[Federal Register Volume 80, Number 186 (Friday, September 25, 2015)]
[Rules and Regulations]
[Pages 58123-58155]
[FR Doc No: 2015-24015]

Vol. 80

Friday,

No. 186

September 25, 2015

Part V

Securities and Exchange Commission

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17 CFR Parts 270 and 274

Removal of Certain References to Credit Ratings and Amendment to the
Issuer Diversification Requirement in the Money Market Fund Rule; Final
Rule

Federal Register / Vol. 80 , No. 186 / Friday, September 25, 2015 /
Rules and Regulations

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 270 and 274

[Release No. IC-31828; File No. S7-07-11]
RIN 3235-AL02

Removal of Certain References to Credit Ratings and Amendment to
the Issuer Diversification Requirement in the Money Market Fund Rule

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting certain amendments, initially proposed in March 2011 and re-
proposed in July 2014, related to the removal of credit rating
references in rule 2a-7, the principal rule that governs money market
funds, and Form N-MFP, the form that money market funds use to report
information to the Commission each month about their portfolio
holdings, under the Investment Company Act of 1940 (``Investment
Company Act'' or ``Act''). The amendments will implement provisions of
the Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-
Frank Act''). In addition, the Commission is adopting amendments to
rule 2a-7's issuer diversification provisions to eliminate an exclusion
from these provisions that is currently available for securities
subject to a guarantee issued by a non-controlled person.

DATES: Effective Date: October 26, 2015; Compliance Date: October 14,
2016.

FOR FURTHER INFORMATION CONTACT: Adam Bolter, Senior Counsel; Erin C.
Loomis, Senior Counsel; Amanda Hollander Wagner, Senior Counsel;
Thoreau Bartmann, Branch Chief; or Sarah G. ten Siethoff, Assistant
Director, Investment Company Rulemaking Office, at<PHONE_NUMBER>,
Division of Investment Management, Securities and Exchange Commission,
100 F Street NE., Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
    A. Credit Rating References
    B. Exclusion from the Issuer Diversification Requirement
II. Discussion
    A. Eligible Securities
    B. Conditional Demand Features
    C. Monitoring Minimal Credit Risks
    D. Stress Testing
    E. Form N-MFP
    F. Exclusion from the Issuer Diversification Requirement
III. Compliance Period for the Final Rule and Form Amendments
IV. Paperwork Reduction Act Analysis
V. Economic Analysis
VI. Regulatory Flexibility Act Certification
Statutory Authority

I. Background

A. Credit Rating References

    Section 939A of the Dodd-Frank Act requires each federal agency,
including the Commission, to ``review any regulation issued by such
agency that requires the use of an assessment of the credit-worthiness
of a security or money market instrument and any references to or
requirements in such regulations regarding credit ratings.'' \1\ That
section further provides that each such agency shall ``modify any such
regulations identified by the review . . . to remove any reference to
or requirement of reliance on credit ratings and to substitute in such
regulations such standard of credit-worthiness as each respective
agency shall determine as appropriate for such regulations.'' \2\
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    \1\ Public Law 111-203, Sec. 939A(a)(1)-(2). Section 939A of the
Dodd-Frank Act applies to all federal agencies.
    \2\ Public Law 111-203, Sec. 939A(b). Section 939A of the Dodd
Frank Act provides that agencies shall seek to establish, to the
extent feasible, uniform standards of creditworthiness, taking into
account the entities the agencies regulate and the purposes for
which those entities would rely on such standards.
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    As a step toward implementing these mandates, and as a complement
to similar initiatives by other federal agencies,\3\ in March 2011 the
Commission proposed to replace references to credit ratings issued by
nationally recognized statistical rating organizations (``NRSROs'') in
two rules and four forms under the Securities Act of 1933 (``Securities
Act'') and the Investment Company Act, including rule 2a-7 and Form N-
MFP under the Investment Company Act.\4\ We subsequently adopted
certain of the rule provisions proposed in 2011: Namely, amendments to
rule 5b-3 under the Investment Company Act, new rule 6a-5 under the
Investment Company Act, and amendments to Forms N-1A, N-2, and N-3
under the Securities Act and the Investment Company Act.\5\ But in
light of comments received on the 2011 proposed amendments to rule 2a-7
and Form N-MFP, and in conjunction with the wider money market fund
reforms that the Commission adopted in July 2014 (the ``2014 money
market fund reforms''),\6\ we decided to re-propose the amendments to
rule 2a-7 and Form N-MFP instead of adopting them directly following
the 2011 proposal.\7\ Specifically, the 2014 re-proposed amendments to
rule 2a-7 and Form N-MFP (the ``2014 Proposing Release,'' ``Proposing
Release,'' or ``proposal'') \8\ responded to concerns that commenters
raised with respect to the 2011 proposal.
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    \3\ A number of other federal agencies have also taken action to
implement Section 939A of the Dodd-Frank Act, as discussed in
Removal of Certain References to Credit Ratings and Amendment to the
Issuer Diversification Requirement in the Money Market Fund Rule,
Investment Company Act Release No. 31184 (Jul. 23, 2014) [79 FR
47986 (Aug. 14, 2014)] (``2014 Proposing Release'' or ``Proposing
Release'').
    \4\ See References to Credit Ratings in Certain Investment
Company Act Rules and Forms, Investment Company Act Release No.
29592 (Mar. 3, 2011) [76 FR 12896 (Mar. 9, 2011)] (``2011 Proposing
Release'').
    \5\ In December 2013, we adopted amendments removing references
to credit ratings in rule 5b-3 and eliminating the required use of
credit ratings in Forms N-1A, N-2, and N-3. See Removal of Certain
References to Credit Ratings under the Investment Company Act,
Investment Company Act Release No. 30847 (Dec. 27, 2013) [79 FR 1316
(Jan. 8, 2014)] (``2013 Ratings Removal Adopting Release''). We
adopted new rule 6a-5 on November 19, 2012. See Purchase of Certain
Debt Securities by Business and Industrial Development Companies
Relying on an Investment Company Act Exemption, Investment Company
Act Release No. 30268 (Nov. 19, 2012) [77 FR 70117 (Nov. 23, 2012)].
    \6\ See Money Market Fund Reform; Amendments to Form PF,
Investment Company Act Release No. 31166 (Jul. 23, 2014) [79 FR
47736 (Aug. 14, 2014)] (``2014 Money Market Fund Adopting
Release'').
    \7\ See 2014 Proposing Release, supra note 3.
    \8\ For clarity and because the re-proposal issued in July 2014
functions as the proposal for this adopting release, we refer to the
re-proposal simply as the proposal throughout.
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    We received 16 comment letters on the 2014 proposal.\9\ The
majority of commenters generally supported the proposed amendments to
varying degrees.\10\ However, many commenters expressed concern about
the proposed ``exceptionally strong'' standard to replace credit
ratings references in the requirements of rule 2a-7 for those
securities eligible to be purchased by money market funds.\11\ These

commenters suggested that the proposed ``exceptionally strong''
standard could lead to interpretive confusion in light of the similar
existing ``minimal credit risk'' requirement, and might potentially
change the kinds of securities that funds could purchase, contrary to
the intent of the proposal to retain a similar degree of credit quality
standards as under current rule 2a-7.\12\
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    \9\ The comment letters on the Proposing Release (File No. S7-
07-11) are available at http://www.sec.gov/comments/s7-07-11/s70711.shtml. The Commission received 18 comment letters on the
Proposing Release, but 2 of these letters did not discuss amendments
to remove NRSRO credit ratings references from rule 2a-7 and Form N-
MFP.
    \10\ Comment Letter of Chris Barnard (Aug. 23, 2014) (``Barnard
Comment Letter''); Comment Letter of Michael Mark-Berger (Jul. 28,
2014) (``Berger Comment Letter''); Comment Letter of BlackRock, Inc.
(Oct. 14, 2014) (``BlackRock Comment Letter''); Comment Letter of
CFA Institute (Oct. 14, 2014) (``CFA Institute Comment Letter'');
Comment Letter of the Investment Company Institute (Oct. 14, 2014)
(``ICI Comment Letter''); Comment Letter of the Independent
Directors Council (Oct. 7, 2014) (``IDC Comment Letter''); Comment
Letter of Invesco Ltd. (Oct. 14, 2014) (``Invesco Comment Letter'');
Comment Letter of Mutual Fund Directors Forum (Sep. 14, 2014)
(``MFDF Comment Letter''); Comment Letter of Charles Schwab
Investment Management, Inc. (Oct. 14, 2014) (``Schwab Comment
Letter'').
    \11\ We proposed to replace the reference to NRSRO credit
ratings in rule 2a-7's definition of ``eligible security'' with a
required finding that each security's issuer ``has an exceptionally
strong capacity to meet its short-term financial obligations.'' See
2014 Proposing Release, supra note 3, at section II.A.1. Many
commenters expressed concern about this proposed standard. See
Comment Letter of Better Markets, Inc. (Oct. 14, 2014) (``Better
Markets Comment Letter''); Comment Letter of the Consumer Federation
of America (Oct. 14, 2014) (``CFA Comment Letter''); Comment Letter
of the Dreyfus Corporation (Oct. 14, 2014) (``Dreyfus Comment
Letter''); Comment Letter of Fidelity Investments (Oct. 14, 2014)
(``Fidelity Comment Letter''); ICI Comment Letter; Comment Letter of
the Committee on Investment Management Regulation of the New York
City Bar (Oct. 14, 2014) (``NYC Bar Comment Letter''); Schwab
Comment Letter; Comment Letter of the Securities Industry and
Financial Markets Association (Oct. 14, 2014) (``SIFMA Comment
Letter''); Comment Letter of Vanguard (Oct. 14, 2014) (``Vanguard
Comment Letter''); see also infra section II.A.
    \12\ See, e.g., Dreyfus Comment Letter; Fidelity Comment Letter.
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    In adopting final amendments to rule 2a-7 and Form N-MFP to
implement Section 939A of the Dodd-Frank Act, we have carefully
considered the comments received, and the final amendments include
certain modifications intended to respond to commenters' concerns. As
proposed, we are adopting amendments to rule 2a-7 that would remove
references to ratings and adopt a uniform standard to define an
eligible security to be a security that has been determined to present
minimal credit risks. However, we have eliminated the proposed
``exceptionally strong capacity'' standard from this determination, and
as a substitute for this finding, the final rule amendments require
that a minimal credit risk determination include, to the extent
appropriate, an analysis of the guidance factors discussed in the
preamble of the Proposing Release.\13\ We believe that this approach
will better fulfill the original goals of the rulemaking by replacing
credit ratings references with a new standard that includes objective
factors, which is designed to retain a similar degree of credit quality
in money market fund portfolios as under the current rule.
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    \13\ See rule 2a-7(a)(11); see also infra section II.A.
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    For these reasons, we are also adopting a similar approach for
funds to determine whether a long-term security subject to a
conditional demand feature is an eligible security.\14\ Finally, we are
also adopting other amendments to rule 2a-7 and Form N-MFP, including
the requirement that funds engage in ongoing monitoring of their
portfolio securities and perform stress testing for a credit
deterioration rather than specifically for a ratings downgrade,
substantially as they were proposed, with certain changes as discussed
below.
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    \14\ See rule 2a-7(d)(2)(iii); see also infra section II.B.
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B. Exclusion From the Issuer Diversification Requirement

