DOL Guidance About Swap Clearing and ERISA Plans

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) requires that swap transactions go through a clearing process.

Due to a lack of clarity regarding whether certain parties involved in the clearing process were acting as fiduciaries for purposes of the Employee Retirement Income Security Act (ERISA), swap dealers and other market participants were reluctant to begin working on compliance with these and other requirements.

On February 7, 2013, the Department of Labor (DOL) issued Advisory Opinion 2013-01A (Opinion) in which it provided some clarification. Therefore, plan sponsors and their advisers should begin reviewing their portfolios to determine whether their plans invest in swaps and what needs to be done to comply with Dodd-Frank, the Commodity Futures Trading Commission (CFTC) regulations, and ERISA.    

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A swap is a contractual agreement between two counterparties, such as an ERISA-governed plan or an ERISA-governed “plan asset” entity and another party, often a dealer in swaps. The parties agree to exchange or “swap” cash flows or other rights. Swaps are commonly used by plans to extend duration in liability driven investing (LDI) strategies or to hedge against the risks of fluctuations in interest rates or currency valuations. They are used by both defined benefit and defined contribution retirement plans.  These plans typically enter into swaps through their investment advisers, pursuant to an investment management agreement, who in turn enter into umbrella agreements with swap dealers.   

Dodd-Frank and regulations issued by the CFTC require that swaps be “cleared.” This means that the plan and swap dealer submit the swap contract to a clearing member (CM) and a central counterparty (CCP). The swap counterparties also give cash or liquid securities to the CM as margin. The CM acts as a guarantor to the swap. In the event one of the swap counterparties fails to meet its obligations, the CM is contractually obligated to the CCP to provide remedies to the CCP, and the CCP in turn is obligated to provide remedies to the non-defaulting counterparty. For example, the CM can use margin deposits to make the non-defaulting party whole or to otherwise engage in close-out and/or risk reducing transactions.

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In the Opinion, the DOL concluded that the CM and CCP were not fiduciaries under ERISA and that the margin deposits were not “plan assets.” The DOL recognized that to determine otherwise would defeat the intent of Congress to reduce risk present in the over-the-counter swap marketplace by requiring most swaps to be cleared. In fact, the swaps clearing process established by Dodd-Frank and the CFTC regulations would not function if parties involved in the clearing process were acting as ERISA fiduciaries.    

While the DOL’s position was not all that surprising with regard to fiduciary and plan asset status, the Opinion did raise an issue under ERISA’s prohibited transaction provisions. The DOL opined that the CM, but not the CCP, is a “party in interest,” which means that a statutory or class exemption must be used to prevent non-exempt prohibited transactions with the CM. While the Opinion went through great lengths to explain why the qualified professional asset manager or “QPAM” exemption would work, the DOL mentioned no other exemption. The absence of such discussion begs the question whether any other exemptions may be used from the DOL’s perspective.    

In reviewing the DOL’s analysis of application of the QPAM exemption, certain other exemptions, such as those for an n-house asset manager (INHAM), bank collective trusts, and insurance company separate accounts should work. However, the availability of the widely used “service provider” statutory exemption in section 408(b)(17) of ERISA is far from clear. This can be problematic for plans and funds whose advisers do not qualify as QPAMs or for plan sponsor fiduciaries that are not QPAMs or INHAMs that wish to enter into swaps.        

So, the next logical question is what plan sponsors and their advisers should do now. The Opinion should remove a significant impediment to Dodd-Frank, CFTC and ERISA compliance efforts by swap dealers, CMs, and CCPs. So, advisers who manage ERISA plan assets should expect amendments to their umbrella agreements. The CMs will likely want representations as to QPAM status or the applicability of other exemptions, while the advisers will want to make sure agreements with the CMs contain information outlined in the Opinion to assure the QPAM exemption disclosure requirements are met.    

Advisers, in turn, should ask plan sponsors and their fiduciaries to make corresponding representations via amendments to management agreements. That language should be carefully reviewed by plan sponsor fiduciaries, who should make sure their advisers are taking steps to comply with Dodd-Frank and ERISA with respect to swaps. Applicable compliance deadlines will be here sooner than you think. An ERISA-governed plan must comply with the clearing requirements by September 9, 2013. Entities such as private investment funds that use swaps must comply by June 10, 2013.  

David C. Kaleda is a principal in Groom Law Group.  

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

Access Data Reveals Top Growth Opportunities

Mutual fund and exchange-traded fund (ETF) assets through broker/dealers and registered investment advisers (RIAs) had more than 30% growth in 2012 than wirehouses.

According to figures from Access Data, total stock and bond mutual fund and ETF assets distributed by independent and regional broker/dealers and registered investment advisers (RIAs) grew at more than twice the rate compared with the wirehouse channel.

The data allows mutual fund managers small and large to identify the most profitable growth opportunities by channel, distributor, and product type.

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Independent and regional broker/dealers and RIAs have become an increasingly important distribution channel for mutual fund and ETF firms, according to Frank Polefrone, senior vice president of Access Data. “By better understanding which channels are driving the most sales, firms can identify their best prospects and opportunities in this increasingly competitive environment,” Polefrone said.

Long-term mutual fund and ETF assets with independent and regional broker/dealers and RIAs accounted for more than $3 trillion, or approximately 40% of total long-term mutual fund assets held on the books of third-party distributors at the end of 2012. The assets held by independent and regional broker/dealers and RIAs grew 33% and 32% in 2012, respectively. This data, organized by product type and distribution channels, is among the unique detailed insights provided by Access Data’s Market Intelligence offering.

Access Data’s Market Intelligence offering provides a complete industry view, tracking more than 90% of long term mutual funds and ETF assets under management. Shored up by a partnership announced in 2012, with Strategic Insight, an Asset International company, Access Data offers industry asset and net new flow information for mutual funds and ETFs, segmented by distribution channels and financial intermediary firms. More than 80 fund and ETF firms now rely on Access Data for increased visibility into market share information by product type and distribution channel to uncover growth opportunities.

According to Avi Nachmany, executive vice president and director of research at Strategic Insight, the independent and regional broker/dealer and RIA channels attracted the highest net inflows into stock and bond mutual funds of any channel during 2012, with $67 billion and $56 billion of net deposits, respectively.

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“Distribution data in the form of bottom-up granularity by broker/dealer and RIA firms offered by Access Data is now combined with Strategic Insight’s top-down analytics and integrated data,” Nachmany said. “Leveraging such details about fund distribution, which in many cases were not available previously, allows mutual fund managers small and large to identify the most profitable growth opportunities by channel, distributor, and product type. This new data transparency allows senior management to make better strategic decisions, and sales management to execute more profitably on that strategy.”

Access Data’s Market Intelligence offering delivers data transparency for omnibus accounts across the widest store of distributor data of long-term mutual fund and ETF assets distributed through third parties, including RIAs and independent broker/dealers. The solution tracks asset positions and net flows, calculates market share by channel, intermediary and product, performs peer group comparisons and analysis by Morningstar category, and estimates market penetration down to the firm and office location.

Mutual funds and ETFs can gain competitive market advantage in new market segments and create territory optimization plans that align sales resources to growth channels and regions. “Now, firms can confidently deploy resources where they will be most effective – and pinpoint their best opportunities to sell specific products,” Polefrone said.

Access Data Corp., a Broadridge Financial Solutions company, offers mutual funds and ETFs exclusive insight into assets and net flows to pinpoint the best opportunities in fast-growing market segments. More information is available at their website.

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