Removal of Certain References to Credit Ratings Under the Investment Company Act, 1316-1330 [2013-31425]
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Federal Register / Vol. 79, No. 5 / Wednesday, January 8, 2014 / Rules and Regulations
Part A, Subpart III, Section 44701:
General requirements.’’ Under that
section, Congress charges the FAA with
promoting safe flight of civil aircraft in
air commerce by prescribing regulations
for practices, methods, and procedures
the Administrator finds necessary for
safety in air commerce. This regulation
is within the scope of that authority
because it addresses an unsafe condition
that is likely to exist or develop on
products identified in this rulemaking
action.
(a) Effective Date
This AD is effective January 23, 2014.
SECURITIES AND EXCHANGE
COMMISSION
(b) Affected ADs
None.
17 CFR Parts 239, 270, and 274
Regulatory Findings
We determined that this AD will not
have federalism implications under
Executive Order 13132. This AD will
not have a substantial direct effect on
the States, on the relationship between
the national government and the States,
or on the distribution of power and
responsibilities among the various
levels of government.
For the reasons discussed above, I
certify this AD:
(1) Is not a ‘‘significant regulatory
action’’ under Executive Order 12866,
(2) Is not a ‘‘significant rule’’ under
the DOT Regulatory Policies and
Procedures (44 FR 11034, February 26,
1979),
(3) Will not affect intrastate aviation
in Alaska to the extent that it justifies
making a regulatory distinction, and
(4) Will not have a significant
economic impact, positive or negative,
on a substantial number of small entities
under the criteria of the Regulatory
Flexibility Act.
We prepared a regulatory evaluation
of the estimated costs to comply with
this AD and placed it in the AD docket.
(d) Reason
This AD was prompted by a review by RR
of the cyclic life of critical-life-limited parts
(LLPs) for RB211–524 series engines. We are
issuing this AD to prevent the failure of
certain LLPs, which could result in
uncontained engine damage and damage to
the airplane.
List of Subjects in 14 CFR Part 39
Air transportation, Aircraft, Aviation
safety, Incorporation by reference,
Safety.
(g) Related Information
(1) For more information about this AD,
contact Robert Green, Aerospace Engineer,
Engine Certification Office, FAA, Engine &
Propeller Directorate, 12 New England
Executive Park, Burlington, MA 01803;
phone: 781–238–7754; fax: 781–238–7199;
email: robert.green@faa.gov.
(2) Refer to MCAI European Aviation
Safety Agency AD 2013–0246, dated October
10, 2013, for more information. You may
examine the MCAI in the AD docket on the
Internet at https://www.regulations.gov by
searching for and locating it in Docket No.
FAA–2013–1004.
Adoption of the Amendment
Accordingly, under the authority
delegated to me by the Administrator,
the FAA amends 14 CFR part 39 as
follows:
PART 39—AIRWORTHINESS
DIRECTIVES
1. The authority citation for part 39
continues to read as follows:
■
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Authority: 49 U.S.C. 106(g), 40113, 44701.
§ 39.13
[Amended]
2. The FAA amends § 39.13 by adding
the following new airworthiness
directive (AD):
■
2013–26–10 Rolls-Royce plc: Amendment
39–17719; Docket No. FAA–2013–1004;
Directorate Identifier 2013–NE–34–AD.
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(c) Applicability
This AD applies to all Rolls-Royce plc (RR)
RB211–524G2–19, RB211–524G3–19,
RB211–524H–36, and RB211–524H2–19
turbofan engines with high-pressure (HP)
compressor rotor stage 1 and stage 2 discs,
part number LK70608, LK76030, LK86621,
UL19877, UL19878, UL19879, or UL24023,
installed.
(e) Actions and Compliance
Comply with this AD within the
compliance times specified, unless already
done.
(1) Within 30 days after the effective date
of this AD, reduce the cyclic life limit for the
affected HP compressor rotor stage 1 and
stage 2 discs to 7,390 flight cycles (FC).
(2) After the effective date of this AD,
remove each affected HP compressor rotor
stage 1 and stage 2 disc from service before
the part exceeds 7,390 FC.
(3) After the effective date of this AD, do
not return to service any engine that has an
HP compressor rotor stage 1 and stage 2 disc
installed, if the disc has more than 7,390 FC.
(f) Alternative Methods of Compliance
(AMOCs)
The Manager, Engine Certification Office,
FAA, may approve AMOCs to this AD. Use
the procedures found in 14 CFR 39.19 to
make your request.
(h) Material Incorporated by Reference
None.
Issued in Burlington, Massachusetts, on
December 23, 2013.
Carlos A. Pestana,
Acting Assistant Directorate Manager, Engine
& Propeller Directorate, Aircraft Certification
Service.
[FR Doc. 2014–00083 Filed 1–7–14; 8:45 am]
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[Release Nos. 33–9506; IC–30847; File No.
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RIN 3235–AL02
Removal of Certain References to
Credit Ratings Under the Investment
Company Act
Securities and Exchange
Commission.
ACTION: Final rule.
AGENCY:
The Securities and Exchange
Commission (‘‘Commission’’) is
adopting amendments to a rule and
three forms under the Investment
Company Act of 1940 (‘‘Investment
Company Act’’) and the Securities Act
of 1933 (‘‘Securities Act’’) in order to
implement a provision of the DoddFrank Wall Street Reform and Consumer
Protection Act (‘‘Dodd-Frank Act’’).
Specifically, rule 5b–3 under the
Investment Company Act contains a
reference to credit ratings in
determining when an investment
company (‘‘fund’’) may treat a
repurchase agreement as an acquisition
of securities collateralizing the
repurchase agreement for certain
purposes under the Investment
Company Act. The amendments we are
adopting today replace this reference to
credit ratings with an alternative
standard designed to retain a similar
degree of credit quality to that in current
rule 5b–3. The Commission is also
adopting amendments to Forms N–1A,
N–2, and N–3 under the Investment
Company Act and Securities Act to
eliminate the required use of NRSRO
credit ratings when a fund chooses to
depict its portfolio holdings by credit
quality.
SUMMARY:
Effective Date: February 7, 2014;
Compliance Date: July 7, 2014.
FOR FURTHER INFORMATION CONTACT:
Adam Bolter, Senior Counsel, Thoreau
Bartmann, Branch Chief, or C. Hunter
Jones, Assistant Director (202) 551–
6792, Office of Investment Company
Rulemaking, Division of Investment
Management, Securities and Exchange
Commission, 100 F Street NE.,
Washington, DC 20549–8549.
SUPPLEMENTARY INFORMATION: The
Commission is adopting amendments to
rule 5b–3 [17 CFR 270.5b–3] under the
Investment Company Act.1 The
DATES:
1 15 U.S.C. 80a. Unless otherwise noted, all
references to statutory sections are to the
Investment Company Act, and all references to
rules under the Investment Company Act are to
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Federal Register / Vol. 79, No. 5 / Wednesday, January 8, 2014 / Rules and Regulations
Commission is also adopting
amendments to Forms N–1A [17 CFR
239.15A and 17 CFR 274.11A], N–2 [17
CFR 239.14 and 17 CFR 274.11a–1], and
N–3 [17 CFR 239.17a and 17 CFR
274.11b] under the Investment
Company Act and the Securities Act.2
Table of Contents
I. Background
II. Prior Actions of the Commission and
Other Regulators
III. Discussion
A. Rule 5b–3
B. Forms N–1A, N–2, and N–3
IV. Paperwork Reduction Act
V. Economic Analysis
VI. Final Regulatory Flexibility Analysis
Statutory Authority
Text of Rule and Rule and Form
Amendments
I. Background
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The first use of a reference to ratings
or rating agencies in Commission rules
was in 1975, when the Commission
adopted the term ‘‘nationally recognized
statistical rating organization’’
(‘‘NRSRO’’) as part of amendments to
the net capital rule for broker-dealers,
rule 15c3–1 under the Securities
Exchange Act of 1934 (‘‘Exchange Act’’)
(the ‘‘Net Capital Rule’’).3 The
Commission eventually included
references to credit ratings issued by
NRSROs in other rules under the
securities laws, including the
Investment Company Act.4 In addition,
credit ratings by NRSROs have been
used as benchmarks in federal and state
legislation, rules administered by other
federal agencies, and foreign regulatory
schemes.5 Even prior to the enactment
Title 17, Part 270 of the Code of Federal Regulations
[17 CFR part 270].
2 15 U.S.C. 77a.
3 See Adoption of Uniform Net Capital Rule and
an Alternative Net Capital Requirement for Certain
Brokers and Dealers, Exchange Act Release No.
11497 (June 26, 1975) [40 FR 29795 (July 16, 1975)];
17 CFR 240.15c3–1. The Net Capital Rule prescribes
minimum net capital requirements for brokerdealers and it uses NRSRO credit ratings to
determine the amount of the charge to capital a
broker-dealer must apply to certain types of debt
instruments. See 17 CFR 240.15c3–1. The
regulatory purpose was to provide a method for
determining net capital charges on different grades
of debt securities under the Net Capital Rule. See
17 CFR 240.15c3–1.
4 See, e.g., Acquisition and Valuation of Certain
Portfolio Instruments by Registered Investment
Companies, Investment Company Act Release No.
14983 (Mar. 12, 1986) [51 FR 9773 (Mar. 21, 1986)]
(incorporating the concept of NRSROs into the
definition of ‘‘eligible security’’ in rule 2a–7
(governing money market funds)).
5 See, e.g., Report to Congress on Credit Ratings,
Board of Governors of the Federal Reserve System
(July 2011); References to Credit Ratings in FDIC
Regulations, Federal Deposit Insurance Corporation
(July 2011); and Basel Committee on Banking
Supervision, Stocktaking on the use of credit
ratings, Joint Forum (June 2009).
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of the Dodd-Frank Act,6 concerns about
the wide-spread use of NRSRO credit
ratings in statutes and regulations
prompted the Commission to explore
whether to eliminate references to credit
ratings in Commission rules because of
the potential overreliance by investors
and, investment advisers and other
financial professionals on these ratings,
and whether there are practical
alternatives to NRSRO credit ratings that
could be used as benchmarks in
regulations.7
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.’’ 8 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.’’ 9
As a step toward implementing these
mandates, in March 2011 the
Commission proposed to replace
references to ratings issued by NRSROs
in two Commission rules and four
Commission forms under the
Investment Company Act, including
rule 5b–3 and Forms N–1A, N–2, and
N–3.10 We received 26 comment letters
6 See
Public Law 111–203, 124 Stat. 1376 (2010).
infra section II.A (discussing other
Commission actions to remove references to credit
ratings from its rules). See also infra section II.B
(discussing actions of other regulators to remove
references to credit ratings from their rules).
8 Public Law 111–203, sec. 939A(a)(1)–(2).
Section 939A of the Dodd-Frank Act applies to all
federal agencies.
9 Public Law 111–203, sec. 939A(b).
10 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’’). Specifically, we proposed to:
(i) Remove references to credit ratings in rules 2a–
7 and 5b–3 under the Investment Company Act and
replace them with alternative standards of
creditworthiness; (ii) adopt new rule 6a–5 under the
Investment Company Act that would establish a
creditworthiness standard to replace the credit
rating reference in section 6(a)(5) removed by the
Dodd-Frank Act; (iii) eliminate required disclosures
of credit ratings in Form N–MFP; and (iv) remove
the requirement that credit ratings be used when
portraying credit quality in shareholder reports
from Forms N–1A, N–2, and N–3. The Commission
adopted new rule 6a–5 on November 19, 2012 and
noted in its 2013 proposing release for money
market reform that the Commission would address
references to credit ratings in rule 2a–7 and Form
N–MFP in a separate rulemaking. See Purchase of
Certain Debt Securities by Business and Industrial
Development Companies Relying on an Investment
7 See
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1317
on the proposed rule and form
amendments.11 Several commenters
addressed specific provisions of the
proposal to amend rule 5b–3 and Forms
N–1A, N–2, and N–3, which we discuss
in more detail below.
We are adopting, largely as proposed,
amendments to rule 5b–3 and Forms N–
1A, N–2, and N–3 to implement section
939A of the Dodd-Frank Act and
effectuate Congressional intent to
reduce reliance on NRSRO credit
ratings.12 As discussed below, the
amendments replace a reference to
required NRSRO credit ratings in rule
5b–3 for certain securities held by funds
as collateral for repurchase agreements
with an alternative standard that is
designed to retain a similar degree of
credit quality. We are also amending
Forms N–1A, N–2, and N–3 to eliminate
the required use of NRSRO credit
ratings by funds that choose to use
credit quality categorizations in the
required table, chart, or graph of
portfolio holdings. Under the
amendments, funds that choose to use
credit quality to depict portfolio
holdings must include a description of
how the credit quality of the holding
was determined. If a fund chooses to use
credit ratings issued by a credit rating
agency to depict the credit quality of
portfolio holdings, the fund must
Company Act Exemption, Investment Company Act
Release No. 30268 (Nov. 19, 2012) [77 FR 70117
(Nov. 23, 2012)]; Money Market Fund Reform;
Amendments to Form PF, Investment Company Act
Release No. 30551 (June 5, 2013) [78 FR 36834 (June
19, 2013)]. Rule 3a–7 under the Investment
Company Act also contains a reference to ratings.
In August 2011, in a concept release soliciting
comment on the treatment of asset-backed issuers
under the Investment Company Act, we sought
comment on the role, if any, that credit ratings
should continue to play in the context of rule 3a–
7. See Treatment of Asset-Backed Issuers under the
Investment Company Act, Investment Company Act
Release No. 29779 (Aug. 31, 2011) [76 FR 55308
(Sept. 7, 2011)] at section III.A.1.
11 Most of these commenters criticized removing
credit ratings from rule 2a–7, but acknowledged
that the Commission’s proposal was in response to
the mandate in the Dodd-Frank Act. The
Commission plans to address these comments in a
future rulemaking. See supra note 10. The comment
letters on the 2011 Proposing Release (File No. S7–
07–11) are available at https://www.sec.gov/
comments/s7-07-11/s70711.shtml. In addition, to
facilitate public input on the Dodd-Frank Act, we
provided a series of email links, organized by topic
on our Web site at https://www.sec.gov/spotlight/
regreformcomments.shtml. The public comments
we received on section 939A of the Dodd-Frank Act
are available on our Web site at https://www.sec.gov/
comments/df-title-ix/credit-rating-agencies/creditrating-agencies.shtml.
12 See Section 939A of the Dodd-Frank Act.
Section 939A was intended, at least in part, to
address potential over-reliance on NRSRO credit
ratings resulting from perceived governmentendorsement of NRSROs. See Report of the House
of Representatives Financial Services Committee to
Accompany H.R. 4173, H. Rep. No. 111–517 at 871
(2010).
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Federal Register / Vol. 79, No. 5 / Wednesday, January 8, 2014 / Rules and Regulations
include a description of how the credit
ratings were identified and selected.
In a separate release, the Commission
is adopting final amendments to remove
references to credit ratings from rules on
broker-dealer financial responsibility
and confirmations of transactions. These
amendments follow the Commission’s
April 2011 proposed rules in which we
proposed to amend rules and one form
under the Exchange Act applicable to
broker-dealer financial responsibility,
distributions of securities, and
confirmations of transactions in order to
remove references to credit ratings
pursuant to section 939A of the DoddFrank Act.13
II. Prior Actions of the Commission and
Other Regulators
As part of our implementation of
section 939A, we have reviewed our
prior actions and those of other
regulators. As discussed below, both the
Commission and other regulators have
proposed and issued several final rules
towards implementation of the mandate
under section 939A of the Dodd-Frank
Act. In some cases, the references to
credit ratings were replaced with an
alternative standard of credit quality
designed to retain the same degree of
credit quality and liquidity as reflected
by the use of credit ratings.
A. Prior Commission Actions
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The Commission has long been
concerned with the use of credit ratings
and has taken a variety of actions even
before the enactment of the Dodd-Frank
Act regarding the use of NRSRO credit
ratings in its rules. For example, in
1994, the Commission published a
concept release soliciting comment on,
among other things, whether the
Commission should eliminate
references to NRSRO credit ratings from
certain rules.14 The Commission
13 See Removal of Certain References to Credit
Ratings under the Securities Exchange Act of 1934,
Exchange Act Release No. 64352 (Apr. 27, 2011) [76
FR 26550 (May 6, 2011)] (requesting public
comment on proposed amendments to rule 15c3–
1 (17 CFR 240.15c3–1), rule 15c3–3 (17 CFR
240.15c3–3), rule 17a–4 (17 CFR 240.17a–4), rules
101 and 102 of Regulation M (17 CFR 242.101 and
242.102), and rule 10b–10 (17 CFR 240.10b–10),
and one form—the General Instructions to Form X–
17A–5, Part IIB (17 CFR 249.617)—to remove
references to credit ratings and, in certain cases,
substitute alternative standards of
creditworthiness). For purposes of implementing
section 939(e) of the Dodd-Frank Act, which
eliminated provisions in sections 3(a)(41) and
3(a)(53)(A) of the Exchange Act that referenced
NRSRO credit ratings, the Commission also
requested comment in the proposing release on
potential standards of creditworthiness to replace
the credit rating references.
14 See Nationally Recognized Statistical Rating
Organizations, Exchange Act Release No. 34616
(Aug. 31, 1994) [59 FR 46314 (Sep. 7, 1994)]; see
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continued to consider the use of credit
ratings in its rules, when in 2003, we
sought comment on alternative
benchmarks that could be used to meet
the Commission’s regulatory
objectives.15 Finally, in 2008, the
Commission proposed amendments to
remove references to NRSRO credit
ratings from certain of its rules under
the Securities Act, Exchange Act, and
Investment Company Act.16 As
previously noted, after the enactment of
the Dodd-Frank Act, in 2011, the
Commission proposed to remove credit
ratings references from certain rules and
forms under the Investment Company
Act.17 Also in 2011, the Commission
separately proposed and adopted
amendments removing references to
credit ratings in rules and forms under
the Securities Act and the Exchange Act
related to offerings of securities or issuer
disclosure.18 Generally, in these prior
also Capital Requirements for Brokers or Dealers
Under the Securities Exchange Act of 1934,
Exchange Act Release No. 39457 (Dec. 17, 1997) [62
FR 68018 (Dec. 30, 1997)].
15 See Rating Agencies and the Use of Credit
Ratings under the Federal Securities Laws,
Exchange Act Release No. 47972 (June 4, 2003) [68
FR 35258 (June 12, 2003)]; see also Report on the
Role and Function of Credit Rating Agencies in the
Operation of the Securities Markets: As Required by
Section 702(b) of the Sarbanes-Oxley Act of 2002,
Commission (Jan. 2003).
16 See, e.g., References to Ratings of Nationally
Recognized Statistical Rating Organizations,
Exchange Act Release No. 58070 (July 1, 2008) [73
FR 40088 (July 11, 2008)]. In October 2009, the
Commission adopted several of the 2008 proposed
amendments and re-opened for comment the
remaining amendments. See References to Ratings
of Nationally Recognized Statistical Rating
Organizations, Exchange Act Release No. 60789
(Oct. 5, 2009) [74 FR 52358 (Oct. 9, 2009)] (adopting
release).
17 See 2011 Proposing Release supra note 10. One
aspect of that rule proposal has already been
adopted. New rule 6a–5, adopted by the
Commission, replaced a credit rating requirement
(removed by Congress as part of the Dodd-Frank
Act) applicable to debt securities that certain
business and industrial development companies
(‘‘BIDCOs’’) relying on the Investment Company Act
exemption in section 6(a)(5) may invest in. Under
new rule 6a–5, a BIDCO that relies on the
exemption in section 6(a)(5) may invest in certain
debt securities, provided that the BIDCO board
determines, at the time of purchase, that the debt
security is (1) of no greater than moderate credit
risk and (2) is sufficiently liquid. The standard for
liquidity is whether the security can be sold at or
near its carrying value within a reasonably short
period of time. 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)].
18 See Security Ratings, Securities Act Release No.
9186 (Feb. 9, 2011) [76 FR 8946 (Feb. 16, 2011)];
see also Security Ratings, Securities Act Release No.
9245 (July 27, 2011) [76 FR 46603 (Aug. 3, 2011)]
(adopting amendments to rule 134 (17 CFR
230.134), rule 138 (17 CFR 230.138), rule 139 (17
CFR 230.139), rule 168 (17 CFR 230.168), Form S–
3 (17 CFR 239.13), Form S–4 (17 CFR 239.25), Form
F–3 (17 CFR 239.33), and Form F–4 (17 CFR 230.
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actions, the Commission has proposed
or adopted amendments to its rules that
seek to retain a similar degree of credit
quality to that in the rule being
amended by replacing credit ratings
references with a two-part standard that
includes an assessment of the credit
quality and the liquidity of the security,
the details of which vary according to
the requirements of the particular rule
or form.
B. Actions of Other Regulators
A number of other federal agencies
have also taken action to implement
section 939A of the Dodd-Frank Act,
including regulations proposed or
adopted by the Commodity Futures
Trading Commission (‘‘CFTC’’),19 the
Office of the Comptroller of the
Currency (‘‘OCC’’),20 the National Credit
Union Administration (‘‘NCUA’’),21 the
Federal Housing Finance Agency
(‘‘FHFA’’),22 the Department of Labor
(‘‘DOL’’),23 and jointly by the OCC and
Federal Reserve Board (‘‘FRB’’).24 The
actions taken by these other regulators
were considered in adopting today’s
amendments.
III. Discussion
A. Rule 5b–3
Rule 5b–3 allows funds to treat the
acquisition of a repurchase agreement as
an acquisition of securities
collateralizing the repurchase agreement
for certain diversification and brokerdealer counterparty limit purposes
under the Investment Company Act 25 if
34) under the Securities Act; rescinding Form F–9
(17 CFR 239.39); adopting amendments to the
Securities Act and Exchange Act forms and rules
that referred to Form F–9 to eliminate those
references; and amending Schedule 14A (17 CFR
240.14a–101) under the Exchange Act).
19 CFTC, Removing Any Reference to or Reliance
on Credit Ratings in Commission Regulations;
Proposing Alternatives to the Use of Credit Ratings,
76 FR 44262 (July 25, 2011).
20 OCC, Alternatives to the Use of External Credit
Ratings in the Regulations of the OCC, 77 FR 35253
(June 13, 2012).
21 NCUA, Alternatives to the Use of Credit
Ratings, 77 FR 74103 (Dec. 13, 2012).
22 FHFA, Removal of References to Credit Ratings
in Certain Regulations Governing the Federal Home
Loan Banks, 78 FR 30784 (May 23, 2013).
23 DOL, Proposed Amendments to Class
Prohibited Transaction Exemptions to Remove
Credit Ratings Pursuant to the Dodd-Frank Wall
Street Reform and Consumer Protection Act, 78 FR
37572 (June 21, 2013).
24 OCC & FRB, Regulatory Capital Rules:
Regulatory Capital, Implementation of Basel III,
Capital Adequacy, Transition Provisions, Prompt
Corrective Action, Standardized Approach for Riskweighted Assets, Market Discipline and Disclosure
Requirements, Advanced Approaches Risk-Based
Capital Rule, and Market Risk Capital Rule, 78 FR
62018 (Oct. 11, 2013).
25 Section 5(b)(1) of the Investment Company Act
limits the amount that a fund that holds itself out
as being a diversified investment company may
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the obligation of the seller to repurchase
the securities from the fund is
‘‘collateralized fully.’’ 26 In a typical
investment company repurchase
agreement, a fund enters into a contract
with a broker, dealer, or bank (the
‘‘counterparty’’ to the transaction) to
purchase securities. The counterparty
agrees to repurchase the securities at a
specified future date, or on demand, for
a price that is sufficient to return to the
fund its original purchase price, plus an
additional amount representing a return
to the fund on its investment.
Economically, a repurchase agreement
functions as a loan from the fund to the
counterparty, in which the securities
purchased by the fund serve as
collateral for the loan.27
Under current requirements, a
repurchase agreement is collateralized
fully if, among other things, the
collateral for the repurchase agreement
consists entirely of (i) cash items, (ii)
government securities,28 (iii) securities
invest in the securities of any one issuer (other than
the U.S. Government). This provision may limit the
number and principal amounts of repurchase
agreements that a diversified fund may enter into
with any one counterparty. Section 12(d)(3) of the
Investment Company Act generally prohibits a fund
from acquiring an interest in a broker, dealer, or
underwriter. Because a repurchase agreement may
be considered to be the acquisition of an interest in
the counterparty, section 12(d)(3) may limit a fund’s
ability to enter into repurchase agreements with
many of the firms that act as repurchase agreement
counterparties. Rule 12d3–1 provides an exemption
from the prohibitions of section 12(d)(3) under
certain conditions, which exemption a fund may be
able to rely on in the event the repurchase
agreement fails to meet the look-through
requirements of rule 5b–3. See Rule 5b–3 Adopting
Release, infra note 27, at section II.C. The ability of
funds to rely on rule 5b–3 of the Investment
Company Act may affect the degree to which a fund
invests in repurchase agreements.
