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CFTC Adopts CIEBA Recommendation to Better Protect Pension Assets

  • By Deborah Forbes
  • Published: 2012-01-18

At its January 11 meeting, the Commodity Futures Trading Commission (CFTC) voted 4 to 1 to approve new protections for customer collateral provided to a swaps dealer. Although it adopted the legally separate but operationally commingled (LSOC) model, the CFTC also incorporated permitting full physical segregation for swaps collateral as recommended by the Committee on Investment of Employee Benefit Assets, or CIEBA, which represents more than 100 of the nation’s largest pension funds.

Many large pension plans use derivative investments, known as interest rate swaps. CIEBA members use swaps to manage the risk of declines in interest rates. Drops in interest rates increase the value of a plan’s liabilities as well as increase the funding requirements imposed on the company sponsoring the plan. If CIEBA members, who collectively manage $1.5 trillion of defined benefit and defined contribution plan assets on behalf of 17 million plan participants and beneficiaries, could not hedge against interest rate risks, their pension liabilities would become much more volatile and their plan costs would increase significantly.

In order to make swaps transactions more transparent, the Dodd-Frank Act directed the CFTC to require most swaps to be cleared on an exchange rather than traded on the over-the-counter (OTC) market. Last year the CFTC’s proposed rule adopted the LSOC model, based on the current treatment of customer collateral for cleared futures transactions, and it did not explicitly permit physical segregation of customer collateral. In the OTC market, swaps customers have the option of placing their collateral with a third party custodian, usually a bank, and CIEBA members urged the CFTC to make these same protections available to cleared swaps.

CIEBA advised the CFTC that, while the LSOC model was an improvement over the current futures model, there were still significant risks to pension plans. These risks include investment risk, misappropriation risk, recordkeeping risk, lack of access to collateral, and lack of transparency. CIEBA urged the CFTC to also allow collateral for cleared swaps to be held by third-party custodians in individual physically segregated account in the customer’s name.

The LSOC proposal

The recent MF Global bankruptcy made it clear that the LSOC proposal would not provide customers, particularly pension plans, with adequate protection of their assets and would expose them to greater risks than they face today. The benefits of LSOC depend heavily on accurate recordkeeping by the swaps dealer, especially during times of financial stress. Because customer collateral would be comingled in an omnibus account on behalf of the dealer, only the dealer would be able to determine what assets actually belonged to a particular customer. It is precisely the recordkeeping that failed in the case of MF Global. Although MF Global filed for bankruptcy almost three months ago, the bankruptcy trustee reported January 12 that between $600 million and $1.2 billion in customer funds remain unaccounted for.

In light of the MF Global collapse, CIEBA again recommended that the CFTC provide additional protection for customers’ collateral. CIEBA urged the CFTC to delay mandatory clearing of swaps until a physical segregation option was available to swaps customers. CIEBA also recommended that the CFTC consider requiring swaps dealers to give customers the right to elect physical segregation of their collateral.

Last week the CFTC made it clear that swap dealers could voluntarily provide physical segregation of assets. Thus, pension plans’ collateral can continue to be held in third-party safekeeping accounts. This is an important first step toward making the swaps market more transparent and providing greater protection to pension plans’ assets.

In his opening remarks, Commissioner Bart Chilton noted that “the lessons of MF Global teach us that we don’t have the luxury of time in making additional progress to protect customers. We need to do more. And we need to do it now.” At the meeting, Chairman Gary Gensler asked the CFTC staff to “make recommendations on further safeguarding client collateral on an individual basis,” and the CFTC’s lead staff attorney for the rule, Robert Wasserman, stated that the CFTC will propose additional enhancements “with dispatch.”

Commissioner Jill Sommers voted against the rule because it will apply only to swaps and not to futures or options. CIEBA is advising the CFTC to make these protections available to futures and options as well as to swaps.

CIEBA is also urging the CFTC to require swaps dealers to offer their customers the option of full physical segregation of assets. Swaps customers, particularly pension plans, need to be assured that their collateral is protected. The new CFTC rules must increase protections for pension assets—not put them at greater risk.

Learn more about CIEBA

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All rights reserved.

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