s remaining maturity.6 The expected loss for each security is aggregated and corresponds to a theoretical bond rating, which we compare to a benchmark 12-month security at the same rating level.7

A schematic showing how, for the purpose of benchmarking a portfolio’s credit profile, the expected loss associated with a given security’s rating is adjusted for its maturity can be seen in the diagram below. For example, a Aa3-rated security with a 90-day remaining maturity is estimated to represent a similar amount of expected loss as that of a Aa1-rated security with a one-year remaining maturity.

6 For more information on the Credit Matrix, see “Frequently Asked Questions about Moody's Ratings of Managed Funds: Moody's Credit Matrix for Managed Funds,”

published in March 2006. The report should be read with the proposed modification regarding the reinvestment assumption, as noted above. 7 We currently use a benchmark 13-month security, based on the Rule 2a-7 requirement that the maturity of a fund’s assets will not exceed 397 days. As part of the

proposed new methodology, we plan to change the benchmark to 12 months, which will be more consistent with the 12-month benchmark within our long-term rating spectrum. In any event, the difference between the results under a 12-month benchmark and a13-month benchmark is minor.

http://v3.moodys.com/researchdocumentcontentpage.aspx?docid=PBS_SF69871�


8 SEPTEMBER 7, 2010


FIGURE 3

Deriving Portfolio Credit Profile

UNDERLYING SECURITY MATURITY

(DAYS) Aaa Aa1 Aa2 Aa3 A1 A2

30 Aaa Aaa Aaa Aa1 Aa1 Aa2

60 Aaa Aaa Aaa Aa1 Aa2 Aa2

90 Aaa Aaa Aa1 Aa1 Aa2 Aa3

120 Aaa Aaa Aa1 Aa2 Aa2 Aa3

180 Aaa Aaa Aa1 Aa2 Aa3 A1

270 Aaa Aa1 Aa1 Aa2 Aa3 A1

1 Year Aaa Aa1 Aa2 Aa3 A1 A2

2 Year Aa2 Aa3 A1 A2 A3 Baa1

Note: The chart is based on Moody’s Credit Matrix. It assumes that each asset with a maturity below the 12-month benchmark will be reinvested in instruments with the same rating and be rolled to the 12-month point. Assets maturing beyond 12-months are assessed at their respective maturities.

The use of the Credit Matrix in the proposed methodology is consistent with the approach we have historically used with one adjustment. In the proposed methodology, it is assumed that each asset, at maturity, will be reinvested in instruments with the same rating and remaining maturity resulting in greater portfolio expected loss than previously. This continual rollover assumption is more conservative than the liquidation assumption currently used, which assumes that cash from maturing assets is invested in government/treasury securities. The revised assumption introduces greater differentiation into the relative ranking of money market funds and provides more information to investors.8

Portfolio Stability Profile

A fund’s portfolio credit profile provides information about its maturity-adjusted weighted average credit quality and, therefore, exposure to credit risk. However, money market funds are also susceptible to interest rate and liquidity risks that could adversely affect their principal value and ability to meet liquidity draws on demand. To assess the relative risk of such disruptions, we propose assessing portfolio stability by evaluating the fund’s asset profile, the portfolio’s liquidity position, and its sensitivity to market risk, using a scorecard to highlight and capture these factors in a consistent way.

Using the scorecard, we would evaluate three key factors that we consider relevant to a money market fund’s ability to maintain mark-to-market value and avoid a disruption in its efforts to meet investor redemptions, as outlined below:

8 The input to the Credit Matrix, notably the underlying securities ratings, would also be subject to review by a rating committee. The input and/or the Credit Matrix

results may be adjusted by a rating committee to reflect the potential changes to credit ratings on review for potential upgrade or downgrade, for unrated securities, and for securities that may be vulnerable to particularly rapid rating transitions.


9 SEPTEMBER 7, 2010


FIGURE 4

Deriving Portfolio Stability Profile – Scorecard Parameters

SCORE

FACTOR WEIGHT 1+ 1 2 3 4

Asset profile 20%

WAM <30 days <60 days <90 days <120 days >120 days

Top 3 obligor concentration <7.5% <15% <30% <50% >50%

Fund liquidity 40%

Overnight Liquidity / Largest 3 investors >100% >90% >75% >25% <25%

Overnight Liquidity / Fund AUM >30% >20% >10% >5% <5%

7 Day Liquidity / Largest 3 investors >130% >120% >100% >33% <33%

Fund exposure to market risk 40%

NAV stress > 0.9950 > 0.9900 > 0.9850 > 0.9800 < 0.9800

The goal of the proposed methodology is to differentiate among money market funds based on each fund’s intrinsic risk profile and its likely response to market stresses. The values for the parameters we have listed under each factor for a given score are indicative rather than absolute and, as such, are intended to help us determine the relative strengths and weaknesses of money market funds. Nonetheless, while the scorecard provides a framework for thinking about certain fund risks, the final rating outcome is subject to rating committee discussion and adjustments, as appropriate, to reflect the unique characteristics of a fund and its management.

Portfolio Stability – Asset Profile Our assessment of a fund’s asset profile is based on two main measures: the portfolio’s WAM and its asset concentration.

WAM is well recognized as a key factor that drives a money market fund’s sensitivity to changes in interest rates. It also indirectly affects the fund’s liquidity profile and its ability to meet its redemption obligations in the short term.9

The importance of WAM was recognized in recent amendments to the regulation of money market funds in both the US and Europe. In the US, the SEC’s Rule 2a-7 under the Investment Company Act of 1940 was modified to limit money market funds’ investment criteria so that the portfolio WAM is 60 days or shorter. In Europe, the Council of European Securities Regulators (CESR) recently promulgated a new definition of money market funds.

Assets with shorter-term maturities are normally more liquid given their shorter life cycle and, as such, they would also be easier to liquidate in case of market stress.

10

9 WAM may not capture the actual maturities of Floating Rate Notes (FRN) because WAM is calculated using an FRN’s reset date instead of its maturity date. In cases

where a fund holds a meaningful percentage of FRNs, Moody’s may decide to use the Weighted Average Life (WAL) of the portfolio instead of WAM in its Asset Profile assessment. WAL calculation is based on the final maturity of such securities, regardless of the reset dates of their interest rates. Rule 2a-7 also includes now a WAL limitation of 120 days.

Under the new CESR definition, “Short-Term Money Market Funds” can only have a portfolio WAM of 60 days or shorter. The second

10 On 19 May 2010, CESR published the guidelines for a common definition of European money market funds. The Guidelines take effect on 1 July 2011. CESR’s Guidelines apply to both collective investment undertakings authorized under the UCITS Directive (2009/65/EC) and to collective investment undertakings that market themselves as money market funds, but are not UCITS-compliant.