26 Rule 5b–3(a). The term ‘‘collateralized fully’’ is
defined in rule 5b–3(c)(1). In general, under rule
5b–3, a fund investing in a repurchase agreement
looks to the value and liquidity of the securities
collateralizing the repurchase agreement rather than
the creditworthiness of the counterparty for
satisfaction of the repurchase agreement. See Rule
5b–3 Adopting Release, infra note 27, at section
II.A.3. But see rule 2a–7(c)(4)(ii)(A) (requiring
money market fund boards to evaluate the
counterparty’s creditworthiness).
27 See Treatment of Repurchase Agreements and
Refunded Securities as an Acquisition of the
Underlying Securities, Investment Company Act
Release No. 25058 (July 5, 2001) [66 FR 36156 (July
11, 2001)] (‘‘Rule 5b–3 Adopting Release’’).
Repurchase agreements provide funds with a
convenient means to invest excess cash on a
secured basis, generally for short periods of time.
28 Government Security means ‘‘any security
issued or guaranteed as to principal or interest by
the United States, or by a person controlled or
supervised by and acting as an instrumentality of
the Government of the United States pursuant to
authority granted by the Congress of the United
States; or any certificate of deposit for any of the
foregoing.’’ Section 2(a)(16) of the Investment
Company Act. Government securities include, for
example, U.S. Treasury notes and bonds, and
securities issued by the Federal Home Loan
Mortgage Company (‘‘Freddie Mac’’), Federal
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that at the time the repurchase
agreement is entered into are rated in
the highest rating category by the
‘‘requisite NRSROs’’ 29 or (iv) unrated
securities that are of a comparable
quality to securities that are rated in the
highest rating category by the requisite
NRSROs, as determined by the fund’s
board of directors or its delegate.30
When the Commission proposed rule
5b-3, we explained that the highest
rating category requirement in the
definition of fully collateralized was
designed to help ensure that the market
value of the collateral would remain
stable and that the fund could liquidate
the collateral quickly in the event of a
default by the counterparty. The high
quality requirement was also designed
to limit a fund’s exposure to the ability
of the counterparty to maintain
sufficient collateral, and reflected the
understanding that securities of lower
quality may be subject to greater price
fluctuation.31
Today we are amending rule 5b–3 to
eliminate the requirement that collateral
other than cash or government securities
be rated in the highest category by the
requisite NRSROs or be of comparable
quality. In place of this requirement, the
amended rule requires that collateral
other than cash or government securities
consist of securities that the fund’s
board of directors (or its delegate)
determines at the time the repurchase
agreement is entered into are: (i) Issued
by an issuer that has an exceptionally
strong capacity to meet its financial
obligations on the securities
collateralizing the repurchase
agreement; and (ii) sufficiently liquid
that they can be sold at approximately
their carrying value in the ordinary
course of business within seven
calendar days.32
The new credit quality standard we
are adopting is designed to retain a
degree of credit quality that is similar to
the existing standard under rule 5b–3
1319
and consistent with the two-part
approach we have taken in establishing
credit quality standards to replace credit
rating references in other rules under
the federal securities laws.33 We note
that our amendment to rule 5b–3 does
not affect a money market fund that
seeks special treatment of its repurchase
agreement holdings under the
diversification provisions of rule 2a–7
because in order to obtain such
treatment, a money market fund is
limited to investing in repurchase
agreements collateralized by cash items
or government securities (which remain
unaffected by our amendments today).34
We are adopting the liquidity
component of the new standard as
proposed, but we have revised the credit
quality component from what was
proposed to address certain
commenters’ concerns.
We proposed that collateral issuers be
required to have the ‘‘highest capacity’’
to meet their financial obligations on the
collateral securities.35 Three of the five
commenters who addressed the
proposed amendments to rule 5b–3
argued that this standard is not
consistent with the standard established
by the ratings reference in the current
rule because the proposed standard does
not contemplate any variation in
creditworthiness among issuers that
meet the highest rating standard.36
Commenters suggested that short-term
collateral securities rated ‘‘A–1+’’ or
‘‘A–1’’ by Standard & Poor’s both would
satisfy the rating condition under the
current rule, but that only those rated
‘‘A–1+’’ would likely have satisfied the
credit standard under our proposal.37
Accordingly, as these commenters
recommended, the amended rule
requires an issuer to have an
‘‘exceptionally strong’’ capacity to meet
its financial obligations on the collateral
securities.38 We are adopting this
33 See
supra section II.A.
rule 2a–7(a)(5).
35 See proposed rule 5b–3(c)(1)(iv)(C)(1).
36 Federated Investors, Inc. Comment Letter (Apr.
25, 2011) (‘‘Federated Comment Letter’’);
Investment Company Institute Comment Letter
(Apr. 25, 2011) (‘‘ICI Comment Letter’’); T. Rowe
Price Associates, Inc. Comment Letter (Apr. 25,
2011) (‘‘T. Rowe Price Comment Letter’’). But see
2011 Proposing Release (discussing the proposed
‘‘highest capacity’’ standard and noting that ‘‘[a]n
issuer of collateral securities that the board (or its
delegate) determined has an exceptionally strong
capacity to repay its short or long-term debt
obligations . . . would satisfy the proposed [highest
capacity] standard’’).
37 See Standard & Poor’s Ratings Definitions, infra
note 39 at 5 (which may designate an ‘‘A–1’’ rating
with a plus sign to designate the obligor’s capacity
to meet its financial obligations is extremely
strong).
38 See ICI Comment Letter; Federated Comment
Letter (supporting the ICI Comment Letter); and T.
34 See
National Mortgage Association (‘‘Fannie Mae’’), and
Government National Mortgage Association
(‘‘Ginnie Mae’’).
29 The term ‘‘requisite NRSROs’’ means any two
NRSROs that have issued a rating with respect to
a security or class of debt obligations of an issuer
or, if only one NRSRO has issued a rating with
respect to such security or class of debt obligations
of an issuer at the time the investment company
acquires the security, that NRSRO. Rule 5b–3(c)(6).
This definition is deleted under the amended rule.
30 Rule 5b–3(c)(1)(iv). The term ‘‘unrated
securities’’ means securities that have not received
a rating from the requisite NRSROs. Rule 5b–3(c)(8).
This definition is deleted under the amended rule.
31 See Treatment of Repurchase Agreements and
Refunded Securities as an Acquisition of the
Underlying Securities, Investment Company Act
Release No. 24050 (Sept. 23, 1999) [64 FR 52476
(Sept. 29, 1999)] (‘‘Rule 5b–3 Proposing Release’’)
at n.43 and accompanying text.
32 Amended rule 5b–3(c)(1)(iv)(C).
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standard, as revised from our proposal,
because we believe that, like the current
rule, it permits some variation in
creditworthiness among issuers while
being designed to retain a degree of risk
limitation similar to the current rule.39
In the case of asset-backed securities
that serve as collateral, an evaluation of
the capacity of the issuer to meet its
financial commitment on the security
should include an assessment of the
quality of the underlying assets and the
structure of the asset-backed security.40
As discussed above, we are adopting
the liquidity component of the new
standard as proposed. The liquidity
standard in the amended rule is similar
to the standard used in rule 2a–7
governing money market funds, and is
also used in other rules under the
Investment Company Act.41 No
Rowe Price Comment Letter (generally agreeing
with the ICI Comment Letter).
39 See Fitch Ratings, International Issuer and
Credit Rating Scales, https://www.fitchratings.com/
web_content/ratings/fitch_ratings_definitions_and_
scales.pdf (stating that a rating of AAA is used in
cases of ‘‘exceptionally strong capacity for payment
of financial commitments’’); Moody’s Investor
Service Rating Symbols and Definitions, https://
www.moodys.com/
researchdocumentcontentpage.aspx?docid=PBC_
79004 (stating that ratings of Aaa are of the ‘‘highest
quality, subject to the lowest level of credit risk’’);
and Standard & Poor’s Ratings Definitions, https://
img.en25.com/Web/StandardandPoors/Ratings_
Definitions.pdf (stating that for a rating of AAA,
‘‘[t]he obligor’s capacity to meet its financial
commitment on the obligation is extremely
strong’’).
40 See Revisions to Rules Regulating Money
Market Funds, Investment Company Act Release
No. 19959 (Dec. 17, 1993) [58 FR 68585 (Dec. 28,
1993)] at text accompanying nn.108–109 (‘‘[t]he
credit quality of a typical asset backed security
depends both upon the structure of the security and
the quality of the underlying assets.’’); Money
Market Fund Reform, Investment Company Act
Release No. 29132 (Feb. 23, 2010) [75 FR 10060
(Mar. 4, 2010)] at text accompanying n.131 (noting
that the minimal credit risk analysis that a money
market fund board (or its delegate) must conduct
before investing in an asset-backed security should
include, among other things, (i) an analysis of the
underlying assets to ensure they are properly
valued and provide sufficient asset coverage for the
cash flow required to fund the asset-backed security
under various market conditions and (ii) an analysis
of the terms of any liquidity or other support
provided by the sponsor of the asset-backed
security). See also Alternatives to the Use of
External Credit Ratings in the Regulations of the
Office of the Comptroller of the Currency (June 4,
2012) [77 FR 35253 (June 13, 2012)] at text
following n.2 (in adopting an issuer-based credit
quality standard to replace credit ratings, the OCC
indicates that, in the case of a structured finance
transaction, principal and interest repayment is not
necessarily solely reliant on the direct debt
repaying capacity of the issuer or obligor).
41 See rule 2a–7(a)(19) (defining illiquid security
to mean a security that cannot be sold or disposed
of in the ordinary course of business within seven
calendar days at approximately the value ascribed
to it by the fund). See also rule 10f–3(a)(3)
(requiring, among other things, that ‘‘eligible
municipal securities’’ be sufficiently liquid that
they can be sold at or near their carrying value
within a reasonably short period of time).
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commenters addressed the proposed
liquidity standard.
We expect that securities that actively
trade in a secondary market at the time
of the acquisition of the repurchase
agreement will satisfy the liquidity
component of the standard. We also
understand that most securities used to
collateralize repurchase agreements
generally actively trade in a secondary
market.42 Securities that do not actively
trade in a secondary market would
likely require a more in-depth
evaluation by the board or its delegate
to determine whether they meet the
liquidity standard.
The final amendments do not, as one
commenter suggested, include specific
factors or tests that the board or its
delegate must apply in performing its
credit analysis.43 This commenter
acknowledged that a reliable and
objective shorthand measure of credit
risk that could be incorporated into
Commission regulations is currently
unavailable.44 The Commission
considered including specific factors for
funds to consider in performing credit
analysis under rule 5b–3. On balance,
we believe that, in the context of rule
5b–3, the new credit quality standards
provide sufficiently clear criteria under
which a fund board or its delegate can
make determinations regarding credit
quality and liquidity for this particular
purpose. Fund boards should also be
familiar with applying similar credit
quality standards used in other
Commission rules.45 Fund boards may
42 Repurchase agreements are often collateralized
by securities that include, but are not limited to,
agency collateralized mortgage-backed obligations
(‘‘CMOs’’), agency debentures and strips, agency
mortgage-backed securities, private label CMOs,
corporate debt, equity securities, money market
instruments and U.S. Treasury securities. See, e.g.,
Tri-Party Repo Statistical Data (as of August 2013),
https://www.newyorkfed.org/banking/tpr_infr_
reform_data.html. The securities that often
collateralize repurchase agreements trade
frequently. For example, data from the Securities
Industry and Financial Markets Association for
January through August 2013 shows average daily
trading volume, in billions of dollars, as follows:
Agency debentures and strips ($7.1); agency
mortgage-backed securities ($242.9); corporate debt
($145.4); U.S. Treasury securities ($551.4) (available
at https://www.sifma.org/research/statistics.aspx).
43 See Better Markets Comment Letter (Apr. 25,
2011) (‘‘Better Markets Comment Letter’’). This
commenter suggested certain factors that they
believed funds should be required to consider when
evaluating the creditworthiness of an issuer or a
debt security.
44 Id. We note that another commenter that
recommended that we establish an objective
standard for credit quality determinations did not
provide any examples of such criteria. See New
York City Bar Committee on Investment
Management Regulation Comment Letter (Apr. 29,
2011) (‘‘NY City Bar Comment Letter’’).
45 See adopting release, supra note 16 (the
Commission adopted amendments to rule 10f–3,
revising the definition of ‘‘eligible municipal
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also consult external resources and
Commission staff guidance (if
applicable) for additional guidance on
making credit quality determinations in
certain circumstances.46
The new credit quality standard is
intended to achieve the same objectives
that the credit rating requirement was
designed to achieve, i.e., to limit
collateral securities to those that are
likely to retain a sufficiently stable
market value and that, under ordinary
circumstances, the fund would be able
to liquidate quickly, at or near their
carrying value in the event of a
counterparty default.47 Amended rule
5b–3 would not, however, prohibit a
fund board from establishing its own
additional criteria for what the fund
may accept as collateral for repurchase
agreements under the amended rule.
Under the final rule, as was proposed,
the fund’s board will be required to
make credit quality determinations for
all collateral securities that are not cash
items or government securities, rather
than just for unrated securities. In
addition, as in the current rule, the
amended rule continues to permit the
board to delegate these credit quality
and liquidity determinations.48 We do
not agree with the concerns of one
commenter that this determination will
impose undue burdens on the board
because the determination is similar to
what rule 5b–3 currently requires a fund
board (or its delegate) to make with
respect to unrated collateral securities.49
In addition, the amended rule will
continue to permit the board of directors
to delegate credit quality and liquidity
determinations that the board believes
security’’ by replacing references to credit ratings
with a similar two-part credit quality standard). See
also text accompanying note 49.
46 See, e.g., Tri-Party Repo Infrastructure, Reform
Task Force, https://www.newyorkfed.org/
tripartyrepo/. See cf. Securities and Exchange
Commission, Division of Investment Management,
IM Guidance Update, Counterparty Risk
Management Practices With Respect to Tri-Party
Repurchase Agreements (July 2013) (providing
guidance to funds on the legal and operational steps
that funds should consider if a counterparty fails
and defaults on its obligations under a tri-party
repurchase agreement), available at https://
www.sec.gov/divisions/investment/guidance/imguidance-2013-03.pdf.
47 See supra note 31.
48 This is similar to rule 2a–7, which permits the
board to delegate decisions regarding credit quality.
See rule 2a–7(e).
49 See NY City Bar Comment Letter (asserting that
fund boards would be assigned responsibility for
making determinations that are not within their
expertise and arguing that the ability to delegate the
determination does not relieve them of ultimate
responsibility). See also infra section V.b.2. See rule
5b–3(c)(1)(iv)(D) (requiring that unrated securities
other than government securities be ‘‘of comparable
quality’’ to securities rated in the highest category
by requisite NRSROs).
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are within the delegate’s expertise if the
board retains sufficient oversight.50
Under the amended rule, when
determining credit quality and liquidity,
the board (or its delegate) may
incorporate into its analysis ratings,
reports, opinions and other assessments
issued by third parties, including
NRSROs. A board should evaluate the
basis for using any third-party
assessment, including an NRSRO rating,
in determining whether collateral meets
the new standard and would not rely on
the use of an NRSRO rating as a
standard by itself without evaluating the
quality of each NRSRO’s assessment. In
this way, the board could determine
which third-party providers are credible
and reliable and provide assessments
that would be most appropriate to
incorporate in making determinations
under the amended rule. Delegation of
these functions, as well as the use of
third-party providers, may help to limit
the potential increase in burdens on the
board. One commenter suggested that
we not allow a fund board to consider
credit ratings in determining if a
repurchase agreement is fully
collateralized, stating that this would
conflict with section 939A of the DoddFrank Act.51 We believe, however, that
credit ratings can serve as a useful data
point for evaluating credit quality, and
as noted above, a fund’s board (or its
delegate) may not rely solely on the
credit ratings of an NRSRO without
performing additional due diligence.
A fund that enters into repurchase
agreements and relies on rule 5b–3 must
maintain written policies and
procedures that are reasonably designed
to comply with the conditions of the
rule, including the credit quality and
liquidity requirements we are adopting
today, and funds may therefore have to
amend their policies and procedures.52
50 See Amended rule 5b–3(c)(1)(iv)(C); see also
2011 Proposing Release, supra note 10, at n.51 (‘‘As
in the current rule, the proposed rule would permit
the board to delegate this credit quality and
liquidity determination.’’). We expect that a fund’s
written policies and procedures would include
guidelines for the fund’s delegate (typically, the
investment adviser) in making required
determinations under rule 5b–3 and oversight of the
fund adviser’s compliance in making such
determinations. See rule 38a–1. These policies and
procedures typically would identify the process to
be followed by the board (or its delegate) in making
these credit and liquidity evaluations, including, as
appropriate, the types of data to be used or factors
to be considered and the person(s) or position(s)
responsible. They also typically would provide for
regular reporting to the board, as appropriate, about
these evaluations, to allow the board to provide
effective oversight of the process.
51 See Better Markets Comment Letter.
52 Registered funds are required to adopt and
implement written policies and procedures
reasonably designed to prevent the fund’s violation
of federal securities laws. See rule 38a–1(a); see also
infra sections IV.A and V.B.
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We also understand that credit quality
standards for securities collateralizing
repurchase agreements are typically
negotiated in the agreements between
funds and counterparties.53 We
understand that those standards
currently include a rating (for rated
collateral securities) and any additional
criteria that a fund manager considers
necessary to ensure that the credit
quality of collateral securities meets the
fund’s requirements, or, for unrated
securities, a comparable credit quality
standard. The amended rule does not
prohibit fund boards (or their delegates)
from considering the credit quality
standards in current repurchase
agreements and policies and procedures
adopted to comply with the current rule
as part of their analysis, provided that
fund boards (or their delegates)
determine that the ratings specified in
the repurchase agreements and policies
and procedures meet the standards we
are adopting today, and that the
agencies providing the ratings used in
the policies and procedures are credible
and reliable for that use. A fund could
also revise its repurchase agreements
and policies and procedures to change
or eliminate the consideration of
specific credit ratings or to incorporate
other third-party evaluations of credit
quality.54
As discussed above, amended rule
5b–3 replaces the requirement that
collateral for repurchase agreements
consist of securities rated in the highest
category by the requisite NRSROs (other
than cash and government securities)
with a requirement that the collateral
other than cash and government
securities consist of securities issued by
an issuer that has an exceptionally
strong capacity to meet its financial
obligations and that are sufficiently
liquid. Consistent with the protection of
investors and as necessary and
appropriate in the public interest, we
are also amending rule 5b–3 to define an
issuer to include an issuer of an
unconditional guarantee of the
53 Many repurchase market participants will only
accept AAA-rated paper such as government bonds
as collateral. See Moorad Choudhry, The Repo
Handbook (2d ed. 2010) at 298. Counterparties to
repurchase agreements generally assess
counterparty credit risk exposure based on the
‘‘haircut’’—For example, $100 of securities
collateralizing a loan of $97 produces a 3% haircut.
The haircut may be greater depending on the
counterparties’ assessment of the collateral
provider’s creditworthiness. See Repo and
Securities Lending, Staff Report No. 529, Federal
Reserve Bank of New York (Dec. 2011, Rev. Feb.
2013). Assessments of credit quality are not
standardized but are participant specific and
negotiated at the time of the transaction. Id.
54 See 2011 Proposing Release, supra note 10, at
n.58. An estimate of the potential costs is discussed
infra at section IV.A.
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1321
security.55 We proposed this
amendment to preserve a fund’s ability
to use the same types of collateral
securities as it currently uses to satisfy
the conditions of rule 5b–3. We received
no comments on this aspect of the
proposal and are adopting it as
proposed. Thus, under amended rule
5b–3, a collateral security with an
unconditional guarantee, the issuer of
which meets the new credit quality test,
satisfies that element of the standard.
B. Forms N–1A, N–2, and N–3
We are also adopting amendments to
Forms N–1A, N–2, and N–3 to remove
the required use of credit ratings
assigned by an NRSRO. Forms N–1A,
N–2, and N–3, among other things,
contain the requirements for
shareholder reports of mutual funds,
closed-end funds, and certain insurance
company separate accounts that offer
variable annuities.56
Currently, Forms N–1A, N–2, and N–
3 require shareholder reports to include
a table, chart, or graph depicting
portfolio holdings by reasonably
identifiable categories (e.g., type of
security, industry sector, geographic
region, credit quality, or maturity).57
The forms require the categories to be
selected in a manner reasonably
designed to depict clearly the types of
investments made by the fund, given its
investment objectives. If credit quality is
used to present portfolio holdings, the
forms currently require that credit
quality be depicted using the credit
ratings assigned by a single NRSRO. We
are amending Forms N–1A, N–2, and N–
3, as proposed, to no longer require the
use of NRSRO credit ratings by funds
that choose to use credit quality
categorizations in the required table,
chart, or graph of portfolio holdings.
Accordingly, funds that choose to show
credit quality categorizations in the
required table, chart, or graph may use
alternative categorizations that are not
based on NRSRO credit ratings.
In a change from the 2011 Proposing
Release, however, under the amended
forms, funds that choose to continue to
55 Amended rule 5b–3(c)(4) (defining ‘‘issuer’’ to
mean ‘‘the issuer of a collateral security or the
issuer of an unconditional obligation of a person
other than the issuer of the collateral security to
undertake to pay, upon presentment by the holder
of the obligation (if required), the principal amount
of the underlying collateral security plus accrued
interest when due or upon default.’’).
56 Open-end management investment companies,
commonly known as mutual funds, use Form N–
1A. Closed-end management investment companies
use Form N–2. Separate accounts organized as
management investment companies that offer
variable annuity contracts use Form N–3.
57 Item 27(d)(2) of Form N–1A; Instruction 6(a) to
Item 24 of Form N–2; Instruction 6(i) to Item 28(a)
of Form N–3.
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use credit ratings will no longer be
restricted to using the credit ratings
assigned by a single NRSRO.
Accordingly, funds that choose to depict
credit quality using credit ratings
assigned by a credit rating agency may
use different credit rating agencies for
split-rated securities (i.e., securities that
have received different ratings from
multiple credit rating agencies) and they
may use ratings provided by credit
rating agencies that are not NRSROs.58
Funds will also be required to describe
how the credit quality of the holdings
was determined, and if credit ratings are
used, a description of how they were
identified and selected.59
Four of the five substantive comments
we received on the proposed
amendments to Forms N–1A, N–2, and
N–3, supported eliminating the required
use of NRSRO credit ratings to depict
credit quality.60 Two of these
commenters noted that shareholders
would benefit from information about
the credit quality of a fund’s portfolio
securities, whether determined by an
NRSRO or internally.61
Although most commenters supported
eliminating the required use of credit
ratings to depict credit quality, four
commenters opposed the proposed
requirement that a fund that chooses to
use NRSRO credit ratings must use the
credit ratings of a single NRSRO.
Instead, these commenters
recommended that when a security is
split-rated, the fund be permitted to
choose which NRSRO rating to use,
provided the choice is made
consistently pursuant to a disclosed
policy.62 These commenters argued that
58 We are replacing the term ‘‘ratings’’ with
‘‘credit ratings’’ and ‘‘nationally recognized
statistical rating organization ‘NRSRO’ ’’ with
‘‘credit rating agency’’ as defined under the
Exchange Act. See sections 3(a)(60) [15 U.S.C.
78c(a)(60)] and 3(a)(61) [15 U.S.C. 78c(a)(61)] of the
Exchange Act, which define ‘‘credit rating’’ and
‘‘credit rating agency’’, respectively.
59 See Amended Item 27(d)(2) of Form N–1A;
Amended Instruction 6(a) to Item 24 of Form N–2;
Amended Instruction 6(i) to Item 28(a) of Form
N–3.
60 ICI Comment Letter; Vanguard Comment Letter;
T. Rowe Price Comment Letter; Federated Comment
Letter (supporting the ICI’s comments). The fifth
commenter argued that the Commission is not
required to remove references to credit ratings from
the forms pursuant to section 939A of the DoddFrank Act. See BlackRock Comment Letter.
Regardless of whether the Commission is required
to remove from the forms references to credit
ratings, the Commission believes that the removal
of such references is consistent with the purpose of
section 939A of the Dodd-Frank Act.
61 ICI Comment Letter; Federated Comment Letter
(supporting the ICI’s comments).
62 ICI Comment Letter; Vanguard Comment Letter;
T. Rowe Price Comment Letter; Federated Comment
Letter (supporting the ICI’s comments). Two
commenters noted that the Financial Industry
Regulatory Authority (‘‘FINRA’’) permits funds to
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this approach would benefit funds and
investors by allowing funds to disclose
credit quality information in
shareholder reports in a manner
consistent with marketing materials and
internal investment policies.63
We agree with commenters and have
revised the final form amendments to
provide this additional degree of
flexibility. Accordingly, the amended
forms permit funds to consider
alternative approaches to presenting
credit quality that accurately and
effectively describe the credit quality of
the fund’s portfolio. For example, under
the amended forms, a fund could have
a policy of disclosing the median credit
quality rating for split-rated securities
instead of only using the ratings of a
single credit rating agency (when more
than two rating agencies rate the
security).64 In the 2011 Proposing
Release, we proposed to maintain the
general requirement that ratings be
selected from a single NRSRO because
we were concerned about the possibility
that a fund may select the most
favorable credit ratings among credit
ratings assigned by multiple NRSROs.