    Rule 2a-7's risk limiting conditions require a money market fund's
portfolio to be diversified, both as to the issuers of the securities
it acquires and providers of guarantees and demand features related to
those securities.\15\ When we proposed the amendments to rule 2a-7 that
were adopted as part of the 2014 money market fund reforms, we
discussed and sought comment on alternatives to the rule's
diversification provisions that we had considered to appropriately
limit money market funds' risk exposure.\16\ Some of the comments we
received in response prompted us to re-evaluate the current exclusion
to the issuer diversification requirement for securities subject to a
guarantee issued by a non-controlled person.\17\ In consideration of
these comments, and consistent with our reform goal of limiting
concentrated exposure of money market funds to particular economic
enterprises, as part of the 2014 proposal we proposed an amendment that
would eliminate this exclusion from rule 2a-7's issuer diversification
requirement.\18\
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    \15\ See rule 2a-7(d)(3).
    \16\ See Money Market Fund Reform; Amendments to Form PF,
Investment Company Act Release No. 30551 (Jun. 5, 2013) [78 FR 36834
(Jun. 19, 2013)] (``2013 Money Market Fund Proposing Release'').
    \17\ See, e.g., 2014 Money Market Fund Adopting Release, supra
note 6, at n.1612 and accompanying text. Current rule 2a-7's risk
limiting conditions generally require that money market funds limit
their investments in the securities of any one issuer of a first
tier security (other than government securities) to no more than 5
percent of total assets. Money market funds must also generally
limit their investments in securities subject to a demand feature or
a guarantee to no more than 10 percent of total assets from any one
provider. Notwithstanding these conditions, a money market fund is
not required to be diversified with respect to issuers of securities
that are subject to a guarantee issued by a non-controlled person.
See current rule 2a-7(d)(3); see also infra section II.F (detailed
discussion of current issuer diversification requirements).
    \18\ See Proposing Release, supra note 3, at section II.C.
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    We received 8 comment letters discussing the proposed issuer
diversification amendment,\19\ with most of these commenters opposing
the proposed amendment.\20\ After carefully considering the comments we
received, as well as the staff's updated analysis of relevant data, the
Commission is adopting the proposed diversification amendments as
proposed.\21\ We believe that, on balance, adopting the proposed issuer
diversification amendment will help increase the resiliency of money
market funds, and thereby better protect their investors, by limiting
their ability to have concentrated exposure to any particular issuer.
We are also adopting several technical amendments to Form N-MFP and the
portfolio diversification provisions of rule 2a-7.\22\
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    \19\ See Better Markets Comment Letter; BlackRock Comment
Letter; Dreyfus Comment Letter; ICI Comment Letter; Schwab Comment
Letter; Comment Letter of the Structured Finance Industry Group
(Oct. 14, 2014) (``SFIG Comment Letter''); SIFMA Comment Letter;
Vanguard Comment Letter.
    \20\ See BlackRock Comment Letter; Dreyfus Comment Letter; ICI
Comment Letter; SFIG Comment Letter; SIFMA Comment Letter; Vanguard
Comment Letter.
    \21\ See rule 2a-7(d)(3).
    \22\ See infra sections II.E. and II.F.
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II. Discussion

A. Eligible Securities

    Under current rule 2a-7, money market funds must limit their
portfolio investments to securities that are both ``eligible
securities'' and have been determined by fund boards to pose minimal
credit risks to the fund.\23\ Currently, rule 2a-7 defines ``eligible
securities'' largely by reference to NRSRO ratings, and generally
requires that 97% of a fund's portfolio securities be rated in the top
short-term credit quality category by an NRSRO \24\ (known as ``first
tier'' securities).\25\
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    \23\ Current rule 2a-7(d)(2)(i).
    \24\ Rule 2a-7 limits a money market fund's portfolio
investments to ``eligible securities,'' or securities that have
received credit ratings from the ``requisite NRSROs'' in one of the
two highest short-term rating categories or comparable unrated
securities. A requisite NRSRO is an NRSRO that a money market fund's
board of directors has designated for use (a ``designated NRSRO'')
and that issues credit ratings that the board determines, at least
annually, are sufficiently reliable for the fund to use in
determining the eligibility of portfolio securities. See current
rule 2a-7(a)(11), (a)(24).
    \25\ Current rule 2a-7(a)(12). The rule currently also permits
up to 3% of a fund's portfolio to be invested in so called ``second
tier'' securities, or securities which are rated in the second
highest short-term credit quality category by an NRSRO. Current rule
2a-7(d)(2)(ii).
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    The proposal would have eliminated the rule's reference to NRSRO
ratings in the eligible security definition, and consolidated the
minimal credit risk standard into a single new standard under rule 2a-
7's definition of eligible security.\26\ As a substitute for NRSRO
ratings in the eligible security definition, the proposed new standard
would have required an eligible security to be a security with a
remaining

maturity of 397 calendar days or less that the fund's board of
directors (or its delegate \27\) determined presents minimal credit
risks, which determination would have included a finding that the
security's issuer has an exceptionally strong capacity to meet its
short-term financial obligations. Thus, under our proposal, a money
market fund would have been limited to investing in securities that the
fund's board (or its delegate) had determined present minimal credit
risks, notwithstanding any rating the security may have received. To
assist funds in their minimal credit risk determination under the
revised standard, the proposal also included as guidance a number of
factors that funds should consider, to the extent appropriate, as part
of that process.\28\ These credit analysis factors were presented in
both a primary list of factors generally applicable to all securities,
and a secondary list of factors applicable to specific asset classes.
In addition, under the proposal, fund boards would no longer have been
required to designate NRSROs or to use their ratings to determine first
or second tier status.\29\ Accordingly, the proposal would have
eliminated the distinction between first and second tier securities,
and would have removed the prohibition on funds investing more than 3
percent of their portfolios in second tier securities.\30\ The intent
of these proposed amendments was to remove references to NRSRO ratings
from rule 2a-7 while retaining a degree of credit risk similar to that
permitted under the current rule.
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    \26\ See proposed rule 2a-7(a)(11).
    \27\ See current rule 2a-7(j) (permitting a money market fund's
board to delegate to the fund's investment adviser or officers a
number of the determinations required to be made by the fund's board
under the rule, including minimal credit risk determinations).
    \28\ Proposing Release, supra note 3, at 47991-47993. The
proposal also requested comment on these factors and whether
codifying these factors would further ensure that funds use
objective factors and market data in making credit quality
determinations and thereby promote uniformity in making minimal
credit risk determinations and/or assist money market fund managers
in understanding their obligations pertaining to portfolio quality
under rule 2a-7.
    \29\ See proposed rule 2a-7(a)(11); 2a-7(d)(2); current rule 2a-
7(d)(2)(ii). In conforming changes, the proposal would have moved
the requirement currently in the definition of eligible security
that the issuer of a demand feature or guarantee promptly notify the
holder of the security in the event the demand feature or guarantee
is substituted with another demand feature or guarantee (if such
substitution is permissible) to the paragraphs of the rule that
address securities subject to guarantees and conditional demand
features. Compare current rule 2a-7(a)(12)(iii)(B) with proposed
rule 2a-7(d)(2)(ii) and 2a-7(d)(2)(iii)(D). We are adopting these
amendments as proposed.
    \30\ Money market funds also are currently limited from
investing more than 0.5% of their assets in second tier securities
of a single issuer and 2.5% of their portfolios in second tier
securities issued, guaranteed or subject to a demand feature issued
by the same entity. See current rule 2a-7(d)(3)(i)(C) and 2a-
7(d)(3)(iii)(C). These limits also would be eliminated under the
final rule.
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    Most of the commenters who discussed the proposed definition of
``eligible security'' generally supported it,\31\ although, as
described below, many of these commenters expressed certain
reservations about details of the Commission's approach and various
aspects of the proposed definition. Two commenters supported the
elimination of the first and second tier distinction.\32\ However, two
other commenters expressed concern that removal of the distinction and
the limit on second tier securities could lead to funds purchasing more
risky securities.\33\ Some of the commenters who supported the
amendment stated that the Commission's proposed definition of eligible
security would provide an appropriate substitute standard of
creditworthiness in rule 2a-7.\34\ Other commenters who opposed the
definition,\35\ and even some that generally supported the Commission's
approach,\36\ cautioned that the lack of objective criteria in the
proposed definition could make it more likely that money market funds
would increase their exposure to riskier securities. Specifically, some
commenters argued that the proposed definition would produce an
incentive for money market funds to reach for yield.\37\ A number of
commenters also contended that the proposed definition might decrease
uniformity among funds in evaluating credit risk, which could cause
certain funds to present significantly greater risks to investors than
others.\38\
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    \31\ See, e.g., CFA Institute Comment Letter; MFDF Comment
Letter; Schwab Comment Letter.
    \32\ See Fidelity Comment Letter; MFDF Comment Letter.
    \33\ See Better Markets Comment Letter; CFA Comment Letter.
    \34\ CFA Institute Comment Letter; Invesco Comment Letter; MFDF
Comment Letter.
    \35\ CFA Comment Letter; Vanguard Comment Letter.
    \36\ BlackRock Comment Letter; CFA Institute Comment Letter.
    \37\ See id.
    \38\ BlackRock Comment Letter; CFA Comment Letter; CFA Institute
Comment Letter; NYC Bar Comment Letter; Schwab Comment Letter;
Vanguard Comment Letter.
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    Some commenters who acknowledged that the removal of credit ratings
from rule 2a-7 could create incentives for funds to invest in riskier
securities also suggested that certain countervailing factors would
alleviate this concern. These commenters stated that revising the
definition of eligible security should mitigate concerns about
increased credit risk and decreased uniformity by creating a single
standard for identifying eligible securities, particularly when viewed
in conjunction with the proposed Form N-MFP disclosure requirements and
new disclosure requirements that were adopted as part of the 2014 money
market fund reforms (which we expect would help to expose the increased
volatility and other risks that could accompany greater investment in
riskier portfolio holdings).\39\
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    \39\ See CFA Institute Comment Letter; Invesco Comment Letter;
Schwab Comment Letter; SIFMA Comment Letter.
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    While generally supporting the overall approach of incorporating
the eligible security definition into the general minimal credit risk
determination, multiple commenters expressed concerns about the
proposed secondary ``exceptionally strong capacity'' standard
incorporated in the proposed definition of eligible security. They
suggested that the Commission should reconsider or clarify this
standard for a number of reasons. Several commenters argued that the
word ``exceptional'' implies something unusual or extraordinary, which
could be read as not including a large number of money market
securities of very high credit quality that comprise a portion of money
market fund portfolios today.\40\ Commenters also argued that the word
``exceptional'' is not commonly used with gradations, yet rule 2a-7 was
designed to allow different gradations of high quality securities.\41\
Accordingly, these commenters argued that the proposed standard might
have the effect of restricting the universe of securities which money
market funds could purchase, contrary to the stated goal of the
proposal of seeking to retain a similar degree of credit quality in
fund portfolios as under the current rule.\42\
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    \40\ Fidelity Comment Letter; Dreyfus Comment Letter; ICI
Comment Letter; NYC Bar Comment Letter; Schwab Comment Letter; SIFMA
Comment Letter.
    \41\ Dreyfus Comment Letter; ICI Comment Letter; NYC Bar Comment
Letter; SIFMA Comment Letter.
    \42\ See, e.g., Dreyfus Comment Letter; ICI Comment Letter; NYC
Bar Comment Letter; SIFMA Comment Letter.
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    Some commenters also contended that the ``exceptionally strong
capacity'' language adds an unnecessary standard to a money market
fund's minimal credit risk analysis and imposes burdens on advisers
without any corresponding benefit to investors.\43\ Specifically, these
commenters argued that money market funds' minimal credit risk
determinations already provide the framework for making a