10 SEPTEMBER 7, 2010


category defined by CESR is “Money Market Funds,” which can invest in assets so that the portfolio WAM is limited to six months.

Diversification is one of the key advantages of a money market fund that is expected by investors. Asset concentration is an important factor that may increase the risk of redemption payment disruptions, the risk of higher credit losses in case of liquidation, or market value declines. Concentration could be in several forms, including obligor concentration, security-type concentration, and geographic concentration. Additionally, most money market funds’ portfolios are heavily exposed to the financial sector (mostly to banks), and to specific regions (i.e., the US and Europe), resulting in very small differences among funds on these factors.

Accordingly, to better differentiate between money market funds, the scorecard would focus on measuring the concentration of the top three obligors in fund portfolios. Affiliated obligors of the same corporate family would be counted together, as if they were one, to avoid underestimating an artificial diversification due to multiple legal entities that are all linked to the same parent company.

The asset profile score in the scorecard would be based on an equal weighting of these two factors – WAM and the top three obligor concentration.

Portfolio Stability – Fund Liquidity Another key factor in a fund’s ability to meet its objective of offering redemptions on demand is its liquidity profile. Our evaluation of liquidity incorporates both the maturity structure and quality of the assets, as well as exposure to the risk of large unplanned redemptions. We would evaluate the degree to which a fund is invested in liquid securities, notably Aaa-rated government securities and their maturities, as well as other liquid assets such as securities with a maturity of less than seven days.11

We would then compare the fund portfolio’s liquidity in terms of its granularity relative to its shareholder base and to its AUM. All else being equal, funds with highly liquid assets would have greater ability to meet unexpected redemptions. In addition, a diversified investor base would help to reduce the volatility of outflows that could occur for a fund with a concentrated investor base.

We would also consider the existence and size of committed, unutilized lines of credit, if any, and any other sources of potential liquidity.

We propose using three liquidity profiles, each measuring a different view of a fund’s ability to meet investor redemptions:

(a) Overnight liquidity + Aaa-rated government securities + committed liquidity lines/Top 3 investors

At the most liquid end of the spectrum, cash-on-hand and cash from maturing securities offer the most reliable source of cash to meet redemptions. We would make additional adjustments for near-cash options such as Aaa-rated governments, which should remain liquid in most market environments (although subject to pricing risk), as well as committed liquidity lines arranged by the sponsor. Beyond these sources of liquidity, a fund may realize impaired price levels in selling assets to meet additional liquidity needs or experience a market shutdown for the portfolio’s illiquid securities. We would compare these liquidity elements with the fund’s top-three investors.

11 For government securities, we would consider whether they are fixed or variable rate; treasury bills or government agency securities; or short-dated versus long-dated

government agency securities.




(b) Overnight liquidity + Aaa-rated government securities/Fund AUM

Our second liquidity measure would calculate a fund’s overnight liquidity relative to its AUM. This would test the fund’s liquidity profile relative to its total assets, regardless of the make-up of its investor base.

(c) 7-Day liquidity/Top 3 investors

Finally, we would consider the varying time element of investor demand. As liquidity challenges can extend beyond a single day, our third liquidity measure would assess available liquidity over a one-week time horizon and compare it again with the fund’s top three investors.

In addition to the above three quantitative measures, we would evaluate a fund’s investor base and characteristics, which may affect its liquidity. We would expect a fund whose investors are mostly retail to have a very different liquidity/liability profile than that of one with mostly institutional investors. Investor distribution channels, such as portals or omnibus accounts, may also stress fund liquidity, as they may cause multiple investors to act jointly and potentially cause significant unexpected redemptions.

Portfolio Stability – Fund Exposure to Market Risk Shifts in the marked-to-market value of a money market fund’s invested portfolio can also expose it to the risk of loss if investments decline in value or need to be liquidated to satisfy redemptions when the value of invested assets has fallen below amortized cost. Accordingly, as part of assessing a fund’s portfolio stability, we also propose analyzing exposure to market risk. The key measure of market risk for both constant and variable NAV money market funds will be a stress test of the expected volatility of a money market fund’s mark-to-market NAV, given the type of assets in which it invests. All else being equal, portfolios showing low expected volatility would be rated more highly than those showing high expected volatility. The stress tests would be applied to the mark-to-market value of the portfolio.

The objective of Moody’s NAV stress test is to measure a fund’s sensitivity to a range of potential market stresses. The parameters for these market stresses are fixed for all funds, such that the stressed fund NAVs can be compared. Moody’s NAV stress test is used to compare the impact on a money market fund of a series of correlated stresses, benchmarked to events witnessed during the financial crisis. While these stresses were not seen all at once during the crisis, the objective of our stress test is to rank funds according to their sensitivity to market risk.

The stress tests we will apply to a fund’s portfolio are:

» Yield curve shift (150 bps curve shift across all securities)

» Credit spread shift (50 bps increase in spread)

» Illiquidity (additional 50 bps increase in spread for a sub-set of securities considered less liquid)

» Credit transition (10% of the portfolio would be subject to credit deterioration approximately consistent with a two-notch downgrade)

» Outflows (40% overnight redemption rate)

The first four stresses would be applied to the value of each asset held by a fund, which would then be re-priced. The fifth stress of a 40% redemption rate would simulate the need to sell at least 40% of a fund’s assets in order to meet investor redemptions. The fund’s NAV would then be re-calculated and




the resulting stressed NAV would be the basis for the market risk score on the scorecard. The above stress tests are based on historical observations of actual stress events and on certain assumptions related to the impact of such events on the fund’s NAV. (See Appendix I for an example of the specific components of this NAV stress test.)

Portfolio Stability Profile – Scorecard Example The scorecard pulls together the respective data for each element and scores it according to our defined parameters. In many cases, the data elements are sourced directly from the fund portfolio, while in some cases, we derive a particular data element by an additional calculation, such as a liquidity score or NAV stress model. An example of the application of the scorecard to a given fund is shown in the table below, where the individual components combine for an overall score of “2” for fund stability.

FIGURE 5

Example of Deriving Portfolio Stability Profile Scores

SCORE

FACTOR WEIGHT 1+ 1 2 3 4

Asset profile 20%

WAM

57 days

Top 3 obligor concentration

23.2%

Fund liquidity 40%

Overnight liquidity / Largest 3 investors

29.5%

Overnight liquidity / Fund AUM

15.1%

7 Day liquidity / Largest 3 investors

47.6%

Fund exposure to market risk 40%

NAV stress

0.9932

Overall Fund Stability Profile 100%

Combining Portfolio Credit and Stability Assessments

The ratings assigned to a money market fund would be a composite assessment of both its portfolio credit profile and stability profile. While the rating would be a balance of these two underlying assessments, fund stability would carry somewhat greater overall weight. This assessment would be subject to potential further adjustment based on an assessment of the fund management firm, sponsor, and other factors, as discussed later in this report. The indicated ratings based on the combination of these two initial components of the analysis are set out below.




