Money market reform. Understanding the impact on defined contribution plans RETIREMENT INSIGHTS IN BRIEF. December 2015

Transcription

1 RETIREMENT INSIGHTS Money market reform Understanding the impact on defined contribution plans December 2015 AUTHORS IN BRIEF New rules governing money market funds (MMFs) will have an impact on defined contribution (DC) plans. Plan sponsors must carefully assess their options before deciding which choice is best for their plan participants. Whether a plan sponsor chooses to maintain or alter its current investment lineup, this will be an important fiduciary decision. As they re-examine their options for a conservative plan offering, plan fiduciaries must evaluate any trade-offs among the three goals of the conservative asset class stability of principal, liquidity and yield. Along with money market funds, conservative offerings include stable value funds, ultra-short bond funds and other hybrid solutions. With longer maturities, these offerings provide higher yields than MMFs with slightly greater risk. Plan sponsors should confer with their investment managers to understand exactly how they will respond to the new regulatory environment and with their recordkeepers to learn which type of money market funds they will administer going forward as many of the new regulatory requirements pose operational challenges to recordkeepers. Ted Ufferfilge Head of Global Short-Term Fixed Income Product Team J.P. Morgan Global Liquidity Andrew Linton Head of Product Development J.P. Morgan Global Liquidity MANY PLAN SPONSORS ARE AWARE OF NEW SEC RULES GOVERNING MONEY MARKET FUNDS THAT WILL TAKE EFFECT IN OCTOBER 2016, but some may have an incomplete understanding of what the new regulations mean for DC plans. That presents a real challenge: The changes are significant, and they will require careful consideration before plan sponsors can make prudent choices for their plan participants. Whether a plan sponsor chooses to maintain or alter its current investment lineup, this will be an important fiduciary decision. Faced with the reality of new MMF regulations, a plan sponsor must thoroughly review its options in order to meet its fiduciary obligation to make an informed, reasoned choice. In the following pages, we offer a guide to new MMF rules and examine their potential impact on DC plans. We: explain the highlights of the new SEC rules assess the impact of the new rules on industry stakeholders explore the range of conservative options available in the new regulatory regime

2 MONEY MARKET REFORM: UNDERSTANDING THE IMPACT ON DEFINED CONTRIBUTION PLANS MONEY MARKET REFORM The SEC announced new MMF rules in July 2014, when it shared substantial amendments to Rule 2a-7 under the Investment Company Act of Like money market fund reform adopted in 2010, the new regulations aim to strengthen the MMF sector and make it more transparent. 1 There are different types of money market funds, and the new SEC rules affect them in different ways. Retail MMFs are defined as funds whose beneficial owners are natural persons language that explicitly includes owners of IRAs and participants in DC plans. Institutional MMFs are defined as non-retail funds. Key elements of the SEC regulations address floating vs. stable net asset value (NAV), liquidity fees and redemption gates. Before we focus on the specifics of the new SEC rules, please see EXHIBIT 1, below, for an overview of the various types of retail and institutional MMFs. Floating vs. stable NAV When the new rules take effect, institutional prime and institutional municipal MMFs must transact at their market-based net asset values, rounded to four decimal places. Fluctuations in the market-based NAV above or below $ can be common but have typically been small. Retail prime, retail municipal and government MMFs can continue to use a $1.00 stable NAV. Because DC plans are considered retail investors, MMFs in DC plans will be able to use a $1.00 stable NAV. 1 After the Reserve Primary Fund broke the buck the day after Lehman Brothers filed for bankruptcy in September 2008 (the fund s net asset value fell below $1.00 per share), and contagion spread through the MMF sector, regulators focused on the need for added safeguards to protect investors and reduce the risk of systemic financial stress. EXHIBIT 1: TYPES OF RETAIL AND INSTITUTIONAL MONEY MARKET FUNDS Liquidity fees and redemption gates Under the new regulations, the board of a money market fund has the power to impose a liquidity fee of up to 2% on all redemptions or temporarily suspend redemptions (impose a gate) if the fund s weekly liquid assets fall below 30% of total assets and if the board determines that it is in the fund s best interests. This is the case for both retail and institutional prime and municipal money market funds. Government MMFs are not required to be subject to the fee and gate provisions, but they may reserve the right to do so, and plan sponsors should review the disclosures of their government MMFs. In many ways, the new SEC rules strengthen the MMF sector, providing greater protection and transparency to shareholders. However, for a variety of reasons, many plan sponsors will look to avoid MMFs that carry a floating NAV or those that can impose liquidity fees and gates. Whether a plan sponsor opts for a government money market fund or a prime MMF, the choice should be carefully vetted. See EXHIBIT 2 (next page) for a detailed look at how the new reforms affect the different types of money market funds. CONSIDERATIONS FOR PLAN SPONSORS The prospect of MMF reform makes this an opportune time for plan sponsors to reassess their plan offerings. Most ERISA lawyers and plan sponsors agree that a prudent plan lineup should include a conservative capital preservation option (for more details, see ERISA and the conservative plan option, page 4). The conservative option has three key goals: stability of principal liquidity yield Money market fund type PRIME MUNICIPAL Investments Invest in short-term obligations of banks and corporations, as well as repurchase agreements (repos) and asset-backed commercial paper Invest in municipal securities, whose interest is exempt from federal income tax GOVERNMENT Invest 99.5% or more of their total assets in cash, government securities and/or government repos U.S. TREASURY Invest solely in debt securities of the U.S. government or repos collateralized by such obligations 2 RETIREMENT INSIGHTS

