DB, DC Funds Could Suffer From Swap Regs; FDIC Chairman Slams Derivatives Spinoffs

(May 3, 2010) — Legislation pending in the Senate could put a stop to the use of swaps and other derivatives by defined benefit and defined contribution plans.

Banning pension use of swaps would have a monumental impact on the volume and value of the transactions. According to Jason Hammersla at The American Benefits Council, companies are pushing for the deletion of a provision that would require swap dealers to assume a fiduciary obligation when entering, or offering to enter, into a swap with a pension plan.

Fiduciary rules prohibit a fiduciary from representing the opposite party in a transaction. Thus, this provision would effectively prohibit swap dealers from entering into swaps with plans, since the swap dealer would be representing both itself and the plan. Plans use swaps to offer stable value funds to 401(k) plans across the country, while defined benefit plans use swaps to control asset volatility. Without this control, companies would have to increase their reserves to address future funding obligations, taking money away from job retention and economic recovery. Under the bill, plans would lose these valuable tools, which would create significant problems for plans going forward, Hammersla said to ai5000.

Federal Deposit Insurance Corp. (FDIC) Chairman Sheila Bair is also opposing legislation that could cut off privileges to banks that fail to segregate swaps trading units.

“If all derivatives market-making activities were moved outside of bank holding companies, most of the activity would no doubt continue, but in less-regulated and more highly leveraged venues,” Bair wrote in an April 30 letter to Senate Banking Chairman Christopher Dodd and Agriculture Committee Chairman Blanche Lincoln, according to Bloomberg. “Even pushing the activity into a bank holding company affiliate would reduce the amount and quality of capital required to be held against this activity.”

Bair, who has frequently been critical of big banks, claimed the proposals pushed by Lincoln would lead to a “weakened, not strengthened, protection of the insured bank,” as some of the riskiest parts of banks’ business would be moved out of federal oversight.

Bair is the third US regulator to voice concern about proposals to thwart participation by banks like Goldman Sachs Group Inc. and JPMorgan Chase & Co., which make billions of dollars each year from their derivatives operations, in swaps. Some lawmakers, according to Bloomberg, assert participation by banks in swaps contributed to the fall of the financial system and they have been trying to shed light on the over-the-counter derivatives market to avoid a repeat of the near collapse of American International Group (AIG), which had a large swaps portfolio.