On balance, we are persuaded by
commenters that the benefits of this
additional flexibility outweigh the
potential ‘‘cherry picking’’ concern. We
believe that the risks associated with
cherry picking ratings are mitigated by
the disclosure requirements discussed
below.65 For example, if a fund
discloses that, with respect to split-rated
securities, it is the fund’s policy to
select the highest credit rating provided
by a credit rating agency, investors will
be on notice that the fund has made a
decision not to include potentially
lower and more conservative measures
of credit quality. In addition, we believe
that in some circumstances selecting
credit ratings from more than one credit
rating agency may reflect a more
comprehensive approach to credit
quality analysis that results in
information about credit quality that
may be more accurate or complete. For
example, a fund that reviews credit
use different approaches to portray the credit
quality of split-rated bonds in marketing materials
(noting further that funds receive credit rating
information through data feeds and that it would be
more cost efficient for funds to rely on a single data
feed to comply with one consistent SEC/FINRA
requirement). See ICI Comment Letter; Vanguard
Comment Letter.
63 See ICI Comment Letter; Federated Comment
Letter (supporting the ICI’s comments); Vanguard
Comment Letter.
64 See infra note 70 and accompanying and
following text (discussing the difference between
using median and average credit ratings).
65 See Amended Item 27(d)(2) of Form N–1A;
Amended Instruction 6(a) to Item 24 of Form N–2;
Amended Instruction 6(i) to Item 28(a) of Form
N–3.
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ratings from three rating agencies,
discards the outliers (i.e., the highest
and lowest ratings), and selects the
middle rating,66 has evaluated credit
quality from a broader set of market
participants that may lead to a more
complete evaluation of credit quality.
Under the amended forms, funds that
choose to depict portfolio holdings
according to credit quality must include
a description of how the credit quality
of the holdings was determined.67 This
description should include a discussion
of the credit quality evaluation process,
the rationale for its selection, and an
overview of the factors considered, such
as the terms of the security (e.g., interest
rate, and time to maturity), the obligor’s
capacity to repay the debt, and the
quality of any collateral. If the fund uses
credit ratings issued by a credit rating
agency to depict credit quality, the fund
should explain how the credit ratings
were identified and selected, and
include this description near, or as part
of, the graphical representation.68 This
description should include, if
applicable, a discussion of: (i) The
criteria considered or process used in
selecting the credit ratings (e.g., the
fund might use the median credit rating
from among three rating agencies 69); (ii)
how the fund evaluated those criteria
(i.e., the due diligence performed); (iii)
how the fund reports credit ratings for
any security that is not rated by the
credit rating agency selected if the fund
has a policy of using the ratings of a
66 See, e.g., Fact Sheet, BlackRock Bond Index
Fund (portraying credit quality using the median
credit rating from among S&P, Moody’s, and Fitch,
when all three agencies rate a security), available
at https://www2.blackrock.com/webcore/litService/
search/getDocument.seam?venue=PUB_IND&
source=CONTENT&serviceName=publicService
View&ContentID=1111147239&venue=FP_ML; Fact
Sheet, Vanguard High-Yield Tax-Exempt Fund
Investor Shares (same), available at https://
personal.vanguard.com/us/funds/snapshot?FundId
=0044&FundIntExt=INT.
67 See supra note 65; see also ICI Comment Letter
(recommending that funds be permitted to choose
which NRSRO rating to use for split-rated
securities, provided that the choice is made
pursuant to a disclosed policy).
68 If a fund does not use credit ratings, its
description of how the credit quality of the holdings
was determined would also need to be near, or as
part of, the graphical representation. See Amended
Item 27(d)(2) of Form N–1A; Amended Instruction
6(a) to Item 24 of Form N–2; Amended Instruction
6(i) to Item 28(a) of Form N–3.
69 For example, Morningstar prefers that bonds be
classified using the Barclays Capital Family of
Indices ratings rules (i.e., use the middle rating of
Moody’s, S&P and Fitch after dropping the highest
and lowest available ratings; if only two rating
agencies rate a security then the lowest rating
should be used; and if only one agency rates a
security then that rating should be used). See
Morningstar Fixed-Income Style Box Methodology
(Apr. 30, 2012) at https://corporate.morning
star.com/us/documents/MethodologyDocuments/
MethodologyPapers/FixedIncomeStyleBoxMeth.pdf.
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single rating agency (e.g., has the fund
selected a designated alternate rating
agency); (iv) how the fund reports credit
ratings for any security that is not rated
by any credit rating agency (i.e., the
process for self-rating); or (v) other fund
policies on selecting credit ratings for
purposes of disclosure. We expect that
this discussion, modified and expanded
upon by funds as appropriate, will
provide investors with insight into how
the fund identified and selected the
credit ratings used in depicting the
fund’s portfolio by credit quality.
We recognize that under the final
form amendments, a fund has a variety
of options when depicting its portfolio
holdings using credit quality. For
example, a fund might choose not to use
credit ratings and could rely instead on
internal credit assessments. If a fund
does not use credit ratings, we note that
it might be misleading for a fund to
describe its portfolio holdings quality
with similar descriptions as the ratings
nomenclature used by rating agencies
(e.g., AAA, Aa), or to characterize the
securities as ‘‘rated.’’ If a fund chooses
to depict its portfolio using credit
ratings issued by a credit rating agency,
a fund could choose to use the median
credit rating from among multiple credit
rating agencies (discarding the highest
and lowest ratings) when a security is
split-rated.70 We note, however, that it
might be misleading for a fund to
disclose an average credit quality rating
that is based on ratings from multiple
credit rating agencies because credit
rating agencies may use different criteria
to evaluate the credit quality of an
issuer. A fund might also choose other
methods for evaluating credit quality of
portfolio securities, such as a policy of
selecting the highest or lowest credit
rating for split-rated securities among
the ratings issued by certain specified
rating agencies.71 As discussed above, a
fund must include in its disclosure a
description of how the credit quality of
the holdings was determined, no matter
the method used.
The amended forms are intended to
provide funds with the flexibility to
present credit ratings in a manner that
more clearly explains the credit quality
of the fund’s portfolio and the method
by which the fund determined that
quality.
70 Id.;
see also supra note 66.
e.g., Fact Sheet, Fidelity Institutional
Money Market Prime Money Market Portfolio—
Institutional CL (categorizing portfolio credit
quality for investment grade taxable and municipal
bond funds and multi-asset class funds with a fixed
income component using the highest credit rating
among Moody’s, S&P, or Fitch), available at
https://fundresearch.fidelity.com/mutual-funds/
composition/31607A208.
IV. Paperwork Reduction Act
Certain provisions of the amendments
we are adopting contain ‘‘collections of
information’’ within the meaning of the
Paperwork Reduction Act of 1995
(‘‘PRA’’).72 The titles for the existing
collections of information we are
amending are: (i) ‘‘Rule 30e–1 under the
Investment Company Act of 1940,
Reports to Stockholders of Management
Companies’’; 73 and (ii) ‘‘Rule 38a–1
under the Investment Company Act of
1940, Compliance procedures and
practices of registered investment
companies.’’ We adopted those rules
pursuant to the Investment Company
Act. There is currently no approved
collection of information for rule 5b–3,
and the amendments do not create any
new collections under that rule. The
amendments to rule 5b–3 do, however,
affect the collection of information
burden for rule 38a–1.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless it displays a currently valid
control number. We published notice
soliciting comments on the collection of
information requirements in the 2011
Proposing Release and submitted the
proposed collections of information to
the Office of Management and Budget
(‘‘OMB’’) for review in accordance with
44 U.S.C. 3507(d) and 5 CFR 1320.11
under the control numbers 3235–0025
(rule 30e–1) and 3235–0586 (rule 38a–
1). We received no comments on the
PRA estimates contained in the 2011
Proposing Release.
A. Rule 38a–1
Rule 5b–3 under the Investment
Company Act allows funds to treat the
acquisition of a repurchase agreement as
an acquisition of securities
collateralizing the repurchase agreement
for purposes of sections 5(b)(1) and
12(d)(3) of the Investment Company Act
under certain conditions. Rule 5b–3, as
amended, requires that the securities
collateralizing a repurchase agreement
consist of securities that the fund’s
board of directors, or its delegate,
determines are issued (or have
unconditional guarantees that are
issued) by an issuer that has an
exceptionally strong capacity to meet its
financial obligations and are highly
71 See,
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72 44
U.S.C. 3501–3520.
amendments to Forms N–1A, N–2, and N–
3 relate solely to the contents of fund shareholder
reports. The PRA burden associated with fund
shareholder reports is included in the burden
associated with the collection of information for
rule 30e–1 under the Investment Company Act
rather than Forms N–1A, N–2 and N–3.
73 The
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1323
liquid.74 To that end, the fund’s board
of directors, pursuant to rule 38a–1
under the Investment Company Act,
must have procedures that are
reasonably designed to ensure that the
fund is able to comply with the
conditions of amended rule 5b–3,
including the credit quality and
liquidity requirements outlined in the
amended rule.75 As discussed above,
these procedures should be designed to
limit collateral securities to those that
are likely to retain a stable market value
and that, in ordinary circumstances, the
fund would be able to liquidate quickly
in the event of a default. This rule 38a–
1 collection of information will be
mandatory for funds that rely on rule
5b–3. Records of information made in
connection with this requirement will
be required to be maintained for
inspection by Commission staff, but the
collection will not otherwise be
submitted to the Commission. To the
extent that the Commission receives
confidential information pursuant to
this collection of information, such
information would be kept confidential,
subject to the provisions of applicable
law.76
We do not anticipate that the
amendments to rule 5b–3 will
significantly change collection of
information burdens under rule 38a–1
because we believe funds would likely
rely significantly on their current
policies and procedures to determine
the credit quality of collateral securities
and comply with amended rule 5b–3.
As we indicated above, we understand
that credit quality standards for
securities collateralizing repurchase
agreements typically are contained in
the repurchase agreements between
funds and counterparties.77 We
understand that those standards
currently include a rating (for rated
collateral securities) and any additional
criteria a fund manager considers
74 Amended rule 5b–3(c)(1)(iv)(C). See supra
section III.A.
75 Under rule 38a–1, funds must have written
policies and procedures reasonably designed to
prevent violation of the federal securities laws. Rule
38a–1(a)(1). Funds thus would have policies and
procedures for complying with rule 5b–3, which
would include policies and procedures relating to
credit quality determinations of unrated collateral
securities, if appropriate.
76 See, e.g., 5 U.S.C. 552. Exemption 4 of the
Freedom of Information Act provides an exemption
for ‘‘trade secrets and commercial or financial
information obtained from a person and privileged
or confidential.’’ 5 U.S.C. 552(b)(4). Exemption 8 of
the Freedom of Information Act provides an
exemption for matters that are ‘‘contained in or
related to examination, operating, or condition
reports prepared by, on behalf of, or for the use of
an agency responsible for the regulation or
supervision of financial institutions.’’ 5 U.S.C.
552(b)(8).
77 See supra note 53 and accompanying text.
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necessary to ensure that the credit
quality of the collateral securities meets
the fund’s requirements, or, for unrated
securities, a comparable credit quality
standard. Counterparties provide
collateral securities to conform to these
standards and funds confirm that the
securities are conforming. As we have
noted above, funds can continue to
consider evaluations of outside sources,
including credit ratings that the board
determines are credible and reliable in
making their credit quality
determinations under the amended rule.
We expect that funds will likely
continue to rely on their current policies
and procedures (i.e., using credit quality
standards that include ratings currently
set forth in their repurchase agreements
with counterparties). Thus, we do not
expect that the amendments to rule 5b–
3 will significantly change the current
collection of information burden
estimates for rule 38a–1.78 Nevertheless,
funds may review their repurchase
agreements and policies and procedures
that address rule 5b–3 compliance and
make technical changes to those
documents in response to the
amendments. Staff estimated in the
proposal and continues to believe that it
will take, on average, 1.5 hours of a
senior business analyst’s time to
perform this review and make any
technical changes for an individual fund
portfolio, for an estimated one-time
additional burden of 15,176 hours for all
fund portfolios (other than money
market fund portfolios).79 Amortized
over three years, the staff estimates that
78 The current approved annual burden for rule
38a–1 under the PRA is 248,455 hours. As
discussed below, as amended, the collection of
information requirement will be 263,631 hours
(248,455 + 15,176).
79 For purposes of this PRA analysis, we assume
that all funds enter into repurchase agreements and
rely on rule 5b–3. We have not included money
market funds in our estimates, however, because
they are subject to different requirements for the
collateralization of repurchase agreements under
rule 2a–7. See text accompanying note 34. The
staff’s estimate is based on staff examination of
industry data as of August 31, 2013 and includes
10,117 fund portfolios. We therefore estimate that
there will be 10,117 respondents to this collection
of information. The amount is calculated as follows:
10,117 fund portfolios × 1.5 hours = 15,176 onetime additional burden hours for all fund portfolios.
We estimate that the one-time additional annual
burden is 1.5 hours per respondent.
The monetized burden hours are calculated as
follows: 15,176 hours × $245 per hour = $3,718,120
one-time additional costs. The staff estimates that
the internal cost for time spent by a senior business
analyst is $245 per hour. This estimate, as well as
other internal time cost estimates made in this
analysis, is derived from SIFMA’s Management and
Professional Earnings in the Securities Industry
2012, modified by Commission staff to account for
an 1800-hour work week and multiplied by 5.35 to
account for bonuses, firm size, employee benefits
and overhead.
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the estimated annual aggregate burden
will be 5,059 burden hours.80
We anticipate that the fund’s board
will review the fund manager’s
recommendation, but that the cost of
this review will be incorporated in the
fund’s overall annual board costs and
would not result in any particular
additional cost. We received no
comments on these estimates and
therefore have not modified them.81
B. Rule 30e–1
The amendments to Forms N–1A,
N–2, and N–3 eliminate the required use
of NRSRO credit ratings by funds that
choose to use credit quality
categorizations in the table, chart, or
graph of portfolio holdings provided in
shareholder reports. The collection of
information is mandatory for those
funds that choose to use credit quality
categorizations in these forms. If a fund
chooses to depict portfolio holdings
according to credit quality, the fund
must include a description of how the
credit quality of the holdings was
determined. If credit ratings assigned by
a credit rating agency are used, the fund
must disclose how it identified and
selected the credit ratings. Responses to
the disclosure requirements will not be
kept confidential.
Although funds would remain
obligated to provide a table, chart, or
graph of portfolio holdings by
reasonably identifiable categories, the
amendments require that certain funds
must make new disclosures. Under our
proposed amendment, we estimated that
there would be no additional collection
of information burden as a result of
proposing to remove the required use of
credit ratings from the forms.82 Under
our amended rule, however, funds that
choose to use credit quality
categorizations must disclose how the
fund made the credit quality
determinations, and if the fund uses
credit ratings issued by a credit rating
agency, the fund must disclose how it
identified and selected the credit
ratings.83
Accordingly, based on staff
experience, the staff estimates that it
80 The amount is calculated as follows: 15,176
burden hours/3 = 5,059 burden hours. Amortized
over three years, staff estimates that the annual
aggregate burden cost will be: $3,718,820/3 =
$1,239,373.
81 The PRA costs have been modified slightly
since the 2011 Proposing Release to reflect a more
current estimate of the number of fund portfolios
affected, as well as updated hourly wages based on
the 2012 SIFMA table.
82 See 2011 Proposing Release, section IV.C.
83 The current approved annual burden for rule
30e–1 under the PRA is 903,000 hours. As
discussed below, as amended, the collection of
information requirement will be 935,049 hours
(903,000 + 32,049).
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will take, on average, 3 hours of an
attorney’s time to perform this review
and make any technical changes to an
individual fund’s disclosures, for an
estimated burden of 32,049 hours for all
funds.84 Amortized over three years, the
staff estimates that the estimated annual
aggregate burden will be 10,683 burden
hours and that there will be
approximately 10,683 respondents.85
V. Economic Analysis
A. Overview
As discussed above, we are adopting
rule and form amendments to
implement section 939A of the DoddFrank Act. The amendments to rule 5b–
3 replace a NRSRO credit rating
standard with alternative credit quality
and liquidity criteria that are designed
to achieve the same purposes as the
NRSRO credit rating standard without
imposing unnecessarily burdensome
costs. The amendments to Forms N–1A,
N–2, and N–3 remove the required use
of credit ratings when portraying credit
quality in shareholder reports, but
require that those funds include a
description of how the credit quality of
the holdings were determined, and if
credit ratings assigned by a credit rating
agency are used, how the credit ratings
were identified and selected. The
regulatory changes adopted today will
directly affect investment companies
registered under the Investment
Company Act and could affect the
demand for rating agencies’ services by
eliminating the required use of NRSRO
credit ratings in rule 5b–3 and Forms N–
1A, N–2, and N–3. The amendments to
84 The staff’s estimate of the number of funds is
based on staff examination of industry data as of
August 31, 2013 and includes 10,683 funds that
collectively file reports on Forms N–1A, N–2, and
N–3 each year. We note that this estimate is
conservative because it is likely that some fund
complexes will achieve economies of scale when
revising their disclosures, do not use credit quality
when describing portfolio holdings, or whose
current disclosures already satisfy the requirements
of the amended rule and thus would not need to
make any changes. The amount is calculated as
follows: 10,683 funds × 3 hours = 32,049 one-time
additional burden hours for all funds. We estimate
that the one-time additional annual burden is 3
hours per respondent.
The monetized burden hours are calculated as
follows: 32,049 hours × $379 per hour =
$12,146,571 one-time additional costs. The staff
estimates that the internal cost for time spent by an
in-house attorney is $379 per hour. This estimate,
as well as other internal time cost estimates made
in this analysis, is derived from SIFMA’s
Management and Professional Earnings in the
Securities Industry 2012, modified by Commission
staff to account for an 1800-hour work week and
multiplied by 5.35 to account for bonuses, firm size,
employee benefits and overhead.
85 The amount is calculated as follows: 32,049
burden hours/3 = 10,683 burden hours. Amortized
over three years, staff estimates that the annual
aggregate burden cost will be: $12,146,571/3 =
$4,048,857.
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rule 5b–3 may also affect other parties
such as repurchase agreement
counterparties (e.g., broker-dealers and
banks), investors, and issuers of
collateral securities. Finally, we
recognize that the elimination of the
required use of NRSRO credit ratings in
rule 5b–3 and Forms N–1A, N–2, and
N–3 may reduce the incentive for credit
rating agencies to register as NRSROs
and thereby be subject to the
Commission’s oversight and statutory
and regulatory requirements applicable
to NRSROs. We received no comments
on the cost-benefit analysis contained
the 2011 Proposing Release.
At the outset, the Commission notes
that, where possible, we have attempted
to quantify the costs and benefits
expected to result from adopting the
amendments to rule 5b–3 and Forms
N–1A, N–2, and N–3. However,
wherever the discussion of costs or
benefits is not quantified in this section
it is because the Commission is unable
to quantify the economic effects because
it lacks the information necessary to
provide a reasonable estimate. For
example, as discussed below, the
Commission does not have available to
it comprehensive information on the
exposure of funds to different
repurchase agreement market segments,
the nature and type of collateral used in
repurchase agreements, or the extent to
which funds rely on rule 5b–3. Because
of this lack of data, including the extent
to which funds may rely on rule 5b–3,
we are unable to quantify the costs to
comply with the amended rule and note
that the costs could vary from our
estimates. We discuss below the
economic baseline, costs and benefits of
our final rule and form amendments,
alternatives considered, as well as the
impact on efficiency, competition, and
capital formation.
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B. Rule 5b–3
Rule 5b–3, as amended, permits a
fund to treat the acquisition of a
repurchase agreement as an acquisition
of securities collateralizing the
repurchase agreement for purposes of
sections 5(b)(1) and 12(d)(3) of the
Investment Company Act if the
collateral other than cash or government
securities consists of securities that the
fund’s board of directors, or its delegate,
determines at the time the repurchase
agreement is entered into are: (i) Issued
by an issuer that has an exceptionally
strong capacity to meet its financial
obligations; and (ii) sufficiently liquid
that they can be sold at approximately
their carrying value in the ordinary
course of business within seven
calendar days.
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1. Economic Baseline
The economic baseline against which
we measure the economic effects of
these amendments is the regulatory
framework as it exists immediately
before the adoption of today’s
amendments. Currently, rule 5b–3
allows funds to treat the acquisition of
a repurchase agreement as an
acquisition of securities collateralizing
the repurchase agreement for certain
diversification and broker-dealer
counterparty limit purposes under the
Investment Company Act if the
obligation of the seller to repurchase the
securities from the fund is
‘‘collateralized fully.’’ In general, under
rule 5b–3, a fund investing in a
repurchase agreement looks to the value
and liquidity of the securities
collateralizing the repurchase agreement
rather than the creditworthiness of the
counterparty for satisfaction of the
repurchase agreement. Under current
requirements, a repurchase agreement is
collateralized fully if, among other
things, the collateral for the repurchase
agreement consists entirely of (i) cash
items, (ii) government securities, (iii)
securities that at the time the repurchase
agreement is entered into are rated in
the highest rating category by the
‘‘Requisite NRSROs’’ or (iv) unrated
securities that are of a comparable
quality to securities that are rated in the
highest rating category by the Requisite
NRSROs, as determined by the fund’s
board of directors or its delegate.
As of the end of 2012, the total
repurchase agreement market
approximated $3 trillion.86 The
repurchase agreement market has two
primary segments, bilateral and triparty.87 The bilateral segment comprises
cash-driven transactions against specific
collateral while the tri-party segment
comprises cash-driven transactions
against general collateral. We believe
that investment companies’ primary
exposure to repurchase agreements is
through the tri-party market, but the
Commission does not have available to
it comprehensive information on the
exposure in either market segment. The
collateral used in the approximately $2
trillion tri-party market is dominated by
government securities: Approximately
35% consists of Treasury securities and
approximately 50% consists of agency
mortgage-backed securities, agency
86 See Financial Stability Oversight Council, 2013
Annual Report at 65–66, available at https://
www.treasury.gov/initiatives/fsoc/Documents/
FSOC%202013%20Annual%20Report.pdf.
87 See id. (noting a third repo market segment—
the general collateral finance market—which
primarily settles inter-dealer transactions on the triparty repo platform).
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1325
debentures, and agency collateralized
mortgage obligations.88
While we believe that many funds
invest in tri-party repurchase
agreements, comprehensive information
about the extent to which funds invest
in these agreements is not available to
us. Nor are we able to estimate how
often funds rely on rule 5b–3 when
entering into repurchase agreements, or
the extent to which fund repurchase
agreements are collateralized with
securities other than cash or government
securities. However, we are able to
estimate the extent of money market
fund participation in the tri-party
repurchase market using Form N–MFP
data, which shows that money market
funds held approximately $591 billion
in tri-party repurchase agreements as of
the end of 2012. While we understand
almost all funds rely on rule 5b–3 on
occasion (for example when
approaching diversification limits or
avoiding restrictions on investments in
certain entities), we do not have the
information necessary to determine how
frequently those funds rely on rule 5b–
3 in their daily transactions in
repurchase agreements. Accordingly, we
are largely unable to quantify the
benefits and costs discussed below.
2. Economic Analysis
Amended rule 5b–3 is intended to
establish a similar credit quality
standard to the NRSRO credit rating
standard we are replacing in order to
achieve the same objectives that the
NRSRO credit rating reference
requirement was designed to achieve in
the existing rule, i.e., limit collateral
securities to those that are likely to
retain a stable market value and that,
under ordinary circumstances, the fund
would be able to liquidate quickly at or
near its carrying value in the event of a
counterparty default. Although
amended rule 5b–3 seeks to maintain a
similar degree of credit quality as the
standard it replaces, the Dodd-Frank Act
mandate is designed to reduce reliance
on NRSRO credit ratings.89
Some fund boards or their delegates,
after independent analysis, might make
a determination of credit quality that
comports with the analysis of the
NRSRO credit ratings and, accordingly,
make no substantive changes to the
funds’ investments in repurchase
agreements. Other fund boards might
turn to non-NRSRO sources (‘‘thirdparty providers’’) to satisfy the new
requirements, which may result in a
different pool of assets from which the
funds may select for collateralizing
88 Id.
89 See
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repurchase agreements. We believe that
this flexibility of allowing for a broader
range of credit quality models will
increase competition for such models,
whether from internal assessments
made by the fund or from external
assessments made by third-party
providers such as credit rating agencies.
As a result, credit assessments, and the
repurchase agreement market in general,
may become more efficient and may
promote capital formation through a
more accurate assessment of credit risk
that may increase investment in
repurchase agreements.
We recognize, as discussed above,
that funds typically establish standards
for the credit quality of collateral
securities (that include credit ratings
and additional credit quality criteria
required by the fund) in repurchase
agreements with counterparties.90
Funds could change their policies and
procedures to reflect changes made to
the rule by the amendments, but the
rule would not prohibit funds from
considering the standards in current
repurchase agreements and policies and
procedures provided that the fund’s
board or its delegate made the
determination that those standards
satisfy the standards in amended rule
5b–3. As a result, amended rule 5b–3
may not significantly change the types
of collateral securities held by funds
relying on rule 5b–3.