FIGURE 6

Deriving Fund’s MF Rating

Aaa Aa A Baa Ba

1+ MF1+ MF1+ MF1 MF2 MF3

1 MF1+ MF1 MF1 MF2 MF3

2 MF1 MF1 MF2 MF3 MF4



PORTFOLIO CREDIT PROFILE

PORT

FOLI

O S

TABI

LITY

PRO

FILE

For example, to obtain a MF1+ rating, a fund’s portfolio stability profile would have to be scored at least “1” as reflected by the scorecard (vertical axis) combined with a Aa (if the score is 1+) or Aaa assessment of the portfolio credit profile (horizontal axis).

Impact of the Fund Manager, Sponsor, and Other Factors

While the indicated result from combining our largely quantitative assessments of a fund’s credit and stability profiles would help foster consistency in our analytical approach, it would not alone determine the final money market fund rating. The assigned rating would take into account other information and judgments we believe are relevant to a fund’s ability to meet its objectives, including factors relating to the sponsor and management firm. The quantitative analysis of a fund portfolio is necessarily a point-in-time assessment, while the qualitative analysis adds to the rating’s predictive ability.

Sponsor Support Sponsor support has proven to be a key factor in ensuring that certain money market funds meet their objectives to preserve principal and provide liquidity, particularly through periods of volatility in the market generally or in a fund’s portfolio specifically. Accordingly, we expect that MF1+ ratings would be achievable only where a fund sponsor’s long-term credit profile is generally considered to be of at least single-A quality and/or Prime-1 on the short term rating scale. Similarly, we expect that MF1 ratings would be associated with fund sponsors having an investment-grade credit profile. There may also be certain circumstances where a sponsor does not meet these criteria but, nonetheless, has a sufficiently strong balance sheet, ample credit facilities, has demonstrated effective contingency planning to cover unexpected redemptions and other adverse events, and strong risk management. We would view these sponsors on a case-by-case basis and evaluate them in relation to the type of funds they sponsor.

We would consider the sponsor’s liquidity position, including unencumbered cash, cash-like instruments, overnight securities, any other options and committed lines of credit in relation to all the sponsor’s liquidity requirements. As we have seen, if one of a sponsor’s liquidity funds experiences




problems, it is very possible that other funds it manages will experience similar problems.12

In addition to a fund sponsor’s ability to provide support in case of a credit, market, or liquidity event, the rating would be influenced by our assessment of the sponsor’s willingness to provide support. Where a sponsor provides a fund with explicit support such as a guarantee or letter of credit, we would review the provisions of those agreements and take them into account in our rating.

Without sufficient liquidity, even a motivated sponsor may find it difficult to provide timely support in a stress scenario. We would conduct a credit assessment of an unrated sponsor sufficient to make such a determination of its creditworthiness.

In assessing the likelihood of a sponsor providing support in the absence of a contractual agreement, we would consider factors such as the strategic importance of the sponsor’s asset management franchise, in general, and its liquidity franchise, in particular. We would also consider the sponsor’s track record for supporting its funds. In making this judgment, we would consider the extent to which the failure of a money market fund would likely affect the sponsor’s brand name or reputation, thereby creating incentive to provide support to its funds. Finally, we would take into account any limitations – legal, regulatory, or accounting – that could restrict a sponsor’s ability to provide support.

Manager Attributes The attributes of a manager that may lead to a rating lower than otherwise suggested by a fund’s portfolio include, notably, its credit process, investment process, control environment, operations quality, and corporate governance as they relate to the fund. The scorecard calibration assumes these attributes are of high caliber. Accordingly, policies and procedures that deviate materially from best practices may result in a lower rating.

Other Considerations Other factors may also negatively affect the rating. For example, the sponsor itself may be suffering from poor financial performance or significant negative press, which could result in degradation of its management capabilities and/or lead investors to lose confidence in its money market funds. This, in turn, could result in significant redemptions and increase the risk of suspension of redemptions. Poor data and/or lack of transparency, which raises the degree of uncertainty about portfolio composition or management, may also result in a downward adjustment.

A fund’s legal documentation, and notably repurchase agreement documentation, may impact the credit quality and liquidity of its assets. Relevant factors that would be considered by Moody’s are the creditworthiness of the repo counterparty, the type of permitted collateral, overcollateralization levels, the asset valuation process, and other terms of the repo agreement.13

12 In the absence of a lender of last resort for money market funds, third parties such as sponsors may seek to play this role. However, given the size of some money market

funds relative to the means of sponsors, most will be unable to address a run on their money market funds in an illiquid market as was experienced in September 2008. 13 Regarding our analysis of repos, see “Developments in Repurchase Agreements (Repo) and Securities Industry Overview,” dated August 2005.





Appendix I

The following example outlines specific components underlying the assessment of the fund portfolio’s exposure to market risk exposure, assessed as part of the evaluation of portfolio stability and captured in the scorecard.

FIGURE 7

Example of Assessing Market Risk Under the MF Scorecard

NOTE:

Portfolio Base NAV: (1) 1.0000

APPLY SHOCK SCENARIO SHOCK NAV

Curve Shift (2) 1.50% 0.0018 NAV reduction

Spread Shift (3) 0.50% 0.0007 NAV reduction

Illiquid Securities (4) 0.50% 0.0001 NAV reduction

Rating Transition (5) 10% 0.0005 NAV reduction

Stressed NAV (6) 0.9965 NAV impact (modeled in tandem)

Outflow impact (7) -40.00% 0.0023 NAV reduction

Stressed NAV with outflows (8) 0.9942 Total NAV impact (modeled in tandem)

The following notes correspond to each item in the above example:

(1) Portfolio base NAV

Shock Scenarios. The following shocks, reflected in a basis point increase to a security’s unadjusted yield, serve to re-price a portfolio.

– Moody’s stress model begins with an assumption that the fund is currently priced at 1.000 NAV. This starting point will be verified and, if warranted, an adjustment will be made, based on the reported mark-to-market value provided by the fund administrator.

(2) Curve shift

(3)

– A parallel 150 basis point curve shift is applied across all security types and maturities.

Spread shift

(4)

– An additional spread is added to credit securities of Aa2 or lower quality. It is adjusted in conjunction with declines in the rating of the underlying security. The spread shift is 50 bps at the Aa2 rating level. Adjustments to lower ratings are based on the relative increase in risk as reflected in Moody’s Weighted Average Rating Factor (WARF) for each rating level.

Illiquidity

(5)

– As recent market conditions have shown, some asset types are more liquid than others. Accordingly, we haircut by another 50 bps security types that we consider likely to be relatively illiquid in stressed market conditions.

