Public Fund CIOs Weigh in on Swaps Regulation

February 22, 2011 ( – The investment chiefs of some of the nation’s largest public pension funds have expressed concerns about proposed regulations regarding swaps.


In a letter to David Stawick, Secretary of the Commodity Futures Trading Commission (CFTC), the group said that the proposed regulation’s objective of protecting vulnerable or gullible parties in the swap market may be well intentioned”.  The group went on to caution, however, that the proposed business conduct standards for swap dealers (SD) and major swap participants (MSP) when they deal with a Special Entity, “could be wholly unworkable and adversely affect pension fund members.”   

The letter – signed by the CIOs of the California Public Employees’ Retirement System (CalPERS), the Public School & Education Employees’ Retirement System of Missouri, the Missouri State Employees’ Retirement System (MOSERS), South Carolina Retirement System Investment Commission, the Pennsylvania Public School Employees’ Retirement System, the State of Wisconsin Investment Board, Colorado PERA, the Utah Retirement Systems, the New Jersey Division of Investments, and the Virginia Retirement System – went on to cite a particular concern about the proposed regulations that would “require that an SD or MSP that offers to enter into, or enters into, a swap with a Special Entity have a reasonable basis to believe that the Special Entity has a representative who is independent of the SD or MSP and who meets certain other requirements.” 

Specifically, the group of pension fund CIOs said “there is an inherent conflict of interest for one of the parties to a transaction also to be responsible for determining who might represent the other side of a transaction. The proposed independent representative requirement would give undue influence to an SD or MSP to determine who qualifies to fill that role.”  Moreover the letter notes that though the meaning of certain proposed relevant terms (“best interests,” “fair pricing,” and “appropriateness”) are “quite vague,” and that SD or MSP “would nonetheless be required to make judgments as to the competency of a particular representative, in effect performing functions customarily performed by a regulatory body or self regulatory organization.” 

The group also took issue with the proposed solution to this inherent conflict – requiring the SD or MSP to make a written record of any determination that a person did not qualify as a representative and to submit such determination to its Chief Compliance Officer for review – calling it “inadequate, because such a review will remain inhouse at the SD or MSP without any independent analysis”.  In effect, SDs and MSPs would have “substantial discretion” in determining who qualifies as an independent representative “and this could be exercised in a completely arbitrary fashion, leaving a Special Entity without recourse,” according to the letter. 

The Alternative

The alternative proposed by the group would allow the Special Entity to choose whether it would rely on the framework set forth in the CFTC proposed regulation or the alternative approach outlined by the group.  Under that alternative, SDs and MSPs would be permitted to enter into off exchange swap transactions with a Special Entity so long as the Special Entity had a representative, either internally or at a third-party, certified as able to evaluate swap transactions.  The SD and MSP would be permitted to rely on the certification broadly for all aspects of the transaction with the Special Entity.  The group noted that this approach would eliminate possible confusion among SDs and MSPs about the extent to which they can rely upon the representations from a Special Entity. 

The group noted that the certification process would involve passage of a proficiency examination to be developed by the CFTC (or by an appropriate self-regulatory organization), and that maintaining the certified independent representative status would also require completing periodic ethics training, similar to that required of registrants.  Under the alternative approach, the requirement to be independent of an SD or MSP would remain. However, the group said that persons employed by a Special Entity that have extensive experience in the swaps and other financial markets could presumably qualify for the certification and thus not be blocked from serving as an independent representative by an SD or MSP.

“The alternative approach would be voluntary, so no person would be forced to take a test to serve as an independent representative,” according to the group.