Amended rule 5b–3 requires the
fund’s board or its delegate to make a
determination about the collateral of
each repurchase agreement. This will
increase the regulatory burden on the
fund’s board,91 but we believe that the
burden is significantly reduced by the
fund board’s ability to incorporate
ratings, reports, analyses, and other
assessments issued by third parties,
including NRSRO ratings that the fund’s
board concludes are credible and
reliable for purposes of making the
evaluation. Moreover, fund boards that
find these increased regulatory burdens
to be excessive can mitigate them by
restricting the fund to repurchase
agreement collateral that consists of
cash and government securities.
If the fund’s board decides to rely
primarily on NRSRO ratings as part of
the process of evaluating credit quality,
the fund may incur some additional
costs from today’s amendments.92
However, some fund boards may decide
not to rely primarily on NRSRO ratings,
perhaps because of a more cost efficient
way of making the required
90 See
91 See
supra text preceding note 53.
NY City Bar Comment Letter, supra note
44.
92 See
supra text following note 53.
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determinations or because they believe
NRSRO ratings are not helpful or
sufficient in evaluating credit quality.
Reducing the emphasis on NRSRO
ratings could also adversely affect the
quality of NRSRO ratings. Currently, the
importance attached to NRSRO ratings
may impart franchise value to the
NRSRO’s ratings business. By
eliminating references to NRSRO ratings
in Federal regulations, section 939A of
the Dodd-Frank Act could reduce these
franchise values and mitigate NRSROs’
incentives to produce credible and
reliable ratings. Moreover, the
Commission recognizes that the
elimination of the required use of credit
ratings in Commission rules and forms
may reduce the incentive for credit
rating agencies to register as NRSROs
with the Commission and thereby be
subject to the Commission’s oversight
and the statutory and regulatory
requirements applicable to NRSROs. To
the extent that the quality and accuracy
of NRSRO ratings is adversely affected,
negative impacts on the capital
allocation process and economic
efficiency would result.
The new methodologies that the
fund’s board employs may result in a
pool of assets from which the fund may
select for collateralizing repurchase
agreements that is different from a pool
based on NRSRO ratings. This may
affect the fund relative to the baseline of
NRSRO ratings by including or
excluding as collateral assets that are
different from the collateral permitted
under the current rule. In turn, this
could increase the credit risk in the pool
of collateral assets or decrease the return
earned by investing in repurchase
agreements. Both of these effects may
lead to a less efficient market for
repurchase agreement collateral. Issuers’
ability to raise capital may also be
adversely affected to the extent that
issuers of collateral securities lose the
regulatory preference that currently
exists because of the required use of
NRSRO ratings within rule 5b–3. We do
not, however, believe that the amended
rule is likely to lead to the acceptance
of riskier collateral in practice because
the standard we are adopting is very
similar to the standard articulated by
the NRSROs for securities that have
received the highest ratings. In addition,
we anticipate that fund boards and
advisers will retain the credit quality
standards in their current repurchase
agreements and their existing policies
and procedures that address compliance
with current rule 5b–3 and include
ratings that they believe are credible and
reliable.
Although we believe that boards of
funds relying on rule 5b–3 have
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established policies and procedures for
complying with the rule,93 funds may
incur costs to revise existing policies
and procedures for investing in
repurchase agreements to comply with
amended rule 5b–3. We recognize that
increased compliance costs are a
necessary result of our amendments to
rule 5b–3 and may disproportionately
impact smaller funds to the extent these
funds do not today have policies and
procedures for assessing
creditworthiness. As noted above, we
are not able to quantify many of the
costs (and benefits) discussed above.
However, we estimate that each fund
will incur, at a minimum, the collection
of information costs discussed in the
Paperwork Reduction Act section for a
total average one-time cost of
approximately $368 per fund.94 Funds
may also incur additional costs in
complying with the amendments which
we are unable to quantify, for the
reasons discussed above.
3. Alternatives
In adopting today’s amendments to
rule 5b–3, the Commission considered,
as noted by one commenter, including
specific factors or tests that a fund board
must apply in performing its credit
analysis under the rule.95 As noted
above, the number and scope of factors
that may be appropriate to making a
credit quality determination with
respect to a security may vary
significantly depending on the
particular security and through time.
Accordingly, we are not adopting
specific factors or tests that a fund board
must apply in performing credit
analysis, but may provide guidance in
the future.96
We also considered different
standards to replace credit ratings that
would help ensure that funds can
liquidate collateral quickly in the event
of a default. These alternatives
included, for example, omitting an
explicit liquidity requirement because
securities in the ‘‘highest rating
category’’ generally are more liquid than
lower quality securities. Other liquidity
alternatives we considered included
limiting collateral securities only to
cash and government securities because
liquidity may decline between the time
of acquisition and the time of default, or
prohibiting a fund from relying on rule
93 See
rule 38a–1(a).
supra note 79 and accompanying text. Staff
estimates that all funds will incur a one-time
aggregate cost of approximately $3.7 million to
make any necessary changes related to collections
of information under the Paperwork Reduction Act.
Id.
95 See supra note 43.
96 See supra notes 43–46 and accompanying text.
94 See
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5b–3 if, at any point after the time a
fund enters into a repurchase
agreement, the collateral could no
longer be liquidated within seven
calendar days. After considering the
alternatives, we believe that amended
rule 5b–3 strikes a better balance than
the alternatives by imposing a liquidity
requirement that is similar to the
liquidity standard inherent to the credit
quality rating required under the current
rule, while not unduly restricting funds’
flexibility to utilize a larger pool of
assets for collateralizing repurchase
agreements.
C. Forms N–1A, N–2, and N–3
Forms N–1A, N–2, and N–3, as
amended, eliminate the required use of
NRSRO credit ratings by funds that
choose to use credit quality
categorizations in the required table,
chart, or graph of portfolio holdings. If
a fund chooses to depict portfolio
holdings according to credit quality, the
fund must include a description of how
the credit quality of the holdings was
determined. If a fund uses credit ratings
assigned by a credit rating agency to
depict credit quality, the fund must
disclose how it identified and selected
the credit ratings.
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1. Economic Baseline
As noted above, the economic
baseline against which we measure the
economic effects is the regulatory
framework as it exists immediately
before the adoption of today’s
amendments. Currently, Forms N–1A,
N–2, and N–3 require shareholder
reports to include a table, chart, or
graph depicting portfolio holdings by
reasonably identifiable categories (e.g.,
type of security, industry sector,
geographic region, credit quality, or
maturity). The forms require the
categories to be selected in a manner
reasonably designed to depict clearly
the types of investments made by the
fund, given its investment objectives. If
credit quality is used to present
portfolio holdings, the forms currently
require that credit quality be depicted
using the credit ratings assigned by a
single NRSRO.
We believe, based on staff experience,
that the majority of funds choose to
depict their portfolios using credit
quality, and accordingly, report credit
ratings from a single NRSRO. As
discussed above, we conservatively
estimate that 10,683 funds collectively
file reports on Forms N–1A, N–2, and
N–3 each year and will be affected by
the amendments.97
97 See
supra note 84.
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2. Economic Analysis
The Dodd-Frank Act mandate is
designed to reduce potential reliance on
NRSRO credit ratings. Under the
amendments, funds have greater
flexibility to assess and depict credit
quality, which may lead to betterinformed investors who can, in turn,
make better capital allocation decisions.
Accordingly, better-informed investors
may make more effective investment
decisions based on their risk tolerance
and may promote increased competition
among funds. We note, however, that
funds might choose to report credit
quality in a more positive light than is
possible under the prior requirement to
use the credit ratings from a single
NRSRO. However, as discussed above,
the disclosure requirements we are
adopting today should mitigate many of
the potential adverse consequences. As
a result, today’s amendments may have
a varied effect on investors’ ability to
make effective capital allocation
choices.
Because we do not anticipate that
these amendments will result in large
changes in the portfolios held by funds
or their investors, we do not believe the
amendments would have more than a
marginal effect on efficiency or capital
formation. A potential benefit may arise
by allowing funds to use different credit
rating agencies for split-rated securities
because that may promote competition
between credit rating agencies to
provide ratings that are more accurate if
funds use the most accurate ratings for
each part of their portfolios even if those
ratings come from different credit rating
agencies. This may foster innovation in
the industry, and it may foster the
growth of niche credit rating agencies.
Although some funds may eliminate the
specific use of credit ratings in their
depiction of portfolio credit quality, we
anticipate that many of those funds are
likely to consider some outside analyses
in evaluating the credit quality of
portfolio securities.98 A fund’s
consideration of external analyses by
third-party sources determined to be
credible and reliable may contribute to
the accuracy of funds’ determinations
and thus help funds arrive at consistent
and more accurate depictions of credit
quality.
Under the amended forms, funds may
continue to depict portfolio holdings as
they do today: Funds can continue to
depict portfolio holdings without
98 Funds may elect to use a combination of
factors, including NRSRO credit ratings, in
depicting credit quality; or funds may use or
establish entirely new methods of depicting credit
quality. See ICI Comment Letter; Federated
Comment Letter (supporting the ICI Comment
Letter).
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making reference to credit quality, and
funds can continue to depict portfolio
holdings using credit ratings from one
NRSRO. Today’s amendments impose
no new costs on funds that depict
portfolio holdings based on criteria
other than credit quality, but they do
impose small additional costs on funds
that choose to portray portfolio holdings
using credit ratings from one NRSRO
because they must make new
disclosures about how the ratings were
identified and selected. We believe that
the majority of costs related to today’s
amendments to Forms N–1A, N–2, and
N–3 are the costs described above
related to the collections of information
under the Paperwork Reduction Act.
Accordingly, we estimate that funds on
average will incur costs of
approximately $1,137 per fund in
complying with the amendments.99 In
addition, funds may voluntarily incur
additional costs if they choose to
develop and apply new methodologies
to depict credit quality. Funds that
choose to do so will incur a cost not
only to determine the credit quality of
portfolio holdings but also a cost to
include in the registration statement a
description of how the credit quality of
portfolio holdings was determined, and
if credit ratings are used, how the
ratings were identified and selected.
3. Alternatives
In adopting the amendments to the
forms, the Commission considered
replacing the required use of credit
ratings with an option to depict a fund’s
portfolio by credit quality using the
credit ratings of only a single credit
rating agency. This approach, proposed
in 2011, was intended to eliminate the
possibility that a fund could choose to
use NRSRO credit ratings and then
select the most favorable ratings among
the credit ratings assigned by multiple
NRSROs. As discussed above, a number
of commenters suggested that funds be
permitted to use the credit ratings
assigned by more than one NRSRO for
split-rated securities, provided the
choice is made consistently, pursuant to
a disclosed policy. On balance, we
believe that the benefits of this
additional flexibility outweigh the
potential costs associated with the
possibility that funds cherry pick the
highest credit rating available. We note
that the risks associated with cherry
picking ratings are mitigated by the fact
that the forms, as amended, require that
99 See supra note 84 and accompanying text. Staff
estimates that all funds will incur a one-time
aggregate cost of approximately $12.1 million to
make any necessary changes to the registration
statement related to collections of information
under the Paperwork Reduction Act. Id.
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funds disclose how they identified and
selected the credit ratings, which would
include, for example, a fund policy that
selects the highest credit rating
available.
VI. Final Regulatory Flexibility
Analysis
The Commission has prepared the
following Final Regulatory Flexibility
Analysis (‘‘FRFA’’) in accordance with
section 4(a) of the Regulatory Flexibility
Act regarding the rule and form
amendments we are adopting today to
give effect to provisions of the DoddFrank Act.100 The FRFA relates to
amendments to rule 5b–3 under the
Investment Company Act and Forms N–
1A, N–2, and N–3 under the Investment
Company Act and Securities Act. We
prepared an Initial Regulatory
Flexibility Analysis (‘‘IRFA’’) in
conjunction with the 2011 Proposing
Release in March 2011.101
A. Need for and Objectives of the Rule
and Form Amendments
As described more fully in sections I
and III of this Release, to implement
section 939A of the Dodd-Frank Act, the
Commission is adopting amendments to
(i) rule 5b–3 to eliminate references to
the credit rating and replace it with an
alternative standard of creditworthiness
that is intended to achieve the same
objectives that the credit rating
requirement was designed to achieve
and (ii) Forms N–1A, N–2, and N–3 to
eliminate the required use of NRSRO
credit ratings by funds that choose to
use credit quality categorizations in the
required table, chart, or graph of
portfolio holdings in their shareholder
reports, and to permit funds that choose
to depict credit quality using credit
ratings assigned by a credit rating
agency to use different credit rating
agencies for split-rated securities.
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B. Significant Issues Raised by Public
Comment
In the 2011 Proposing Release, we
requested comment on the IRFA. In
particular, we sought comment on how
many small entities would be subject to
the proposed rule and form
amendments and whether the effect of
the proposed rule and form
amendments on small entities subject to
them would be economically
significant. None of the comment letters
we received addressed the IRFA. None
of the comment letters made comments
about the effect of the rule and form
100 5
U.S.C. 604(a).
2011 Proposing Release, supra note 10, at
section VIII.
101 See
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amendments on small investment
companies.
C. Small Entities Subject to the Rule and
Form Amendments
The amendments to rule 5b–3 and
Forms N–1A, N–2, and N–3 under the
Investment Company Act would affect
funds, including entities that are
considered to be a small business or
small organization (collectively, ‘‘small
entity’’) for purposes of the Regulatory
Flexibility Act.
Investment Companies. Under
Commission rules, for purposes of the
Investment Company Act and the
Regulatory Flexibility Act, an
investment company is a small entity if
it, together with other investment
companies in the same group of related
investment companies, has net assets of
$50 million or less as of the end of its
most recent fiscal year.102 Based on a
current review of filings submitted to
the Commission, we estimate that 171
investment companies may be
considered small entities and that all of
these investment companies may
potentially rely on rule 5b–3.103 As
discussed above, we recognize that
increased compliance costs are a
necessary result of the amendments to
rule 5b–3 and may disproportionately
impact smaller funds to the extent these
funds do not have policies and
procedures for assessing
creditworthiness. Based on a current
review of filings submitted to the
Commission, we estimate that
approximately 131 investment
companies that meet the definition of
small entity would be subject to the
amendments to Forms N–1A, N–2, and
N–3.
D. Projected Reporting, Recordkeeping,
and Other Compliance Requirements
Rule 5b–3. The amendments to rule
5b–3 allow a fund to treat the
acquisition of a repurchase agreement as
an acquisition of securities
collateralizing the repurchase agreement
for purposes of sections 5(b)(1) and
12(d)(3) of the Investment Company Act
if the collateral other than cash or
government securities consists of
securities that the fund’s board of
directors (or its delegate) determines at
the time the repurchase agreement is
entered into are: (i) Issued by an issuer
that has an exceptionally strong
capacity to meet its financial
obligations; and (ii) sufficiently liquid
102 17
CFR 270.0–10(a).
183 investment companies that meet the
definition of small entity include 12 business
development companies, which are subject to
sections 5 and 12 of the Investment Company Act.
15 U.S.C. 80a–58; 15 U.S.C. 80a–59.
103 The
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that they can be sold at approximately
their carrying value in the ordinary
course of business within seven
calendar days. A fund that acquires
repurchase agreements and intends the
acquisition to be treated as an
acquisition of the collateral securities
must determine whether it must change
its policies for evaluating collateral
securities under the amended rule and
must adopt and implement written
policies and procedures reasonably
designed to comply with the conditions
of amended rule 5b–3, including these
credit quality and liquidity
requirements that we are adopting.104
The costs associated with the
amendments to rule 5b–3 are those
discussed in section IV.A and V.B
above.
Forms N–1A, N–2, and N–3. The
amendments to Forms N–1A, N–2, and
N–3 apply to open-end management
investment companies, closed-end
management investment companies,
and separate accounts organized as
management investment companies that
offer variable annuity contracts,
including those that are small entities.
The amendments to Forms N–1A, N–2,
and N–3 eliminate the required use of
NRSRO credit ratings by funds that
choose to use credit quality
categorizations in the required table,
chart, or graph of portfolio holdings in
their shareholder reports. If a fund
chooses to depict portfolio holdings
according to credit quality, it must
include a description of how the credit
quality of the holdings was determined,
and if credit ratings assigned by a credit
rating agency are used to depict credit
quality, the fund must disclose how it
identified and selected the credit
ratings. The amended forms also permit
funds that choose to depict credit
quality using credit ratings assigned by
a credit rating agency to use different
credit rating agencies for split-rated
securities. The costs associated with the
amendments to the forms are those
discussed in section IV.B and V.C
above.
E. Agency Action To Minimize Effect on
Small Entities
The Regulatory Flexibility Act directs
us to consider significant alternatives
that would accomplish our stated
objectives, while minimizing any
significant adverse effect on small
entities. In connection with the rule and
form amendments, the Commission
considered the following alternatives: (i)
Establishing different compliance
standards or timetables that take into
account the resources available to small
104 17
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08JAR1
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entities; (ii) clarifying, consolidating, or
simplifying compliance and reporting
requirements under the rule for small
entities; (iii) use of performance rather
than design standards; and (iv)
exempting small entities from all or part
of the requirements.
We believe that special compliance or
reporting requirements for small
entities, or an exemption from coverage
for small entities, is not appropriate or
consistent with investor protection or
the Dodd-Frank Act. We believe that,
with respect to rule 5b–3, different
credit quality standards, special
compliance requirements or timetables
for small entities, or an exemption from
coverage for small entities, may create a
risk that those entities could acquire
repurchase agreements with collateral
that is less likely to retain its market
value or liquidity in the event of a
counterparty default. Further
consolidation or simplification of the
rule and form amendments for funds
that are small entities is inconsistent
with the Commission’s goals of fostering
investor protection.
The form amendments apply to all
investment companies that use Forms
N–1A, N–2, and N–3 to register under
the Investment Company Act and to
offer their securities under the
Securities Act. If the Commission had
excluded small entities from the form
amendments, small entities would have
been required to use NRSRO credit
ratings if they chose to depict credit
quality, while other entities would not
have been subject to that requirement.
We believe that special compliance or
reporting requirements, or an
exemption, for small entities would not
be appropriate because the amended
requirement—eliminating the required
use of credit ratings where a fund
chooses to depict the fund’s portfolio
based on credit quality—is intended to
eliminate potential reliance on NRSRO
credit ratings resulting from the
perception that the Commission
endorses the ratings because of their
required use in Commission forms.
We have endeavored through the form
amendments to minimize regulatory
burdens on investment companies,
including small entities, while meeting
our regulatory objectives. We have
endeavored to clarify, consolidate, and
simplify the requirements applicable to
investment companies, including those
that are small entities. Finally, the
amendments will use performance
rather than design standards for
determining the credit quality of
specific securities. For these reasons, we
have not adopted alternatives to rule
5b–3 and Forms N–1A, N–2, and N–3.
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Statutory Authority
The Commission is adopting
amendments to rule 5b–3 under the
authority set forth in sections 6(c) and
38(a) of the Investment Company Act
[15 U.S.C. 80a–6(c), 80a–37(a)] and
section 939A of the Dodd-Frank Act.
The Commission is adopting
amendments to Form N–1A, Form N–2,
and Form N–3 under the authority set
forth in sections 5, 6, 7, 10 and 19(a) of
the Securities Act [15 U.S.C. 77e, 77f,
77g, 77j, and 77s(a)]; sections 8, 24(a),
30 and 38 of the Investment Company
Act [15 U.S.C. 80a–8, 80a–24(a), 80a–29,
and 80a–37]; and section 939A of the
Dodd-Frank Act.
List of Subjects
17 CFR Part 239
Reporting and recordkeeping
requirements, Securities.
17 CFR Parts 270 and 274
Investment companies, Reporting and
recordkeeping requirements, Securities.
Text of Rule and Rule and Form
Amendments
For reasons set out in the preamble,
Title 17, Chapter II of the Code of
Federal Regulations is amended as
follows:
PART 239—FORMS PRESCRIBED
UNDER THE SECURITIES ACT OF 1933
1. The authority citation for Part 239
is revised to read in part as follow:
■
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s,
77z–2, 77z–3, 77sss, 78c, 78l, 78m, 78n,
78o(d), 78o–7, 78o–7 note, 78u–5, 78w(a),
78ll, 78mm, 80a–2(a), 80a–3, 80a–8, 80a–9,
80a–10, 80a–13, 80a–24, 80a–26, 80a–29,
80a–30, 80a–37, and Pub. L. 111–203, sec.
939A, 124 Stat. 1376 (2010), unless otherwise
noted.
*
*
*
*
*
PART 270—RULES AND
REGULATIONS, INVESTMENT
COMPANY ACT OF 1940
2. The authority citation for Part 270
is revised to read in part as follows:
■
Authority: 15 U.S.C. 80a–1 et seq., 80a–
34(d), 80a–37, 80a–39, and Pub. L. 111–203,
sec. 939A, 124 Stat. 1376 (2010), unless
otherwise noted.
*
*
*
*
*
■ 3. Section 270.5b–3 is amended by:
■ a. Adding ‘‘or’’ at the end of paragraph
(c)(1)(iv)(B);
■ b. Revising paragraph (c)(1)(iv)(C);
■ c. Removing paragraph (c)(1)(iv)(D);
■ d. Removing paragraphs (c)(5), (c)(6),
and (c)(8);
■ e. Redesignating paragraph (c)(4) as
(c)(5);
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1329
f. Adding new paragraph (c)(4); and
g. Redesignating paragraph (c)(7) as
paragraph (c)(6).
The revisions and addition read as
follows:
■
■
§ 270.5b–3 Acquisition of repurchase
agreement or refunded security treated as
acquisition of underlying securities.
*
*
*
*
*
(c) * * *
(1) * * *
(iv) * * *
(C) Securities that the investment
company’s board of directors, or its
delegate, determines at the time the
repurchase agreement is entered into:
(1) Each issuer of which has an
exceptionally strong capacity to meet its
financial obligations; and
Note to paragraph (c)(1)(iv)(C)(1): For a
discussion of the phrase ‘‘exceptionally
strong capacity to meet its financial
obligations’’ see Investment Company Act
Release No. 30847, (December 27, 2013).
(2) Are sufficiently liquid that they
can be sold at approximately their
carrying value in the ordinary course of
business within seven calendar days;
and
*
*
*
*
*
(4) Issuer, as used in paragraph
(c)(1)(iv)(C)(1) of this section, means the
issuer of a collateral security or the
issuer of an unconditional obligation of
a person other than the issuer of the
collateral security to undertake to pay,
upon presentment by the holder of the
obligation (if required), the principal
amount of the underlying collateral
security plus accrued interest when due
or upon default.
*
*
*
*
*
PART 239—FORMS PRESCRIBED
UNDER THE SECURITIES ACT OF 1933
PART 274—FORMS PRESCRIBED
UNDER THE INVESTMENT COMPANY
ACT OF 1940
4. The authority citation for Part 274
is revised to read in part as follows:
■
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s,
78c(b), 78l, 78m, 78n, 78o(d), 80a–8, 80a–24,
80a–26, 80a–29, and Pub. L. 111–203, sec.
939A, 124 Stat. 1376 (2010), unless otherwise
noted.
*
*
*
*
*
5. Form N–1A (referenced in
§§ 239.15A and 274.11A) is amended by
revising Item 27(d)(2) to read as follows:
■
Note: The text of Form N–1A does not, and
these amendments will not, appear in the
Code of Federal Regulations.
FORM N–1A
*
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*
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*
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Item 27. Financial Statements
*
*
*
*
*
(d) Annual and Semi-Annual Reports.
* * *
(2) Graphical Representation of
Holdings. One or more tables, charts, or
graphs depicting the portfolio holdings
of the Fund by reasonably identifiable
categories (e.g., type of security,
industry sector, geographic region,
credit quality, or maturity) showing the
percentage of net asset value or total
investments attributable to each. The
categories and the basis of presentation
(e.g., net asset value or total
investments) should be selected, and the
presentation should be formatted, in a
manner reasonably designed to depict
clearly the types of investments made
by the Fund, given its investment
objectives. If the Fund depicts portfolio
holdings according to credit quality, it
should include a description of how the
credit quality of the holdings were
determined, and if credit ratings, as
defined in section 3(a)(60) of the
Securities Exchange Act [15 U.S.C.
78(c)(a)(60)], assigned by a credit rating
agency, as defined in section 3(a)(61) of
the Securities Exchange Act [15 U.S.C.
78(c)(a)(61)], are used, explain how they
were identified and selected. This
description should be included near, or
as part of, the graphical representation.
*
*
*
*
*
■ 6. Form N–2 (referenced in §§ 239.14
and 274.11a–1) is amended by revising
Instruction 6.a. to Item 24 to read as
follows:
Note: The text of Form N–2 does not, and
these amendments will not, appear in the
Code of Federal Regulations.
