Public pension plan administrators say proposed swap advisor sophistication rules could backfire and put the plans at the mercy of the swap dealers and swap counterparties.
The administrators – who represent public employee retirement systems in states such as California, Colorado, Missouri, Texas, Virginia and Wisconsin – discuss proposed swap market “independent representative standards” in a comment letter submitted to the U.S. Securities and Exchange Commission (SEC) in August.
Representatives from the retirement systems talked about their views with officials from the Commodity Futures Trading Commission (CFTC) in person earlier this week, according to a notice on the CFTC website.
Public plan administrators are taking an interest in swaps because the SEC and the CFTC are in the process of implementing provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 that call for the agencies to work together to create a swap market regulation system, also to create rules to protect “special entities” – including endowments, and pension plans governed by the Employee Retirement Income Security Act (ERISA – from getting into risky swap arrangements without understanding the risks.
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A swap is an arrangement that one party can use to trade an income stream with another party. Investors, speculators and others use swaps to manage risk from variations in, or speculate on, changes in, interest rates, exchange rates and the likelihood that debtors will default on their obligations.
Congress put swap provisions in the Dodd-Frank Act because of concerns that use of unregulated credit default swaps and other unregulated swaps had led market participants to assume risks that they did not understand, and that the confusion about swaps risk might have caused, or exacerbated, the credit market crisis that started in 2007.
The SEC states in a proposed special entity regulation that a swap market player that knows it is working with a special entity, or believes it may be working with a special entity, must “have a reasonable basis to believe that the special entity has a representative who is independent” of the swap market entity.
The “qualified independent representative” need not necessarily be independent of the special entity, but the swap market player must check to see that the independent representative “has sufficient knowledge to evaluate the transaction and risks” and “undertakes a duty to act in the best interests of the special entity.”
The American Benefits Council, Washington, and other groups representing big employers have argued that aggressive enforcement of the special entity independent representative rules is unnecessary for ERISA plans because ERISA already requires plans to have independent, knowledgeable, prudent advisors, and that no prudent advisor would rely on advice from a swap dealer or swap counterparty.
The Consumer Federation of America, Washington, and other consumer groups have argued that the SEC and the CFTC should make swap market players document in writing why they believe a special entity’s independent representative understands swaps well enough to get the special entity involved in a swap arrangement.