definitive finding of creditworthiness, and previously provided staff
guidance regarding minimal credit risk factors has enhanced clarity and
consistency in the application of this standard across the
industry.\44\ Commenters argued that the ``exceptionally strong
capacity'' standard would result in confusion for the industry \45\ and
operational and procedural burdens \46\ that money market funds'
current minimal credit risk analysis does not entail. Commenters
raising these concerns advocated for a modified approach that restricts
money market fund investments to those that the fund's board (or the
board's delegate) determines present minimal credit risks, but this
determination would not involve an additional finding that the
security's issuer has an exceptionally strong capacity to meet its
short-term financial obligations (or any similar finding).\47\ In
addition, some commenters argued that the difference between the
``exceptionally strong'' and ``very strong'' (the proposed new standard
relating to conditional demand features discussed below) standards is
not readily apparent, and argued that a consistent credit risk standard
should apply equally to eligible securities and securities subject to a
conditional demand feature, as discussed below.\48\
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    \43\ Dreyfus Comment Letter; Fidelity Comment Letter; SIFMA
Comment Letter.
    \44\ Dreyfus Comment Letter; Fidelity Comment Letter; SIFMA
Comment Letter. In addition to presenting updated guidance on credit
analysis factors, see supra note 28, the Proposing Release noted
that Commission staff has previously provided guidance on specific
factors that a board could consider in making minimal credit risk
determinations under rule 2a-7. See Letter to Registrants from
Kathryn McGrath, Director, Division of Investment Management, SEC
(May 8, 1990) (``1990 Staff Letter''); see also Letter to Matthew
Fink, President, Investment Company Institute from Kathryn McGrath,
Director, Division of Investment Management, SEC (Dec. 6, 1989)
(``1989 Staff Letter'').
    \45\ Dreyfus Comment Letter; Fidelity Comment Letter.
    \46\ Fidelity Comment Letter.
    \47\ Dreyfus Comment Letter; Fidelity Comment Letter; SIFMA
Comment Letter.
    \48\ IDC Comment Letter; Schwab Comment Letter; see infra
section II.B.
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    Numerous commenters expressed support for the guidance factors
included in the Proposing Release.\49\ One commenter, however, objected
to the inclusion of the asset-specific factors, suggesting that they
could become stale and outdated.\50\ Commenters who supported the use
of these factors stated that the factors were consistent with best
practices and appropriately tailored.\51\ Some commenters presented
technical recommendations about specific guidance factors.\52\ One
commenter suggested including additional guidance factors regarding
counterparty relationships and the effects of rising interest rates on
credit risk.\53\
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    \49\ See, e.g., Better Markets Comment Letter; BlackRock Comment
Letter; CFA Comment Letter; ICI Comment Letter; IDC Comment Letter;
NYC Bar Comment Letter; Schwab Comment Letter.
    \50\ ICI Comment Letter.
    \51\ IDC Comment Letter; MFDF Comment Letter.
    \52\ Fidelity Comment Letter; ICI Comment Letter. The first
commenter provided suggestions regarding guidance on two of the
asset-specific credit factors, asset-backed securities and
repurchase agreements. These suggestions have been adopted in this
release, as discussed below. The second commenter suggested that the
phrase ``worst case scenario'' should be removed from the list of
general factors. Because the phrase limited the situations that
might be analyzed under this factor, we are not including this
phrase in the final rule. See rule 2a-7(a)(11)(i)(C).
    \53\ CFA Institute Comment Letter.
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    Commenters' opinions varied on whether the guidance factors should
be codified. Multiple commenters expressed support for preserving the
factors as guidance, rather than codifying them, in order to provide
funds with flexibility and the ability to respond to changing market
conditions, financing terms, laws, and regulations.\54\ Conversely,
some commenters urged the Commission to codify the guidance factors as
part of rule 2a-7.\55\ One commenter argued that codification of the
factors would enhance investor protections.\56\ Another commenter
stated that the inclusion of the factors in rule 2a-7 would promote
uniform credit quality standards in the absence of specific NRSRO
ratings requirements, and would facilitate inspections by Commission
staff to aid in maintaining those standards.\57\ The commenters who
specifically mentioned the secondary list of asset-specific factors
mostly supported them.\58\ Two of these commenters believed that the
asset-specific factors should be incorporated into the rule,\59\ but
others opposed codification of any of the factors, including the asset-
specific ones.\60\ One commenter opposed the inclusion of the asset-
specific factors even as guidance, stating that the dynamic nature of
the marketplace could cause such specific guidance to become stale and
outdated.\61\
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    \54\ ICI Comment Letter; IDC Comment Letter; Schwab Comment
Letter. Similarly, some commenters suggested that the Commission
reiterate that the list of factors is not meant to be exhaustive.
See IDC Comment Letter; MFDF Comment Letter; SIFMA Comment Letter.
    \55\ Better Markets Comment Letter; CFA Comment Letter; NYC Bar
Comment Letter.
    \56\ Better Markets Comment Letter.
    \57\ NYC Bar Comment Letter. Two of the commenters supporting
codification also recommended that the Commission require a fund's
analysis of the factors to be appropriately documented. See Better
Markets Comment Letter; CFA Comment Letter.
    \58\ Better Markets Comment Letter; BlackRock Comment Letter;
MFDF Comment Letter; NYC Bar Comment Letter; Schwab Comment Letter.
    \59\ Better Markets Comment Letter; NYC Bar Comment Letter.
    \60\ See, e.g., BlackRock Comment Letter; Schwab Comment Letter;
ICI Comment Letter. See also CFA Institute Comment Letter (providing
a list of factors that it considered appropriate, comprised of only
the primary factors with two suggested additions, though it did not
discuss possible codification).
    \61\ ICI Comment Letter.
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1. Revised ``Eligible Security'' Definition
    After review of comments received, we are today adopting a revised
standard for eligible securities under rule 2a-7 that does not require
an ``exceptionally strong capacity'' fund board finding, but instead
requires a single uniform minimal credit risk finding, based on the
capacity of the issuer or guarantor of a security to meet its financial
obligations.\62\ As a complement to this uniform minimal credit risk
standard, we are also today codifying the general credit analysis
factors into rule 2a-7, the use of which should assist fund boards by
serving as objective and verifiable tools to rely on in the absence of
NRSRO ratings and which should help to achieve our goal of maintaining
a similar degree of credit risk as in current money market fund
portfolios.\63\
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    \62\ Rule 2a-7(a)(11). We are also adopting as proposed the
elimination of the following defined terms from the rule:
``designated NRSRO,'' ``first tier security,'' ``rated security,''
``requisite NRSROs,'' ``second tier security,'' and ``unrated
security.'' We are also making final several proposed revisions of
provisions in the rule that currently reference these terms. See
current rule 2a-7(a)(12) (eligible security); rule 2a-7(d)(2)
(portfolio quality); rule 2a-7(d)(3)(i)(A)(1) and (C) (portfolio
diversification); rule 2a-7(d)(3)(iii)(C) (portfolio
diversification); rule 2a-7(f)(1) (downgrades); rule 2a-7(h)(3)
(record keeping and reporting); rule 2a-7(j) (delegation). In
addition, fund boards will no longer have to designate NRSROs,
disclose them in the statement of additional information or use
their ratings to determine first or second tier status. Finally, we
are also adopting as proposed a conforming change to the
recordkeeping requirements under the rule to reflect that funds must
retain a written record of the determination that a portfolio
security is an eligible security, including the determination that
it presents minimal credit risks.
    \63\ The codified factors only include the general factors that
were discussed in the Proposing Release. Proposing Release, supra
note 3, at 47991-47992. The asset-specific factors are not codified,
but revised as discussed in section II.A.2 below, and continue to be
included as guidance.
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    We have been persuaded by the commenters that suggested that the
``exceptionally strong capacity'' determination could create an unclear
standard for determining eligible securities that might change the
current credit quality profile of money market funds. Variations in how
this language may be understood could lead to some funds only
purchasing the lowest risk securities possible, creating a risk profile
even more stringent than the

current standard. Others might interpret the standard differently and
not limit their securities purchases in the same way, which might
thereby create significant disparities between money market funds. Such
different interpretations might also lead to difficulties in our
inspection staff's review of compliance with the proposed standard. We
also appreciate commenters' concerns that it may be difficult to
determine the difference between ``exceptionally strong'' and other
similar standards such as ``very strong'' credit quality. Accordingly,
the Commission has decided that adopting a uniform standard based on
the well-developed existing requirement that a security present minimal
credit risks, in conjunction with codifying the general factors to be
considered, as discussed below, will more effectively achieve the goals
of the proposal.
    The requirement that a security present minimal credit risks to a
money market fund has been part of rule 2a-7 since it was adopted in
1983.\64\ The minimal credit risk determination was meant to provide an
independent assurance of safety above and beyond the existence of a
``high quality'' rating by an NRSRO, as explained in the original
adopting release:
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    \64\ Valuation of Debt Instruments and Computation of Current
Price Per Share by Certain Open-End Investment Companies, Investment
Company Act Release No. 13380 (Jul. 11, 1983) [48 FR 32555 (Jul. 18,
1983).]

    [T]he mere fact that an instrument has or would receive a high
quality rating may not be sufficient to ensure stability. The
Commission believes that the instrument must be evaluated for the
credit risk that it presents to the particular fund at that time in
light of the risks attendant to the use of amortized cost valuation
or penny-rounding (emphasis added).\65\
---------------------------------------------------------------------------

    \65\ Id. at 32560.

    Under this existing standard, a board (or its delegate) should
determine that a security presents minimal credit risks not just in
isolation, but also in the context of the fund as a whole. The 2014
Proposing Release made clear that the removal of NRSRO ratings is not
intended to change the current risk profile of money market funds, or
their evaluation of minimal credit risks.\66\ In determining whether a
security presents minimal credit risks, therefore, a board (or its
delegate) should consider not just the individual risks of the
security, but also the overall impact of adding that security to the
fund in light of the fund's other holdings.\67\ Such consideration
might include an examination of correlation of risk among the
securities held or purchased, the credit risks associated with market-
wide stresses, or specific security credit or liquidity disruptions.
Based on comments received, we are persuaded that this existing
requirement to evaluate the minimal credit risk of portfolio securities
on the fund as a whole (not just on a security-by-security basis) will
help mitigate potential risks that money market funds might change
their current credit risk profile after our removal of NRSRO ratings
references from the rule as part of the final amendments.
---------------------------------------------------------------------------

    \66\ See, e.g., Proposing Release, supra note 3, at 47989.
    \67\ In order to clarify that the requirements of the minimal
credit risks analysis have not changed from the original
requirements as described in the 1983 release, the phrase ``to the
fund'' has been added to the final rule definition of eligible
security. Rule 2a-7(a)(11). This phrase is intended to indicate
that, unlike a security's NRSRO rating that measures only the
security's risks in isolation, the minimal credit risk determination
must consider any credit risk introduced by the security to the
entire fund.
---------------------------------------------------------------------------

2. Codified Factors
    Although we believe that the minimal credit risk standard should
serve as an effective limitation on credit risk in money market fund
portfolios even without the proposed secondary ``exceptionally strong''
finding, we appreciate commenters' concerns that eliminating the
``floor'' provided by NRSRO ratings in the rule without a replacement
might lead to fund managers taking on additional credit risk if the
rule does not provide objective and verifiable standards. As discussed
above, several commenters suggested that codifying the general factors
would enhance investor protections and promote uniform credit quality
standards in the absence of specific NRSRO ratings requirements. We
agree.
    Accordingly, the final rule amendments now include, as part of the
analysis of minimal credit risks, a requirement to consider, to the
extent appropriate, the general credit analysis factors from the
Proposing Release.\68\ As noted in the Proposing Release, our staff has
had opportunities to observe how money market fund advisers evaluate
minimal credit risk, and although staff has noted a range in the
quality and breadth of credit risk analyses among the money market
funds examined, staff has also observed that most of the advisers to
these funds evaluate some common factors that bear on the ability of an
issuer or guarantor to meet its short-term financial obligations. Based
on staff observations in examinations and prior staff guidance, we
understand that most money market fund managers already generally take
these factors into account, as appropriate, when they determine whether
a portfolio security presents minimal credit risks. We believe that
codifying the general factors will help provide a uniform and objective
check on credit risk that can be verified by our examiners. We also
believe that incorporating these factors into the rule text will
further promote effective and uniform application of the risk standard.
Although multiple commenters expressed support for preserving the
factors as guidance, rather than codifying them,\69\ the Commission
believes that codification of these factors is justified by the need
for verifiable credit quality determinations in the absence of required
references to NRSRO ratings. In addition, the Commission believes that
the changes to the proposed standard made in this final rule should
reduce the likelihood of increased credit risk because funds will have
to perform a rigorous analysis using the codified factors and consider
how each security affects the aggregate risk of the portfolio.
---------------------------------------------------------------------------

    \68\ Rule 2a-7(a)(11)(i). The Proposing Release included a
second list of asset-specific factors that staff had observed funds
making use of for credit analysis of specific types of securities
which will be retained as guidance as discussed further below.
Proposing Release, supra note 3, at 47992-47993.
    \69\ ICI Comment Letter; IDC Comment Letter; Schwab Comment
Letter. Similarly, some commenters suggested that the Commission
reiterate that the list of factors is not meant to be exhaustive.
See IDC Comment Letter; MFDF Comment Letter; SIFMA Comment Letter.
As noted below, we state that the list of factors in the rule and
the additional factors discussed in this release as guidance are not
meant to be exhaustive, and there may be additional factors that
could be relevant depending on the type of security analyzed.
---------------------------------------------------------------------------

    As discussed above, commenters disagreed over the proposed
elimination of the first and second tier distinction,\70\ with two
commenters expressing concern that removing the distinction and the
limit on second tier securities could lead to funds purchasing more
risky securities.\71\ However, we believe that the codification of the
credit analysis factors in the final rule, combined with the increased
transparency gained through our amendments to Form N-MFP disclosures
(both adopted today, as well as the amendments adopted as part of the
2014 money market fund reforms \72\), should mitigate this concern. The
codified credit factors should establish a minimum baseline that should
help guard against the risk that funds'

approach to credit analysis will become less uniform, or that some
funds would substantially increase the riskiness of their portfolios by
increasing their investments in second tier securities. Such changes
would not likely be consistent with a minimal credit risk analysis
using the factors we are codifying today.
---------------------------------------------------------------------------

    \70\ See Fidelity Comment Letter; MFDF Comment Letter; Better
Markets Comment Letter; CFA Comment Letter.
    \71\ See Better Markets Comment Letter; CFA Comment Letter.
    \72\ For example, the 2014 money market fund reforms eliminated
the 60-day delay in making public the information filed on Form N-
MFP.
---------------------------------------------------------------------------

