In its efforts to prevent a recurrence of the upheaval that occurred in the money market fund sector last September, the Securities and Exchange Commission is considering a number of changes to the regulations governing these funds, as noted in this SEC paper released in June.

An earlier blog post covered several of the proposals outlined by the SEC, such as a cap on the weighted average life maturity of the securities in the fund, along with the idea of allowing a fund to suspend redemptions if the fund’s value was likely to fall below $1 per share.

One proposal, however, is likely to impact corporate treasurers more than I initially thought. That’s the proposal to limit money market funds to holding just the highest-rated, or A1/P1, securities. Under current law, most money market funds can hold up to 5 percent of fund assets in A2/P2 securities.

In early September, 19 treasurers, along with a representative of the U.S. Chamber of Commerce, wrote the SEC to express their concern about the proposal. “As set forth below, we believe this action would have a negative and unintended impact on capital formation that far outweighs any speculative increase in investor protection,” the letter states. The points they raise are valid, and should give regulators pause before they make changes.

The group laid out their concerns. First, the approximately 200 issuers of A2/P2 securities account for 4 million employees and more than $2 trillion in revenue. Moreover, 82 percent of A2/P2 issuers are outside the financial sector; in contrast, about half of A1/P1 issuers are financial companies. “The change would mean cutting out nonfinancial companies,” from the market, particularly for commercial paper, says Jonathan Jachym, regulatory council for the U.S. Chamber’s Center for Capital Markets Competitiveness. Many of the signatories to the letter hail from companies that bear household names, including Alcoa, Inc.; Comcast Inc.; Marriott International, Inc.; and Time Warner, Inc.

Moreover, A2/P2 issuers are high-quality credits. Their 180-day default rate from 1972 to 2006 was .03 percent; that compares with .01 percent for P1-rated securities, according to information from Moody’s. In addition, A2/P2 issuers are required to maintain backstop facilities equal to 100 percent of the securities they issue.

Finally, eliminating the ability of money market funds to hold A2/P2 securities would have done nothing to prevent the run on The Reserve Primary Fund last September. The fund’s exposure to Lehman Brothers brought on its troubles, and Lehman’s commercial paper was rated A1 until the day it filed for bankruptcy.

While the facts the SEC used in analyzing the role of A2/P2 securities were all correct, “the focus was limited,” Jachym says. For instance, the SEC analyzed the credit spreads of A2/P2 commercial paper. Late last year, the spread for A2/P2 over AA commercial paper leapt to about 600 basis points, according to the Federal Reserve. However, this occurred at the same time that the Federal Reserve promised to back A1/P1, but not A2/P2, paper. “That caused the spreads to blow out,” Jachym says.

The likely impact of this proposed change has been enough to galvanize more than a few corporate financial chiefs to action, Jachym says. “They feel like ‘We didn’t cause the problems, but we’re being penalized.’”

Jachym sounds guardedly optimistic when discussing the likely fate of this piece of the larger changes being proposed around the regulation of money market funds — much of which the Chamber supports. “It’s some very credible data we’re citing,” he notes, adding that this particular amendment wouldn’t reduce risk, but would have unintended, negative consequences.

Let’s hope that the regulators pay attention. ###