DOL Clarifies Application of ERISA Rules to Cleared Swaps

by Morgan Lewis
Contact

New guidance defers to the Dodd-Frank/CFTC framework for regulating the swaps clearing process.

On February 7, the U.S. Department of Labor (DOL) issued an advisory opinion[1] on the application of the ERISA fiduciary rules to the categories of swaps subject to mandatory clearing under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). In Advisory Opinion 2013-01A, the DOL responded to questions on how the various parties to a cleared swap with an ERISA plan—specifically, the clearing member who deals directly with the plan (Clearing Member) and the central counterparty that acts as the clearing organization and ultimate swap counterparty to the plan (Clearing Organization)—would be treated under ERISA's fiduciary responsibility and prohibited transaction rules.

Intending to defer to Congress's understanding of how swaps are to be traded and cleared under Dodd-Frank and to avoid subjecting market participants to potentially inconsistent obligations, the DOL crafted responses, based on interpretations of ERISA, to industry questions that it believes would not "impair or impinge upon the swaps framework" required under Dodd-Frank. In adopting positions similar to those it previously adopted for futures transactions (which are also subject to mandatory clearing), the DOL has found certain limits in the application of ERISA where other regulatory and contractual frameworks govern. The DOL indicated that it conferred with U.S. Commodity Futures Trading Commission (CFTC) officials in crafting this guidance and that the CFTC staff does not believe the conclusions the DOL reached are inconsistent with CFTC's regulation of cleared swaps.

Responses to Key Questions

The advisory opinion addresses the following five main questions:

  1. Margin "Plan Asset" Status: Is margin held by a Clearing Member or a Clearing Organization in connection with a cleared swap considered to be a "plan asset" under ERISA?

    DOL Response: No, because the margin is in the nature of a performance bond to assure performance under the swap, and the plan, as a swap counterparty, will have no right to any assets held in the margin account. Rather, the plan's assets in a cleared swap are limited to the contractual rights embodied in the swap contract and under applicable law.
  2. Clearing Member Fiduciary Status: Is a Clearing Member an ERISA fiduciary to a plan when it exercises contractual rights against the plan in the event of a plan default or other specified event, including offsetting the plan's posted margin?

    DOL Response: No, because the margin held by the Clearing Member is not considered a "plan asset." However, were the Clearing Member to provide "investment advice" or "recommendations" (within the meaning of ERISA) to the plan in conjunction with a swap, the Clearing Member would be a fiduciary to the plan.
  3. Clearing Member Party in Interest Status: Is a Clearing Member a party in interest to a plan under ERISA when it is representing the plan in a cleared swap?

    DOL Response: Yes, the Clearing Member is a party in interest because it is providing services to the plan under a direct contractual agreement with the plan.
  4. Clearing Organization Party in Interest Status: Is a Clearing Organization a party in interest to a plan under ERISA when it acts as a counterparty to the plan?

    DOL Response: No, the Clearing Organization does not become a party in interest to the plan solely by acting as a counterparty and providing related clearing services with respect to the cleared swap because it is providing services to the Clearing Member, not to the plan.
  5. Exemptions for "Subsidiary" Transactions with the Clearing Member: Are Prohibited Transaction Exemption (PTE) 84-14 and PTE 96-23—the Qualified Professional Asset Manager (QPAM) and In-House Asset Manager (INHAM) Exemptions—available to cover dealings between a Clearing Member and a plan, including the provision of services and guarantees by the Clearing Member for the benefit of the plan and the Clearing Member's implementation of liquidation and close-out transactions?

    DOL Response: Yes, because each of these exemptions covers "subsidiary" transactions to a "primary" transaction. Thus, so long as the plan fiduciary reviews the terms and conditions of the subsidiary transactions in conjunction with its review of the primary transaction—the swap in this case—these exemptions will cover the actions of the Clearing Member when it exercises contractual rights under the primary transaction.