    Therefore, the final rule requires a money market fund's board (or
its delegate) to consider, in making its minimal credit risk
determinations, the capacity of each security's issuer, guarantor, or
provider of a demand feature, to meet its financial obligations, and in
doing so, consider, to the extent appropriate, the following factors:
(1) Financial condition; (2) sources of liquidity; (3) ability to react
to future market-wide and issuer- or guarantor-specific events,
including ability to repay debt in a highly adverse situation; and (4)
strength of the issuer or guarantor's industry within the economy and
relative to economic trends, and issuer or guarantor's competitive
position within its industry.\73\ In incorporating the credit analysis
factors into the rule, we have revised them to make them as generally
applicable as possible to all money market funds. As we discussed in
the Proposing Release, and as reflected in a number of comments
received, we understand that the majority of the industry already
typically considers these factors when making minimal credit risk
determinations.\74\ One commenter's recommendation suggested that we
include as a codified factor an analysis of the existence, nature, and
magnitude of any counterparty relationships.\75\ However, in its
observations of how money market funds evaluate minimal credit risk,
our staff has not identified this factor as one of the common factors
that bear on the ability of an issuer or guarantor to meet its short-
term financial obligations and we are not aware of other information
that suggests that many money market funds are currently performing (or
have the information readily available to perform) this type of
analysis. Accordingly, we are not including as a codified factor an
analysis of counterparty relationships, although we believe that, to
the extent that funds have such information available, analyzing
counterparty relationships should assist funds in making minimal credit
risk determinations.
---------------------------------------------------------------------------

    \73\ As explained in the Proposing Release, many of these
considerations have been included in staff guidance as well as in
best practices for determining minimal credit risk set forth in
Appendix I of the Report of the Money Market Working Group submitted
to the Board of Governors of the Investment Company Institute in
2009. See also 1990 Staff Letter and 1989 Staff Letter, supra note
44.
    \74\ See Proposing Release, supra note 3, section II.A.1, at nn.
53-57 and accompanying text.
    \75\ CFA Institute Comment Letter.
---------------------------------------------------------------------------

    As discussed in the Proposing Release, the financial condition
factor generally should include examination of recent financial
statements, including consideration of trends relating to cash flow,
revenue, expenses, profitability, short-term and total debt service
coverage, and leverage (including financial and operating leverage).
The second factor, sources of liquidity, generally should include
consideration of bank lines of credit and alternative sources of
liquidity. The third factor, involving market-wide events, generally
should include analysis of risk from various scenarios, including
changes to the yield curve or spreads, especially in a changing
interest rate environment. The fourth factor, the competitive position
of the firm and its industry, generally should include consideration of
diversification of sources of revenue, if applicable.\76\ As explained
in the proposal, in addition to the codified factors used to evaluate
the issuer or guarantor of a security, a minimal credit risk evaluation
may also include consideration of whether the price and/or yield of the
security itself is similar to that of other securities in the fund's
portfolio.\77\
---------------------------------------------------------------------------

    \76\ See Proposing Release, supra note 3, section II.A.1, at
47991-47992.
    \77\ See 2014 Proposing Release, supra note 3. This
consideration is not being incorporated into the rule text because
it does not relate to the overall strength of a security's issuer or
guarantor, as do the codified factors. We therefore believe that it
would be more useful for a fund's manager to evaluate a security's
price and/or yield (as compared with other similar portfolio
securities) as a way to quickly assess the appropriateness of a
given security, and hence is provided only as guidance.
---------------------------------------------------------------------------

    The Commission is not codifying the asset-specific factors into the
final rule text. As one commenter pointed out,\78\ overly specific and
numerous factors could over time become dated. Consistent with the
concern raised by this commenter, the Commission is mindful of the
pitfalls that may result from codifying too many factors, and/or
factors that are not sufficiently broad and yet relevant enough to
withstand changing markets over time. The Commission believes that
keeping these asset-specific factors as guidance may help avoid any
unintended burden while providing funds with additional and potentially
relevant considerations that may be useful when making minimal credit
risk determinations in the absence of required references to NRSRO
ratings. Accordingly, we are limiting the factors we are codifying into
the rule itself to the list of general factors that we believe are
sufficiently universal and tested enough to avoid this problem, but
that will form the basis of a rigorous analysis. Nonetheless, where
relevant, funds may wish to consider whether the asset-specific factors
should also be evaluated in making minimal credit risk determinations,
especially if they make significant investment in such asset classes.
In addition, we have included a cross reference in the rule text to the
guidance regarding the asset specific factors, to better inform readers
of the applicability of the asset specific factor guidance discussed
here.\79\
---------------------------------------------------------------------------

    \78\ ICI Comment Letter.
    \79\ We have also incorporated technical recommendations from
two commenters on the assets specific factor guidance. ICI Comment
Letter; Fidelity Comment Letter. We have (1) combined the two
bullets on repurchase agreements into one; (2) altered language in
the guidance on repurchase agreements, reflecting increased
standardization of the market; and (3) removed the reference to
analyzing underlying assets in the asset-backed securities bullet.
---------------------------------------------------------------------------

    Accordingly, to the extent applicable, fund advisers may wish to
consider the following asset-specific factors:
     For municipal securities: (i) Sources of repayment; (ii)
issuer demographics (favorable or unfavorable); \80\ (iii) the issuer's
autonomy in raising taxes and revenue; (iv) the issuer's reliance on
outside revenue sources, such as revenue from a state or federal
government entity; and (v) the strength and stability of the supporting
economy.\81\
---------------------------------------------------------------------------

    \80\ Demographics could include considerations such as the type,
size, diversity and growth or decline of the local government's tax
base, including income levels of residents, and magnitude of
economic activity.
    \81\ See 1989 Staff Letter, supra note 44 (additional factors
such as sources of repayment, autonomy in raising taxes and revenue,
reliance on outside revenue sources and strength and stability of
the supporting economy should be considered with respect to tax-
exempt securities); see also Guidance on Due Diligence Requirements
in Determining Whether Securities are Eligible for Investment,
Office of the Comptroller of the Currency, Docket ID OCC-2012-0006
[77 FR 35259 (Jun. 13, 2012)] (``OCC Guidance'') (matrix of examples
of factors for national banks and federal savings associations to
consider as part of a robust credit risk assessment framework (``OCC
credit risk factors'') for certain investment securities includes
capacity to pay and assess operating and financial performance
levels and trends).
---------------------------------------------------------------------------

     For conduit securities under rule 2a-7: \82\ Analysis of
the underlying

obligor for all securities except asset-backed securities (including
asset-backed commercial paper).\83\
---------------------------------------------------------------------------

    \82\ Under rule 2a-7, a ``conduit security'' means a security
issued by a municipal issuer involving an arrangement or agreement
entered into, directly or indirectly, with a person other than a
municipal issuer, which arrangement or agreement provides for or
secures repayment of the security. Rule 2a-7(a)(7). A ``municipal
issuer'' is defined under the rule to mean a state or territory of
the United States (including the District of Columbia), or any
political subdivision or public instrumentality of a state or
territory of the United States. Id. A conduit security does not
include a security that is: (i) Fully and unconditionally guaranteed
by a municipal issuer; (ii) payable from the general revenues of the
municipal issuer or other municipal issuers (other than those
revenues derived from an agreement or arrangement with a person who
is not a municipal issuer that provides for or secures repayment of
the security issued by the municipal issuer); (iii) related to a
project owned and operated by a municipal issuer; or (iv) related to
a facility leased to and under the control of an industrial or
commercial enterprise that is part of a public project which, as a
whole, is owned and under the control of a municipal issuer. Id.
    \83\ See OCC Guidance, supra note 81 (OCC credit risk factors
for revenue bonds include consideration of the obligor's financial
condition and reserve levels).
---------------------------------------------------------------------------

     For asset-backed securities, such as asset-backed
commercial paper: (i) Analysis of the terms of any liquidity or other
support provided; and (ii) legal and structural analyses to determine
that the particular asset-backed security involves no more than minimal
credit risks for the money market fund.\84\
---------------------------------------------------------------------------

    \84\ See Money Market Fund Reform, Investment Company Act
Release No. 29132 (Feb. 23, 2010) [75 FR 10060 (Mar. 4, 2010)]
(``2010 Money Market Fund Adopting Release'') at section II.A.3
(citing Revisions to Rules Regulating Money Market Funds, Investment
Company Act Release No. 21837 (Mar. 21, 1996) [61 FR 13956 (Mar. 28,
1996)] (``1996 Money Market Fund Adopting Release'') at section
II.E.4).
---------------------------------------------------------------------------

     For other structured securities, such as variable rate
demand notes,\85\ tender option bonds,\86\ extendible bonds\87\ or
``step up'' securities,\88\ or other structures: In addition to
analysis of the issuer or obligor's financial condition, analysis of
the protections for the money market fund provided by the legal
structure of the security.\89\
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    \85\ A variable rate demand obligation (``VRDO'') (which
includes variable rate demand notes) is a security for which the
interest rate resets on a periodic basis and holders are able to
liquidate their security through a ``put'' or ``tender'' feature, at
par. To ensure that the securities are able to be ``put'' or
``tendered'' by a holder in the event that a remarketing agent is
unable to remarket the security, a VRDO typically operates with a
liquidity facility--a Letter of Credit or Standby Bond Purchase
Agreement--that ensures that an investor is able to liquidate its
position. See Electronic Municipal Market Access, Understanding
Variable Rate Demand Obligations, available at http://emma.msrb.org/EducationCenter/UnderstandingVRDOs.aspx.
    \86\ A tender option bond is an obligation that grants the
bondholder the right to require the issuer or specified third party
acting as agent for the issuer (e.g., a tender agent) to purchase
the bonds, usually at par, at a certain time or times prior to
maturity or upon the occurrence of specified events or conditions.
See Municipal Securities Rulemaking Board, Glossary of Municipal
Securities Terms, Tender Option Bond, available at http://www.msrb.org/glossary/definition/tender-option-bond.aspx. Tender
option bonds are synthetically created by a bond dealer or other
owner of a long-term municipal obligation purchased in either the
primary or secondary markets, or already in a portfolio.
    \87\ An extendible bond is a long-term debt security with an
embedded option for either the investor or the issuer to extend its
maturity date. To qualify as an eligible security under rule 2a-7,
the issuer must not have the right to extend the maturity of the
bond so that it is more than 397 days to maturity at any time.
Typically, if an extendible bond is of the type that qualifies as an
eligible security under rule 2a-7, a money market fund will have the
option to either extend the maturity of the bond to no more than 397
days in the future, or elect not to extend, in which case the bond's
maturity must be no longer than 397 days at that time.
    \88\ A ``step up'' security pays an initial interest rate for
the first period, and then a higher rate for the following periods.
    \89\ See OCC Guidance, supra note 81 (OCC credit risk factors
for structured securities include evaluation and understanding of
specific aspects of the legal structure including loss allocation
rules, potential impact of performance and market value triggers,
support provided by credit and liquidity enhancements, and adequacy
of structural subordination).
---------------------------------------------------------------------------

     For repurchase agreements under rule 2a-7: A financial
analysis and assessment of the minimal credit risk of the counterparty,
an assessment as to whether the haircut level is appropriate for the
particular type of collateral based upon price volatility in the market
for such collateral type, and a legal analysis of the protections for
the money market fund provided by the terms of the repurchase
agreements.
    The list of factors in the rule and the additional factors
discussed in this release as guidance are not meant to be exhaustive,
and there may be additional factors that could be relevant depending on
the type of security analyzed. We recognize that the range and type of
specific factors appropriate for consideration could vary depending on
the category of issuer and particular security or credit enhancement
under consideration, and that the board (or its delegate) therefore may
determine to include other factors in its credit assessment.\90\ We
also recognize that specific purchases may require more or less
analysis depending on the security's risk characteristics. As discussed
in greater detail below, amended rule 2a-7 will also require that the
written record of the minimal credit risk determination address any
factors considered and the analysis of those factors.\91\
---------------------------------------------------------------------------

    \90\ As discussed in the 2014 Proposing Release, supra note 3,
money market fund boards of directors typically delegate minimal
credit risk determinations to the fund's adviser, as provided for in
rule 2a-7(j).
    \91\ See infra section II.C.; rule 2a-7(h)(3).
---------------------------------------------------------------------------