3 MONEY MARKET REFORM: UNDERSTANDING THE IMPACT ON DEFINED CONTRIBUTION PLANS EXHIBIT 2: HOW NEW SEC RULES IMPACT MONEY MARKET FUNDS Money market fund type NAV Liquidity fee Redemption gate PRIME FUND (Institutional) PRIME FUND (Retail) MUNICIPAL FUND (Institutional) MUNICIPAL FUND (Retail) Floating Stable Floating Stable Yes, must impose a 1% fee on all redemptions if: The fund s weekly liquid assets fall below 10% of its total assets May impose fees up to 2% on all redemptions if: The fund s weekly liquid assets fall below 30% of its total assets and the fund s board determines that such a fee is in the best interest of the fund GOV T/TREASURY Stable No No Yes, may suspend withdrawals from the fund if: The fund s weekly liquid assets fall below 30% The fund s board determines that imposing such a gate is in the fund s best interest Gates must be limited to no more than 10 business days in any consecutive 90-day period For plan participants and plan sponsors, the capital preservation option plays a variety of roles. Participants who are looking to protect principal or shield a portion of their assets from market volatility can invest in a capital preservation strategy. Plan sponsors can also use the capital preservation option to manage plan forfeitures and distributions. When plan sponsors review the place of the conservative option in their plan offering, they will ask a range of questions. Among them: How do plan participants use the conservative option? What are the trade-offs among stability, liquidity and yield? Can the option be simply explained to plan participants? What is the appropriate level of risk? What will investment managers do? Plan sponsors should discuss the impact of MMF reform with their investment managers, making sure they understand precisely how their managers will respond to the new regulatory environment. What is their manager s current offering? Plan sponsors will specifically want to know whether managers will make retail prime MMFs available to plan investors. The managers may request shareholder approval for changes in their MMFs. If so, fiduciaries will need to review the proposal and decide how to vote. What will recordkeepers do? Plan sponsors that include MMFs as a conservative option should confer with their recordkeepers to see what type of MMFs they will administer going forward. Many of the new regulatory requirements present operational and infrastructure challenges; these may impede a recordkeeper s ability to handle a floating NAV, gates and fees. (For example, while a gate may be imposed at any time of the day, most recordkeepers are set up for end-of-day pricing and would thus be unable to determine a fund s NAV if a gate was imposed earlier in the day.) Additionally, gates and fees must be prominently disclosed to participants; some recordkeepers and plan sponsors will be concerned that new disclosures could create confusion among participants. Range of conservative options in DC plans As plan sponsors re-examine their options for a conservative plan offering within the context of new SEC regulations, they can think of the possibilities along a risk spectrum. In this context, they should evaluate the trade-offs among the three goals of the conservative option stability of principal, liquidity and yield. At the lowest end of the risk spectrum are government MMFs, including 100% U.S. Treasury MMFs, which will continue to have a stable NAV and are not required to be subject to the new fee and gate provisions. Further up the risk spectrum are prime funds. These may be prime mutual funds SEC-registered products governed by the Investment Company Act of 1940 or they may be J.P. MORGAN ASSET MANAGEMENT 3