Credit transition – While a stress event may be due to either market volatility or liquidity, a fund’s portfolio remains exposed to the potential for correlated credit deterioration. We address the potential for credit transitions under a stress scenario by selecting at random 10% of the securities




in a portfolio and re-pricing them in line with a two-notch downgrade (of actual or estimated long-term ratings). This adjustment is purely made for market risk assessment purposes and has no bearing on Moody’s expectation of rating transitions among the underlying investments.

(6) Final stressed NAV

(7)

– On considering the above shock scenarios, Moody’s stress model re-prices a fund’s portfolio to assess the fund’s NAV when faced with all these stress scenarios combined. The combined effect of these stresses on the fund’s NAV is greater than the sum of each scenario’s impact. This stressed NAV is assessed prior to any outflows.

Outflow impact – Amid market turmoil, it can be expected that many investors will seek to liquidate their investments. As a result, the unrealized and realized losses to a fund’s NAV are borne solely by the remaining investors, so that the negative impact on NAV is exacerbated further.




Moody’s Related Research

Rating Methodologies

» Moody’s Managed Funds Credit Quality Ratings Methodology, July 2004 (81138)

» Moody’s Money Market and Bond Fund Market Risk Ratings, July 2004 (81135)

Industry Outlooks

» Money Market Funds: 2010 Outlook (123802)

» Asset Management Industry: 2009 Review and 2010 Outlook (123358)

Special Reports

» Sponsor Support Key to Money Market Funds, August 2010 (126231)

» U.S. Money Funds' Risks are Reduced, But Susceptibility to Liquidity Risk Remains, February 2010 (122990)

» New European Money Market Fund Definitions Should be Positive for Credit Quality, November 2009 (120981)

» U.S. Treasury Extends Temporary Guarantee Program for Money Market Funds, December 2008 (112095)

» Money Market Investor Funding Facility and Other Federal Measures Promote Liquidity in Short-term Markets, November 2008 (112891)

» Parental Support in Money Market Funds: Moody’s Perspective, November 2008 (112003)

Rating List

» Global Managed Investments: Managed Funds Ratings List, August 2010

Website

» Managed Investments on Moodys.com

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients.





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Report Number: 126642

Author Yaron Ernst

Senior Production Associate Ginger Kipps

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2 November 2010

Yaron Ernst Moody's Investors Service One Canada Square Canary Wharf London E14 5FA

Dear Mr Ernst RBS Asset Management is grateful for the opportunity to respond to your consultation document of 7th September 2010 and to comment on the proposed revisions to the money market fund rating methodology and symbols.


Yes to enhanced information and greater differentiation, and no to as we are proposing.

The indication that we have had is that funds that take only Government risk will be rated MF1+ under these proposals together with a handful of the most liquid of the Prime Funds. Substantially all of the remainder of the Prime funds will be rated MF1. Assuming that this is the case then little differentiation of consequence will be added by implementing these proposals.

Money market fund investors do not get the risk information that they have a right to expect. This will be corrected to some extent for US regulated funds by developments in the SEC’s 2a7 Regulations which will require the publication of portfolio lists and shadow NAV information, but this will leave an opportunity for a provider of standardised and more comprehensive, directly comparable risk information to exploit, even for those funds.


We can’t say because we don’t have enough detail or an impact analysis.

Our conversations with Moody’s personnel have led us to believe that the full detail of the analytical models and their proposed implementation has not yet been finalised. For example we are told that the consultation paper does not give the full granularity of the Credit Matrix which is to be used to generate the portfolio credit profile. In these circumstances we are not able to comment on the relative emphasis and the calibration of the different factors.

The range of analytics proposed covers most aspects of fund operation and so should provide a basis for differentiation. The concern is that reserving the discretion to apply a subjective adjustment to any of the analytical outcomes has the potential to undermine the clarity that would otherwise be added by the application of the tools.

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From what we do know we would like to make the following observations;

SPONSOR SUPPORT

The Global Treasury Funds plc prospectus states ‘Shares of the Fund are not deposits or obligations of, or guaranteed or endorsed by, any bank. An investment in the Fund involves certain investment risks, including the possible loss of principal.’

PORTFOLIO CREDIT PROFILE

We would support an initiative that incentivises funds to operate shorter dated and higher quality portfolios. We strongly believe in the value added by our credit and portfolio management processes and so disagree strongly with the aspect of the proposal that multiplies up the credit risk of a short dated trade. The explanatory rationale given, that the presence of lower rated short dated portfolio components is indicative of a preferred and continuing portfolio composition and hence an increased level of risk, completely ignores the impact of the credit and portfolio management processes that we operate and the two hundred and fifty or so occasions we have in a year to rethink our placement of overnight trades. To be clear, if any credit at all is given to the value of our credit and portfolio management process then short dated trades carry less risk to fund investors than twelve month trades of any maturity.

The mapping table presented in the consultation document details maturity buckets which imply cliffs in credit factors rather than a smooth surface. Marked changes in credit factors arising out of a one day reduction in residual maturity or a one notch upgrade are not practical or desirable from the perspective of the portfolio manager.

PORTFOLIO STABILITY PROFILE

Asset profile – under these proposals it is likely that portfolios will become shorter dated overall and therefore that there will be more short dated trades which will, in all likelihood be of larger size. As it stands the Top 3 obligor concentration would imply a less stable portfolio from this. We don’t think this is the objective or desirable and so we believe that this metric should concern itself with holdings that have more than five working days to maturity only.

Fund liquidity – analytically this consideration is entirely relevant, but practically there are concerns about how it is to be implemented effectively whilst respecting the issue of client confidentiality. The proposed metric takes no account of what the details or circumstances of the Top 3 obligors are. Issues such as control, correlation and risk aggregation are material to this metric working effectively and no guidelines are given as to how these are to be evaluated for reporting purposes. Frankly this raises the question of how effectively Moody’s will be able to monitor and manage this metric in practice.

Our management practice is to undertake a behavioural review of past fund flows and to combine this with the ability to analyse the behaviour of specific affiliated or correlated risk concentrations.

As a final point the document gives no indication as to how the three ratios are to be viewed over time. The implication is that the ratio results are to be calculated on a spot basis on discrete reporting dates when, in our view, the pattern of behaviour revealed by a daily time series would be more relevant and informative.

Fund exposure to market risk – in our view the single most important factor in operating a money market fund is maintaining the ability to realise the investments at or close to par in a short time frame. So our view is that this analysis is highly relevant. However we are concerned that we do not know what dataset will be backing the analyses, for example, what is illiquid and what are the pricing implications? (why?), or what pricing impact does a downgrade have? (and why?). Without this information it is not possible to evaluate the proposal or to manage the portfolio to the rating criteria.

Again, analytically this is an elegant approach but it has limitations in that past price movements are no guide to current market liquidity and therefore the practical ability to realise an asset in a short timeframe.