B. Conditional Demand Features

    Rule 2a-7 limits money market funds to investing in securities with
remaining maturities of no more than 397 days.\92\ A long-term security
subject to a conditional demand feature \93\ (``underlying security''),
however, may be determined under the current rule to be an eligible
security (or a first tier security) if among other conditions: (i) The
conditional demand feature is an eligible security or a first tier
security; and (ii) the underlying security (or its guarantee) has
received either a short-term rating or a long-term rating, as the case
may be, within the highest two categories from the requisite NRSROs or
is a comparable unrated security.\94\ The rule currently requires this
analysis of both the short-term and long-term credit aspects of the
demand instrument because a security subject to a conditional demand
feature combines both short-term and long-term credit risks.\95\
---------------------------------------------------------------------------

    \92\ See current rule 2a-7(a)(12).
    \93\ A conditional demand feature is a demand feature that a
fund may be precluded from exercising because of the occurrence of a
condition. See rule 2a-7(a)(6) (defining ``conditional demand
feature'' as a demand feature that is not an unconditional demand
feature); rule 2a-7(a)(30) and proposed rule 2a-7(a)(25) (defining
``unconditional demand feature'' as a demand feature that by its
terms would be readily exercisable in the event of a default in
payment of principal or interest on the underlying security). For
purposes of rule 2a-7, a demand feature allows the security holder
to receive, upon exercise, the approximate amortized cost of the
security, plus accrued interest, if any, at the later of the time of
exercise or the settlement of the transaction, paid within 397
calendar days of exercise. Current rule 2a-7(a)(9).
    \94\ Current rule 2a-7(d)(2)(iv). Although underlying securities
are generally long-term securities when issued originally, they
become short-term securities when the remaining time to maturity is
397 days or less.
    \95\ The quality of a conditional demand instrument depends both
on the ability of the issuer of the underlying security to meet
scheduled payments of principal and interest and upon the
availability of sufficient liquidity to allow a holder of the
instrument to recover the principal amount and accrued interest upon
exercise of the demand feature. See Acquisition and Valuation of
Certain Portfolio Instruments by Registered Investment Companies,
Investment Company Act Release No. 14607 (Jul. 1, 1985) [50 FR 27982
(Jul. 9, 1985)], at n.33. The current rule permits the determination
of whether a security subject to an unconditional demand feature is
an eligible or first tier security to be based solely on whether the
unconditional demand feature is an eligible or first tier security
because credit and liquidity support will be provided even in the
event of default of the underlying security. See current rule 2a-
7(d)(2)(iii).
---------------------------------------------------------------------------

    The Commission's proposal would have required a similar analysis,
but consistent with Section 939A of the Dodd-Frank Act, it would have
removed the requirement in the rule that the fund board (or its
delegate) consider credit ratings of underlying securities.\96\ Under

the proposal, a fund would have had to determine, as with any short-
term security, that the conditional demand feature is an eligible
security.\97\ In addition, a fund's board of directors (or its
delegate) would have had to evaluate the long-term risk of the
underlying security and determine that it (or its guarantor) ``has a
very strong capacity for payment of its financial commitments.'' \98\
We proposed this standard because it was similar to those articulated
by credit rating agencies for long-term securities assigned the second
highest rating.\99\ Because the conditional demand feature could be
terminated by a ratings downgrade, we believed that the underlying
security should present only limited credit risk.\100\
---------------------------------------------------------------------------

    \96\ In a conforming change, the Commission proposed to remove
two provisions in current rule 2a-7 that reference credit ratings in
connection with securities subject to a demand feature or guarantee
of the same issuer that are second tier securities: Rule 2a-
7(d)(3)(i)(C) (limiting a fund's investments in securities subject
to a demand feature or guarantee of the same issuer that are second
tier securities to 2.5% of the fund's total assets); rule 2a-
7(f)(1)(iii) (providing that if, as a result of a downgrade, more
than 2.5% of a fund's total assets are invested in securities issued
by or subject to demand features from a single institution that are
second tier securities, a fund must reduce its investments in these
securities to no more than 2.5% of total assets by exercising the
demand feature at the next succeeding exercise date(s)). In other
conforming changes, the Commission proposed to amend two rules under
the Act that reference the definition of ``demand feature'' and
``guarantee'' under rule 2a-7, which references would have changed
under the proposed amendments. Specifically, the Commission proposed
to amend: (i) Rule 12d3-1(d)(7)(v), to replace the references to
``rule 2a-7(a)(8)'' and ``rule 2a-7(a)(15)'' with ``Sec.  270.2a-
7(a)(9)'' and ``Sec.  270.2a-7(a)(16)''; and (ii) rule 31a-1(b)(1),
to replace the phrase ``(as defined in Sec.  270.2a-7(a)(8) or Sec.
270.2a-7(a)(15) respectively)'' with ``(as defined in Sec.  270.2a-
7(a)(9) or Sec.  270.2a-7(a)(16) respectively.)'' We are adopting
these changes as proposed.
    \97\ See proposed rule 2a-7(d)(2)(iii)(A). The Proposing Release
also reiterated the existing monitoring and substitutability
requirements for conditional demand features in rule 2a-7, and noted
that the Commission believed it would be prudent for a money market
fund to avoid investing in securities whose eligibility as portfolio
securities depended on a conditional demand feature that may be
terminated if the underlying portfolio security is downgraded a
single ratings category. See Proposing Release, supra note 3, at
n.90 and accompanying and preceding text.
    \98\ Proposed rule 2a-7(d)(2)(iii)(C). An underlying security
that is a short-term security (because its remaining maturity is
less than 397 days, although its original maturity may have been
longer) also would have had to meet the proposed standard.
    \99\ See Proposing Release, supra note 3, at n.83 and
accompanying text.
    \100\ Id, at n.89 and accompanying text.
---------------------------------------------------------------------------

    The commenters who addressed this section generally opposed the
proposed approach of requiring a different ``very strong'' standard for
conditional demand features as compared to the proposed ``exceptionally
strong'' standard for all other eligible securities. Instead, most
commenters that addressed this issue suggested that the Commission
adopt a single uniform standard for both eligible securities and
conditional demand features as such a uniform standard would eliminate
any potential inconsistences and confusion. We agree, and therefore the
final amendments do not include the proposed ``very strong'' standard
for conditional demand features, but instead apply the single uniform
minimal credit risk standard (including an analysis of relevant
factors) for all eligible security determinations, including
conditional demand features.
    Most commenters' discussion of the credit analysis of securities
subject to conditional demand features focused on aligning the credit
quality standard for these securities with the standard used to
identify eligible securities generally.\101\ One commenter stated that
employing the same standard would minimize confusion among
investors.\102\ Another commenter argued that the termination of a
conditional demand feature has much the same effect as a default on
other securities, and thus the degree of risk permitted with respect to
the termination of a conditional demand feature should be equivalent to
the risk of default with respect to other eligible securities.\103\
Commenters were split in their opinions about what uniform standard to
use, if the same credit quality standard were to be employed for
eligible securities and securities subject to a conditional demand
feature. Some argued that the ``very strong'' capacity standard should
be used in both contexts.\104\ Commenters who advised that the minimal
credit risk standard should stand alone, without an additional
``exceptionally strong capacity'' finding (or similar finding),
maintained that this stand-alone minimal credit risk standard should
apply equally to eligible securities and securities subject to a
conditional demand feature.\105\
---------------------------------------------------------------------------

    \101\ Dreyfus Comment Letter; ICI Comment Letter; IDC Comment
Letter; Schwab Comment Letter.
    \102\ IDC Comment Letter.
    \103\ ICI Comment Letter. See also supra note 93.
    \104\ ICI Comment Letter; Schwab Comment Letter.
    \105\ Dreyfus Comment Letter; Fidelity Comment Letter.
---------------------------------------------------------------------------

    We agree with these commenters' concerns and are adopting the rule
amendments without the proposed ``very strong capacity'' standard.\106\
Instead, the final amendments require application of a single uniform
``minimal credit risk'' standard that will apply to all securities
purchased by money market funds, pursuant to the revised eligible
security definition as discussed above.\107\ We agree with commenters'
reasoning that a uniform credit quality standard would be appropriate
given the similar degree of risk presented by the termination of a
conditional demand feature and the default of a portfolio security. We
also agree with commenters that the difference between the terms ``very
strong'' and ``exceptionally strong'' is not readily apparent and that
a uniform minimal credit risk standard will thus reduce confusion, and
still preserve a similar degree of credit quality to that currently
present in fund portfolios. Therefore, under the uniform standard that
we are adopting today for conditional demand features, a fund's board
(or its delegate) must determine that both the conditional demand
feature and the underlying security (or guarantee) are eligible
securities.\108\
---------------------------------------------------------------------------

    \106\ Rule 2a-7(d)(2)(iii).
    \107\ Rule 2a-7(a)(11).
    \108\ The credit risk standard that is being adopted for
conditional demand features aligns the credit quality standard for
these securities with the standard used to identify eligible
securities by requiring the fund's board (or its delegate) to
determine that these securities are eligible securities. We note
that such a determination, by expressly incorporating the definition
of eligible securities, will also incorporate the requirement of a
fund to consider, to the extent appropriate, the general credit
analysis factors discussed above. Rule 2a-7(a)(11); see supra
section II.A.2 (``Codified Factors'').
---------------------------------------------------------------------------

    As noted in the Proposing Release and reiterated here, we do not
believe that securities that are rated by NRSROs in the third-highest
category for long-term ratings (or comparable unrated securities) would
satisfy the standard that underlying securities present minimal credit
risks to the fund. We also note that funds currently can invest
exclusively in underlying securities rated in the second-highest
category if the instrument meets the other conditions for
eligibility.\109\ We estimate that most underlying securities held by
money market funds (77 percent) are rated in the second-highest long-
term category, and a smaller portion (23 percent) are rated in the
highest long-term category.\110\ For these reasons, we do not currently
anticipate that funds are likely to increase the portion of their
underlying securities that are rated in the second-highest long-term
category as a result of the adopted amendments (since these funds do
not currently invest in these securities to the extent permitted under
existing rules).
---------------------------------------------------------------------------

    \109\ Current rule 2a-7(d)(2)(iv).
    \110\ See infra note 258 and accompanying text.
---------------------------------------------------------------------------

C. Monitoring Minimal Credit Risks

    Currently, rule 2a-7 requires a money market fund board (or its
delegate) to promptly reassess whether a security that has been
downgraded by an NRSRO continues to present minimal credit risks, and
to take such action as it determines is in the best interests of the

fund and its shareholders.\111\ In the Proposing Release, the
Commission proposed to eliminate this requirement and instead require
each money market fund to adopt written procedures that would require
the fund adviser to provide an ongoing review of the credit quality of
each portfolio security to determine that the security continues to
present minimal credit risks.\112\
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    \111\ Rule 2a-7(f)(1)(i)(A). This current reassessment is not
required, however, if the downgraded security is disposed of or
matures within five business days of the specified event and in the
case of certain events (specified in rule 2a-7(f)(1)(i)(B)), the
board is subsequently notified of the adviser's actions. Rule 2a-
7(f)(1)(ii). In addition, rule 2a-7 requires ongoing review of the
minimal credit risks associated with securities for which maturity
is determined by reference to a demand feature. Rule 2a-7(g)(3).
    \112\ Proposing Release, supra note 3, at 47994-47996; proposed
rule 2a-7(g)(3). The Commission proposed to remove current rule 2a-
7(f)(1)(i) (downgrades) and 2a-7(g)(3) (securities for which
maturity is determined by reference to demand features). Proposed
rule 2a-7 included a new paragraph (g)(3), which would contain the
required procedures for the ongoing review of credit risks.
---------------------------------------------------------------------------

    As discussed in the Proposing Release, such ongoing monitoring of
minimal credit risks would include the determination of whether the
issuer of the portfolio security, and the guarantor or provider of a
demand feature, to the extent relied upon by the fund to determine
portfolio quality, maturity or liquidity, continues to have the
capacity to repay its financial obligations such that the security
presents minimal credit risks. The review would typically update the
information that was used to make the initial minimal credit risk
determination and would have to be based on, among other things,
financial data of the issuer or provider of the guarantee or demand
feature.\113\ The Commission noted that funds could continue to
consider external factors, including credit ratings, as part of the
ongoing monitoring process.\114\
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    \113\ See proposed rule 2a-7(g)(3)(ii).
    \114\ We note that a fund adviser's obligation to monitor risks
to which the fund is exposed will, as a practical matter, require
the adviser to monitor for downgrades by relevant credit rating
agencies because such a downgrade would likely affect the security's
market value.
---------------------------------------------------------------------------