FORM N–2
*
*
*
*
*
Item 24. Financial Statements
mstockstill on DSK4VPTVN1PROD with RULES
*
*
*
*
*
Instructions:
*
*
*
*
*
6. * * *
a. one or more tables, charts, or graphs
depicting the portfolio holdings of the
Fund by reasonably identifiable
categories (e.g., type of security,
industry sector, geographic region,
credit quality, or maturity) showing the
percentage of net asset value or total
investments attributable to each. The
categories and the basis of presentation
(e.g., net asset value or total
investments) should be selected, and the
presentation should be formatted, in a
manner reasonably designed to depict
clearly the types of investments made
by the Fund, given its investment
objectives. If the Fund depicts portfolio
VerDate Mar<15>2010
15:56 Jan 07, 2014
Jkt 232001
holdings according to credit quality, it
should include a description of how the
credit quality of the holdings were
determined, and if credit ratings, as
defined in section 3(a)(60) of the
Securities Exchange Act [15 U.S.C.
78(c)(a)(60)], assigned by a credit rating
agency, as defined in section 3(a)(61) of
the Securities Exchange Act [15 U.S.C.
78(c)(a)(61)], are used, explain how they
were identified and selected. This
description should be included near, or
as part of, the graphical representation.
*
*
*
*
*
■ 7. Form N–3 (referenced in §§ 239.17a
and 274.11b) is amended by revising
Instruction 6.(i) to Item 28(a) to read as
follows:
Note: The text of Form N–3 does not, and
these amendments will not, appear in the
Code of Federal Regulations.
FORM N–3
*
*
*
*
*
Item 28. Financial Statements
(a) * * *
Instructions:
*
*
*
*
*
6. * * *
(i) One or more tables, charts, or
graphs depicting the portfolio holdings
of the Fund by reasonably identifiable
categories (e.g., type of security,
industry sector, geographic region,
credit quality, or maturity) showing the
percentage of net asset value or total
investments attributable to each. The
categories and the basis of presentation
(e.g., net asset value or total
investments) should be selected, and the
presentation should be formatted, in a
manner reasonably designed to depict
clearly the types of investments made
by the Fund, given its investment
objectives. If the Fund depicts portfolio
holdings according to credit quality, it
should include a description of how the
credit quality of the holdings were
determined, and if credit ratings, as
defined in section 3(a)(60) of the
Securities Exchange Act [15 U.S.C.
78(c)(a)(60)], assigned by a credit rating
agency, as defined in section 3(a)(61) of
the Securities Exchange Act [15 U.S.C.
78(c)(a)(61)], are used, explain how they
were identified and selected. This
description should be included near, or
as part of, the graphical representation.
*
*
*
*
*
By the Commission.
Dated: December 27, 2013.
Lynn M. Powalski,
Deputy Secretary.
[FR Doc. 2013–31425 Filed 1–7–14; 8:45 am]
BILLING CODE P
PO 00000
Frm 00028
Fmt 4700
Sfmt 4700
DEPARTMENT OF VETERANS
AFFAIRS
38 CFR Part 17
RIN 2900–AO62
Community Residential Care
Department of Veterans Affairs.
Final rule.
AGENCY:
ACTION:
This rule adopts as final,
without change, an interim final rule
amending the Department of Veterans
Affairs (VA) regulations concerning
approval of non-VA community
residential care (CRC) facilities to allow
VA to waive such facilities’ compliance
with standards that do not jeopardize
the health or safety of residents. As
amended, the regulation allows VA to
grant a waiver of a CRC standard in
those limited circumstances where the
deficiency cannot be corrected to meet
a standard provided for in VA
regulation. This rulemaking also makes
a certain necessary technical
amendment to correct a reference to the
section addressing requests for a
hearing.
SUMMARY:
Effective Date: This final rule is
effective January 8, 2014.
FOR FURTHER INFORMATION CONTACT:
Nancy Quest, Director, Home and
Community Based Services (10P4G),
Veterans Health Administration, 810
Vermont Avenue NW., Washington, DC
20420, (202) 461–6064. (This is not a
toll-free number.)
SUPPLEMENTARY INFORMATION: In an
interim final rule published in the
Federal Register on May 29, 2013, at 78
FR 32124, VA amended 38 CFR 17.65,
which contains VA’s regulations
governing approvals and provisional
approvals of CRC facilities. The interim
final rule allowed VA to waive one or
more of the standards in 38 CFR 17.63
for the approval of a particular CRC
facility, provided that a VA safety expert
certifies that the deficiency does not
endanger the life or safety of the
residents; the deficiency cannot be
corrected; and granting the waiver is in
the best interests of the veteran in the
facility and VA’s CRC program. The
rulemaking also made a certain
necessary technical amendment to
§ 17.66. The interim final rule was
effective immediately upon publication
and provided a 60-day comment period,
which ended on July 29, 2013. VA
received no public comments and
therefore makes no changes to the
regulation.
Based on the rationale set forth in the
interim final rule, VA is adopting the
DATES:
E:\FR\FM\08JAR1.SGM
08JAR1
]]>Agencies
[Federal Register Volume 79, Number 5 (Wednesday, January 8, 2014)]
[Rules and Regulations]
[Pages 1316-1330]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-31425]
=======================================================================
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 239, 270, and 274
[Release Nos. 33-9506; IC-30847; File No. S7-7-11]
RIN 3235-AL02
Removal of Certain References to Credit Ratings Under the
Investment Company Act
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting amendments to a rule and three forms under the Investment
Company Act of 1940 (``Investment Company Act'') and the Securities Act
of 1933 (``Securities Act'') in order to implement a provision of the
Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank
Act''). Specifically, rule 5b-3 under the Investment Company Act
contains a reference to credit ratings in determining when an
investment company (``fund'') may treat a repurchase agreement as an
acquisition of securities collateralizing the repurchase agreement for
certain purposes under the Investment Company Act. The amendments we
are adopting today replace this reference to credit ratings with an
alternative standard designed to retain a similar degree of credit
quality to that in current rule 5b-3. The Commission is also adopting
amendments to Forms N-1A, N-2, and N-3 under the Investment Company Act
and Securities Act to eliminate the required use of NRSRO credit
ratings when a fund chooses to depict its portfolio holdings by credit
quality.
DATES: Effective Date: February 7, 2014; Compliance Date: July 7, 2014.
FOR FURTHER INFORMATION CONTACT: Adam Bolter, Senior Counsel, Thoreau
Bartmann, Branch Chief, or C. Hunter Jones, Assistant Director (202)
551-6792, Office of Investment Company Rulemaking, Division of
Investment Management, Securities and Exchange Commission, 100 F Street
NE., Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to
rule 5b-3 [17 CFR 270.5b-3] under the Investment Company Act.\1\ The
[[Page 1317]]
Commission is also adopting amendments to Forms N-1A [17 CFR 239.15A
and 17 CFR 274.11A], N-2 [17 CFR 239.14 and 17 CFR 274.11a-1], and N-3
[17 CFR 239.17a and 17 CFR 274.11b] under the Investment Company Act
and the Securities Act.\2\
---------------------------------------------------------------------------
\1\ 15 U.S.C. 80a. Unless otherwise noted, all references to
statutory sections are to the Investment Company Act, and all
references to rules under the Investment Company Act are to Title
17, Part 270 of the Code of Federal Regulations [17 CFR part 270].
\2\ 15 U.S.C. 77a.
---------------------------------------------------------------------------
Table of Contents
I. Background
II. Prior Actions of the Commission and Other Regulators
III. Discussion
A. Rule 5b-3
B. Forms N-1A, N-2, and N-3
IV. Paperwork Reduction Act
V. Economic Analysis
VI. Final Regulatory Flexibility Analysis
Statutory Authority
Text of Rule and Rule and Form Amendments
I. Background
The first use of a reference to ratings or rating agencies in
Commission rules was in 1975, when the Commission adopted the term
``nationally recognized statistical rating organization'' (``NRSRO'')
as part of amendments to the net capital rule for broker-dealers, rule
15c3-1 under the Securities Exchange Act of 1934 (``Exchange Act'')
(the ``Net Capital Rule'').\3\ The Commission eventually included
references to credit ratings issued by NRSROs in other rules under the
securities laws, including the Investment Company Act.\4\ In addition,
credit ratings by NRSROs have been used as benchmarks in federal and
state legislation, rules administered by other federal agencies, and
foreign regulatory schemes.\5\ Even prior to the enactment of the Dodd-
Frank Act,\6\ concerns about the wide-spread use of NRSRO credit
ratings in statutes and regulations prompted the Commission to explore
whether to eliminate references to credit ratings in Commission rules
because of the potential overreliance by investors and, investment
advisers and other financial professionals on these ratings, and
whether there are practical alternatives to NRSRO credit ratings that
could be used as benchmarks in regulations.\7\
---------------------------------------------------------------------------
\3\ See Adoption of Uniform Net Capital Rule and an Alternative
Net Capital Requirement for Certain Brokers and Dealers, Exchange
Act Release No. 11497 (June 26, 1975) [40 FR 29795 (July 16, 1975)];
17 CFR 240.15c3-1. The Net Capital Rule prescribes minimum net
capital requirements for broker-dealers and it uses NRSRO credit
ratings to determine the amount of the charge to capital a broker-
dealer must apply to certain types of debt instruments. See 17 CFR
240.15c3-1. The regulatory purpose was to provide a method for
determining net capital charges on different grades of debt
securities under the Net Capital Rule. See 17 CFR 240.15c3-1.
\4\ See, e.g., Acquisition and Valuation of Certain Portfolio
Instruments by Registered Investment Companies, Investment Company
Act Release No. 14983 (Mar. 12, 1986) [51 FR 9773 (Mar. 21, 1986)]
(incorporating the concept of NRSROs into the definition of
``eligible security'' in rule 2a-7 (governing money market funds)).
\5\ See, e.g., Report to Congress on Credit Ratings, Board of
Governors of the Federal Reserve System (July 2011); References to
Credit Ratings in FDIC Regulations, Federal Deposit Insurance
Corporation (July 2011); and Basel Committee on Banking Supervision,
Stocktaking on the use of credit ratings, Joint Forum (June 2009).
\6\ See Public Law 111-203, 124 Stat. 1376 (2010).
\7\ See infra section II.A (discussing other Commission actions
to remove references to credit ratings from its rules). See also
infra section II.B (discussing actions of other regulators to remove
references to credit ratings from their rules).
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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.'' \8\ 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.'' \9\
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\8\ Public Law 111-203, sec. 939A(a)(1)-(2). Section 939A of the
Dodd-Frank Act applies to all federal agencies.
\9\ Public Law 111-203, sec. 939A(b).
---------------------------------------------------------------------------
As a step toward implementing these mandates, in March 2011 the
Commission proposed to replace references to ratings issued by NRSROs
in two Commission rules and four Commission forms under the Investment
Company Act, including rule 5b-3 and Forms N-1A, N-2, and N-3.\10\ We
received 26 comment letters on the proposed rule and form
amendments.\11\ Several commenters addressed specific provisions of the
proposal to amend rule 5b-3 and Forms N-1A, N-2, and N-3, which we
discuss in more detail below.
---------------------------------------------------------------------------
\10\ 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''). Specifically, we proposed to: (i) Remove references to
credit ratings in rules 2a-7 and 5b-3 under the Investment Company
Act and replace them with alternative standards of creditworthiness;
(ii) adopt new rule 6a-5 under the Investment Company Act that would
establish a creditworthiness standard to replace the credit rating
reference in section 6(a)(5) removed by the Dodd-Frank Act; (iii)
eliminate required disclosures of credit ratings in Form N-MFP; and
(iv) remove the requirement that credit ratings be used when
portraying credit quality in shareholder reports from Forms N-1A, N-
2, and N-3. The Commission adopted new rule 6a-5 on November 19,
2012 and noted in its 2013 proposing release for money market reform
that the Commission would address references to credit ratings in
rule 2a-7 and Form N-MFP in a separate rulemaking. 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)]; Money Market Fund Reform; Amendments to Form PF, Investment
Company Act Release No. 30551 (June 5, 2013) [78 FR 36834 (June 19,
2013)]. Rule 3a-7 under the Investment Company Act also contains a
reference to ratings. In August 2011, in a concept release
soliciting comment on the treatment of asset-backed issuers under
the Investment Company Act, we sought comment on the role, if any,
that credit ratings should continue to play in the context of rule
3a-7. See Treatment of Asset-Backed Issuers under the Investment
Company Act, Investment Company Act Release No. 29779 (Aug. 31,
2011) [76 FR 55308 (Sept. 7, 2011)] at section III.A.1.
\11\ Most of these commenters criticized removing credit ratings
from rule 2a-7, but acknowledged that the Commission's proposal was
in response to the mandate in the Dodd-Frank Act. The Commission
plans to address these comments in a future rulemaking. See supra
note 10. The comment letters on the 2011 Proposing Release (File No.
S7-07-11) are available at https://www.sec.gov/comments/s7-07-11/s70711.shtml. In addition, to facilitate public input on the Dodd-
Frank Act, we provided a series of email links, organized by topic
on our Web site at https://www.sec.gov/spotlight/regreformcomments.shtml. The public comments we received on section
939A of the Dodd-Frank Act are available on our Web site at https://www.sec.gov/comments/df-title-ix/credit-rating-agencies/credit-rating-agencies.shtml.
---------------------------------------------------------------------------
We are adopting, largely as proposed, amendments to rule 5b-3 and
Forms N-1A, N-2, and N-3 to implement section 939A of the Dodd-Frank
Act and effectuate Congressional intent to reduce reliance on NRSRO
credit ratings.\12\ As discussed below, the amendments replace a
reference to required NRSRO credit ratings in rule 5b-3 for certain
securities held by funds as collateral for repurchase agreements with
an alternative standard that is designed to retain a similar degree of
credit quality. We are also amending Forms N-1A, N-2, and N-3 to
eliminate the required use of NRSRO credit ratings by funds that choose
to use credit quality categorizations in the required table, chart, or
graph of portfolio holdings. Under the amendments, funds that choose to
use credit quality to depict portfolio holdings must include a
description of how the credit quality of the holding was determined. If
a fund chooses to use credit ratings issued by a credit rating agency
to depict the credit quality of portfolio holdings, the fund must
[[Page 1318]]
include a description of how the credit ratings were identified and
selected.
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\12\ See Section 939A of the Dodd-Frank Act. Section 939A was
intended, at least in part, to address potential over-reliance on
NRSRO credit ratings resulting from perceived government-endorsement
of NRSROs. See Report of the House of Representatives Financial
Services Committee to Accompany H.R. 4173, H. Rep. No. 111-517 at
871 (2010).
---------------------------------------------------------------------------
In a separate release, the Commission is adopting final amendments
to remove references to credit ratings from rules on broker-dealer
financial responsibility and confirmations of transactions. These
amendments follow the Commission's April 2011 proposed rules in which
we proposed to amend rules and one form under the Exchange Act
applicable to broker-dealer financial responsibility, distributions of
securities, and confirmations of transactions in order to remove
references to credit ratings pursuant to section 939A of the Dodd-Frank
Act.\13\
---------------------------------------------------------------------------
\13\ See Removal of Certain References to Credit Ratings under
the Securities Exchange Act of 1934, Exchange Act Release No. 64352
(Apr. 27, 2011) [76 FR 26550 (May 6, 2011)] (requesting public
comment on proposed amendments to rule 15c3-1 (17 CFR 240.15c3-1),
rule 15c3-3 (17 CFR 240.15c3-3), rule 17a-4 (17 CFR 240.17a-4),
rules 101 and 102 of Regulation M (17 CFR 242.101 and 242.102), and
rule 10b-10 (17 CFR 240.10b-10), and one form--the General
Instructions to Form X-17A-5, Part IIB (17 CFR 249.617)--to remove
references to credit ratings and, in certain cases, substitute
alternative standards of creditworthiness). For purposes of
implementing section 939(e) of the Dodd-Frank Act, which eliminated
provisions in sections 3(a)(41) and 3(a)(53)(A) of the Exchange Act
that referenced NRSRO credit ratings, the Commission also requested
comment in the proposing release on potential standards of
creditworthiness to replace the credit rating references.
---------------------------------------------------------------------------
II. Prior Actions of the Commission and Other Regulators
As part of our implementation of section 939A, we have reviewed our
prior actions and those of other regulators. As discussed below, both
the Commission and other regulators have proposed and issued several
final rules towards implementation of the mandate under section 939A of
the Dodd-Frank Act. In some cases, the references to credit ratings
were replaced with an alternative standard of credit quality designed
to retain the same degree of credit quality and liquidity as reflected
by the use of credit ratings.
A. Prior Commission Actions
The Commission has long been concerned with the use of credit
ratings and has taken a variety of actions even before the enactment of
the Dodd-Frank Act regarding the use of NRSRO credit ratings in its
rules. For example, in 1994, the Commission published a concept release
soliciting comment on, among other things, whether the Commission
should eliminate references to NRSRO credit ratings from certain
rules.\14\ The Commission continued to consider the use of credit
ratings in its rules, when in 2003, we sought comment on alternative
benchmarks that could be used to meet the Commission's regulatory
objectives.\15\ Finally, in 2008, the Commission proposed amendments to
remove references to NRSRO credit ratings from certain of its rules
under the Securities Act, Exchange Act, and Investment Company Act.\16\
As previously noted, after the enactment of the Dodd-Frank Act, in
2011, the Commission proposed to remove credit ratings references from
certain rules and forms under the Investment Company Act.\17\ Also in
2011, the Commission separately proposed and adopted amendments
removing references to credit ratings in rules and forms under the
Securities Act and the Exchange Act related to offerings of securities
or issuer disclosure.\18\ Generally, in these prior actions, the
Commission has proposed or adopted amendments to its rules that seek to
retain a similar degree of credit quality to that in the rule being
amended by replacing credit ratings references with a two-part standard
that includes an assessment of the credit quality and the liquidity of
the security, the details of which vary according to the requirements
of the particular rule or form.
---------------------------------------------------------------------------
\14\ See Nationally Recognized Statistical Rating Organizations,
Exchange Act Release No. 34616 (Aug. 31, 1994) [59 FR 46314 (Sep. 7,
1994)]; see also Capital Requirements for Brokers or Dealers Under
the Securities Exchange Act of 1934, Exchange Act Release No. 39457
(Dec. 17, 1997) [62 FR 68018 (Dec. 30, 1997)].
\15\ See Rating Agencies and the Use of Credit Ratings under the
Federal Securities Laws, Exchange Act Release No. 47972 (June 4,
2003) [68 FR 35258 (June 12, 2003)]; see also Report on the Role and
Function of Credit Rating Agencies in the Operation of the
Securities Markets: As Required by Section 702(b) of the Sarbanes-
Oxley Act of 2002, Commission (Jan. 2003).
\16\ See, e.g., References to Ratings of Nationally Recognized
Statistical Rating Organizations, Exchange Act Release No. 58070
(July 1, 2008) [73 FR 40088 (July 11, 2008)]. In October 2009, the
Commission adopted several of the 2008 proposed amendments and re-
opened for comment the remaining amendments. See References to
Ratings of Nationally Recognized Statistical Rating Organizations,
Exchange Act Release No. 60789 (Oct. 5, 2009) [74 FR 52358 (Oct. 9,
2009)] (adopting release).
\17\ See 2011 Proposing Release supra note 10. One aspect of
that rule proposal has already been adopted. New rule 6a-5, adopted
by the Commission, replaced a credit rating requirement (removed by
Congress as part of the Dodd-Frank Act) applicable to debt
securities that certain business and industrial development
companies (``BIDCOs'') relying on the Investment Company Act
exemption in section 6(a)(5) may invest in. Under new rule 6a-5, a
BIDCO that relies on the exemption in section 6(a)(5) may invest in
certain debt securities, provided that the BIDCO board determines,
at the time of purchase, that the debt security is (1) of no greater
than moderate credit risk and (2) is sufficiently liquid. The
standard for liquidity is whether the security can be sold at or
near its carrying value within a reasonably short period of time.
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)].
\18\ See Security Ratings, Securities Act Release No. 9186 (Feb.
9, 2011) [76 FR 8946 (Feb. 16, 2011)]; see also Security Ratings,
Securities Act Release No. 9245 (July 27, 2011) [76 FR 46603 (Aug.
3, 2011)] (adopting amendments to rule 134 (17 CFR 230.134), rule
138 (17 CFR 230.138), rule 139 (17 CFR 230.139), rule 168 (17 CFR
230.168), Form S-3 (17 CFR 239.13), Form S-4 (17 CFR 239.25), Form
F-3 (17 CFR 239.33), and Form F-4 (17 CFR 230. 34) under the
Securities Act; rescinding Form F-9 (17 CFR 239.39); adopting
amendments to the Securities Act and Exchange Act forms and rules
that referred to Form F-9 to eliminate those references; and
amending Schedule 14A (17 CFR 240.14a-101) under the Exchange Act).
---------------------------------------------------------------------------
B. Actions of Other Regulators
A number of other federal agencies have also taken action to
implement section 939A of the Dodd-Frank Act, including regulations
proposed or adopted by the Commodity Futures Trading Commission
(``CFTC''),\19\ the Office of the Comptroller of the Currency
(``OCC''),\20\ the National Credit Union Administration (``NCUA''),\21\
the Federal Housing Finance Agency (``FHFA''),\22\ the Department of
Labor (``DOL''),\23\ and jointly by the OCC and Federal Reserve Board
(``FRB'').\24\ The actions taken by these other regulators were
considered in adopting today's amendments.
---------------------------------------------------------------------------
\19\ CFTC, Removing Any Reference to or Reliance on Credit
Ratings in Commission Regulations; Proposing Alternatives to the Use
of Credit Ratings, 76 FR 44262 (July 25, 2011).
\20\ OCC, Alternatives to the Use of External Credit Ratings in
the Regulations of the OCC, 77 FR 35253 (June 13, 2012).
\21\ NCUA, Alternatives to the Use of Credit Ratings, 77 FR
74103 (Dec. 13, 2012).
\22\ FHFA, Removal of References to Credit Ratings in Certain
Regulations Governing the Federal Home Loan Banks, 78 FR 30784 (May
23, 2013).
\23\ DOL, Proposed Amendments to Class Prohibited Transaction
Exemptions to Remove Credit Ratings Pursuant to the Dodd-Frank Wall
Street Reform and Consumer Protection Act, 78 FR 37572 (June 21,
2013).
\24\ OCC & FRB, Regulatory Capital Rules: Regulatory Capital,
Implementation of Basel III, Capital Adequacy, Transition
Provisions, Prompt Corrective Action, Standardized Approach for
Risk-weighted Assets, Market Discipline and Disclosure Requirements,
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital
Rule, 78 FR 62018 (Oct. 11, 2013).
---------------------------------------------------------------------------
III. Discussion
A. Rule 5b-3
Rule 5b-3 allows funds to treat the acquisition of a repurchase
agreement as an acquisition of securities collateralizing the
repurchase agreement for certain diversification and broker-dealer
counterparty limit purposes under the Investment Company Act \25\ if
[[Page 1319]]
the obligation of the seller to repurchase the securities from the fund
is ``collateralized fully.'' \26\ In a typical investment company
repurchase agreement, a fund enters into a contract with a broker,
dealer, or bank (the ``counterparty'' to the transaction) to purchase
securities. The counterparty agrees to repurchase the securities at a
specified future date, or on demand, for a price that is sufficient to
return to the fund its original purchase price, plus an additional
amount representing a return to the fund on its investment.
Economically, a repurchase agreement functions as a loan from the fund
to the counterparty, in which the securities purchased by the fund
serve as collateral for the loan.\27\
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\25\ Section 5(b)(1) of the Investment Company Act limits the
amount that a fund that holds itself out as being a diversified
investment company may invest in the securities of any one issuer
(other than the U.S. Government). This provision may limit the
number and principal amounts of repurchase agreements that a
diversified fund may enter into with any one counterparty. Section
12(d)(3) of the Investment Company Act generally prohibits a fund
from acquiring an interest in a broker, dealer, or underwriter.
Because a repurchase agreement may be considered to be the
acquisition of an interest in the counterparty, section 12(d)(3) may
limit a fund's ability to enter into repurchase agreements with many
of the firms that act as repurchase agreement counterparties. Rule
12d3-1 provides an exemption from the prohibitions of section
12(d)(3) under certain conditions, which exemption a fund may be
able to rely on in the event the repurchase agreement fails to meet
the look-through requirements of rule 5b-3. See Rule 5b-3 Adopting
Release, infra note 27, at section II.C. The ability of funds to
rely on rule 5b-3 of the Investment Company Act may affect the
degree to which a fund invests in repurchase agreements.
\26\ Rule 5b-3(a). The term ``collateralized fully'' is defined
in rule 5b-3(c)(1). In general, under rule 5b-3, a fund investing in
a repurchase agreement looks to the value and liquidity of the
securities collateralizing the repurchase agreement rather than the
creditworthiness of the counterparty for satisfaction of the
repurchase agreement. See Rule 5b-3 Adopting Release, infra note 27,
at section II.A.3. But see rule 2a-7(c)(4)(ii)(A) (requiring money
market fund boards to evaluate the counterparty's creditworthiness).
\27\ See Treatment of Repurchase Agreements and Refunded
Securities as an Acquisition of the Underlying Securities,
Investment Company Act Release No. 25058 (July 5, 2001) [66 FR 36156
(July 11, 2001)] (``Rule 5b-3 Adopting Release''). Repurchase
agreements provide funds with a convenient means to invest excess
cash on a secured basis, generally for short periods of time.