4 MONEY MARKET REFORM: UNDERSTANDING THE IMPACT ON DEFINED CONTRIBUTION PLANS commingled funds and collective trusts, short-term investment funds (STIFs) regulated by the Office of the Comptroller of the Currency (OCC), the U.S. banking regulator. Under new SEC rules, prime funds may impose liquidity fees or suspend redemptions in certain conditions; new rules, however, do not require retail prime mutual funds to carry a floating NAV. Stable value funds, often set up as collective investment trusts but not available as SEC-registered products, have stable NAVs. These funds typically are intermediate bond funds combined with wrap contracts. Issued by insurance companies and banks, the contracts provide principal preservation of participant balances, regardless of market conditions. With longer maturities in their portfolios, stable value funds offer higher returns than MMFs (1.50%-2.00%, historically) with similar liquidity, but they may impose restrictions on participant redemptions or limit plan sponsor changes to plan lineups. Ultra-short bond funds, which carry a floating NAV, maintain focus on principal preservation, but over a longer period of time (up to one year) when compared with MMFs or stable value funds. While MMFs are restricted to a weighted average maturity (WAM) of 60 days, ultra-short bond fund duration can extend as long as one year. Hybrid solutions may appeal to large DC plans that are looking for a different or customized approach. Among the hybrid solutions are fund-of-fund structures that can be designed to achieve a certain objective. For example, the structure might combine a stable value fund with a bond fund, creating a principal preservation-focused outcome with better return, volatility and flexibility characteristics than might be achieved in the two individual components. New disclosure and participant communications Whether a plan sponsor maintains its current MMF option or implements a change to accommodate new SEC regulations, new disclosures and clear participant communications may be needed. Plan sponsors must explain the thinking behind their choice: why the existing option remains in place or why a change was made. Plan sponsors should clarify any changes in the investment lineup and detail any changes in MMF options, including information on government and prime MMFs, floating NAV, redemption fees and gates. ERISA AND THE CONSERVATIVE PLAN OPTION As plan sponsors re-evaluate their plan offerings in the wake of MMF reform, their role as plan fiduciaries will be a key focus. Plan fiduciaries have primary responsibility for the operation and administration of every employee benefit plan. Put simply, this means they can be held liable for the investment of plan assets. A provision in the Employee Retirement Income Security Act of 1974 (ERISA), the law that governs DC plans maintained by private sector employers, provides relief from this liability in certain circumstances. When a plan allows participants to exercise control over their plan investments, Section 404(c) of ERISA generally shifts the responsibility for the investment results from the fiduciary to the participant. Plan sponsors must satisfy very specific requirements to comply with Section 404(c) and take advantage of its protections. One key requirement: Plan sponsors must offer a broad range of investment options. That is defined as no less than three diversified alternatives with different risk and return characteristics that in the aggregate enable the plan participant, by choosing among them, to achieve a portfolio with aggregate risk and return characteristics at any point within the range normally appropriate for the participant. As plan sponsors and the DC industry have interpreted the Section 404(c) requirements, one of those diversified alternatives must be a conservative fund option designed to facilitate the preservation of capital. 4 RETIREMENT INSIGHTS

5 MONEY MARKET REFORM: UNDERSTANDING THE IMPACT ON DEFINED CONTRIBUTION PLANS CONCLUSION A prudent evaluation of a plan offering is never a simple exercise, and particular care is needed when new regulations come into play. Plan sponsors must first understand the new rules in sufficient detail; only then can they project the likely impact on their plans. At that point, they can research all their possible options and determine which would make the best fit with their own participants. Finally, once the choice is made and before its actual implementation, plan sponsors should clearly communicate the changes to participants. None of these steps should be taken quickly or lightly. Plan sponsors should begin the evaluation process well before the new MMF rules take effect in October J.P. MORGAN ASSET MANAGEMENT 5

6 6 RETIREMENT INSIGHTS THIS PAGE INTENTIONALLY LEFT BLANK

7 An investment in the Fund is not insured or guaranteed by the FDIC or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund. Cash alternatives are not federally guaranteed and may lose value. Cash alternative portfolios have interest rate, inflation and credit risks that are associated with the underlying assets owned by the portfolio. Investments in cash and cash equivalents may result in a lower yield than lower-quality or longer-term investments. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. These views and strategies described may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. Past performance is no guarantee of future results. Please note that investments in foreign markets are subject to special currency, political and economic risks. JPMorgan Distribution Services, Inc., member of FINRA/SIPC. J.P. Morgan Asset Management is the marketing name for the asset management business of JPMorgan Chase & Co., and its affiliates worldwide. 270 Park Avenue, New York, NY JPMorgan Chase & Co., December 2015 RI-MMFREFORM 4d03c02a8002f3ca

8 RETIREMENT INSIGHTS J.P. MORGAN ASSET MANAGEMENT 270 Park Avenue I New York, NY 10017