    All of the commenters who addressed the ongoing monitoring
provision supported the proposed requirement.\115\ Commenters agreed
with the Commission's belief that most fund advisers currently engage
in similar types of ongoing monitoring and that an explicit monitoring
requirement would not significantly change current fund practices,\116\
nor would it impose significant extra costs.\117\ Commenters also
stated that the ongoing monitoring requirement would assist funds to
better position themselves to quickly identify potential risks of
credit events that could impact portfolio security prices.\118\
Accordingly, as discussed in more detail below, we are now adopting
these amendments as proposed.\119\
---------------------------------------------------------------------------

    \115\ See Barnard Comment Letter; BlackRock Comment Letter; CFA
Institute Comment Letter; Dreyfus Comment Letter; Fidelity Comment
Letter; ICI Comment Letter; IDC Comment Letter; Invesco Comment
Letter; Schwab Comment Letter; Vanguard Comment Letter.
    \116\ All commenters that specifically addressed this issue
agreed with the Commission's understanding of current practices. See
BlackRock Comment Letter; Fidelity Comment Letter; Barnard Comment
Letter; Schwab Comment Letter. Although the NYC Bar Comment Letter
did not specifically answer this question, it suggested that the
Proposing Release had not presented a sufficiently detailed
description of those current practices. This comment is discussed
further below.
    \117\ The only commenter to address the question about costs
stated that it did not believe that most funds would experience
additional costs beyond the initial adoption and implementation. See
Schwab Comment Letter.
    \118\ Fidelity Comment Letter; Schwab Comment Letter; Barnard
Comment Letter.
    \119\ Rule 2a-7(g)(3).
---------------------------------------------------------------------------

1. Frequency of Monitoring
    Three commenters requested more specificity regarding the frequency
of the monitoring requirement.\120\ One of these commenters requested
that the Commission adopt a specific periodic basis for the ongoing
review, so that the process would occur with a minimum frequency.\121\
The other two commenters requested that the Commission make clear that
``ongoing'' monitoring does not necessarily mean a constant or daily
evaluation.
---------------------------------------------------------------------------

    \120\ Better Markets Comment Letter; NYC Bar Comment Letter;
SIFMA Comment Letter.
    \121\ Better Markets Comment Letter.
---------------------------------------------------------------------------

    We are not specifying a periodic basis for the ongoing monitoring
requirement adopted today. As a preliminary matter, doing so would
conflict with the intent of an explicit ongoing monitoring requirement.
Specifying a periodic frequency for monitoring might suggest that
regular awareness of the credit profile of portfolio securities is not
required, and might also interfere with the discretion of fund managers
to react to changing market conditions. In addition, as discussed
above, specifying the frequency of monitoring would be inconsistent
with our understanding of how a majority of the industry currently
evaluates minimal credit risk.\122\
---------------------------------------------------------------------------

    \122\ Similarly, in response to the Commission's query as to
whether the rule should include specific objective events that would
require a reevaluation of minimal credit risks, the only commenter
to address the question stated that such a change might cause fund
managers to limit their reviews to those triggering events, rather
than truly evaluating risk on an ongoing basis. Schwab Comment
Letter. We agree, and are not requiring specific events that would
trigger a reevaluation.
---------------------------------------------------------------------------

    Although we are not codifying a specific frequency upon which
monitoring must occur, we expect that for purposes of the rule, ongoing
monitoring would mean that monitoring efforts should occur on a regular
and frequent basis. We understand that many funds today engage in daily
monitoring of changes in the markets or conditions relating to issuers
that may affect their credit evaluation of portfolio holdings, and do
so even on an hourly basis if there are rapidly changing events. We
believe that this type of monitoring is consistent with the ongoing
monitoring requirement adopted today.
    One commenter who requested a specific periodic basis for minimal
credit risk evaluations also suggested that the Commission require that
the fund's board be notified when a portfolio security no longer meets
the minimal credit risk standard (and thus, the definition of an
eligible security).\123\ As a general matter, the Commission expects,
as explained in the Proposing Release, that a fund board generally will
establish procedures for the adviser to notify the board when a
security no longer meets the minimal credit risk standard, and thus
expect that a board would be notified as the commenter suggested. We
also note that under current rule 2a-7 and the final rule, a fund must
dispose of a security that is no longer an eligible security, unless
the board makes a finding that it would not be in the interests of the
fund to do so.\124\ Therefore, if a fund chooses not to dispose of a
security that is no longer an ``eligible security,'' the fund's board
will already have had the notice sought by this commenter, and thus we
do not believe that further specific notification requirements are
necessary.
---------------------------------------------------------------------------

    \123\ Better Markets Comment Letter.
    \124\ Current rule 2a-7(f)(2)(ii).
---------------------------------------------------------------------------

2. Recordkeeping
    Today, funds are required to retain a written record of the
determination that a portfolio security is an eligible security,
including the determination that it presents minimal credit risks. If
the proposed requirement to conduct an ongoing review of the credit
quality of a fund's portfolio securities were adopted, rule 2a-7's
current recordkeeping requirement could have been understood to require
the fund to provide for an ongoing documentation of the adviser's
ongoing review, which could prove burdensome. Accordingly, we had
proposed to make conforming amendments to the recordkeeping provision,
requiring the fund to maintain and preserve a written record of the
determination that a portfolio security presents minimal credit risks
at

the time the fund acquires the security, or at such later times (or
upon such events) that the board of directors determines that the
investment adviser must reassess whether the security presents minimal
credit risks.\125\
---------------------------------------------------------------------------

    \125\ See proposed rule 2a-7(h)(3).
---------------------------------------------------------------------------

    One commenter objected to the way the recordkeeping provision was
phrased, stating that the rule was not clear as to the extent of the
monitoring and whether and when recordkeeping was required.\126\
However, another commenter expressed support for how the Commission
proposed the new recordkeeping requirement.\127\ We are adopting the
amendments as proposed and reiterate that the recordkeeping amendments
require recordkeeping of the minimal credit risk determination only
when the security is first acquired or during periodic or event-driven
reassessments, as determined by the board (or its delegate).
---------------------------------------------------------------------------

    \126\ NYC Bar Comment Letter.
    \127\ ICI Comment Letter.
---------------------------------------------------------------------------

3. Other Issues
    Three commenters objected to the nature of the standard to be
applied in determining minimal credit risks through ongoing
monitoring.\128\ Two of these commenters objected to the need to
determine on an ongoing basis that the capacity to repay short-term
financial obligations is ``exceptionally strong.'' The other commenter
requested that the standard be made clearer and stronger by inclusion
of the specific factors to be considered in determining whether a
security presents minimal credit risks. We note that the final amended
definition of ``eligible security'' addresses these comments by
eliminating the ``exceptionally strong'' standard and also codifying
general credit analysis factors.\129\
---------------------------------------------------------------------------

    \128\ Dreyfus Comment Letter; BlackRock Comment Letter; Better
Markets Comment Letter.
    \129\ Rule 2a-7(a)(11). See supra section II.A.
---------------------------------------------------------------------------

    The proposed amendments specified that government securities would
not be subject to the initial minimal credit risk determination or the
ongoing monitoring requirement. One commenter suggested that money
market funds held in the fund's portfolio, which also would not be
subject to the initial minimal credit risk determination, should be
treated the same and carved out of the ongoing monitoring requirement
as well.\130\ We are not making such a change to the rule because we
believe there are significant differences between the risk profile of
government securities and shares of money market funds, as was evident
in the recent financial crisis, that make ongoing monitoring prudent
for shares of money market funds.\131\ Nonetheless, the difference in
risk profiles between shares of money market funds and other portfolio
securities may influence the specific written ongoing monitoring
procedures adopted by the board pursuant to this final rule.\132\
---------------------------------------------------------------------------

    \130\ ICI Comment Letter. (The Vanguard Comment Letter expressed
support for the ICI comments.) The ICI Comment Letter also suggested
two technical corrections to the ongoing monitoring provision, which
the Commission is adopting. First, the language of clause (i) of 2a-
7(g)(3) has been made consistent with the language of clause (ii)
and now includes reference to the financial data of a provider of a
guarantee or demand feature in addition to the financial data of an
issuer of a security. Also, an erroneous citation in 2a-7(g)(3)(ii)
has been corrected.
    \131\ For example, in the 2014 Money Market Fund Adopting
Release, we discussed how investor money flowed out of institutional
prime money market funds and into government money market funds (and
government securities) during the financial crisis following the
Reserve Primary Fund's ``breaking the buck.'' See 2014 Money Market
Fund Adopting Release, supra note 6, at sections II.B and D.
    \132\ For example, a fund may decide to use different outside
sources to assist it in evaluating the ongoing credit quality of
portfolio securities it determines present a heightened credit risk
profile (as compared with other portfolio securities held by the
fund).
---------------------------------------------------------------------------

    We believe that explicitly requiring that funds perform ongoing
monitoring of credit risks will help to ensure that funds are better
positioned to quickly identify potential risks of credit events that
could impact portfolio security prices and ultimately, for certain
funds, the ability of the fund to maintain its stable net asset
value.\133\ Accordingly, we are adopting these amendments largely as
proposed.
---------------------------------------------------------------------------

    \133\ As under the current rule and discussed in the proposal,
the process undertaken by the fund's board (or adviser) for
establishing credit quality and the records documenting that process
would be subject to review in regulatory examinations by Commission
staff. See 2014 Proposing Release, supra note 3. In the context of
such an examination, a fund should be able to support each minimal
credit risk determination it makes with appropriate documentation to
reflect that process and determination. A fund that acquires
portfolio securities without having adopted, maintained, or
implemented written policies and procedures reasonably designed to
assess minimal credit risk, as required under rules 2a-7 and 38a-1,
could be subject to disciplinary action for failure to comply with
those rules. See id. See also Ambassador Capital Management LLC, et
al., Investment Company Act Release No. 30809 (Nov. 26, 2013).
---------------------------------------------------------------------------

D. Stress Testing

    Money market funds currently must adopt written procedures for
stress testing their portfolios and perform stress tests according to
these procedures on a periodic basis.\134\ These required tests include
consideration of certain hypothetical events, including the downgrade
of particular portfolio security positions.\135\ In the Proposing
Release, the Commission proposed to replace this reference to ratings
downgrades in the stress testing requirement with a hypothetical event
that is designed to have a similar impact on a money market fund's
portfolio, namely an ``event indicating or evidencing credit
deterioration'' of particular portfolio security positions.\136\ Thus,
under the proposed amendments, funds could continue to test their
portfolios against a potential downgrade or default in addition to any
other indication or evidence of credit deterioration they determine
appropriate.
---------------------------------------------------------------------------

    \134\ See current rule 2a-7(g)(8).
    \135\ See current rule 2a-7(g)(8)(i).
    \136\ Proposing Release, supra note 3, at 47996-47997; proposed
rule 2a-7(g)(8)(i)(B) (the proposal would require stress testing for
an event indicating or evidencing the credit deterioration, such as
a downgrade or default, of a portfolio security position
representing various portions of the fund's portfolio (with varying
assumptions about the resulting loss in the value of the security),
in combination with various levels of an increase in shareholder
redemptions).
---------------------------------------------------------------------------

    All commenters addressing the stress testing amendment supported
it.\137\ One commenter suggested that allowing a choice of hypothetical
events to be used would improve disclosure by increasing variation in
the testing.\138\ Another commenter stated that it would prefer
retaining the original reference to a downgrade, but that the proposed
change was appropriate.\139\ We continue to believe that amending the
stress testing provision as proposed will continue to promote effective
stress testing while implementing Section 939A of the Dodd-Frank Act.
Accordingly, we are adopting the amendment as proposed.
---------------------------------------------------------------------------

    \137\ ICI Comment Letter; Barnard Comment Letter; BlackRock
Comment Letter; CFA Institute Comment Letter; MFDF Comment Letter;
Vanguard Comment Letter.
    \138\ CFA Institute Comment Letter.
    \139\ MFDF Comment Letter.
---------------------------------------------------------------------------

E. Form N-MFP

    As part of the money market fund reforms adopted in 2010, money
market funds must provide to the Commission a monthly electronic filing
of portfolio holdings information on Form N-MFP.\140\ The information
that money market funds must disclose with respect to each portfolio
security (and any guarantee, demand feature, or other enhancement
associated with the portfolio security) includes the name of each
designated NRSRO for the portfolio security and the rating assigned to
the security.\141\ Our staff, however, issued a

no-action letter in response to the passage of Section 939A of the
Dodd-Frank Act indicating that, among other things, they would not
object if a fund did not ``designate NRSROs and [did] not make related
disclosures in its statement of additional information before the
Commission has completed the review of rule 2a-7 required by the [Dodd-
Frank Act] and has made any modifications to the rule.'' \142\
Notwithstanding the staff's position, many funds are already reporting
this information on Form N-MFP.
---------------------------------------------------------------------------

