by Maureen O’Brien, Karen A. Simonsen and Adrienne Walker Porter
Pension plans use swaps to manage interest rate risks and other risks and to reduce volatility with respect to funding obligations. The Dodd-Frank Act established a comprehensive regulatory framework for swaps. The legislation was enacted to reduce risk, increase transparency and promote market integrity within the financial system, including the comprehensive regulation and required registration of swap dealers and major swap participants.
The Dodd-Frank Act has introduced new challenges in managing risks and liabilities of pension plans by subjecting ERISA plans to new requirements under the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). If pension plans are unable to use swaps, plan costs and funding volatility could rise sharply. This would undermine participants’ retirement security and would force employers to reserve, in the aggregate, billions of additional dollars to address increased funding volatility. In order to meet the rulemaking objectives specified under the Dodd-Frank Act, regulators and Congress have introduced significant changes that may impact how pension plans manage their funded status.
- In December of 2010, the CFTC released proposed regulations outlining business conduct standards for swap dealers and major swap participants. The regulations highlighted the issue that swap dealers engaging in typical business activities with respect to “special entities” could be treated as ERISA fiduciaries. (The Dodd-Frank Act provides that a special entity includes an employee benefit plan.) ERISA provides that, generally, any transaction between a fiduciary and the ERISA plan with respect to which it owes fiduciary duties is prohibited. Therefore, in effect, the proposed regulations may preclude swap dealers from entering into swap transactions with employee benefit plans subject to ERISA. Additionally, the Department of Labor’s proposed rule relating to the definition of the term “fiduciary” under ERISA may include advisors that perform plan asset valuations, which is an activity conducted by swap dealers under the CFTC proposed regulations.
- On April 12, 2011, the CFTC issued proposed regulations establishing minimum initial and variation margin requirements for non-cleared swaps entered into by CFTC-regulated swap dealers and major swap participants. Under the proposed rules, pension plans would be included in the category of high-risk financial entities, subject to the most stringent requirements. Such high-risk financial entities are required to post collateral and are limited to the type of assets that may be used to post margin. This change could significantly increase the cost of managing pension plans.
- On May 4, 2011, the U.S. House of Representatives Agriculture Committee approved H.R. 1573, legislation providing the CFTC and SEC with 18 additional months to finalize many of the rules relating to swaps. The rules defining swaps-related products and participants and the rules relating to reporting recordkeeping, however, are to be finalized by July 15, 2011. The CFTC also recently released a notice reopening the comment period for many of the proposed regulations related to the Dodd-Frank Act.
Plan sponsors should continue to monitor the regulatory and legislative activity surrounding pension plans’ ability to use swaps under the Dodd-Frank Act.
