Swaps are an important tool of ERISA pension plans and any disruption to the way they are currently exercised would have a negative effect on those plans, the companies sponsoring the plans and plan participants, according to Bella Sanevich, general counsel of NISA Investment Advisors, L.L.C. who testified on behalf of the American Benefits Council and the Committee on Investment of Employee Benefit Assets before the Congressional Committee on Agriculture on Oct. 12.
The organizations wanted to address the swap-related problems raised by the Dodd-Frank Wall Street Reform and Consumer Protection Act for private retirement plans governed by the Employee Retirement Income Security Act of 1974.
ERISA pension plans use swaps to manage the risk resulting from the volatility inherent in determining the present value of a pension plan’s liability and to manage plan funding obligations imposed on companies maintaining defined benefit plans, she said.
“The risk being managed is largely interest rate risk. If swaps were to become materially less available or become significantly more costly to pension plans, funding volatility and cost could increase substantially,” Sanevich said. “This would put Americans’ retirement assets at greater risk and force companies in the aggregate to reserve billions of additional dollars to satisfy possible funding obligations, most of which may never need to be contributed to the plan because the risks being reserved against may not materialize. Those greater reserves would have an enormous effect on the working capital that would be available to companies to create new jobs and for other business activities that promote economic growth. The greater funding volatility could also undermine the security of participants’ benefits.”
When interest rates fall, depending on plan assets, that drop could increase the plan’s liabilities by a large margin, creating a shortfall in the plan.
Under the general pension funding rules, shortfalls must be amortized over seven years causing plan sponsors to suddenly owe large annual contributions to the plan, which would “present enormous business challenges as well as increased risks for participants,” she said.
“Swaps are an important hedging tool for plan sponsors. Hedging interest rate risk with swaps effectively would avoid this result by creating an asset—a swap—that would rise in value” by the same amount as the deficit created by an interest rate drop.
Without swaps, many businesses would try to manage their pension risk in other ways, such as through increased use of bonds. The bond market is “far too small to replace swaps entirely as a means for plans to hedge their risks. There are not nearly enough bonds available, especially in the long durations that plans need,” she added. Higher demand for bonds could just exacerbate the problem by increasing the present value of plan liabilities.
Sanevich also told the committee that her clients had four main concerns about the Dodd-Frank Act:
- Business conduct standards. The Dodd-Frank Act directed the SEC and the CFTC to impose business conduct standards on swap dealers and major swap Participants with heightened standards applicable when dealers and MSPs enter into swaps with a ―Special Entity (which includes ERISA plans). These rules were intended to protect ERISA plans that enter into swaps. As proposed by the CFTC and, to a lesser extent, the SEC, these standards would have very harmful effects on ERISA plans and could operate to eliminate their ability to use swaps.
- Margin requirements. The CFTC and the prudential regulators have proposed margin requirements that would treat ERISA plans as entities that pose a systemic risk to the financial system. Accordingly, the proposed rules would impose very costly margin requirements on ERISA plans that enter into swaps. These requirements will create more risk for ERISA plans and will divert plan assets away from more productive uses that could benefit participants. In some cases, the requirements could even discourage plans from entering into swaps due to the significant increase in opportunity cost as well as actual cost.
- Cost/benefit analysis. We believe that an appropriately thorough cost/benefit analysis would clearly reveal that the treatment of ERISA plans in the proposed business conduct standards and the margin requirements would have significant costs and no real benefit. We are concerned that the unique nature of ERISA plans has not been taken into account in the regulatory process, and a more detailed cost/benefit analysis is needed to avoid serious unintended consequences.
- Effective date. The retirement plan community will need substantial time to prepare to comply with an entirely new system. Near-term effective dates can only bring substantial harm by triggering confusion and misunderstandings that undermine our country’s retirement security. In this regard, it is essential that the rules have sufficiently long implementation dates so that plans and their advisors can plan for an orderly transition to the new system without unnecessary, harmful and costly disruptions. Moreover, plans and their advisors will need to establish additional operational and compliance systems, and the rules should be sequenced in a manner so that new systems do not have to be modified to take into account rules issued subsequently.