No, and certainly not on the basis of the implementation timetable Moody’s has set out.

Most money market investors are governed by investment policies that reference either the Aaa – C rating scale or require them to invest in assets of the highest rated category. Therefore the use of a modifier is much preferable to the imposition of a distinct rating scale. Investment policies are sanctioned by boards who meet infrequently to discuss considered papers from their investment managers. Our conversations indicate that investors are generally unaware of Moody’s proposals and therefore need to be informed, to be given time to assimilate the proposals and to manage their internal approval processes. A transition period of not less than twelve months would be required if these changes are to be implemented and a Moody’s rating is to remain relevant to investors.

Enhanced disclosure about rating drivers would be welcomed immediately and irrespective of any rating criteria change.


No, and no.

Just for example, and to give an idea of the kind of issues that arise with these proposals, it is not clear from the consultation paper whether a money market fund may invest in another money market fund and how that investment would be treated under the credit matrix in generating the Portfolio Credit Profile under these criteria.

If Moody’s proceeds with the new rating scale on the basis of the implementation timescale it has set out we would expect investors to disregard the new ratings in their evaluations at least until such time as their internal policy processes had had time to digest and reflect the changes.

GENERAL COMMENT

Managing the re-rating process If there are to be marked changes in rating criteria then it is in many ways akin to Moody’s changing the basis of the contract with the money market funds it rates.

In our view Moody’s should manage the rerating process by indicating to fund sponsors some way in advance of implementation what rating it intends to ascribe to their funds under the revised criteria and the distribution of ratings for all funds that is proposed.

Then if a fund was not happy with the result of its re-rating it could have the opportunity to amend its modus operandi to meet the criteria for a higher or lower rating and manage commercial implications for a fund and its sponsor.

As it stands there is no indication in the document as to whether changed management practice, such as maintaining a higher level of liquidity, could change a rating or whether the application of the subjective override would mean that such tuning was not possible. It would be very helpful to have some further insight into rating transition possibilities and expectations based on Moody’s own heightened expectation of differentiating between funds.

We look forward to working with you to refine and develop these proposals and would be happy to discuss these comments as you wish. Yours sincerely Martin Curran Senior Portfolio Manager Portfolio & Investment Management The Royal Bank of Scotland plc Direct tel: +44 20 7085 8183 Email: [email protected]

Institutional Money Market Funds Association Ltd, 65 Kingsway, London, WC2B 6TD

Telephone: 020 7269 4669 Fax: 020 7831 9975 E-mail: [email protected]

Company limited by guarantee in England and Wales. Registered number 4014176. Registered office: 65 Kingsway, London, WC2B 6TD

5 November 2010 Yaron Ernst Moody’s Investors Service One Canada Square Canary Wharf London E14 5FA

Dear Yaron

Money Market Fund Rating Methodology and SymbolsMoney Market Fund Rating Methodology and SymbolsMoney Market Fund Rating Methodology and SymbolsMoney Market Fund Rating Methodology and Symbols The Institutional Money Market Funds Association (IMMFA) are grateful for the opportunity to comment on the proposed revisions to the money market fund rating methodology and symbols. IMMFA welcomes the review of the existing criteria and the attempts to better address the risks to which money market funds may become exposed. A number of changes have already been made within the industry, instigated both voluntarily and by regulatory change. We embrace all attempts to improve the resilience of the industry. Although supportive of any attempt to improve the industry, we have a number of reservations about the proposals within the Request for Comment. The revised methodology seems to place increased emphasis on qualitative factors, with the potential for the determining factor to be subjective judgment rather than quantitative analysis. We do not consider that this will result in a transparent process for fund managers or, and more importantly, investors and could therefore be counter to one of the objectives of the revised methodology. We also have concerns about the introduction of a revised rating scale, particularly as this will be an entirely new concept for investors. Implementing amendments to investment policies are often not something which can be effected quickly or easily, and we fear investors may be drawn towards only the highest rated funds due to both misconceptions about the risks involved in lower rated funds and a potential absence of identifiable differentiators between funds with various ratings. We outline our specific views on the proposed methodology, symbology and implementation below. We would welcome the opportunity to discuss these matters with you in more detail. Yours sincerely Nathan Douglas IMMFA Secretary General

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IMMFA responseIMMFA responseIMMFA responseIMMFA response

Request for CommentRequest for CommentRequest for CommentRequest for Comment::::

Moody’s Proposed New Money Market Fund Rating MethodologyMoody’s Proposed New Money Market Fund Rating MethodologyMoody’s Proposed New Money Market Fund Rating MethodologyMoody’s Proposed New Money Market Fund Rating Methodology and Symbols and Symbols and Symbols and Symbols

Methodology A money market fund rating has traditionally been an opinion on the investment quality of shares in the fund and incorporates an assessment of the creditworthiness of the assets in the fund. This is accepted and understood, both by investors and the fund management community who have demonstrated their support for this approach. However, we are concerned that the proposed methodology would place increasing emphasis on aspects other than the credit quality of the assets, some of which will not directly impact the ability of the fund to preserve capital. The supporting material provided for the teleconference on 14 September identifies the ability of the qualitative factors to adjust the rating derived from the combination of the scorecard and credit matrix by one notch, either up or down. Furthermore, whilst the scorecard will allocate weightings to the specific factors being assessed, there does not appear to be any weighting placed on the qualitative factors. This suggests that the final determining factor in the award of a rating would no longer be the quantitative assessment of the fund, but would rather be the qualitative factors. All such qualitative factors can only be assessed on a subjective basis, and do not provide any tangible evidence which can be used to determine whether the fund is able to provide security and liquidity. We do not agree that the final determinant of a fund rating should be anything other than quantitative factors. We include below some specific comments on aspects of the proposed methodology: Liquidity The proposal to require funds to hold overnight liquidity equal to the three largest investors takes no account of the type or definition of investor, nor any relationship between the investor and the sponsor. The type of investor, and any relationship with that investor, can have a significant impact on the volatility of that investment. The definition will also have an impact; defining an investor as the investing entity would present a different proposition from a definition based upon an aggregation of investment from the same group of companies. Neither of these possibilities is reflected within the proposed methodology; however, we consider it a necessity that if this liquidity requirement is maintained, there must be an assessment of the underlying investors and the definition of investor in order to determine what liquidity obligations may be imposed upon the fund. We also consider that it may be more prudent to assess client concentrations within the portfolio rather than basing the amount of liquidity purely on the size of the largest clients. Experience has shown that client concentrations can result in significant volatility within a fund, and should therefore be appropriately managed. However, the proposed methodology does not take this possibility into account; we believe that it should, and that the management of this risk is more pressing than the need to hold liquidity equal to the size of the three largest clients. NAV stress test We do not consider it appropriate to assume all assets within the portfolio are perfectly correlated. For example, there is likely to be a negative correlation between the credit quality of corporate and government securities. However, the proposed NAV stress test does not appear to take into account the possibility that any negative correlations may exist. We request Moody’s