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Under current requirements, a repurchase agreement is
collateralized fully if, among other things, the collateral for the
repurchase agreement consists entirely of (i) cash items, (ii)
government securities,\28\ (iii) securities that at the time the
repurchase agreement is entered into are rated in the highest rating
category by the ``requisite NRSROs'' \29\ or (iv) unrated securities
that are of a comparable quality to securities that are rated in the
highest rating category by the requisite NRSROs, as determined by the
fund's board of directors or its delegate.\30\ When the Commission
proposed rule 5b-3, we explained that the highest rating category
requirement in the definition of fully collateralized was designed to
help ensure that the market value of the collateral would remain stable
and that the fund could liquidate the collateral quickly in the event
of a default by the counterparty. The high quality requirement was also
designed to limit a fund's exposure to the ability of the counterparty
to maintain sufficient collateral, and reflected the understanding that
securities of lower quality may be subject to greater price
fluctuation.\31\
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\28\ Government Security means ``any security issued or
guaranteed as to principal or interest by the United States, or by a
person controlled or supervised by and acting as an instrumentality
of the Government of the United States pursuant to authority granted
by the Congress of the United States; or any certificate of deposit
for any of the foregoing.'' Section 2(a)(16) of the Investment
Company Act. Government securities include, for example, U.S.
Treasury notes and bonds, and securities issued by the Federal Home
Loan Mortgage Company (``Freddie Mac''), Federal National Mortgage
Association (``Fannie Mae''), and Government National Mortgage
Association (``Ginnie Mae'').
\29\ The term ``requisite NRSROs'' means any two NRSROs that
have issued a rating with respect to a security or class of debt
obligations of an issuer or, if only one NRSRO has issued a rating
with respect to such security or class of debt obligations of an
issuer at the time the investment company acquires the security,
that NRSRO. Rule 5b-3(c)(6). This definition is deleted under the
amended rule.
\30\ Rule 5b-3(c)(1)(iv). The term ``unrated securities'' means
securities that have not received a rating from the requisite
NRSROs. Rule 5b-3(c)(8). This definition is deleted under the
amended rule.
\31\ See Treatment of Repurchase Agreements and Refunded
Securities as an Acquisition of the Underlying Securities,
Investment Company Act Release No. 24050 (Sept. 23, 1999) [64 FR
52476 (Sept. 29, 1999)] (``Rule 5b-3 Proposing Release'') at n.43
and accompanying text.
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Today we are amending rule 5b-3 to eliminate the requirement that
collateral other than cash or government securities be rated in the
highest category by the requisite NRSROs or be of comparable quality.
In place of this requirement, the amended rule requires that collateral
other than cash or government securities consist of securities that the
fund's board of directors (or its delegate) determines at the time the
repurchase agreement is entered into are: (i) Issued by an issuer that
has an exceptionally strong capacity to meet its financial obligations
on the securities collateralizing the repurchase agreement; and (ii)
sufficiently liquid that they can be sold at approximately their
carrying value in the ordinary course of business within seven calendar
days.\32\
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\32\ Amended rule 5b-3(c)(1)(iv)(C).
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The new credit quality standard we are adopting is designed to
retain a degree of credit quality that is similar to the existing
standard under rule 5b-3 and consistent with the two-part approach we
have taken in establishing credit quality standards to replace credit
rating references in other rules under the federal securities laws.\33\
We note that our amendment to rule 5b-3 does not affect a money market
fund that seeks special treatment of its repurchase agreement holdings
under the diversification provisions of rule 2a-7 because in order to
obtain such treatment, a money market fund is limited to investing in
repurchase agreements collateralized by cash items or government
securities (which remain unaffected by our amendments today).\34\ We
are adopting the liquidity component of the new standard as proposed,
but we have revised the credit quality component from what was proposed
to address certain commenters' concerns.
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\33\ See supra section II.A.
\34\ See rule 2a-7(a)(5).
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We proposed that collateral issuers be required to have the
``highest capacity'' to meet their financial obligations on the
collateral securities.\35\ Three of the five commenters who addressed
the proposed amendments to rule 5b-3 argued that this standard is not
consistent with the standard established by the ratings reference in
the current rule because the proposed standard does not contemplate any
variation in creditworthiness among issuers that meet the highest
rating standard.\36\ Commenters suggested that short-term collateral
securities rated ``A-1+'' or ``A-1'' by Standard & Poor's both would
satisfy the rating condition under the current rule, but that only
those rated ``A-1+'' would likely have satisfied the credit standard
under our proposal.\37\ Accordingly, as these commenters recommended,
the amended rule requires an issuer to have an ``exceptionally strong''
capacity to meet its financial obligations on the collateral
securities.\38\ We are adopting this
[[Page 1320]]
standard, as revised from our proposal, because we believe that, like
the current rule, it permits some variation in creditworthiness among
issuers while being designed to retain a degree of risk limitation
similar to the current rule.\39\ In the case of asset-backed securities
that serve as collateral, an evaluation of the capacity of the issuer
to meet its financial commitment on the security should include an
assessment of the quality of the underlying assets and the structure of
the asset-backed security.\40\
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\35\ See proposed rule 5b-3(c)(1)(iv)(C)(1).
\36\ Federated Investors, Inc. Comment Letter (Apr. 25, 2011)
(``Federated Comment Letter''); Investment Company Institute Comment
Letter (Apr. 25, 2011) (``ICI Comment Letter''); T. Rowe Price
Associates, Inc. Comment Letter (Apr. 25, 2011) (``T. Rowe Price
Comment Letter''). But see 2011 Proposing Release (discussing the
proposed ``highest capacity'' standard and noting that ``[a]n issuer
of collateral securities that the board (or its delegate) determined
has an exceptionally strong capacity to repay its short or long-term
debt obligations . . . would satisfy the proposed [highest capacity]
standard'').
\37\ See Standard & Poor's Ratings Definitions, infra note 39 at
5 (which may designate an ``A-1'' rating with a plus sign to
designate the obligor's capacity to meet its financial obligations
is extremely strong).
\38\ See ICI Comment Letter; Federated Comment Letter
(supporting the ICI Comment Letter); and T. Rowe Price Comment
Letter (generally agreeing with the ICI Comment Letter).
\39\ See Fitch Ratings, International Issuer and Credit Rating
Scales, https://www.fitchratings.com/web_content/ratings/fitch_ratings_definitions_and_scales.pdf (stating that a rating of AAA
is used in cases of ``exceptionally strong capacity for payment of
financial commitments''); Moody's Investor Service Rating Symbols
and Definitions, https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004 (stating that
ratings of Aaa are of the ``highest quality, subject to the lowest
level of credit risk''); and Standard & Poor's Ratings Definitions,
https://img.en25.com/Web/StandardandPoors/Ratings_Definitions.pdf
(stating that for a rating of AAA, ``[t]he obligor's capacity to
meet its financial commitment on the obligation is extremely
strong'').
\40\ See Revisions to Rules Regulating Money Market Funds,
Investment Company Act Release No. 19959 (Dec. 17, 1993) [58 FR
68585 (Dec. 28, 1993)] at text accompanying nn.108-109 (``[t]he
credit quality of a typical asset backed security depends both upon
the structure of the security and the quality of the underlying
assets.''); Money Market Fund Reform, Investment Company Act Release
No. 29132 (Feb. 23, 2010) [75 FR 10060 (Mar. 4, 2010)] at text
accompanying n.131 (noting that the minimal credit risk analysis
that a money market fund board (or its delegate) must conduct before
investing in an asset-backed security should include, among other
things, (i) an analysis of the underlying assets to ensure they are
properly valued and provide sufficient asset coverage for the cash
flow required to fund the asset-backed security under various market
conditions and (ii) an analysis of the terms of any liquidity or
other support provided by the sponsor of the asset-backed security).
See also Alternatives to the Use of External Credit Ratings in the
Regulations of the Office of the Comptroller of the Currency (June
4, 2012) [77 FR 35253 (June 13, 2012)] at text following n.2 (in
adopting an issuer-based credit quality standard to replace credit
ratings, the OCC indicates that, in the case of a structured finance
transaction, principal and interest repayment is not necessarily
solely reliant on the direct debt repaying capacity of the issuer or
obligor).
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As discussed above, we are adopting the liquidity component of the
new standard as proposed. The liquidity standard in the amended rule is
similar to the standard used in rule 2a-7 governing money market funds,
and is also used in other rules under the Investment Company Act.\41\
No commenters addressed the proposed liquidity standard.
---------------------------------------------------------------------------
\41\ See rule 2a-7(a)(19) (defining illiquid security to mean a
security that cannot be sold or disposed of in the ordinary course
of business within seven calendar days at approximately the value
ascribed to it by the fund). See also rule 10f-3(a)(3) (requiring,
among other things, that ``eligible municipal securities'' be
sufficiently liquid that they can be sold at or near their carrying
value within a reasonably short period of time).
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We expect that securities that actively trade in a secondary market
at the time of the acquisition of the repurchase agreement will satisfy
the liquidity component of the standard. We also understand that most
securities used to collateralize repurchase agreements generally
actively trade in a secondary market.\42\ Securities that do not
actively trade in a secondary market would likely require a more in-
depth evaluation by the board or its delegate to determine whether they
meet the liquidity standard.
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\42\ Repurchase agreements are often collateralized by
securities that include, but are not limited to, agency
collateralized mortgage-backed obligations (``CMOs''), agency
debentures and strips, agency mortgage-backed securities, private
label CMOs, corporate debt, equity securities, money market
instruments and U.S. Treasury securities. See, e.g., Tri-Party Repo
Statistical Data (as of August 2013), https://www.newyorkfed.org/banking/tpr_infr_reform_data.html. The securities that often
collateralize repurchase agreements trade frequently. For example,
data from the Securities Industry and Financial Markets Association
for January through August 2013 shows average daily trading volume,
in billions of dollars, as follows: Agency debentures and strips
($7.1); agency mortgage-backed securities ($242.9); corporate debt
($145.4); U.S. Treasury securities ($551.4) (available at https://www.sifma.org/research/statistics.aspx).
---------------------------------------------------------------------------
The final amendments do not, as one commenter suggested, include
specific factors or tests that the board or its delegate must apply in
performing its credit analysis.\43\ This commenter acknowledged that a
reliable and objective shorthand measure of credit risk that could be
incorporated into Commission regulations is currently unavailable.\44\
The Commission considered including specific factors for funds to
consider in performing credit analysis under rule 5b-3. On balance, we
believe that, in the context of rule 5b-3, the new credit quality
standards provide sufficiently clear criteria under which a fund board
or its delegate can make determinations regarding credit quality and
liquidity for this particular purpose. Fund boards should also be
familiar with applying similar credit quality standards used in other
Commission rules.\45\ Fund boards may also consult external resources
and Commission staff guidance (if applicable) for additional guidance
on making credit quality determinations in certain circumstances.\46\
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\43\ See Better Markets Comment Letter (Apr. 25, 2011) (``Better
Markets Comment Letter''). This commenter suggested certain factors
that they believed funds should be required to consider when
evaluating the creditworthiness of an issuer or a debt security.
\44\ Id. We note that another commenter that recommended that we
establish an objective standard for credit quality determinations
did not provide any examples of such criteria. See New York City Bar
Committee on Investment Management Regulation Comment Letter (Apr.
29, 2011) (``NY City Bar Comment Letter'').
\45\ See adopting release, supra note 16 (the Commission adopted
amendments to rule 10f-3, revising the definition of ``eligible
municipal security'' by replacing references to credit ratings with
a similar two-part credit quality standard). See also text
accompanying note 49.
\46\ See, e.g., Tri-Party Repo Infrastructure, Reform Task
Force, https://www.newyorkfed.org/tripartyrepo/. See cf. Securities
and Exchange Commission, Division of Investment Management, IM
Guidance Update, Counterparty Risk Management Practices With Respect
to Tri-Party Repurchase Agreements (July 2013) (providing guidance
to funds on the legal and operational steps that funds should
consider if a counterparty fails and defaults on its obligations
under a tri-party repurchase agreement), available at https://www.sec.gov/divisions/investment/guidance/im-guidance-2013-03.pdf.
---------------------------------------------------------------------------
The new credit quality standard is intended to achieve the same
objectives that the credit rating requirement was designed to achieve,
i.e., to limit collateral securities to those that are likely to retain
a sufficiently stable market value and that, under ordinary
circumstances, the fund would be able to liquidate quickly, at or near
their carrying value in the event of a counterparty default.\47\
Amended rule 5b-3 would not, however, prohibit a fund board from
establishing its own additional criteria for what the fund may accept
as collateral for repurchase agreements under the amended rule.
---------------------------------------------------------------------------
\47\ See supra note 31.
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Under the final rule, as was proposed, the fund's board will be
required to make credit quality determinations for all collateral
securities that are not cash items or government securities, rather
than just for unrated securities. In addition, as in the current rule,
the amended rule continues to permit the board to delegate these credit
quality and liquidity determinations.\48\ We do not agree with the
concerns of one commenter that this determination will impose undue
burdens on the board because the determination is similar to what rule
5b-3 currently requires a fund board (or its delegate) to make with
respect to unrated collateral securities.\49\ In addition, the amended
rule will continue to permit the board of directors to delegate credit
quality and liquidity determinations that the board believes
[[Page 1321]]
are within the delegate's expertise if the board retains sufficient
oversight.\50\
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\48\ This is similar to rule 2a-7, which permits the board to
delegate decisions regarding credit quality. See rule 2a-7(e).
\49\ See NY City Bar Comment Letter (asserting that fund boards
would be assigned responsibility for making determinations that are
not within their expertise and arguing that the ability to delegate
the determination does not relieve them of ultimate responsibility).
See also infra section V.b.2. See rule 5b-3(c)(1)(iv)(D) (requiring
that unrated securities other than government securities be ``of
comparable quality'' to securities rated in the highest category by
requisite NRSROs).
\50\ See Amended rule 5b-3(c)(1)(iv)(C); see also 2011 Proposing
Release, supra note 10, at n.51 (``As in the current rule, the
proposed rule would permit the board to delegate this credit quality
and liquidity determination.''). We expect that a fund's written
policies and procedures would include guidelines for the fund's
delegate (typically, the investment adviser) in making required
determinations under rule 5b-3 and oversight of the fund adviser's
compliance in making such determinations. See rule 38a-1. These
policies and procedures typically would identify the process to be
followed by the board (or its delegate) in making these credit and
liquidity evaluations, including, as appropriate, the types of data
to be used or factors to be considered and the person(s) or
position(s) responsible. They also typically would provide for
regular reporting to the board, as appropriate, about these
evaluations, to allow the board to provide effective oversight of
the process.
---------------------------------------------------------------------------
Under the amended rule, when determining credit quality and
liquidity, the board (or its delegate) may incorporate into its
analysis ratings, reports, opinions and other assessments issued by
third parties, including NRSROs. A board should evaluate the basis for
using any third-party assessment, including an NRSRO rating, in
determining whether collateral meets the new standard and would not
rely on the use of an NRSRO rating as a standard by itself without
evaluating the quality of each NRSRO's assessment. In this way, the
board could determine which third-party providers are credible and
reliable and provide assessments that would be most appropriate to
incorporate in making determinations under the amended rule. Delegation
of these functions, as well as the use of third-party providers, may
help to limit the potential increase in burdens on the board. One
commenter suggested that we not allow a fund board to consider credit
ratings in determining if a repurchase agreement is fully
collateralized, stating that this would conflict with section 939A of
the Dodd-Frank Act.\51\ We believe, however, that credit ratings can
serve as a useful data point for evaluating credit quality, and as
noted above, a fund's board (or its delegate) may not rely solely on
the credit ratings of an NRSRO without performing additional due
diligence.
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\51\ See Better Markets Comment Letter.
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A fund that enters into repurchase agreements and relies on rule
5b-3 must maintain written policies and procedures that are reasonably
designed to comply with the conditions of the rule, including the
credit quality and liquidity requirements we are adopting today, and
funds may therefore have to amend their policies and procedures.\52\ We
also understand that credit quality standards for securities
collateralizing repurchase agreements are typically negotiated in the
agreements between funds and counterparties.\53\ We understand that
those standards currently include a rating (for rated collateral
securities) and any additional criteria that a fund manager considers
necessary to ensure that the credit quality of collateral securities
meets the fund's requirements, or, for unrated securities, a comparable
credit quality standard. The amended rule does not prohibit fund boards
(or their delegates) from considering the credit quality standards in
current repurchase agreements and policies and procedures adopted to
comply with the current rule as part of their analysis, provided that
fund boards (or their delegates) determine that the ratings specified
in the repurchase agreements and policies and procedures meet the
standards we are adopting today, and that the agencies providing the
ratings used in the policies and procedures are credible and reliable
for that use. A fund could also revise its repurchase agreements and
policies and procedures to change or eliminate the consideration of
specific credit ratings or to incorporate other third-party evaluations
of credit quality.\54\
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\52\ Registered funds are required to adopt and implement
written policies and procedures reasonably designed to prevent the
fund's violation of federal securities laws. See rule 38a-1(a); see
also infra sections IV.A and V.B.
\53\ Many repurchase market participants will only accept AAA-
rated paper such as government bonds as collateral. See Moorad
Choudhry, The Repo Handbook (2d ed. 2010) at 298. Counterparties to
repurchase agreements generally assess counterparty credit risk
exposure based on the ``haircut''--For example, $100 of securities
collateralizing a loan of $97 produces a 3% haircut. The haircut may
be greater depending on the counterparties' assessment of the
collateral provider's creditworthiness. See Repo and Securities
Lending, Staff Report No. 529, Federal Reserve Bank of New York
(Dec. 2011, Rev. Feb. 2013). Assessments of credit quality are not
standardized but are participant specific and negotiated at the time
of the transaction. Id.
\54\ See 2011 Proposing Release, supra note 10, at n.58. An
estimate of the potential costs is discussed infra at section IV.A.
---------------------------------------------------------------------------
As discussed above, amended rule 5b-3 replaces the requirement that
collateral for repurchase agreements consist of securities rated in the
highest category by the requisite NRSROs (other than cash and
government securities) with a requirement that the collateral other
than cash and government securities consist of securities issued by an
issuer that has an exceptionally strong capacity to meet its financial
obligations and that are sufficiently liquid. Consistent with the
protection of investors and as necessary and appropriate in the public
interest, we are also amending rule 5b-3 to define an issuer to include
an issuer of an unconditional guarantee of the security.\55\ We
proposed this amendment to preserve a fund's ability to use the same
types of collateral securities as it currently uses to satisfy the
conditions of rule 5b-3. We received no comments on this aspect of the
proposal and are adopting it as proposed. Thus, under amended rule 5b-
3, a collateral security with an unconditional guarantee, the issuer of
which meets the new credit quality test, satisfies that element of the
standard.
---------------------------------------------------------------------------
\55\ Amended rule 5b-3(c)(4) (defining ``issuer'' to mean ``the
issuer of a collateral security or the issuer of an unconditional
obligation of a person other than the issuer of the collateral
security to undertake to pay, upon presentment by the holder of the
obligation (if required), the principal amount of the underlying
collateral security plus accrued interest when due or upon
default.'').
---------------------------------------------------------------------------
B. Forms N-1A, N-2, and N-3
We are also adopting amendments to Forms N-1A, N-2, and N-3 to
remove the required use of credit ratings assigned by an NRSRO. Forms
N-1A, N-2, and N-3, among other things, contain the requirements for
shareholder reports of mutual funds, closed-end funds, and certain
insurance company separate accounts that offer variable annuities.\56\
---------------------------------------------------------------------------
\56\ Open-end management investment companies, commonly known as
mutual funds, use Form N-1A. Closed-end management investment
companies use Form N-2. Separate accounts organized as management
investment companies that offer variable annuity contracts use Form
N-3.
---------------------------------------------------------------------------
Currently, Forms N-1A, N-2, and N-3 require shareholder reports to
include a table, chart, or graph depicting portfolio holdings by
reasonably identifiable categories (e.g., type of security, industry
sector, geographic region, credit quality, or maturity).\57\ The forms
require the categories to be selected in a manner reasonably designed
to depict clearly the types of investments made by the fund, given its
investment objectives. If credit quality is used to present portfolio
holdings, the forms currently require that credit quality be depicted
using the credit ratings assigned by a single NRSRO. We are amending
Forms N-1A, N-2, and N-3, as proposed, to no longer require the use of
NRSRO credit ratings by funds that choose to use credit quality
categorizations in the required table, chart, or graph of portfolio
holdings. Accordingly, funds that choose to show credit quality
categorizations in the required table, chart, or graph may use
alternative categorizations that are not based on NRSRO credit ratings.
---------------------------------------------------------------------------
\57\ Item 27(d)(2) of Form N-1A; Instruction 6(a) to Item 24 of
Form N-2; Instruction 6(i) to Item 28(a) of Form N-3.
---------------------------------------------------------------------------
In a change from the 2011 Proposing Release, however, under the
amended forms, funds that choose to continue to
[[Page 1322]]
use credit ratings will no longer be restricted to using the credit
ratings assigned by a single NRSRO. Accordingly, funds that choose to
depict credit quality using credit ratings assigned by a credit rating
agency may use different credit rating agencies for split-rated
securities (i.e., securities that have received different ratings from
multiple credit rating agencies) and they may use ratings provided by
credit rating agencies that are not NRSROs.\58\ Funds will also be
required to describe how the credit quality of the holdings was
determined, and if credit ratings are used, a description of how they
were identified and selected.\59\
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\58\ We are replacing the term ``ratings'' with ``credit
ratings'' and ``nationally recognized statistical rating
organization `NRSRO' '' with ``credit rating agency'' as defined
under the Exchange Act. See sections 3(a)(60) [15 U.S.C. 78c(a)(60)]
and 3(a)(61) [15 U.S.C. 78c(a)(61)] of the Exchange Act, which
define ``credit rating'' and ``credit rating agency'', respectively.
\59\ See Amended Item 27(d)(2) of Form N-1A; Amended Instruction
6(a) to Item 24 of Form N-2; Amended Instruction 6(i) to Item 28(a)
of Form N-3.
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Four of the five substantive comments we received on the proposed
amendments to Forms N-1A, N-2, and N-3, supported eliminating the
required use of NRSRO credit ratings to depict credit quality.\60\ Two
of these commenters noted that shareholders would benefit from
information about the credit quality of a fund's portfolio securities,
whether determined by an NRSRO or internally.\61\
---------------------------------------------------------------------------
\60\ ICI Comment Letter; Vanguard Comment Letter; T. Rowe Price
Comment Letter; Federated Comment Letter (supporting the ICI's
comments). The fifth commenter argued that the Commission is not
required to remove references to credit ratings from the forms
pursuant to section 939A of the Dodd-Frank Act. See BlackRock
Comment Letter. Regardless of whether the Commission is required to
remove from the forms references to credit ratings, the Commission
believes that the removal of such references is consistent with the
purpose of section 939A of the Dodd-Frank Act.
\61\ ICI Comment Letter; Federated Comment Letter (supporting
the ICI's comments).
---------------------------------------------------------------------------
Although most commenters supported eliminating the required use of
credit ratings to depict credit quality, four commenters opposed the
proposed requirement that a fund that chooses to use NRSRO credit
ratings must use the credit ratings of a single NRSRO. Instead, these
commenters recommended that when a security is split-rated, the fund be
permitted to choose which NRSRO rating to use, provided the choice is
made consistently pursuant to a disclosed policy.\62\ These commenters
argued that this approach would benefit funds and investors by allowing
funds to disclose credit quality information in shareholder reports in
a manner consistent with marketing materials and internal investment
policies.\63\
---------------------------------------------------------------------------
\62\ ICI Comment Letter; Vanguard Comment Letter; T. Rowe Price
Comment Letter; Federated Comment Letter (supporting the ICI's
comments). Two commenters noted that the Financial Industry
Regulatory Authority (``FINRA'') permits funds to use different
approaches to portray the credit quality of split-rated bonds in
marketing materials (noting further that funds receive credit rating
information through data feeds and that it would be more cost
efficient for funds to rely on a single data feed to comply with one
consistent SEC/FINRA requirement). See ICI Comment Letter; Vanguard
Comment Letter.
\63\ See ICI Comment Letter; Federated Comment Letter
(supporting the ICI's comments); Vanguard Comment Letter.
---------------------------------------------------------------------------
We agree with commenters and have revised the final form amendments
to provide this additional degree of flexibility. Accordingly, the
amended forms permit funds to consider alternative approaches to
presenting credit quality that accurately and effectively describe the
credit quality of the fund's portfolio. For example, under the amended
forms, a fund could have a policy of disclosing the median credit
quality rating for split-rated securities instead of only using the
ratings of a single credit rating agency (when more than two rating
agencies rate the security).\64\ In the 2011 Proposing Release, we
proposed to maintain the general requirement that ratings be selected
from a single NRSRO because we were concerned about the possibility
that a fund may select the most favorable credit ratings among credit
ratings assigned by multiple NRSROs. On balance, we are persuaded by
commenters that the benefits of this additional flexibility outweigh
the potential ``cherry picking'' concern. We believe that the risks
associated with cherry picking ratings are mitigated by the disclosure
requirements discussed below.\65\ For example, if a fund discloses
that, with respect to split-rated securities, it is the fund's policy
to select the highest credit rating provided by a credit rating agency,
investors will be on notice that the fund has made a decision not to
include potentially lower and more conservative measures of credit
quality. In addition, we believe that in some circumstances selecting
credit ratings from more than one credit rating agency may reflect a
more comprehensive approach to credit quality analysis that results in
information about credit quality that may be more accurate or complete.