    \140\ See rule 30b1-7; see also 2010 Money Market Fund Adopting
Release, supra note 84, at 10082-10086.
    \141\ See current Form N-MFP Items 34 (requiring disclosure of
each designated NRSRO for a portfolio security and the credit rating
given by the designated NRSRO for each portfolio security); 37b-c
(requiring disclosure of each designated NRSRO and the credit rating
given by the designated NRSRO for each portfolio security demand
feature); 38b-c (requiring disclosure of each designated NRSRO and
the credit rating given by the designated NRSRO for each portfolio
security guarantee); and 39c-d (requiring disclosure of each
designated NRSRO and the credit rating given by the designated NRSRO
for each portfolio security enhancement).
    \142\ Letter to Karrie McMillan, General Counsel, Investment
Company Institute from Robert E. Plaze, Associate Director, Division
of Investment Management, SEC (Aug. 19, 2010). Because the
requirements of this rule supersede the staff letter, the letter is
withdrawn as of the compliance date of this rule.
---------------------------------------------------------------------------

    Instead of disclosure of designated NRSRO ratings, the Commission's
Proposing Release would have required that each money market fund
disclose, for each portfolio security, (i) each rating assigned by any
NRSRO if the fund or its adviser subscribes to that NRSRO's services,
as well as the name of the agency providing the rating, and (ii) any
other NRSRO rating that the fund's board of directors (or its delegate)
considered in making its minimal credit risk determination, as well as
the name of the agency providing the rating.\143\
---------------------------------------------------------------------------

    \143\ See proposed Form N-MFP Item C.10. In a conforming change,
the proposal would have also amended Form N-MFP Item C.9 to require
disclosure of whether the portfolio security is an eligible
security. We did not receive any comments on this provision. This
conforming change is now adopted in the final rule.
---------------------------------------------------------------------------

    Most commenters addressing the proposed provision supported the
Commission's proposal to require disclosure of NRSRO ratings, though
many commenters suggested changes, in particular related to the
subscription requirements, as discussed below.\144\ As suggested by
commenters, we are not adopting the proposed requirement that a fund
disclose the ratings of the NRSROs to which it subscribes. We are,
however, adopting as proposed, a requirement that funds disclose those
NRSRO ratings that the fund's board of directors (or its delegate)
considered, if any, in making its minimal credit risk determination for
a given security, along with the name of the agency that provided the
rating.
---------------------------------------------------------------------------

    \144\ See Consumer Federation of America Comment Letter; Better
Markets Comment Letter; MFDF Comment Letter; BlackRock Comment
Letter; Schwab Comment Letter.
---------------------------------------------------------------------------

1. Use of Subscriptions
    Many commenters stated that requiring funds to disclose each rating
assigned by any NRSRO that a fund or its adviser subscribes to would
create unnecessary cost burdens for money market funds, as well as
cause other problems.\145\ These commenters explained that funds do not
consider every rating of every NRSRO they subscribe to when determining
the credit profile of a given security. They stated that subscriptions
are often used for many other reasons, such as evaluating pricing
levels, monitoring market activity and context, and assessing other
securities. These commenters also suggested that such disclosures would
be unhelpful or even misleading to investors, since the ratings
disclosed would often be unrelated to the determinations of minimal
credit risks. One commenter stated that the required disclosure of
every rating of a portfolio security for which the fund has a
subscription would discourage subscriptions, and potentially interfere
with the NRSRO market.\146\ Another commenter suggested that any
usefulness of receiving this information on Form N-MFP for purposes of
Commission monitoring was minimal because the information is readily
available elsewhere.\147\ In addition, one commenter suggested that
NRSROs may decide that inclusion of ratings information on Form N-MFP
constitutes publication of the ratings and therefore assess extra fees
associated with publication.\148\ In regard to the general requirement
of disclosing any NRSRO ratings on Form N-MFP, one commenter objected
that the proposed provision conflicts with Section 939A of the Dodd-
Frank Act.\149\
---------------------------------------------------------------------------

    \145\ MFDF Comment Letter; BlackRock Comment Letter; ICI Comment
Letter; Vanguard Comment Letter; SIFMA Comment Letter; Fidelity
Comment Letter.
    \146\ ICI Comment Letter.
    \147\ SIFMA Comment Letter.
    \148\ Schwab Comment Letter.
    \149\ SIFMA Comment Letter.
---------------------------------------------------------------------------

    After considering the comments received, we are persuaded by those
commenters who argued, as discussed above, that requiring disclosure of
each rating assigned by any NRSRO if the fund or its adviser subscribes
to that NRSRO's services, as well as the name of the agency providing
the rating, is unnecessary and potentially misleading. Except as
discussed elsewhere in the section, these commenters did not oppose
general disclosure of ratings information on Form N-MFP, provided the
requirement is not based on subscribing to an NRSRO's service.\150\
Consequently, the final rule requires that funds disclose on Form N-MFP
any NRSRO rating that the fund's board of directors (or its delegate)
considered in making its minimal credit risk determination for that
particular security, as well as the name of the agency providing the
rating. This requirement will provide meaningful and concise
information to investors and the SEC regarding the process by which a
fund evaluates its securities. If a fund's adviser has considered more
than one NRSRO rating in making a minimal credit risk determination for
a particular portfolio security, the Form N-MFP disclosure will need to
reflect each rating considered. We believe this information on ratings
will be useful both to the Commission and to investors to monitor
credit ratings that funds use in evaluating the credit quality of
portfolio securities and to evaluate risks that fund managers take.
Moreover, we believe this requirement is consistent with many funds'
current Form N-MFP disclosure practices.\151\ Disclosures of individual
portfolio securities ratings will provide investors, Commission staff,
and others with a snapshot of potential trends in a fund's overall risk
profile, which can in turn impose discipline on the industry to
continually research and evaluate whether that profile is changing.
---------------------------------------------------------------------------

    \150\ Commenters did not specifically object to our proposed
disclosure requirement based on a fund board's (or its delegate's)
``consideration'' of such ratings in making minimal credit risk
determinations.
    \151\ See Proposing Release, supra note 3, at section II.B.
---------------------------------------------------------------------------

    In regard to the comment that requiring disclosure might trigger
the charging of publication fees by the NRSROs, numerous money market
funds currently voluntarily report ratings on Form N-MFP, and we are
not aware of the imposition of such fees on funds. In regard to the
comment suggesting that requiring disclosure of ratings on Form N-MFP
conflicts with Section 939A of the Dodd-Frank Act, we believe that
requiring disclosure of the NRSRO ratings considered satisfies the
requirements of Section 939A. We do not believe that requiring
disclosure of credit ratings considered by funds as part of their
minimal credit risk determinations conflicts with Section 939A, which
requires federal agencies to ``remove any reference to or requirement
of reliance on credit ratings. . . .''

2. Other Issues
    Some commenters suggested that fund Web site disclosure of NRSRO
ratings would be more useful and effective than disclosure on Form N-
MFP.\152\ These commenters stated that such Web site disclosure could
be made clearer and more understandable for investors than the proposed
disclosure. Although we appreciate the benefits associated with Web
site disclosure, we expect that the ready public availability of the
information on Form N-MFP should achieve many of the same benefits. We
also note that the 2014 money market reforms eliminated the 60-day
delay on public availability of the information filed on Form N-MFP
(making such information public immediately upon filing). Accordingly,
we are not adopting a fund Web site disclosure requirement for NRSRO
ratings at this time. We note, however, that nothing in our final rule
prohibits money market funds from making such disclosure on fund Web
sites.
---------------------------------------------------------------------------

    \152\ Schwab Comment Letter; ICI Comment Letter; Fidelity
Comment Letter.
---------------------------------------------------------------------------

    One commenter suggested another approach that we did not propose,
namely that the Commission require disclosure on Form N-MFP of the
factors that a fund considers when determining whether a security
presents minimal credit risks and the details of that
determination.\153\ The commenter stated that this expanded disclosure
would enhance investors' and regulators' understanding of risks in
money market fund portfolios. We believe that expanding disclosures in
this way is unlikely to provide additional useful information because
all funds will be required to use the codified general factors that we
had initially proposed as guidance. All funds will now have to apply
the specific factors the Commission is requiring in the rule and retain
records of the specifics of the determination made for possible review
by the Commission. Although public disclosure of the details of the
reasoning behind the funds evaluation of each factor and overall
minimal credit risk determination would provide additional information
to investors, we currently do not believe that many investors would be
likely to benefit from this potentially voluminous disclosure for each
security held. Such a disclosure requirement would also effectively
require funds to publicly disclose their entire credit risk evaluation
process, which may include proprietary data. On balance, it is not
clear that the potential benefits of this particular disclosure would
justify the potentially significant costs. Therefore, we are not
adopting such a disclosure requirement at this time.
---------------------------------------------------------------------------

    \153\ Better Markets Comment Letter.
---------------------------------------------------------------------------

    Finally, one commenter stated that government money market funds
should not have to disclose ratings information.\154\ We note that no
money market funds, including government money market funds, are
required by the final rule to disclose ratings information if that
information is not considered in evaluating a particular security.
Accordingly, to the extent that government money market funds do not
consider ratings in selecting portfolio securities, any burden should
be minimal.
---------------------------------------------------------------------------

    \154\ ICI Comment Letter.
---------------------------------------------------------------------------

3. Technical Amendments
    In addition to the substantive amendments to Form N-MFP, the
Commission is also making a technical change to one of the definitions
of ``money market fund'' on Form N-MFP.\155\ We are also making a
technical change to the definition of ``collateralized fully'' in rule
2a-7.\156\
---------------------------------------------------------------------------

    \155\ The definition in the heading of the Instructions did not
match the version in the Definitions section. For consistency and
clarity, we are now adopting the heading definition in both places,
as well as on Form N-1A.
    \156\ See rule 2a-7(a)(5). We are eliminating from the
definition of ``collateralized fully'' in rule 2a-7(a)(5) an
erroneous cross reference to rule 5b-3(c)(1)(iv)(D) (which has since
been removed). See 2013 Ratings Removal Adopting Release, supra note
5.
---------------------------------------------------------------------------

F. Exclusion From the Issuer Diversification Requirement

    We are amending the rule 2a-7 diversification provision as
proposed.\157\ Under the current rule, in addition to the provisions
regarding credit quality discussed above, rule 2a-7's risk limiting
conditions require a money market fund's portfolio to be diversified,
both as to the issuers of the securities it acquires and providers of
guarantees (and demand features) \158\ related to those
securities.\159\ These diversification provisions were designed to
diversify the risks to which money market funds may be exposed and
thereby reduce the impact of any single issuer's or guarantor's (or
demand feature provider's) financial distress on a fund.\160\
Generally, money market funds must today limit their investments in the
securities of any one issuer of a first tier security to no more than 5
percent of total assets, other than with respect to government
securities and securities subject to a guarantee by a non-controlled
person.\161\ A single state money market fund, however, may also
currently invest up to 25 percent of its total assets in the securities
of any single issuer.\162\ In addition to the issuer diversification
provisions, money market funds must generally limit their investments
in securities subject to a guarantee (or demand feature) to no more
than 10 percent of total assets from any one provider.\163\ A money
market