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conduct further analysis to determine where negative correlations should be included within the NAV stress test. Sponsor support As we have highlighted to you on various previous occasions, we do not consider that the rating of a money market fund should include an assessment of the ability and willingness of the sponsor to support the funds. A money market fund is an investment product. It is not guaranteed, there is no legal recourse from the fund to any third party and the value of an investment could go down or up. This is made clear to the investor at the point of sale and provided for in the documentation associated with the fund. The investor must accept the risk associated with the product before an investment is made, and the decision on whether to invest – in this or any other investment product – should not be based on whether any sponsoring entity is likely to offer support in times of need. It is not therefore correct to provide an investor with an opinion on whether the sponsor will support the fund when there is no legal obligation to do so. The potential impact of the proposals would be to introduce further artificial expectations within investors. For any fund which achieves one of the highest ratings, and is therefore assessed as having a sponsor that is both willing and able to support the fund, the expectation of investors will always be that this fund will be supported. If that fund is subsequently not supported, the credibility of the fund, the sponsor, the rating and potentially the industry will be severely compromised. We do not think this is an outcome which should arise by virtue of an independent opinion on the capital security and liquidity of the fund. The decision on whether to support a fund remains at the discretion of the sponsor. It will be influenced by any number of factors, none of which are likely to be within the remit of the public to understand or appreciate. We fail to see how a third party can therefore assess whether there is a likelihood of support being provided, especially when any such support will always be assessed on a case-by-case basis. Money market funds are not priced to include the provision of any sponsor support. However, any indication that the sponsor is both willing and able to support will lead investors to assume that this service will be provided and has been factored into the cost. If any such support was to be provided by the product, the fee structure would be materially different and significantly higher. The product would be a completely different proposition, and there would be a completely different investment decision to be made. A significant increase in fees is not in the best interests of investors, and we do not consider it acceptable for the revised rating criteria to result in a repricing of the industry. We would also like to highlight the recent Federal Reserve Board paper on The Cross Section of Money Market Fund Risks and Financial Crisis. Part of this paper identifies the fact that sponsor support can result in moral hazard, whereby the decision of the portfolio manager can be unduly influenced by the underlying assumption that irrespective of the investment management decisions made, the fund will be supported. If this is true, we do not consider it appropriate or prudent to provide a fund rating which includes an assessment of sponsor support. Any rating which includes an assumption that a sponsor will support the fund could inadvertently result in moral hazard and induce additional – and unwarranted – risk within the portfolio. If sponsor support can result in moral hazard and additional risk within the portfolio, then we fail to see what benefit there is – whether to investors or the money market fund industry – in placing increased emphasis on the role of sponsor support. Regulators and the money market fund industry have taken action over the course of the last two years to reduce risk within the funds, and to limit the potential for any crystallisation of risk to occur which would require recourse to any third party. The funds should be assessed on their ability to stand independently, purely because there is no contractual or legal recourse which any fund has to any third party.

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And in the absence of such a relationship, it is misleading to provide investors with any suggestion that third party support will be provided to any fund. Symbology The revised rating scale, based upon a ‘Managed Fund’ scale and with five different ratings, will be a completely new concept for investors and one which they will not be accustomed to. The new symbology, with a gradation of rating, will be more complex than that which has existed before. The decision to invest in a money market fund, which until now has assessed whether the fund holds a triple-A rating or not, will have to consider the rating awarded by Moody’s, where this sits in the risk spectrum and how it may correlate with the existing triple-A ratings awarded by the other credit rating agencies. When the new symbology is combined with the complexity surrounding the proposed assessment of the fund and the subjectivity contained within the analysis, we consider that many investors will consider this new symbology too difficult or too time consuming to understand. In such instances, investors would undoubtedly be drawn towards the existing triple-A rating from other credit rating agencies. We appreciate the rationale behind seeking to introduce a gradation of ratings. However, we are unclear on the extent to which funds rated along the MF scale will be sufficiently differentiated. The ability for Moody’s to move the rating derived from the credit matrix and scorecard approaches based upon qualitative factors will add a further level of complexity as investors seek to ascertain the practical differences between funds with varying ratings. In reality, there may be very little difference in risk between a fund with, for example, a MF1 or MF2 rating, especially as we expect that a fund currently rated Aaa could potentially find itself (at least) rated MF1+, MF1 or MF2 under the proposed revised scale and methodology. On this basis, and in the absence of a discernable increase in return which should coincide with an increase in risk, investors may morph towards the highest rated funds. Any fund which then has not achieved the MF1+ rating could potentially encounter difficulties as investors seek to withdraw investment in favour of higher rated products. Redemption requests would be instantly received and could introduce instability in the fund, with potential repercussions for other funds and the broader money market. Our understanding, from speaking with investors, is that there remains a desire to have an independent opinion on the ability of a money market fund to provide capital security and liquidity. This is accepted as being expressed through the award, or not, of a triple-A rating. The familiarity with the concept of the triple-A fund rating has resulted in it being established within the psyche of treasurers throughout the corporate world. For so long as this is being retained elsewhere, investment will continue to be drawn towards triple-A rated funds. In their absence, investment will morph towards those funds which hold the highest ratings – since the highest rating will be the close approximation to the triple-A rating. The intention to differentiate the rating from the traditional long-term rating scale should be welcomed. However, this can be achieved without the fundamental shift in symbology which has been proposed. A symbology which utilises the traditional Aaa to D rating and clearly articulates that the rating relates to a money market fund is our desired outcome. This would provide consistency with the current symbols, and would thereby not introduce any unintended volatility within one of the funds, the industry or the broader money market. Monitoring The nature of many of the factors included within the scorecard is such that the relative positioning of the fund at any point in time could easily swing from one score to another. As an example, a fund which receives a large investment that is unexpected to be returned to the

