Clearing Up Money Market Fund Reform Misunderstanding

Retirement plans will not necessarily have to divest from retail money market funds under SEC’s pending reforms, but plan sponsors and advisers may decide it's best.

Some qualified retirement plan sponsors and service providers are misinterpreting the likely impact of the Securities and Exchange Commission’s (SEC) money market fund reforms, opining the rulemaking will necessarily drive defined contribution (DC) plans away from retail money market funds.

The SEC is focusing on educating the retirement planning industry about the likely impacts of money market fund reforms adopted in 2014. In short, the rule amendments require providers to establish a floating net asset value (NAV) for institutional prime money market funds, which will allow the daily share prices of these funds to fluctuate along with changes in the market-based value of fund assets. The rule updates also provide non-government retail money market funds with new tools, known as liquidity fees and redemption gates, to address potential runs on fund assets. 

The retirement space is still in the process of digesting the rule changes. The good news is that sponsors and advisers have until October 2016 to decide how they will address the nearly 900-pages of rulemaking. But the timeline is tighter than some may think, given the complexity of money market funds and the potential for a late-mover premium should too many sponsors wait until the last minute to make changes.

One important section of the rulemaking for plan sponsors and service providers to understand starts at page 225, running through about page 271. The passage contains helpful discussion of what it takes to qualify as a retail money market fund, and how floating NAVs will be calculated and applied, along with guidance about the fees and redemption gates that have caused some Employee Retirement Income Security Act (ERISA) fiduciaries to doubt whether they’ll still be able to offer retail money market funds.

This is a common misconception—that retirement plan fiduciaries will be flat out required to start using government-sponsored money market funds, which will not gain the use of liquidity fees and/or redemption gates. In fact this is not the case, and the rules provide important exceptions for investing in retail money market funds that could ease plan sponsors’ fiduciary concerns.

NEXT: Important NAV exceptions

Critical for plan sponsors to understand is the fact that there is an exception for the floating NAV requirement for any money market fund that is a retail fund—and retail funds are defined under the new rulemaking as funds in which only natural persons can invest.

The money market fund rulemaking generally understands DC retirement plans as collections of natural persons, rather than as a distinct class of institutional investors. This, in turn, means most DC plans will be able to continue to invest in retail money market funds.

A big question for plan sponsors will be whether they feel comfortable, considering their fiduciary duty, with the prospect of plan participants potentially facing liquidity fees and gates within retail money market funds. The impact of these gates could potentially be dramatic, should a situation like the 2008 financial crisis occur again. In certain cases of stressed liquidity for a retail money market fund, a liquidity fee would go into place that could damage plan participant returns. In other cases, a redemption gate could be implemented, lasting up to 10 days, preventing all withdrawals from a money market fund.

Redemption fees and gates are not necessarily at odds with the fiduciary duty, especially if plan sponsors do a good job educating their plan participants up front about the money market fund changes. Indeed, the whole point of implementing liquidity gates and fees is to protect investor assets against sharp drops resulting from runs on money market fund assets. It could be distressing for a plan participant to face a liquidity fee or redemption gate, but plan sponsors can protect themselves from liability by educating participants about this possibility, and coaching them to stick with their long-term investing goals even during short-term periods of market stress.

NEXT: Other money market fund considerations

Plan sponsors and advisers should also be prepared to face changes coming from fund providers and recordkeepers.

Even in cases where a DC plan decides it is comfortable sticking with its current money market fund option, the plan’s recordkeeper or investment provider could decide change is necessary. This situation is likely to be faced by at least some plan sponsors, given that more and more fund providers are adding and changing options to get ready for the rule implementation in fall 2016.

Something else to consider is that it will be harder, if not impossible, for defined benefit (DB) plans to qualify as natural person investors. Therefore DB plans are probably likelier to have to switch to government money market funds, or another similar asset class.

Both DB and DC sponsors will have to be vigilant with regards to their recordkeeper’s shifting capabilities under the rulemaking. There are still a lot of operational systems issues that need to be addressed to ensure that the liquidity fees and redemption gates can smoothly go into effect.

On its website, the SEC urges retirement planning professionals to read a recently issued FAQ publication that addresses a number of retirement plan-related issues under the money market fund reforms. In particular FAQ 16 (which explains issues related to retail funds) and 17 (about forfeiture accounts) as well as FAQs 26-31 about the operation of fees and gates may all be of interest.

A link to the FAQs is here.