A life insurer is asking federal financial services regulators to revise a proposed regulation that could sharply restrict the types of assets it could use to meet margin requirements.
Representatives from Principal Life Insurance Company, a unit of Principal Financial Group Inc., Des Moines, Iowa (NYSE:PFG), made that argument earlier this month in a meeting with officials from the U.S. Commodity Futures Trading Commission (CFTC) and also in a comment letter submitted the CFTC and other federal agencies in August.
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.
The CFTC and the U.S. Securities and Exchange Commission 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.
Many swaps would be cleared by clearinghouses and face relatively light federal regulation. Other uncleared, over-the-counter (OTC) swaps would face heavier regulation.
The agencies are dealing with matters such as “initial margin requirements,” or the amount of collateral that a company must post when setting up an OTC swap arrangement, and “variation margin requirements,” or the amount of additional collateral a company must post when the market moves against the company.
The SEC and CFTC want the life insurers and other companies using OTC swaps to use high-quality, liquid assets, to help guard against the kind of liquidity crisis and credit market freeze that started in 2007.
Julia Lawler, Principal’s chief investment officer, says in the August comment letter that the current proposal is too rigid.
Principal Life uses swaps to try to reduce the risks associated with assets that back life insurance policies, annuities and other products that often have long durations, Lawler says.
Because of the long-term nature of the assets and liabilities, and because of the accounting rules that govern the life insurance business, “the vast majority of Principal Life’s derivatives transactions are over-the-counter … bilaterally negotiated transactions with highly rated counterparties,” Lawler says.
Principal Life expects to be classified as a low-risk financial end user, and, because its counterparties are high-quality, it does not normally post or collect initial margin on OTC derivatives trades, Lawler says.