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investor for at least a month will place that investment over a suitable time horizon. Depending upon the size of the investment relative to the other clients in the fund, this could limit the ability of a fund to meet the liquidity parameters associated with the rating that is currently held. Theoretically, the rating should be amended to reflect the revised risk associated with the fund. Any frequent amendment of a rating would however introduce unwarranted volatility. If the rating of the fund is constantly changing, investors will either be inclined to exit the fund for those periods when the rating is deemed not high enough, or will seek a mass exit at once. Neither outcome is particularly desirable, from the perspective of the investor, fund manager and also the broader money markets due to the instability this could potentially induce. We would therefore welcome further clarity on the monitoring that will be performed, the frequency of this monitoring, and the sensitivity of the rating to changes in the underlying composition of the fund and its clients. Implementation If however you seek to implement the proposals in a similar way to how they have been drafted, the proposed timeline for application (as communicated in the teleconference of 14 September) for rating transition in early 2011 is overly aggressive and unacceptable. Many investors in a money market fund have a requirement within their investment guidelines to only invest short term cash in a ‘triple-A rated money market fund’. Anything which does not hold this precise rating could not be invested in. Changes to these investment guidelines are not something which can often be implemented either quickly or easily. Forcing through a change as substantive as you have proposed can only be implemented via a long transitional period to allow investors in the funds to acclimatise themselves with the new methodology, and to appropriately amend their investment guidelines to reflect the new rating symbols. Failure to implement over a lengthy period will result in (unnecessary and avoidable) volatility within the funds rated by Moody’s as investors redeem by virtue of not being able to invest in a non-Aaa rated product irrespective of their position on the new Managed Fund rating scale. It is not unreasonably to hypothesise that this could cause a large amount of redemptions and place stress on these funds. The timeline for implementation must therefore be reconsidered. We would suggest that a period where both the existing Aaa rating and the new MF rating were used would allow investors to appreciate the change which is occurring. A one year period should be sufficient to allow investors to consider their investment guidelines and whether any changes were necessary. It would also be long enough to allow a phased transition for those investors seeking to redeem from a fund which no longer held the highest rating (and as is required by some regulatory obligations, e.g. for Local Authorities). We offer to work with you to find an implementation solution which is agreeable to you, the industry and most importantly, the shareholders in the funds.

October 6 2010

US Rates Strategy

[email protected]

Jim Lee Head of STM Strategy and Head of Futures and Options Strategy

+1203 897 4652

[email protected]

Mike Novack Short Term Markets and Financing

+1203 897 3800 [email protected]

www.rbsm.com/strategy Bloomberg: RBSR<GO>

Please see the last page of this publication for important disclosures.

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Moody’s Proposed New Money Market Fund Ratings

On the 7th September, Moody’s proposed a new method for rating money market funds. Section 938 of the Dodd-Frank Wall Street and Consumer Protection Act prohibits nationally recognized statistical rating organizations from having multiple definitions for the same rating symbol. Moody’s cites various reasons for their new methodology, and the Dodd-Frank US financial reform bill is just one of the several reasons. The main thrust of Moody’s proposal is that the longer term ratings be discontinued and that given the premise that investors can withdraw their money on demand, the new ratings are based on the opinion of the fund’s ability to do the following:

1. Preserve principal.

2. Provide liquidity to investors.

Moody’s Proposed New Ratings Summary

Source: Moody’s

Moody’s is requesting comments from market participants by the 5th November

We take a look at their proposed changes and give our views.

The Royal Bank of Scotland

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Moodys’ New Money Market Fund Rating Proposal

On the 7th September, Moody’s proposed a new method for rating money market funds. Section 938 of the Dodd-Frank Wall Street and Consumer Protection Act prohibits nationally recognized statistical rating organizations from having multiple definitions for the same rating symbol. Moody’s cites various reasons for their new methodology, and the Dodd-Frank US financial reform bill is just one of the several reasons. The main thrust of Moody’s proposal is that the longer term ratings be discontinued and that given the premise that investors can withdraw their money on demand, the new ratings are based on the opinion of the fund’s ability to do the following:

Preserve principal.

Provide liquidity to investors.

Moody’s Proposed New Ratings Summary

Source: Moody’s

Moody’s is requesting comments from market participants by the 5th November. Moody’s also have particular questions they seek feedback on. These include the following:






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The View from RBS

The recent Moody’s proposal to change their ratings methodology for money funds threatens to impact the investment philosophy of prime funds who are currently the largest buyers of bank issued CD/CP in the market. The changes seek to more appropriately rate money funds based in their words, seemingly triggered by recent changes in financial regulation and the effects of the financial crisis on money fund principal preservation. The new methodology will rate the funds on two separate axes to arrive at the final rating, the fund’s Credit Profile and Stability Profile, and then overlay on top of that a subjective estimate of parental support to the fund.

The Paradox

Opinions vary on how likely these changes are to be implemented. However, there is a definite consensus that the proposal would make it nearly impossible for a prime fund to maintain a top rating without making changes. If investors in money funds continue to require a top rating from both ratings agencies, this would then lead to serious outflows from prime institutional money market funds into government money market funds. An alternative is that prime funds shift their investment philosophy to shorten duration and focus only on top credits, or split into a conservative top rated fund and a less conservative lower rated fund. Either way, the flows from money funds into bank paper rated below Aa2 would decrease considerably. This would put obvious strain on bank wholesale funding, especially for maturities greater than 3 months based on our understanding of the new Moody's Credit Matrix. Thus, Moody’s proposal is counterproductive to the current regulatory landscape (Basel III, FSA, etc.) which are pushing banks to extend duration and be less reliant on shorter term funding. One possible consequence of Moody’s proposal is drain of a huge amount of wholesale liquidity from non-highly rated banks, which could result in higher libor rates and a steeper money market curve in 2011.

Our initial conversations with several portfolio managers in the money market fund universe, along with industry experts and Moody’s themselves, has led us to the conclusion that the new rules as proposed are much more restrictive than the recent SEC 2a7 regulations enacted only a short while ago. The ambiguous nature of several components of the stability profile only add to the difficulty in fully understanding the effects of the changes.

As a result of these conversations, a key conclusion is that these rules will effectively shorten the duration of money fund investments and shift into more highly rated assets.

According to Imoneynet, all prime funds currently have $1.069 trillion AUM, and of that 56% ($602bio) are AAA rated. But if one focuses


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purely on prime institutional funds, they have a total of $741.5bio AUM, of which 80% ($590bio) are AAA rated. Most portfolio managers predict that few current prime funds will achieve the top MF1+ rating, while one estimate by Moody’s has over 90% of prime funds rated as MF1 or MF2 under the new format. With AAA prime funds being a vital source of funding to banks, the potential loss of the top Moody’s rating could have a huge impact on their focus in the future. The funds will basically have three options in our view:

Adapt to maintain their top rating.

Keep the status quo, i.e. don’t change their modus operandi, which could result in outflows from investors that require the top rating.

Drop the Moody’s rating completely, hoping that investors will rely solely on S&P or look to Fitch as the second ratings agency.

Moody’s Proposed Methodology

Moody’s proposed methodology is based on the following:

Portfolio Credit Profile


Sponsor Support

Other criteria such as manager’s attributes, legal documentation, repo documentation, permitted collateral to name but a few.

We consider the Portfolio Stability Profile, to be the most important.


Moody’s Portfolio Stability Profile

Source: Moody’s


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Some important issues with the methodology as proposed focus on the Portfolio Stability Profile measure, which according to Moody’s is the more important of the two.