Observations and Implications

General Implications

In seeking guidance from the government on applying the ERISA fiduciary rules to cleared swaps, the financial services industry argued that the DOL should follow the same positions it applied in its 1982 letter on futures transactions. The DOL has largely done so. If the DOL had done otherwise, it would likely have required detailed exemptive relief, raising additional questions and creating complicated issues on how participants in the clearing process could comply with the different regulatory regimes—CFTC rules and ERISA regulation—as each has a very different focus. By determining, based on deference to the applicable regulatory framework, that parties engaged in the various steps of cleared swaps do not become ERISA fiduciaries, the DOL has largely harmonized its interpretation of ERISA with Congress's intent to require mandatory clearing of certain swaps.

On a more general level, the language of the advisory opinion is interesting in light of the DOL's current initiative to revise the definition of an "investment advice" fiduciary under ERISA. One of the issues raised regarding the DOL's proposed redefinition of "fiduciary" is that the DOL staff did not sufficiently take into account the realities of how the markets operate, potentially creating conflicts of interest that would prevent plans from engaging in certain types of arrangements and transactions. Thus, it will be interesting to see if the DOL's willingness to defer to congressional intent and avoid market disruptions will extend to its re-proposal, which is expected to be released later this year.

Fiduciary Responsibilities

It is important to note that, in the course of the advisory opinion, the DOL emphasized the responsibilities of plan fiduciaries entering into swaps on behalf of a plan, including that they must act prudently, and spelled out specific factors that fiduciaries should take into account. While this reflects prior guidance applying the ERISA prudence rule to derivatives transactions, such as swaps, the current guidance directly considers cleared swaps and adds to the list of factors in the prior guidance (i) the contractual rights a plan grants to a Clearing Member in the event of default and (ii) whether the plan has received adequate consideration for its potential economic exposure. Consideration of these contractual rights is also described as necessary for a Clearing Member's exercise of those rights to be covered by the QPAM exemption. Fiduciaries should be sure to take these factors into account in their investment process.

In describing how swaps are cleared, the DOL indicated that, when entering into a contract with a Clearing Member, a plan "is not relying on any communication of a Clearing Member as investment advice or as a recommendation under ERISA to enter into swaps." If that were not the case, despite the guidance in the advisory opinion, the Clearing Member would become an ERISA fiduciary to the plan with regard to particular swaps, potentially triggering conflicts of interest in the trading and clearing process. Thus, care must be given to the communications between a plan and a Clearing Member in order to avoid the Clearing Member becoming a fiduciary to the plan.

Prohibited Transaction Exemptions

The prohibited transactions portion of the opinion focuses only on two class exemptions as being available to cover the guarantee, liquidation, and close-out transactions, under the view that these are "subsidiary" parts of the "primary" swap transaction. What is not discussed is whether additional exemptions may also be available, including PTE 90-1 (for insurance company pooled separate accounts) and PTE 91-38 (for bank collective investment funds), in addition to section 408(b)(2) of ERISA covering the basic service relationship with a Clearing Member. However, there is no guidance as to whether the same "subsidiary transactions" concept would apply under these exemptions to cover the close-out and risk-reduction transactions in the same manner as under PTE 84-14. Nevertheless, as the application of this concept is based on an explanation of the exemptive relief available under PTE 84-14, rather than the terms of the exemption itself, there would not appear to be any reason why the same concept should not apply to the scope of relief under the other exemptions. In any event, it would be necessary to determine in each instance that the conditions of a particular exemption can be satisfied.

Security-Based Swaps

The request to DOL for an advisory opinion focused solely on CFTC-regulated swaps, given the imminent deadlines for mandatory clearing under the CFTC rules. As a result, the DOL advisory opinion does not deal with "security-based swaps," a separate category that is subject to regulation by the Securities and Exchange Commission (SEC) rather than the CFTC. Considering Congress's intent to require mandatory clearing of certain SEC-regulated security-based swaps and assuming the clearing mechanism for security-based swaps operates in a similar manner, in the absence of further guidance, it is difficult to see why the same interpretations would not apply to cleared security-based swaps. Nevertheless, the advisory opinion, by its terms, is limited to issues relating to CFTC-regulated swaps.


[1]. View the advisory opinion here.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morgan Lewis | Attorney Advertising

Written by:

Morgan Lewis
Contact
more
less

Morgan Lewis on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!