DOL Guidance About Swap Clearing and ERISA Plans

March 14, 2013 ( - 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.    

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.

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, principal, Groom Law Group, Chartered  

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.