fund is permitted to take on greater indirect exposure to a guarantor
because rather than looking solely to the issuer, the money market fund
would have two potential sources of repayment--the issuer whose
securities are subject to the guarantees and the providers of those
guarantees if the issuer defaults. Most recently, the Commission
adopted amendments to certain provisions of these diversification
requirements as part of the 2014 money market fund reforms.\164\
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    \157\ We are also adopting several technical amendments to the
portfolio diversification provisions of rule 2a-7, as described
below in this section.
    \158\ A ``demand feature'' means a feature permitting the holder
of a security to sell the security at an exercise price equal to the
approximate amortized cost of the security plus accrued interest, if
any, at the later of the time of exercise or the settlement of the
transaction, paid within 397 calendar days of exercise. Rule 2a-
7(a)(9) (definition of demand feature). A ``guarantee'' as defined
in rule 2a-7 includes an unconditional demand feature. See rule 2a-
7(a)(18) (definition of guarantee). An ``unconditional demand
feature'' means a demand feature that by its terms would be readily
exercisable in the event of a default in payment of principal or
interest on the underlying security or securities. Rule 2a-7(a)(30)
(definition of unconditional demand feature).
    \159\ See current rule 2a-7(d)(3). The diversification
requirements of rule 2a-7 differ in significant respects from the
requirements for diversified management investment companies under
section 5(b)(1) of the Investment Company Act. A money market fund
that satisfies the applicable diversification requirements of
paragraphs (d)(3) and (e) of rule 2a-7 is deemed to have satisfied
the requirements of section 5(b)(1). Rule 2a-7(d)(3)(v). Subchapter
M of the Internal Revenue Code contains other diversification
requirements for a money market fund to be a ``regulated investment
company'' for federal income tax purposes. 26 U.S.C. 851 et seq.
    \160\ See Money Market Fund Reform, Investment Company Act
Release No 28807 (Jun. 30, 2009) [74 FR 32688 (Jul. 8, 2009)]
(``2009 Money Market Fund Proposing Release'') at n.220 and
accompanying text; Revisions to Rules Regulating Money Market Funds,
Investment Company Act Release No. 17589 (Jul. 17, 1990) [55 FR
30239 (Jul. 25, 1990)], at text accompanying n.23 (``Diversification
limits investment risk to a fund by spreading the risk of loss among
a number of securities.'').
    \161\ Current rule 2a-7(d)(3)(i)(A) and (B). A fund also may
invest no more than 0.5 percent of fund assets in any one issuer of
a second tier security. Current rule 2a-7(d)(3)(i)(C). The rule
provides a safe harbor under which a taxable or national tax-exempt
fund may invest up to 25 percent of its total assets in the first
tier securities of a single issuer for a period of up to three
business days after acquisition (but a fund may use this exception
for only one issuer at a time). Current rule 2a-7(d)(3)(i)(A).
Because the amendments we are adopting today eliminate the
distinction between first and second tier securities, the issuer
diversification requirements and the safe harbor, as amended, will
not refer to or rely on a portfolio security's rating.
    \162\ Current rule 2a-7(d)(3)(i)(B).
    \163\ Rule 2a-7 also provides a ``fifteen percent basket'' for
tax-exempt (including single state) money market funds, under which
as much as 15 percent of the value of securities held in a tax-
exempt fund's portfolio may be subject to guarantees or demand
features from a single institution. See rule 2a-7(d)(3)(iii)(B). The
tax-exempt fund, however, may only use the 15 percent basket to
invest in demand features or guarantees issued by non-controlled
persons that are first tier securities. See rule 2a-7(d)(3)(iii).
Under the amendments we are adopting today, the 15 percent basket
will be available with respect to any demand feature or guarantee
issued by a non-controlled person without regard to the rating of
the security, guarantee or demand feature.
    \164\ See 2014 Money Market Fund Adopting Release, supra note 6.
Among other things, the 2014 money market fund amendments require
that money market funds treat certain entities that are affiliated
with each other as single issuers when applying the 5 percent issuer
diversification provision of rule 2a-7 and treat the sponsors of
asset-backed securities as guarantors subject to the 10 percent
diversification provision of rule 2a-7 applicable to guarantees and
demand features, unless the fund's board makes certain findings.
These amendments were intended to increase the resiliency of and
reduce risk in money market funds by limiting their ability to
concentrate investments in a single economic enterprise.
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    Notwithstanding the 5 percent issuer diversification provision,
rule 2a-7 currently does not require a money market fund to be
diversified with respect to issuers of securities that are subject to a
guarantee by a non-controlled person.\165\ This exclusion could allow,
for example, a fund to invest a significant portion or all of the value
of its portfolio in securities issued by the same entity if the
securities were guaranteed by different non-controlled person
guarantors and none of the guaranteed securities had a value exceeding
10 percent of the fund's total assets. We continue to be concerned that
a fund that relies on this issuer diversification exclusion could have
a highly concentrated portfolio and would be subject to substantial
risk if the single issuer in whose securities it had such a significant
investment were to come under stress or default.
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    \165\ See current rule 2a-7(d)(3). A guarantee issued by a non-
controlled person means a guarantee issued by a person that,
directly or indirectly, does not control, and is not controlled by
or under common control with the issuer of the security subject to
the guarantee (control means ``control'' as defined in section
2(a)(9) of the Act) (15 U.S.C. 80a-2(a)(9)), or a sponsor of a
special purpose entity (``SPE'') with respect to an asset-backed
security. Rule 2a-7(a)(17).
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    The diversification amendments that we adopt today will remove the
current exclusion to the issuer diversification requirement for
securities subject to a guarantee issued by a non-controlled person.
That is, under this amendment, each money market fund that invests in
securities subject to a guarantee (whether or not the guarantor is a
non-controlled person) will have to comply with both the 10 percent
diversification requirement for the guarantor as well as the 5 percent
diversification requirement for the issuer.\166\
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    \166\ But see rule 2a-7(e). If the fund's board of directors has
determined that the fund is not relying on a guarantee to determine
the quality, maturity or liquidity of a portfolio security and
maintains a record of this determination, then the fund need not
comply with the 10 percent guarantor diversification requirement
with respect to such guarantee.
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    One commenter supported the proposed issuer diversification
amendment.\167\ Another commenter did not specifically oppose the
proposal but questioned the additive value of the proposed
amendment.\168\ The majority of commenters, however, that discussed the
diversification proposal opposed it, for a variety of reasons as
further discussed below.\169\
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    \167\ See Better Markets Comment Letter. This commenter also
opined that there was no rationale for setting a more generous limit
for guarantors of the securities than for issuers and that
accordingly, the Commission should strengthen the diversification
requirements by preventing any one guarantor from guaranteeing more
than 5 percent of a fund's assets as opposed to 10 percent.
    \168\ See Schwab Comment Letter.
    \169\ See BlackRock Comment Letter; Dreyfus Comment Letter; ICI
Comment Letter; SFIG Comment Letter; SIFMA Comment Letter; Vanguard
Comment Letter.
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1. Credit Quality of the Guarantor and Two Sources of Repayment
    In cases where a money market fund invests in a security subject to
a guarantee, the guarantor assumes the credit risks presented by a
particular issuer by agreeing to provide principal and interest
payments in the event the issuer of the underlying security is unable
to do so. Accordingly, rule 2a-7 allows a money market fund to look to
the credit quality of the guarantor as opposed to the issuer to meet
rule 2a-7's portfolio quality provisions.\170\ Several commenters
emphasized a money market fund's ability to rely on the credit quality
of the guarantor in this case, arguing that it is appropriate to direct
the minimal credit risk determination to the guarantor as opposed to
refocusing the analysis on issuer concentration risk.\171\ One of these
commenters also suggested that securities subject to a guarantee in
many cases trade on the basis of the credit quality of the provider of
that guarantee, and thus exposure to the underlying security issuer may
not be relevant to a money market fund's ability to maintain a stable
net asset value in these cases.\172\ Another commenter suggested that
complying with the proposed requirement for guaranteed securities could
be construed to require the manager to also conduct a credit review and
on-going monitoring of the issuer.\173\ We are not amending the
provision in rule 2a-7 that permits money market funds to look to the
credit quality of the guarantor as opposed to the issuer to meet rule
2a-7's portfolio quality provisions.
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    \170\ See rule 2a-7(d)(2)(iii).
    \171\ See Dreyfus Comment Letter; Schwab Comment Letter; SIFMA
Comment Letter.
    \172\ See SIFMA Comment Letter.
    \173\ See Schwab Comment Letter.
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    As we discussed in the Proposing Release, by permitting money
market funds a higher 10 percent limit on their indirect exposures to a
single provider of a guarantee than the 5 percent limit on direct
investments in any one issuer, rule 2a-7 permits a money market fund to
take on greater indirect exposures to providers of guarantees. As we
previously discussed, and as acknowledged by commenters, a money market
fund is permitted to take on greater indirect exposure because, rather
than looking solely to the issuer, the money market fund would have two
potential sources of repayment--the issuer whose securities are subject
to the guarantees and the providers of those guarantees if the issuer
defaults.\174\ Both the issuer and the guarantor would have to default
at the same time for the money market fund to suffer a loss. And if a
guarantor were to come under stress, the issuer may be able to obtain a
replacement.\175\
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    \174\ See BlackRock Comment Letter; SFIG Comment Letter.
    \175\ See, e.g., Revisions to Rules Regulating Money Market
Funds, Investment Company Act Release No. 19959 (Dec. 17, 1993) [58
FR 68585 (Dec. 28, 1993)] at n.83 and accompanying text (observing
that, if the guarantor of one of the money market fund's securities
comes under stress, ``issuers or investors generally can either put
the instrument back on short notice or persuade the issuer to obtain
a substitute for the downgraded institution'').
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    By diversifying solely against the guarantor, as is the case under
the current issuer diversification exclusion, a fund could rely on the
guarantors' credit quality or repayment ability, not the issuer's.
Thus, in addition to looking to the credit quality of the guarantor as
opposed to the issuer to meet rule 2a-7's portfolio quality provisions,
the fund would also effectively substitute the credit of the guarantor
for that of the issuer for diversification purposes, without imposing
the tighter 5 percent requirement that rule 2a-7 generally applies for
issuer diversification. This means that a fund could have a highly
concentrated portfolio and could be subject to substantial risk if it
has a significant investment in securities of a

single issuer, and such issuer were to come under stress or default. As
we stated in the Proposing Release, we are concerned that a money
market fund relying on the exclusion from the issuer diversification
provision need only comply with the 10 percent guarantor
diversification requirement, notwithstanding the credit substitution
discussed above. In consideration of our reform goal of limiting
concentrated exposure of money market funds to particular economic
enterprises, we continue to believe that ignoring a fund's exposure to
the issuer in these circumstances is not appropriate.\176\
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    \176\ See 2014 Money Market Fund Adopting Release, supra note 6,
at text following n.1600 and accompanying n.1601. The exclusion from
the 5 percent issuer diversification requirement for certain
guaranteed securities was adopted in the 1996 money market fund
amendments to provide flexibility in municipal investments, and was
premised on the ability of a money market fund to rely on the
guarantee if an issuer became distressed. See 1996 Money Market Fund
Adopting Release, supra note 84.
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    In the Proposing Release, we requested comment as to whether
commenters agreed with our proposed approach to treat securities
subject to a guarantee by a non-controlled person similar to other
securities with a guarantee under rule 2a-7, or whether we should
instead require that a guarantor be treated as the issuer and subject
to a 5 percent diversification requirement when a money market fund is
relying exclusively on the credit quality of the guarantor or when the
security need not meet the issuer diversification requirements. We also
asked in the 2013 Money Market Fund Proposing Release more generally
whether we should continue to distinguish between a fund's exposure to
guarantors and issuers by providing different diversification
requirements for these exposures.\177\ We explained that rule 2a-7
permits a money market fund, when determining if a security subject to
a guarantee satisfies the credit quality standards, to rely exclusively
on the credit quality of the guarantor.\178\ As in the Proposing
Release, we also specifically asked whether the guarantor should be
treated as the issuer and subject to a 5 percent diversification
requirement whenever the money market fund is relying exclusively on
the credit quality of the guarantor. Although most commenters did not
specifically address this issue, one commenter argued that guarantors
and demand feature providers should generally be subject to the same 5
percent issuer diversification requirements instead of a higher 10
percent limit.\179\ We continue to believe, however, that the approach
we are adopting today is preferable to making both the guarantor and
issuer subject to a 5 percent diversification requirement because,
among other things, the approach we are adopting today would treat
securities subject to a guarantee by a non-controlled person similarly
to other securities with a guarantee under rule 2a-7.
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    \177\ See 2013 Money Market Fund Proposing Release, supra note
16, at sections III.J.1-2.
    \178\ Rule 2a-7(d)(2)(iii). As noted above, a money market fund
is permitted to take on greater indirect exposure because the fund
has two potential sources of repayment. However, the fact that a
money market fund has both the issuer and guarantor as sources of
repayment may not fully reduce the risks of the investment in all
cases because in the event that both the issuer and guarantor
default at the same time the fund could suffer a loss. Additionally,
the issuer of the guaranteed securities need not satisfy rule 2a-7's
credit quality requirements.
    \179\ See Better Markets Comment Letter.
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    As discussed further in the economic analysis section below, we
believe that the potential costs of requiring both the guarantor and
issuer to be subject to a 5 percent diversification requirement would
likely be more significant than the costs of the amendment we are
adopting today. As of the end of April 2015, we estimate that
approximately 110 (of 214) prime money market funds had total exposure
to a single entity (including directly issued, asset-backed commercial
paper sponsorship, and provision of guarantees and demand features) in
excess of 5 percent. If we adopted an amendment that both the guarantor
and issuer are subject to a 5 percent diversification requirement, any