The Securities and Exchange Commission made the right decision in exempting defined contribution plans — but not defined benefit plans, foundations, endowments and other asset owners — from its new rule requiring the share values of institutional prime money market funds to fluctuate based on market price changes.
The rule moves institutional prime money market funds away from the stable $1-per-share net asset value. The SEC is correct to bringing closer to reality the valuation of the short-term investments.
The rule excludes defined contribution plans from the most fundamental change in money market funds since their creation in the 1970s. For the purposes of the rule, the SEC classified DC plans as part of the retail market.
As the SEC noted in adopting the rule, retail investors pose less risk of runs on money market funds compared with institutional investors, judging by the experience noted in such events as the financial market crisis of 2008.
Money market funds invested primarily in governments securities “pose significantly less risk of heavy investor redemptions than prime funds, have low default risk and are highly liquid even during market stress, and experienced net inflows during the financial crisis,” the SEC noted in the adoption of its new rule.
The exemption affirms the stability of the valuation of money market funds, and that stability will contribute to building investment confidence among defined contribution plan participants until they are ready to move assets to long-term allocations designed to grow in value.
But even with the exemption from floating valuation, defined contribution plan sponsors will have to commit to greater monitoring of money market funds. A decline in the value of a security in an institutional prime fund might affect the underlying risks of money market assets held by other funds, even if rules exempt investors like defined contribution plans from fluctuations in value.
That's because a real or perceived increase in risk could lead to a run of withdrawals from those funds, harming remaining investors. With enhanced monitoring, sponsors could find comfort about the safety of a particular fund in difficult times, or recognize the necessity of changing money market funds in their investment options to avoid taking on increased risk.
Money market funds comprise a small percentage of the overall average allocation of defined contribution and defined benefit plans. They represented 4.1% of the average 401(k) plan allocation in 2012, according to joint research of the Investment Company Institute and the Employee Benefit Research Institute. Corporate defined benefit plans among the 1,000 largest retirement plans in Pensions & Investments' annual survey allocated on average 2.1% to cash — which can include money market funds and other short-term investments — as of last Sept. 30.
But even though the average allocation is small, it is important to defined contribution plan participants. In times of change for them, whether from stress in the market or from adjustments in their own investment fund options, money market funds provide a temporary safe haven.
Participation rates and contribution rates are a constant concern for DC plan sponsors and policymakers. Anything that shakes the confidence of plan participants in their investment options might cause a drop in participation or contributions.
The SEC's move to exempt defined contribution plans from this new rule will help alleviate that concern.
The Department of Labor in 2007 excluded money market funds when it designated qualified default investment alternatives for defined contribution plans. That move recognized that money market funds are not an effective option for participants who should be long-term investors.
The average low level of allocation to money market funds shows many DC plan participants understand the need to allocate their assets with a long-term horizon to generate return and build retirement income.
The newly adopted rules should encourage institutional fund executives, such as those overseeing local government investment pools that use money market funds, to seek a greater understanding of the risks of the underlying securities.
Such risks include floating valuations, and redemption fees and suspension of withdrawals, or so-called gates, that add to liquidity risks.
Depending on their risk tolerance, the analysis of the risks might encourage fund executives to diversify across short-term investment funds, or if the funds are highly correlated, into alternative short-term vehicles.
The new risk of floating valuations and more scrutiny by fund executives should encourage money market fund managers to develop funds that adhere as much as possible to the stable net asset value by keeping the risk level of their underlying investments low. Otherwise the funds risk a withdrawal of assets by institutional investors. The risk of outflows triggered by a decline in valuation should encourage money market fund managers to have greater liquidity to provide for withdrawals, which would temper risk taking.
The exemption for DC plans is unlikely to put additional stress on money market funds or increase the possibility of withdrawals, just as keeping the stable valuation of money market funds invested primarily in government securities is unlikely to add stress.
The new rules will require money market funds to show when their managers provide levels of support. By providing more transparency and a better understanding of risks, money market fund managers might encourage more investment confidence and help themselves by mitigating flights out of their funds in times of economic or market stress.
To keep asset owners from complacency about the risks of money market funds, the federal government has to do its part by adopting and calling attention to a policy that will not provide backstops to the funds in future crises, such as the guarantees it provided during the financial crisis.
Monetary policy of low interest rates poses risks to money market funds and their investors. Low interest rates challenge the ability of money market funds to keep their yields above zero. Money managers waived a record $5.8 billion in expenses last year to keep yields positive. With low yields, money market mutual fund companies cannot sustain their fee structure, which could jeopardize the viability of money market funds and the short-term credit market.
Money market funds in general are important for the cash management operations of corporations as well as federal and local governmental entities. The risk in short-term lending could harm liquidity in the system. The impact of any problem could cascade to adversely affect corporate and governmental operations, which could hurt the valuation of equity and fixed-income securities, affecting institutional investors' entire funds, as the financial crisis showed.
The SEC cannot address the issue of monetary policy, but it focused on issues that should encourage better risk management by money market funds and executives overseeing institutional asset pools. n