To earn a 1+ on the stability profile the fund must have a WAM <30 days, a top 3 obligor concentration <7.5%, and an overnight bucket >30% of AUM. These are the primary factors that limit current prime funds from achieving the top rating, as they are more restrictive than current rules. Additionally, the Fund Exposure to Market Risk, which accounts for 40% of the Stability Profile rating, is extremely subjective. No one understands exactly how this calculation will work, though Moody’s will be releasing more information in the coming weeks.

Stress Test

Within the Portfolio Stability Profile, is the stress test.

Moody’s Stress Tests Applied to Fund’s Portfolios, page 11 of their proposal

Source: Moody’s

Our thoughts:

Yield Curve Shift - Parallel shift of 150bp on NAV - the longer the duration the more NAV impact.

Credit Spread Shift - A 50bp shift would be applied to securities rated Aa2, and more applied to lesser rated securities based upon their Weighted Average Rating Factor (WARF). We asked if we could get a copy of the WARF but apparently it's a complicated model and not something they'd be able to send. Moody’s are going to try and realise some sort of model in a few weeks.

Illiquidity - We asked Moody’s what was liquid or illiquid and highlighted this was a digital haircut (i.e 50bp or 0bp). Moody’s answered that repos would be 0bp, bank CD/CP 0bp, but ABCP might be 50bp. Moody’s said that maybe a 1yr CD might be considered illiquid but when pushed said it would probably be 0bp. It seemed that this is still a grey area that Moody’s has yet to commit to a firm answer.

Credit Transition - Completely subjective.


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Moody’s Deriving Money Market Fund’s MF Rating

Source: Moody’s

An interesting note raised by one portfolio manager is that a fund can "break the buck" in the stress test and still have the middle rating of MF2. Of the 2 “Profile” ratings, the Credit Profile will then become critical in determining the final rating. If most Prime funds receive a Portfolio Stability Profile of 1, to achieve an overall MF1+ rating, they will need to earn a Portfolio Credit Profile of Aaa. Otherwise, they can still fall to Aa or A on the Credit Profile and receive an MF1 rating. That said, a fund’s ability to increase their weighting in Aaa credits will be limited by the limit on their top 3 concentration. This will also obviously limit their ability to extend out with lower credits, since they can only balance the credit scale with top credits so much.

Parental Support A key variable in the proposal is the important given to parental support which is an extremely subjective measure. It is assumed by most within the industry that funds with strong sponsors will be able to achieve a top rating. It is also widely expected that no sponsor will explicitly guarantee a fund, rather Moody’s will estimate the willingness of the parent to support the fund and factor that implicit support into the final ratings. This will put significant pressure on privately sponsored funds (3 of the top 5 prime institutional fund complexes) and smaller funds, as they will be at a significant disadvantage without implicit parental support. Naturally, privately sponsored funds are unsure how much private financial information they will want to provide to prove creditworthiness of the parent.


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Conclusion

It’s a nice idea proposed by Moody’s. Rating money market funds by their ability to preserve principal and provide liquidity is a good goal. However, Moody’s proposals for a new rating methodology for money market funds has stirred up a number of issues.

The key issues are:

Will the current AAA investing universe translate that mandate into MF1 and MF1+ funds or only MF1+ funds?

How quickly can money fund investors re-draft investment documentation to adapt to the new ratings scheme?

Will money fund investors accept Fitch as a second rating, or can they rely solely on S&P?

How willing will private fund sponsors be to provide financial information and/or a fund guarantee?

Parental support-It would appear that those funds which had been received parental assistance in the past will be rated more highly than those who have never received assistance.

Concentration of investments – If only a few money market funds receive the coverted MF1+ rating, this could result in clients having too much exposure to a particular money market fund.

How receptive will Moody’s be to comments by the funds?

A consequence of these proposed changes could be that investors in the money market funds shift out of prime money market funds into government and agency funds, at least until their mandates are updated, if not longer. A corollary of this is that money market fund management companies may bring a new class of fund; ultra conservative money market funds focusing on high quality securities in the 7 to 30 day sector.

We think that few prime funds will be able to achieve the new top rating of MF1+, especially without strong parental support. How Moody’s evaluates parental support could create an advantage for bank sponsored funds over those without strong parents. This would severely limit the amount of liquidity available in the term funding markets as money shifts to government funds or prime funds with stricter investment guidelines. The end result could well be a move higher in Libor rates as banks compete for the smaller supply of term funding, along with a widening in the basis of the Libor curve.

It would seem that Moody’s should listen to the market participants’ responsives and give more details on the precise methodology of their stress testing; subjective testing is just not good enough!


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US Short Term Markets & Financing Strategy Team

Jim Lee Head of STM & Futures Strategy (203) 897-4652 [email protected]

Kevin Stuebe STMF Senior Analyst (203)-897-6640 [email protected]

US Short Term Markets & Financing Sales Contacts:

Steve Monroe Head of STMF Sales 203-897-9290 [email protected]

Ruth Pariser Sales - Stamford 203-897-5059 [email protected]

Rich Simon Sales - Stamford 203-897-5059 [email protected]

Will Goldthwait Sales - Boston 617-423-7690 [email protected]

Chris Monaco Sales - Stamford 203-897-7085 [email protected]

Brian McCarthy Sales - Stamford 203-897-7085 [email protected]

Marcy Wilks Sales - Stamford 203-897-2828 [email protected]

Jon Guss Sales - Stamford 203-897-2828 [email protected]

Erik Skulte Sales - Stamford 203-897-2828 [email protected]

US Short Term Markets & Financing Trading Desk Contacts:

Matt Chasin Head of STM&F USA (203)-897-2824 [email protected]

John Crowley Mortgage Repo (203)-897-2924 [email protected]

Gabe Schneider Mortgage Repo (203)-897-3066 [email protected]

Dan Molloy Mortgage Repo (203)-897-9898 [email protected]

Nelson Young Head of U.S. Treasury Repo (203) 897-2880 [email protected]

Pat O’Meara Specials (203)-897-2880 Patrick.O’[email protected]

Bryan Dick Specials (203) 897-2880 [email protected]

Casey Spezzano Bills (203) 897-2880 [email protected]

Mike Gasparino Treasury Repo (203)-897-2880 [email protected]

Jerry O’Grady Treasury Repo (203)-897-2880 Jeremiah.O’[email protected]

Mike Airey Corporate Repo (203)-897-9827 [email protected]

Mike Hauser Corporate Repo (203) 897-9827 [email protected]

Jeff Black Structured Collateral (203)-897-2502 [email protected]

Roberto Gelber Head of U.S. Money Markets (203)-897-5080 [email protected]

Scott Payseur U.S. Money Markets (203)-897-5080 [email protected]

Tom Giardino U.S. Money Markets (203)-897-5080 [email protected]

Mike Novack U.S. Money Markets (203) 897-3800 [email protected]

Mike Baldwin STMF Analyst (203)-897-2993 [email protected]


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