For example, a fund that reviews credit ratings from three rating
agencies, discards the outliers (i.e., the highest and lowest ratings),
and selects the middle rating,\66\ has evaluated credit quality from a
broader set of market participants that may lead to a more complete
evaluation of credit quality.
---------------------------------------------------------------------------
\64\ See infra note 70 and accompanying and following text
(discussing the difference between using median and average credit
ratings).
\65\ See Amended Item 27(d)(2) of Form N-1A; Amended Instruction
6(a) to Item 24 of Form N-2; Amended Instruction 6(i) to Item 28(a)
of Form N-3.
\66\ See, e.g., Fact Sheet, BlackRock Bond Index Fund
(portraying credit quality using the median credit rating from among
S&P, Moody's, and Fitch, when all three agencies rate a security),
available at https://www2.blackrock.com/webcore/litService/search/getDocument.seam?venue=PUB_IND&source=CONTENT&serviceName=publicServiceView&ContentID=1111147239&venue=FP_ML; Fact Sheet, Vanguard High-Yield Tax-Exempt Fund
Investor Shares (same), available at https://personal.vanguard.com/us/funds/snapshot?FundId=0044&FundIntExt=INT.
---------------------------------------------------------------------------
Under the amended forms, funds that choose to depict portfolio
holdings according to credit quality must include a description of how
the credit quality of the holdings was determined.\67\ This description
should include a discussion of the credit quality evaluation process,
the rationale for its selection, and an overview of the factors
considered, such as the terms of the security (e.g., interest rate, and
time to maturity), the obligor's capacity to repay the debt, and the
quality of any collateral. If the fund uses credit ratings issued by a
credit rating agency to depict credit quality, the fund should explain
how the credit ratings were identified and selected, and include this
description near, or as part of, the graphical representation.\68\ This
description should include, if applicable, a discussion of: (i) The
criteria considered or process used in selecting the credit ratings
(e.g., the fund might use the median credit rating from among three
rating agencies \69\); (ii) how the fund evaluated those criteria
(i.e., the due diligence performed); (iii) how the fund reports credit
ratings for any security that is not rated by the credit rating agency
selected if the fund has a policy of using the ratings of a
[[Page 1323]]
single rating agency (e.g., has the fund selected a designated
alternate rating agency); (iv) how the fund reports credit ratings for
any security that is not rated by any credit rating agency (i.e., the
process for self-rating); or (v) other fund policies on selecting
credit ratings for purposes of disclosure. We expect that this
discussion, modified and expanded upon by funds as appropriate, will
provide investors with insight into how the fund identified and
selected the credit ratings used in depicting the fund's portfolio by
credit quality.
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\67\ See supra note 65; see also ICI Comment Letter
(recommending that funds be permitted to choose which NRSRO rating
to use for split-rated securities, provided that the choice is made
pursuant to a disclosed policy).
\68\ If a fund does not use credit ratings, its description of
how the credit quality of the holdings was determined would also
need to be near, or as part of, the graphical representation. See
Amended Item 27(d)(2) of Form N-1A; Amended Instruction 6(a) to Item
24 of Form N-2; Amended Instruction 6(i) to Item 28(a) of Form N-3.
\69\ For example, Morningstar prefers that bonds be classified
using the Barclays Capital Family of Indices ratings rules (i.e.,
use the middle rating of Moody's, S&P and Fitch after dropping the
highest and lowest available ratings; if only two rating agencies
rate a security then the lowest rating should be used; and if only
one agency rates a security then that rating should be used). See
Morningstar Fixed-Income Style Box Methodology (Apr. 30, 2012) at
https://corporate.morningstar.com/us/documents/MethodologyDocuments/MethodologyPapers/FixedIncomeStyleBoxMeth.pdf.
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We recognize that under the final form amendments, a fund has a
variety of options when depicting its portfolio holdings using credit
quality. For example, a fund might choose not to use credit ratings and
could rely instead on internal credit assessments. If a fund does not
use credit ratings, we note that it might be misleading for a fund to
describe its portfolio holdings quality with similar descriptions as
the ratings nomenclature used by rating agencies (e.g., AAA, Aa), or to
characterize the securities as ``rated.'' If a fund chooses to depict
its portfolio using credit ratings issued by a credit rating agency, a
fund could choose to use the median credit rating from among multiple
credit rating agencies (discarding the highest and lowest ratings) when
a security is split-rated.\70\ We note, however, that it might be
misleading for a fund to disclose an average credit quality rating that
is based on ratings from multiple credit rating agencies because credit
rating agencies may use different criteria to evaluate the credit
quality of an issuer. A fund might also choose other methods for
evaluating credit quality of portfolio securities, such as a policy of
selecting the highest or lowest credit rating for split-rated
securities among the ratings issued by certain specified rating
agencies.\71\ As discussed above, a fund must include in its disclosure
a description of how the credit quality of the holdings was determined,
no matter the method used.
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\70\ Id.; see also supra note 66.
\71\ See, e.g., Fact Sheet, Fidelity Institutional Money Market
Prime Money Market Portfolio--Institutional CL (categorizing
portfolio credit quality for investment grade taxable and municipal
bond funds and multi-asset class funds with a fixed income component
using the highest credit rating among Moody's, S&P, or Fitch),
available at https://fundresearch.fidelity.com/mutual-funds/composition/31607A208.
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The amended forms are intended to provide funds with the
flexibility to present credit ratings in a manner that more clearly
explains the credit quality of the fund's portfolio and the method by
which the fund determined that quality.
IV. Paperwork Reduction Act
Certain provisions of the amendments we are adopting contain
``collections of information'' within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\72\ The titles for the existing
collections of information we are amending are: (i) ``Rule 30e-1 under
the Investment Company Act of 1940, Reports to Stockholders of
Management Companies''; \73\ and (ii) ``Rule 38a-1 under the Investment
Company Act of 1940, Compliance procedures and practices of registered
investment companies.'' We adopted those rules pursuant to the
Investment Company Act. There is currently no approved collection of
information for rule 5b-3, and the amendments do not create any new
collections under that rule. The amendments to rule 5b-3 do, however,
affect the collection of information burden for rule 38a-1.
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\72\ 44 U.S.C. 3501-3520.
\73\ The amendments to Forms N-1A, N-2, and N-3 relate solely to
the contents of fund shareholder reports. The PRA burden associated
with fund shareholder reports is included in the burden associated
with the collection of information for rule 30e-1 under the
Investment Company Act rather than Forms N-1A, N-2 and N-3.
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An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a
currently valid control number. We published notice soliciting comments
on the collection of information requirements in the 2011 Proposing
Release and submitted the proposed collections of information to the
Office of Management and Budget (``OMB'') for review in accordance with
44 U.S.C. 3507(d) and 5 CFR 1320.11 under the control numbers 3235-0025
(rule 30e-1) and 3235-0586 (rule 38a-1). We received no comments on the
PRA estimates contained in the 2011 Proposing Release.
A. Rule 38a-1
Rule 5b-3 under the Investment Company Act allows funds to treat
the acquisition of a repurchase agreement as an acquisition of
securities collateralizing the repurchase agreement for purposes of
sections 5(b)(1) and 12(d)(3) of the Investment Company Act under
certain conditions. Rule 5b-3, as amended, requires that the securities
collateralizing a repurchase agreement consist of securities that the
fund's board of directors, or its delegate, determines are issued (or
have unconditional guarantees that are issued) by an issuer that has an
exceptionally strong capacity to meet its financial obligations and are
highly liquid.\74\ To that end, the fund's board of directors, pursuant
to rule 38a-1 under the Investment Company Act, must have procedures
that are reasonably designed to ensure that the fund is able to comply
with the conditions of amended rule 5b-3, including the credit quality
and liquidity requirements outlined in the amended rule.\75\ As
discussed above, these procedures should be designed to limit
collateral securities to those that are likely to retain a stable
market value and that, in ordinary circumstances, the fund would be
able to liquidate quickly in the event of a default. This rule 38a-1
collection of information will be mandatory for funds that rely on rule
5b-3. Records of information made in connection with this requirement
will be required to be maintained for inspection by Commission staff,
but the collection will not otherwise be submitted to the Commission.
To the extent that the Commission receives confidential information
pursuant to this collection of information, such information would be
kept confidential, subject to the provisions of applicable law.\76\
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\74\ Amended rule 5b-3(c)(1)(iv)(C). See supra section III.A.
\75\ Under rule 38a-1, funds must have written policies and
procedures reasonably designed to prevent violation of the federal
securities laws. Rule 38a-1(a)(1). Funds thus would have policies
and procedures for complying with rule 5b-3, which would include
policies and procedures relating to credit quality determinations of
unrated collateral securities, if appropriate.
\76\ See, e.g., 5 U.S.C. 552. Exemption 4 of the Freedom of
Information Act provides an exemption for ``trade secrets and
commercial or financial information obtained from a person and
privileged or confidential.'' 5 U.S.C. 552(b)(4). Exemption 8 of the
Freedom of Information Act provides an exemption for matters that
are ``contained in or related to examination, operating, or
condition reports prepared by, on behalf of, or for the use of an
agency responsible for the regulation or supervision of financial
institutions.'' 5 U.S.C. 552(b)(8).
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We do not anticipate that the amendments to rule 5b-3 will
significantly change collection of information burdens under rule 38a-1
because we believe funds would likely rely significantly on their
current policies and procedures to determine the credit quality of
collateral securities and comply with amended rule 5b-3. As we
indicated above, we understand that credit quality standards for
securities collateralizing repurchase agreements typically are
contained in the repurchase agreements between funds and
counterparties.\77\ We understand that those standards currently
include a rating (for rated collateral securities) and any additional
criteria a fund manager considers
[[Page 1324]]
necessary to ensure that the credit quality of the collateral
securities meets the fund's requirements, or, for unrated securities, a
comparable credit quality standard. Counterparties provide collateral
securities to conform to these standards and funds confirm that the
securities are conforming. As we have noted above, funds can continue
to consider evaluations of outside sources, including credit ratings
that the board determines are credible and reliable in making their
credit quality determinations under the amended rule. We expect that
funds will likely continue to rely on their current policies and
procedures (i.e., using credit quality standards that include ratings
currently set forth in their repurchase agreements with
counterparties). Thus, we do not expect that the amendments to rule 5b-
3 will significantly change the current collection of information
burden estimates for rule 38a-1.\78\ Nevertheless, funds may review
their repurchase agreements and policies and procedures that address
rule 5b-3 compliance and make technical changes to those documents in
response to the amendments. Staff estimated in the proposal and
continues to believe that it will take, on average, 1.5 hours of a
senior business analyst's time to perform this review and make any
technical changes for an individual fund portfolio, for an estimated
one-time additional burden of 15,176 hours for all fund portfolios
(other than money market fund portfolios).\79\ Amortized over three
years, the staff estimates that the estimated annual aggregate burden
will be 5,059 burden hours.\80\
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\77\ See supra note 53 and accompanying text.
\78\ The current approved annual burden for rule 38a-1 under the
PRA is 248,455 hours. As discussed below, as amended, the collection
of information requirement will be 263,631 hours (248,455 + 15,176).
\79\ For purposes of this PRA analysis, we assume that all funds
enter into repurchase agreements and rely on rule 5b-3. We have not
included money market funds in our estimates, however, because they
are subject to different requirements for the collateralization of
repurchase agreements under rule 2a-7. See text accompanying note
34. The staff's estimate is based on staff examination of industry
data as of August 31, 2013 and includes 10,117 fund portfolios. We
therefore estimate that there will be 10,117 respondents to this
collection of information. The amount is calculated as follows:
10,117 fund portfolios x 1.5 hours = 15,176 one-time additional
burden hours for all fund portfolios. We estimate that the one-time
additional annual burden is 1.5 hours per respondent.
The monetized burden hours are calculated as follows: 15,176
hours x $245 per hour = $3,718,120 one-time additional costs. The
staff estimates that the internal cost for time spent by a senior
business analyst is $245 per hour. This estimate, as well as other
internal time cost estimates made in this analysis, is derived from
SIFMA's Management and Professional Earnings in the Securities
Industry 2012, modified by Commission staff to account for an 1800-
hour work week and multiplied by 5.35 to account for bonuses, firm
size, employee benefits and overhead.
\80\ The amount is calculated as follows: 15,176 burden hours/3
= 5,059 burden hours. Amortized over three years, staff estimates
that the annual aggregate burden cost will be: $3,718,820/3 =
$1,239,373.
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We anticipate that the fund's board will review the fund manager's
recommendation, but that the cost of this review will be incorporated
in the fund's overall annual board costs and would not result in any
particular additional cost. We received no comments on these estimates
and therefore have not modified them.\81\
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\81\ The PRA costs have been modified slightly since the 2011
Proposing Release to reflect a more current estimate of the number
of fund portfolios affected, as well as updated hourly wages based
on the 2012 SIFMA table.
---------------------------------------------------------------------------
B. Rule 30e-1
The amendments to Forms N-1A, N-2, and N-3 eliminate the required
use of NRSRO credit ratings by funds that choose to use credit quality
categorizations in the table, chart, or graph of portfolio holdings
provided in shareholder reports. The collection of information is
mandatory for those funds that choose to use credit quality
categorizations in these forms. If a fund chooses to depict portfolio
holdings according to credit quality, the fund must include a
description of how the credit quality of the holdings was determined.
If credit ratings assigned by a credit rating agency are used, the fund
must disclose how it identified and selected the credit ratings.
Responses to the disclosure requirements will not be kept confidential.
Although funds would remain obligated to provide a table, chart, or
graph of portfolio holdings by reasonably identifiable categories, the
amendments require that certain funds must make new disclosures. Under
our proposed amendment, we estimated that there would be no additional
collection of information burden as a result of proposing to remove the
required use of credit ratings from the forms.\82\ Under our amended
rule, however, funds that choose to use credit quality categorizations
must disclose how the fund made the credit quality determinations, and
if the fund uses credit ratings issued by a credit rating agency, the
fund must disclose how it identified and selected the credit
ratings.\83\
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\82\ See 2011 Proposing Release, section IV.C.
\83\ The current approved annual burden for rule 30e-1 under the
PRA is 903,000 hours. As discussed below, as amended, the collection
of information requirement will be 935,049 hours (903,000 + 32,049).
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Accordingly, based on staff experience, the staff estimates that it
will take, on average, 3 hours of an attorney's time to perform this
review and make any technical changes to an individual fund's
disclosures, for an estimated burden of 32,049 hours for all funds.\84\
Amortized over three years, the staff estimates that the estimated
annual aggregate burden will be 10,683 burden hours and that there will
be approximately 10,683 respondents.\85\
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\84\ The staff's estimate of the number of funds is based on
staff examination of industry data as of August 31, 2013 and
includes 10,683 funds that collectively file reports on Forms N-1A,
N-2, and N-3 each year. We note that this estimate is conservative
because it is likely that some fund complexes will achieve economies
of scale when revising their disclosures, do not use credit quality
when describing portfolio holdings, or whose current disclosures
already satisfy the requirements of the amended rule and thus would
not need to make any changes. The amount is calculated as follows:
10,683 funds x 3 hours = 32,049 one-time additional burden hours for
all funds. We estimate that the one-time additional annual burden is
3 hours per respondent.
The monetized burden hours are calculated as follows: 32,049
hours x $379 per hour = $12,146,571 one-time additional costs. The
staff estimates that the internal cost for time spent by an in-house
attorney is $379 per hour. This estimate, as well as other internal
time cost estimates made in this analysis, is derived from SIFMA's
Management and Professional Earnings in the Securities Industry
2012, modified by Commission staff to account for an 1800-hour work
week and multiplied by 5.35 to account for bonuses, firm size,
employee benefits and overhead.
\85\ The amount is calculated as follows: 32,049 burden hours/3
= 10,683 burden hours. Amortized over three years, staff estimates
that the annual aggregate burden cost will be: $12,146,571/3 =
$4,048,857.
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V. Economic Analysis
A. Overview
As discussed above, we are adopting rule and form amendments to
implement section 939A of the Dodd-Frank Act. The amendments to rule
5b-3 replace a NRSRO credit rating standard with alternative credit
quality and liquidity criteria that are designed to achieve the same
purposes as the NRSRO credit rating standard without imposing
unnecessarily burdensome costs. The amendments to Forms N-1A, N-2, and
N-3 remove the required use of credit ratings when portraying credit
quality in shareholder reports, but require that those funds include a
description of how the credit quality of the holdings were determined,
and if credit ratings assigned by a credit rating agency are used, how
the credit ratings were identified and selected. The regulatory changes
adopted today will directly affect investment companies registered
under the Investment Company Act and could affect the demand for rating
agencies' services by eliminating the required use of NRSRO credit
ratings in rule 5b-3 and Forms N-1A, N-2, and N-3. The amendments to
[[Page 1325]]
rule 5b-3 may also affect other parties such as repurchase agreement
counterparties (e.g., broker-dealers and banks), investors, and issuers
of collateral securities. Finally, we recognize that the elimination of
the required use of NRSRO credit ratings in rule 5b-3 and Forms N-1A,
N-2, and N-3 may reduce the incentive for credit rating agencies to
register as NRSROs and thereby be subject to the Commission's oversight
and statutory and regulatory requirements applicable to NRSROs. We
received no comments on the cost-benefit analysis contained the 2011
Proposing Release.
At the outset, the Commission notes that, where possible, we have
attempted to quantify the costs and benefits expected to result from
adopting the amendments to rule 5b-3 and Forms N-1A, N-2, and N-3.
However, wherever the discussion of costs or benefits is not quantified
in this section it is because the Commission is unable to quantify the
economic effects because it lacks the information necessary to provide
a reasonable estimate. For example, as discussed below, the Commission
does not have available to it comprehensive information on the exposure
of funds to different repurchase agreement market segments, the nature
and type of collateral used in repurchase agreements, or the extent to
which funds rely on rule 5b-3. Because of this lack of data, including
the extent to which funds may rely on rule 5b-3, we are unable to
quantify the costs to comply with the amended rule and note that the
costs could vary from our estimates. We discuss below the economic
baseline, costs and benefits of our final rule and form amendments,
alternatives considered, as well as the impact on efficiency,
competition, and capital formation.
B. Rule 5b-3
Rule 5b-3, as amended, permits a fund to treat the acquisition of a
repurchase agreement as an acquisition of securities collateralizing
the repurchase agreement for purposes of sections 5(b)(1) and 12(d)(3)
of the Investment Company Act if the collateral other than cash or
government securities consists of securities that the fund's board of
directors, or its delegate, determines at the time the repurchase
agreement is entered into are: (i) Issued by an issuer that has an
exceptionally strong capacity to meet its financial obligations; and
(ii) sufficiently liquid that they can be sold at approximately their
carrying value in the ordinary course of business within seven calendar
days.
1. Economic Baseline
The economic baseline against which we measure the economic effects
of these amendments is the regulatory framework as it exists
immediately before the adoption of today's amendments. Currently, rule
5b-3 allows funds to treat the acquisition of a repurchase agreement as
an acquisition of securities collateralizing the repurchase agreement
for certain diversification and broker-dealer counterparty limit
purposes under the Investment Company Act if the obligation of the
seller to repurchase the securities from the fund is ``collateralized
fully.'' In general, under rule 5b-3, a fund investing in a repurchase
agreement looks to the value and liquidity of the securities
collateralizing the repurchase agreement rather than the
creditworthiness of the counterparty for satisfaction of the repurchase
agreement. Under current requirements, a repurchase agreement is
collateralized fully if, among other things, the collateral for the
repurchase agreement consists entirely of (i) cash items, (ii)
government securities, (iii) securities that at the time the repurchase
agreement is entered into are rated in the highest rating category by
the ``Requisite NRSROs'' or (iv) unrated securities that are of a
comparable quality to securities that are rated in the highest rating
category by the Requisite NRSROs, as determined by the fund's board of
directors or its delegate.
As of the end of 2012, the total repurchase agreement market
approximated $3 trillion.\86\ The repurchase agreement market has two
primary segments, bilateral and tri-party.\87\ The bilateral segment
comprises cash-driven transactions against specific collateral while
the tri-party segment comprises cash-driven transactions against
general collateral. We believe that investment companies' primary
exposure to repurchase agreements is through the tri-party market, but
the Commission does not have available to it comprehensive information
on the exposure in either market segment. The collateral used in the
approximately $2 trillion tri-party market is dominated by government
securities: Approximately 35% consists of Treasury securities and
approximately 50% consists of agency mortgage-backed securities, agency
debentures, and agency collateralized mortgage obligations.\88\
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\86\ See Financial Stability Oversight Council, 2013 Annual
Report at 65-66, available at https://www.treasury.gov/initiatives/fsoc/Documents/FSOC%202013%20Annual%20Report.pdf.
\87\ See id. (noting a third repo market segment--the general
collateral finance market--which primarily settles inter-dealer
transactions on the tri-party repo platform).
\88\ Id.
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While we believe that many funds invest in tri-party repurchase
agreements, comprehensive information about the extent to which funds
invest in these agreements is not available to us. Nor are we able to
estimate how often funds rely on rule 5b-3 when entering into
repurchase agreements, or the extent to which fund repurchase
agreements are collateralized with securities other than cash or
government securities. However, we are able to estimate the extent of
money market fund participation in the tri-party repurchase market
using Form N-MFP data, which shows that money market funds held
approximately $591 billion in tri-party repurchase agreements as of the
end of 2012. While we understand almost all funds rely on rule 5b-3 on
occasion (for example when approaching diversification limits or
avoiding restrictions on investments in certain entities), we do not
have the information necessary to determine how frequently those funds
rely on rule 5b-3 in their daily transactions in repurchase agreements.
Accordingly, we are largely unable to quantify the benefits and costs
discussed below.
2. Economic Analysis
Amended rule 5b-3 is intended to establish a similar credit quality
standard to the NRSRO credit rating standard we are replacing in order
to achieve the same objectives that the NRSRO credit rating reference
requirement was designed to achieve in the existing rule, i.e., limit
collateral securities to those that are likely to retain a stable
market value and that, under ordinary circumstances, the fund would be
able to liquidate quickly at or near its carrying value in the event of
a counterparty default. Although amended rule 5b-3 seeks to maintain a
similar degree of credit quality as the standard it replaces, the Dodd-
Frank Act mandate is designed to reduce reliance on NRSRO credit
ratings.\89\
---------------------------------------------------------------------------
\89\ See supra note 12.
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Some fund boards or their delegates, after independent analysis,
might make a determination of credit quality that comports with the
analysis of the NRSRO credit ratings and, accordingly, make no
substantive changes to the funds' investments in repurchase agreements.
Other fund boards might turn to non-NRSRO sources (``third-party
providers'') to satisfy the new requirements, which may result in a
different pool of assets from which the funds may select for
collateralizing
[[Page 1326]]
repurchase agreements. We believe that this flexibility of allowing for
a broader range of credit quality models will increase competition for
such models, whether from internal assessments made by the fund or from
external assessments made by third-party providers such as credit
rating agencies. As a result, credit assessments, and the repurchase
agreement market in general, may become more efficient and may promote
capital formation through a more accurate assessment of credit risk
that may increase investment in repurchase agreements.
We recognize, as discussed above, that funds typically establish
standards for the credit quality of collateral securities (that include
credit ratings and additional credit quality criteria required by the
fund) in repurchase agreements with counterparties.\90\ Funds could
change their policies and procedures to reflect changes made to the
rule by the amendments, but the rule would not prohibit funds from
considering the standards in current repurchase agreements and policies
and procedures provided that the fund's board or its delegate made the
determination that those standards satisfy the standards in amended
rule 5b-3. As a result, amended rule 5b-3 may not significantly change
the types of collateral securities held by funds relying on rule 5b-3.
---------------------------------------------------------------------------
\90\ See supra text preceding note 53.
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Amended rule 5b-3 requires the fund's board or its delegate to make
a determination about the collateral of each repurchase agreement. This
will increase the regulatory burden on the fund's board,\91\ but we
believe that the burden is significantly reduced by the fund board's
ability to incorporate ratings, reports, analyses, and other
assessments issued by third parties, including NRSRO ratings that the
fund's board concludes are credible and reliable for purposes of making
the evaluation. Moreover, fund boards that find these increased
regulatory burdens to be excessive can mitigate them by restricting the
fund to repurchase agreement collateral that consists of cash and
government securities.
---------------------------------------------------------------------------
\91\ See NY City Bar Comment Letter, supra note 44.
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If the fund's board decides to rely primarily on NRSRO ratings as
part of the process of evaluating credit quality, the fund may incur
some additional costs from today's amendments.\92\ However, some fund
boards may decide not to rely primarily on NRSRO ratings, perhaps
because of a more cost efficient way of making the required
determinations or because they believe NRSRO ratings are not helpful or
sufficient in evaluating credit quality. Reducing the emphasis on NRSRO
ratings could also adversely affect the quality of NRSRO ratings.
