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No rating impact from South African MMF regulation, says Fitch

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Fitch Ratings says there are no rating implications following the implementation of new regulations for South African money market funds (MMFs).

Fitch believes that the newly implemented regulatory framework may lead some South African MMFs to consider adding unrated corporate exposures to the portfolio.

Under the previous regulatory framework, issuer diversification and eligibility rules were driven by ratings, while the new regulatory framework replaces ratings with market capitalisation (among other criteria).

In practice, many MMFs may be unable to add unrated exposures to their portfolios given the investment guidelines governing the funds in their investor mandates, which typically include ratings-based limits. Furthermore, the majority of high quality issuers considered for inclusion in MMF portfolios are usually rated.
 
Fitch would not be able to rate a fund with a material unrated corporate exposure at the ‘AA+(zaf)’ fund credit rating level (i.e. where Fitch rates some South African MMFs currently). Fitch bases its fund credit rating analysis on the underlying credit quality of a fund’s portfolio, as expressed in the ratings assigned to the invested instruments. Absent public credit ratings Fitch typically assumes the issuer’s credit quality is equivalent to a ‘CCC(zaf)’ rated issuer, which has a strongly negative impact in Fitch’s calculation of a fund’s weighted average rating factor and as a result its fund credit rating. Consistent with its rating criteria and in only very limited circumstances, Fitch may consider a fund manager’s own internal credit assessment of an unrated issuer in its rating analysis, provided that Fitch is comfortable with the rigour of the fund manager’s credit research process and outputs.
 
As of end-June 2012, no Fitch-rated South African MMF had exposure to unrated corporates. The credit quality of these funds is high and Fitch does not expect any material change in portfolio strategy among the rated funds. Fitch monitors funds’ portfolios at least monthly.

Fitch views positively the clarification of maturity limits for South African MMFs. Under the newly implemented regulatory regime South African MMF’s weighted average maturity (WAM, a measure based on time to the next interest-rate reset date) is limited to 90 days and weighted average life (WAL, a measure based on time to final legal maturity) is limited to 120 days. Previously applicable regulation did not distinguish between WAM and WAL and as a result a temporary 90-day limit was enforced for funds’ WAMs and WALs pending the implementation of the revised regulations.

In Fitch’s opinion, some South African MMFs may now elect to marginally extend their maturity profiles. However, the potential increase to funds’ WALs is limited to an increase of only 30 days so Fitch does not expect any major changes. Rated South African MMFs typically maintain conservative maturity profiles consistent with the newly implemented regulatory framework. The new regulation allows for the use of interest rate risk hedging. Fitch will monitor rated funds and the industry closely to determine the take-up and use of interest rate risk hedging in South African MMFs. Fitch maintains ratings of MMF employing interest rate hedging in other jurisdictions.

Fitch understands that the newly implemented regulatory framework provides for the continued inclusion of asset-backed commercial paper (ABCP) conduits in South African MMFs, subject to minimum issuer (or the related group issuer’s) capital and reserves. Maximum exposure per ABCP conduit will be capped at five per cent per the new regulations and aggregate exposure to ABCP at 20 per cent of a fund’s total portfolio. The aggregate issuer exposure limit is a new addition to the regulatory framework which will limit funds’ maximum exposure to ABCP conduits, while the replacement of ratings-based issuer diversification limits with an issuer limit of five per cent for ABCP will substantially reduce maximum allowable exposure to any individual ABCP conduit. Fitch would therefore expect ABCP to form a smaller but nonetheless still meaningful component of the eligible investment universe of South African MMFs. Funds that do use ABCP will likely need to reduce overall and individual exposures.

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