Currently, the importance attached to NRSRO ratings may impart
franchise value to the NRSRO's ratings business. By eliminating
references to NRSRO ratings in Federal regulations, section 939A of the
Dodd-Frank Act could reduce these franchise values and mitigate NRSROs'
incentives to produce credible and reliable ratings. Moreover, the
Commission recognizes that the elimination of the required use of
credit ratings in Commission rules and forms may reduce the incentive
for credit rating agencies to register as NRSROs with the Commission
and thereby be subject to the Commission's oversight and the statutory
and regulatory requirements applicable to NRSROs. To the extent that
the quality and accuracy of NRSRO ratings is adversely affected,
negative impacts on the capital allocation process and economic
efficiency would result.
---------------------------------------------------------------------------
\92\ See supra text following note 53.
---------------------------------------------------------------------------
The new methodologies that the fund's board employs may result in a
pool of assets from which the fund may select for collateralizing
repurchase agreements that is different from a pool based on NRSRO
ratings. This may affect the fund relative to the baseline of NRSRO
ratings by including or excluding as collateral assets that are
different from the collateral permitted under the current rule. In
turn, this could increase the credit risk in the pool of collateral
assets or decrease the return earned by investing in repurchase
agreements. Both of these effects may lead to a less efficient market
for repurchase agreement collateral. Issuers' ability to raise capital
may also be adversely affected to the extent that issuers of collateral
securities lose the regulatory preference that currently exists because
of the required use of NRSRO ratings within rule 5b-3. We do not,
however, believe that the amended rule is likely to lead to the
acceptance of riskier collateral in practice because the standard we
are adopting is very similar to the standard articulated by the NRSROs
for securities that have received the highest ratings. In addition, we
anticipate that fund boards and advisers will retain the credit quality
standards in their current repurchase agreements and their existing
policies and procedures that address compliance with current rule 5b-3
and include ratings that they believe are credible and reliable.
Although we believe that boards of funds relying on rule 5b-3 have
established policies and procedures for complying with the rule,\93\
funds may incur costs to revise existing policies and procedures for
investing in repurchase agreements to comply with amended rule 5b-3. We
recognize that increased compliance costs are a necessary result of our
amendments to rule 5b-3 and may disproportionately impact smaller funds
to the extent these funds do not today have policies and procedures for
assessing creditworthiness. As noted above, we are not able to quantify
many of the costs (and benefits) discussed above. However, we estimate
that each fund will incur, at a minimum, the collection of information
costs discussed in the Paperwork Reduction Act section for a total
average one-time cost of approximately $368 per fund.\94\ Funds may
also incur additional costs in complying with the amendments which we
are unable to quantify, for the reasons discussed above.
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\93\ See rule 38a-1(a).
\94\ See supra note 79 and accompanying text. Staff estimates
that all funds will incur a one-time aggregate cost of approximately
$3.7 million to make any necessary changes related to collections of
information under the Paperwork Reduction Act. Id.
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3. Alternatives
In adopting today's amendments to rule 5b-3, the Commission
considered, as noted by one commenter, including specific factors or
tests that a fund board must apply in performing its credit analysis
under the rule.\95\ As noted above, the number and scope of factors
that may be appropriate to making a credit quality determination with
respect to a security may vary significantly depending on the
particular security and through time. Accordingly, we are not adopting
specific factors or tests that a fund board must apply in performing
credit analysis, but may provide guidance in the future.\96\
---------------------------------------------------------------------------
\95\ See supra note 43.
\96\ See supra notes 43-46 and accompanying text.
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We also considered different standards to replace credit ratings
that would help ensure that funds can liquidate collateral quickly in
the event of a default. These alternatives included, for example,
omitting an explicit liquidity requirement because securities in the
``highest rating category'' generally are more liquid than lower
quality securities. Other liquidity alternatives we considered included
limiting collateral securities only to cash and government securities
because liquidity may decline between the time of acquisition and the
time of default, or prohibiting a fund from relying on rule
[[Page 1327]]
5b-3 if, at any point after the time a fund enters into a repurchase
agreement, the collateral could no longer be liquidated within seven
calendar days. After considering the alternatives, we believe that
amended rule 5b-3 strikes a better balance than the alternatives by
imposing a liquidity requirement that is similar to the liquidity
standard inherent to the credit quality rating required under the
current rule, while not unduly restricting funds' flexibility to
utilize a larger pool of assets for collateralizing repurchase
agreements.
C. Forms N-1A, N-2, and N-3
Forms N-1A, N-2, and N-3, as amended, eliminate the required use of
NRSRO credit ratings by funds that choose to use credit quality
categorizations in the required table, chart, or graph of portfolio
holdings. If a fund chooses to depict portfolio holdings according to
credit quality, the fund must include a description of how the credit
quality of the holdings was determined. If a fund uses credit ratings
assigned by a credit rating agency to depict credit quality, the fund
must disclose how it identified and selected the credit ratings.
1. Economic Baseline
As noted above, the economic baseline against which we measure the
economic effects is the regulatory framework as it exists immediately
before the adoption of today's amendments. Currently, Forms N-1A, N-2,
and N-3 require shareholder reports to include a table, chart, or graph
depicting portfolio holdings by reasonably identifiable categories
(e.g., type of security, industry sector, geographic region, credit
quality, or maturity). The forms require the categories to be selected
in a manner reasonably designed to depict clearly the types of
investments made by the fund, given its investment objectives. If
credit quality is used to present portfolio holdings, the forms
currently require that credit quality be depicted using the credit
ratings assigned by a single NRSRO.
We believe, based on staff experience, that the majority of funds
choose to depict their portfolios using credit quality, and
accordingly, report credit ratings from a single NRSRO. As discussed
above, we conservatively estimate that 10,683 funds collectively file
reports on Forms N-1A, N-2, and N-3 each year and will be affected by
the amendments.\97\
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\97\ See supra note 84.
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2. Economic Analysis
The Dodd-Frank Act mandate is designed to reduce potential reliance
on NRSRO credit ratings. Under the amendments, funds have greater
flexibility to assess and depict credit quality, which may lead to
better-informed investors who can, in turn, make better capital
allocation decisions. Accordingly, better-informed investors may make
more effective investment decisions based on their risk tolerance and
may promote increased competition among funds. We note, however, that
funds might choose to report credit quality in a more positive light
than is possible under the prior requirement to use the credit ratings
from a single NRSRO. However, as discussed above, the disclosure
requirements we are adopting today should mitigate many of the
potential adverse consequences. As a result, today's amendments may
have a varied effect on investors' ability to make effective capital
allocation choices.
Because we do not anticipate that these amendments will result in
large changes in the portfolios held by funds or their investors, we do
not believe the amendments would have more than a marginal effect on
efficiency or capital formation. A potential benefit may arise by
allowing funds to use different credit rating agencies for split-rated
securities because that may promote competition between credit rating
agencies to provide ratings that are more accurate if funds use the
most accurate ratings for each part of their portfolios even if those
ratings come from different credit rating agencies. This may foster
innovation in the industry, and it may foster the growth of niche
credit rating agencies. Although some funds may eliminate the specific
use of credit ratings in their depiction of portfolio credit quality,
we anticipate that many of those funds are likely to consider some
outside analyses in evaluating the credit quality of portfolio
securities.\98\ A fund's consideration of external analyses by third-
party sources determined to be credible and reliable may contribute to
the accuracy of funds' determinations and thus help funds arrive at
consistent and more accurate depictions of credit quality.
---------------------------------------------------------------------------
\98\ Funds may elect to use a combination of factors, including
NRSRO credit ratings, in depicting credit quality; or funds may use
or establish entirely new methods of depicting credit quality. See
ICI Comment Letter; Federated Comment Letter (supporting the ICI
Comment Letter).
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Under the amended forms, funds may continue to depict portfolio
holdings as they do today: Funds can continue to depict portfolio
holdings without making reference to credit quality, and funds can
continue to depict portfolio holdings using credit ratings from one
NRSRO. Today's amendments impose no new costs on funds that depict
portfolio holdings based on criteria other than credit quality, but
they do impose small additional costs on funds that choose to portray
portfolio holdings using credit ratings from one NRSRO because they
must make new disclosures about how the ratings were identified and
selected. We believe that the majority of costs related to today's
amendments to Forms N-1A, N-2, and N-3 are the costs described above
related to the collections of information under the Paperwork Reduction
Act. Accordingly, we estimate that funds on average will incur costs of
approximately $1,137 per fund in complying with the amendments.\99\ In
addition, funds may voluntarily incur additional costs if they choose
to develop and apply new methodologies to depict credit quality. Funds
that choose to do so will incur a cost not only to determine the credit
quality of portfolio holdings but also a cost to include in the
registration statement a description of how the credit quality of
portfolio holdings was determined, and if credit ratings are used, how
the ratings were identified and selected.
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\99\ See supra note 84 and accompanying text. Staff estimates
that all funds will incur a one-time aggregate cost of approximately
$12.1 million to make any necessary changes to the registration
statement related to collections of information under the Paperwork
Reduction Act. Id.
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3. Alternatives
In adopting the amendments to the forms, the Commission considered
replacing the required use of credit ratings with an option to depict a
fund's portfolio by credit quality using the credit ratings of only a
single credit rating agency. This approach, proposed in 2011, was
intended to eliminate the possibility that a fund could choose to use
NRSRO credit ratings and then select the most favorable ratings among
the credit ratings assigned by multiple NRSROs. As discussed above, a
number of commenters suggested that funds be permitted to use the
credit ratings assigned by more than one NRSRO for split-rated
securities, provided the choice is made consistently, pursuant to a
disclosed policy. On balance, we believe that the benefits of this
additional flexibility outweigh the potential costs associated with the
possibility that funds cherry pick the highest credit rating available.
We note that the risks associated with cherry picking ratings are
mitigated by the fact that the forms, as amended, require that
[[Page 1328]]
funds disclose how they identified and selected the credit ratings,
which would include, for example, a fund policy that selects the
highest credit rating available.
VI. Final Regulatory Flexibility Analysis
The Commission has prepared the following Final Regulatory
Flexibility Analysis (``FRFA'') in accordance with section 4(a) of the
Regulatory Flexibility Act regarding the rule and form amendments we
are adopting today to give effect to provisions of the Dodd-Frank
Act.\100\ The FRFA relates to amendments to rule 5b-3 under the
Investment Company Act and Forms N-1A, N-2, and N-3 under the
Investment Company Act and Securities Act. We prepared an Initial
Regulatory Flexibility Analysis (``IRFA'') in conjunction with the 2011
Proposing Release in March 2011.\101\
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\100\ 5 U.S.C. 604(a).
\101\ See 2011 Proposing Release, supra note 10, at section
VIII.
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A. Need for and Objectives of the Rule and Form Amendments
As described more fully in sections I and III of this Release, to
implement section 939A of the Dodd-Frank Act, the Commission is
adopting amendments to (i) rule 5b-3 to eliminate references to the
credit rating and replace it with an alternative standard of
creditworthiness that is intended to achieve the same objectives that
the credit rating requirement was designed to achieve and (ii) Forms N-
1A, N-2, and N-3 to eliminate the required use of NRSRO credit ratings
by funds that choose to use credit quality categorizations in the
required table, chart, or graph of portfolio holdings in their
shareholder reports, and to permit funds that choose to depict credit
quality using credit ratings assigned by a credit rating agency to use
different credit rating agencies for split-rated securities.
B. Significant Issues Raised by Public Comment
In the 2011 Proposing Release, we requested comment on the IRFA. In
particular, we sought comment on how many small entities would be
subject to the proposed rule and form amendments and whether the effect
of the proposed rule and form amendments on small entities subject to
them would be economically significant. None of the comment letters we
received addressed the IRFA. None of the comment letters made comments
about the effect of the rule and form amendments on small investment
companies.
C. Small Entities Subject to the Rule and Form Amendments
The amendments to rule 5b-3 and Forms N-1A, N-2, and N-3 under the
Investment Company Act would affect funds, including entities that are
considered to be a small business or small organization (collectively,
``small entity'') for purposes of the Regulatory Flexibility Act.
Investment Companies. Under Commission rules, for purposes of the
Investment Company Act and the Regulatory Flexibility Act, an
investment company is a small entity if it, together with other
investment companies in the same group of related investment companies,
has net assets of $50 million or less as of the end of its most recent
fiscal year.\102\ Based on a current review of filings submitted to the
Commission, we estimate that 171 investment companies may be considered
small entities and that all of these investment companies may
potentially rely on rule 5b-3.\103\ As discussed above, we recognize
that increased compliance costs are a necessary result of the
amendments to rule 5b-3 and may disproportionately impact smaller funds
to the extent these funds do not have policies and procedures for
assessing creditworthiness. Based on a current review of filings
submitted to the Commission, we estimate that approximately 131
investment companies that meet the definition of small entity would be
subject to the amendments to Forms N-1A, N-2, and N-3.
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\102\ 17 CFR 270.0-10(a).
\103\ The 183 investment companies that meet the definition of
small entity include 12 business development companies, which are
subject to sections 5 and 12 of the Investment Company Act. 15
U.S.C. 80a-58; 15 U.S.C. 80a-59.
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D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
Rule 5b-3. The amendments to rule 5b-3 allow a fund to treat the
acquisition of a repurchase agreement as an acquisition of securities
collateralizing the repurchase agreement for purposes of sections
5(b)(1) and 12(d)(3) of the Investment Company Act if the collateral
other than cash or government securities consists of securities that
the fund's board of directors (or its delegate) determines at the time
the repurchase agreement is entered into are: (i) Issued by an issuer
that has an exceptionally strong capacity to meet its financial
obligations; and (ii) sufficiently liquid that they can be sold at
approximately their carrying value in the ordinary course of business
within seven calendar days. A fund that acquires repurchase agreements
and intends the acquisition to be treated as an acquisition of the
collateral securities must determine whether it must change its
policies for evaluating collateral securities under the amended rule
and must adopt and implement written policies and procedures reasonably
designed to comply with the conditions of amended rule 5b-3, including
these credit quality and liquidity requirements that we are
adopting.\104\ The costs associated with the amendments to rule 5b-3
are those discussed in section IV.A and V.B above.
---------------------------------------------------------------------------
\104\ 17 CFR 270.38a-1(a).
---------------------------------------------------------------------------
Forms N-1A, N-2, and N-3. The amendments to Forms N-1A, N-2, and N-
3 apply to open-end management investment companies, closed-end
management investment companies, and separate accounts organized as
management investment companies that offer variable annuity contracts,
including those that are small entities. The amendments to Forms N-1A,
N-2, and N-3 eliminate the required use of NRSRO credit ratings by
funds that choose to use credit quality categorizations in the required
table, chart, or graph of portfolio holdings in their shareholder
reports. If a fund chooses to depict portfolio holdings according to
credit quality, it must include a description of how the credit quality
of the holdings was determined, and if credit ratings assigned by a
credit rating agency are used to depict credit quality, the fund must
disclose how it identified and selected the credit ratings. The amended
forms also permit funds that choose to depict credit quality using
credit ratings assigned by a credit rating agency to use different
credit rating agencies for split-rated securities. The costs associated
with the amendments to the forms are those discussed in section IV.B
and V.C above.
E. Agency Action To Minimize Effect on Small Entities
The Regulatory Flexibility Act directs us to consider significant
alternatives that would accomplish our stated objectives, while
minimizing any significant adverse effect on small entities. In
connection with the rule and form amendments, the Commission considered
the following alternatives: (i) Establishing different compliance
standards or timetables that take into account the resources available
to small
[[Page 1329]]
entities; (ii) clarifying, consolidating, or simplifying compliance and
reporting requirements under the rule for small entities; (iii) use of
performance rather than design standards; and (iv) exempting small
entities from all or part of the requirements.
We believe that special compliance or reporting requirements for
small entities, or an exemption from coverage for small entities, is
not appropriate or consistent with investor protection or the Dodd-
Frank Act. We believe that, with respect to rule 5b-3, different credit
quality standards, special compliance requirements or timetables for
small entities, or an exemption from coverage for small entities, may
create a risk that those entities could acquire repurchase agreements
with collateral that is less likely to retain its market value or
liquidity in the event of a counterparty default. Further consolidation
or simplification of the rule and form amendments for funds that are
small entities is inconsistent with the Commission's goals of fostering
investor protection.
The form amendments apply to all investment companies that use
Forms N-1A, N-2, and N-3 to register under the Investment Company Act
and to offer their securities under the Securities Act. If the
Commission had excluded small entities from the form amendments, small
entities would have been required to use NRSRO credit ratings if they
chose to depict credit quality, while other entities would not have
been subject to that requirement. We believe that special compliance or
reporting requirements, or an exemption, for small entities would not
be appropriate because the amended requirement--eliminating the
required use of credit ratings where a fund chooses to depict the
fund's portfolio based on credit quality--is intended to eliminate
potential reliance on NRSRO credit ratings resulting from the
perception that the Commission endorses the ratings because of their
required use in Commission forms.
We have endeavored through the form amendments to minimize
regulatory burdens on investment companies, including small entities,
while meeting our regulatory objectives. We have endeavored to clarify,
consolidate, and simplify the requirements applicable to investment
companies, including those that are small entities. Finally, the
amendments will use performance rather than design standards for
determining the credit quality of specific securities. For these
reasons, we have not adopted alternatives to rule 5b-3 and Forms N-1A,
N-2, and N-3.
Statutory Authority
The Commission is adopting amendments to rule 5b-3 under the
authority set forth in sections 6(c) and 38(a) of the Investment
Company Act [15 U.S.C. 80a-6(c), 80a-37(a)] and section 939A of the
Dodd-Frank Act. The Commission is adopting amendments to Form N-1A,
Form N-2, and Form N-3 under the authority set forth in sections 5, 6,
7, 10 and 19(a) of the Securities Act [15 U.S.C. 77e, 77f, 77g, 77j,
and 77s(a)]; sections 8, 24(a), 30 and 38 of the Investment Company Act
[15 U.S.C. 80a-8, 80a-24(a), 80a-29, and 80a-37]; and section 939A of
the Dodd-Frank Act.
List of Subjects
17 CFR Part 239
Reporting and recordkeeping requirements, Securities.
17 CFR Parts 270 and 274
Investment companies, Reporting and recordkeeping requirements,
Securities.
Text of Rule and Rule and Form Amendments
For reasons set out in the preamble, Title 17, Chapter II of the
Code of Federal Regulations is amended as follows:
PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933
0
1. The authority citation for Part 239 is revised to read in part as
follow:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3,
77sss, 78c, 78l, 78m, 78n, 78o(d), 78o-7, 78o-7 note, 78u-5, 78w(a),
78ll, 78mm, 80a-2(a), 80a-3, 80a-8, 80a-9, 80a-10, 80a-13, 80a-24,
80a-26, 80a-29, 80a-30, 80a-37, and Pub. L. 111-203, sec. 939A, 124
Stat. 1376 (2010), unless otherwise noted.
* * * * *
PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
0
2. The authority citation for Part 270 is revised to read in part as
follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39,
and Pub. L. 111-203, sec. 939A, 124 Stat. 1376 (2010), unless
otherwise noted.
* * * * *
0
3. Section 270.5b-3 is amended by:
0
a. Adding ``or'' at the end of paragraph (c)(1)(iv)(B);
0
b. Revising paragraph (c)(1)(iv)(C);
0
c. Removing paragraph (c)(1)(iv)(D);
0
d. Removing paragraphs (c)(5), (c)(6), and (c)(8);
0
e. Redesignating paragraph (c)(4) as (c)(5);
0
f. Adding new paragraph (c)(4); and
0
g. Redesignating paragraph (c)(7) as paragraph (c)(6).
The revisions and addition read as follows:
Sec. 270.5b-3 Acquisition of repurchase agreement or refunded
security treated as acquisition of underlying securities.
* * * * *
(c) * * *
(1) * * *
(iv) * * *
(C) Securities that the investment company's board of directors, or
its delegate, determines at the time the repurchase agreement is
entered into:
(1) Each issuer of which has an exceptionally strong capacity to
meet its financial obligations; and
Note to paragraph (c)(1)(iv)(C)(1):
For a discussion of the phrase ``exceptionally strong capacity
to meet its financial obligations'' see Investment Company Act
Release No. 30847, (December 27, 2013).
(2) Are sufficiently liquid that they can be sold at approximately
their carrying value in the ordinary course of business within seven
calendar days; and
* * * * *
(4) Issuer, as used in paragraph (c)(1)(iv)(C)(1) of this section,
means the issuer of a collateral security or the issuer of an
unconditional obligation of a person other than the issuer of the
collateral security to undertake to pay, upon presentment by the holder
of the obligation (if required), the principal amount of the underlying
collateral security plus accrued interest when due or upon default.
* * * * *
PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933
PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940
0
4. The authority citation for Part 274 is revised to read in part as
follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m,
78n, 78o(d), 80a-8, 80a-24, 80a-26, 80a-29, and Pub. L. 111-203,
sec. 939A, 124 Stat. 1376 (2010), unless otherwise noted.
* * * * *
0
5. Form N-1A (referenced in Sec. Sec. 239.15A and 274.11A) is amended
by revising Item 27(d)(2) to read as follows:
Note: The text of Form N-1A does not, and these amendments will
not, appear in the Code of Federal Regulations.
FORM N-1A
* * * * *
[[Page 1330]]
Item 27. Financial Statements
* * * * *
(d) Annual and Semi-Annual Reports. * * *
(2) Graphical Representation of Holdings. One or more tables,
charts, or graphs depicting the portfolio holdings of the Fund by
reasonably identifiable categories (e.g., type of security, industry
sector, geographic region, credit quality, or maturity) showing the
percentage of net asset value or total investments attributable to
each. The categories and the basis of presentation (e.g., net asset
value or total investments) should be selected, and the presentation
should be formatted, in a manner reasonably designed to depict clearly
the types of investments made by the Fund, given its investment
objectives. If the Fund depicts portfolio holdings according to credit
quality, it should include a description of how the credit quality of
the holdings were determined, and if credit ratings, as defined in
section 3(a)(60) of the Securities Exchange Act [15 U.S.C.
78(c)(a)(60)], assigned by a credit rating agency, as defined in
section 3(a)(61) of the Securities Exchange Act [15 U.S.C.
78(c)(a)(61)], are used, explain how they were identified and selected.
This description should be included near, or as part of, the graphical
representation.
* * * * *
0
6. Form N-2 (referenced in Sec. Sec. 239.14 and 274.11a-1) is amended
by revising Instruction 6.a. to Item 24 to read as follows:
Note: The text of Form N-2 does not, and these amendments will
not, appear in the Code of Federal Regulations.
FORM N-2
* * * * *
Item 24. Financial Statements
* * * * *
Instructions:
* * * * *
6. * * *
a. one or more tables, charts, or graphs depicting the portfolio
holdings of the Fund by reasonably identifiable categories (e.g., type
of security, industry sector, geographic region, credit quality, or
maturity) showing the percentage of net asset value or total
investments attributable to each. The categories and the basis of
presentation (e.g., net asset value or total investments) should be
selected, and the presentation should be formatted, in a manner
reasonably designed to depict clearly the types of investments made by
the Fund, given its investment objectives. If the Fund depicts
portfolio holdings according to credit quality, it should include a
description of how the credit quality of the holdings were determined,
and if credit ratings, as defined in section 3(a)(60) of the Securities
Exchange Act [15 U.S.C. 78(c)(a)(60)], assigned by a credit rating
agency, as defined in section 3(a)(61) of the Securities Exchange Act
[15 U.S.C. 78(c)(a)(61)], are used, explain how they were identified
and selected. This description should be included near, or as part of,
the graphical representation.
* * * * *
0
7. Form N-3 (referenced in Sec. Sec. 239.17a and 274.11b) is amended
by revising Instruction 6.(i) to Item 28(a) to read as follows:
Note: The text of Form N-3 does not, and these amendments will
not, appear in the Code of Federal Regulations.
FORM N-3
* * * * *
Item 28. Financial Statements
(a) * * *
Instructions:
* * * * *
6. * * *
(i) One or more tables, charts, or graphs depicting the portfolio
holdings of the Fund by reasonably identifiable categories (e.g., type
of security, industry sector, geographic region, credit quality, or
maturity) showing the percentage of net asset value or total
investments attributable to each. The categories and the basis of
presentation (e.g., net asset value or total investments) should be
selected, and the presentation should be formatted, in a manner
reasonably designed to depict clearly the types of investments made by
the Fund, given its investment objectives. If the Fund depicts
portfolio holdings according to credit quality, it should include a
description of how the credit quality of the holdings were determined,
and if credit ratings, as defined in section 3(a)(60) of the Securities
Exchange Act [15 U.S.C. 78(c)(a)(60)], assigned by a credit rating
agency, as defined in section 3(a)(61) of the Securities Exchange Act
[15 U.S.C. 78(c)(a)(61)], are used, explain how they were identified
and selected. This description should be included near, or as part of,
the graphical representation.
* * * * *
By the Commission.
Dated: December 27, 2013.
Lynn M. Powalski,
Deputy Secretary.
[FR Doc. 2013-31425 Filed 1-7-14; 8:45 am]
BILLING CODE P
