Swap or Not? Regulators Assess Stable Value under Dodd-Frank Act

By Randy Myers

Is a stable value fund really a swap?

Under the terms of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the over-the-counter derivatives market now falls under the purview of federal regulators. Those regulators–at the Securities & Exchange is reason to believe that stable value funds do not meet the swap definition and may not fall under swap regulation.

Dodd-Frank defines swaps in several ways: as a put, call, or similar option based on the value of a commodity; as an agreement for an exchange of payments based on the value of a commodity; or as an agreement for a purchase, sale, payment, or delivery based upon the occurrence or non-occurrence of an event or contingency.

During the crafting of Dodd-Frank, stable value managers and wrap providers worried that this broad definition might be read by regulators to include stable value contracts. But backed by the SVIA, the industry convinced Congress that the issue deserved closer scrutiny. So, when Dodd-Frank was finally passed, it specifically called on the SEC and the CFTC to jointly study the issue.

The Act specifies that even if the regulators find that stable value contracts fall within the definition of a swap, they should then determine whether exempting them from swap regulation is appropriate and in the public interest. Until such determinations are made, the requirements of the Dodd-Frank Act pertaining to the regulation of swap contracts do not apply to stable value products.

Anthony Mansfield, an attorney with the law firm of McDermott Will & Emery, has been representing the stable value industry in its efforts to persuade a joint CFTC-SEC study group as to why stable value contracts should not be considered swaps.

“We’ve been very clear that we believe stable value contracts are not swaps,” Mansfield told participants at the 2010 SVIA Fall Forum. “We have even gone so far as to say we have a preference as to whether they are found not to fit the definition, or that they fit the definition but are exempt. We’ve taken the position that they do not fit the definition. Even the perception that stable value is something that necessitated exemption is something I would like to avoid.”

Among the arguments against counting stable value investment contracts as swaps, Mansfield said, are these:

Stable value investment contracts provide benefit responsiveness. Any difference between the market and book value of a stable value fund is a difference that cannot be realized by retirement plan participants through the exercise of the stable value investment contract, Mansfield said. It is simply the nature of stable value products that a participant may only transact at book value. Stable value contracts do not have the optionality that swaps have.

Stable value investment contracts cannot be traded. Each stable value contract is tailored to meet the specific needs of the associated stable value fund and its participants. Stable value contracts cannot be traded or even assigned.

Stable value investment contracts do not have leverage. Stable value funds are not leveraged.

Stable value investment contracts cannot be cleared. Unlike swap contracts that are sufficiently uniform to be cleared, each stable value contract is the product of a lengthy underwriting process that includes a comprehensive review of the associated fund’s investment strategy, relevant benchmarks, and cash flow history, which is unique to a specific defined contribution plan.

Should regulators disagree, Mansfield said, the first impact on the stable value industry will be that banks and insurers issuing stable value wrap contracts will have to determine whether they are, as a result, swap dealers or major swap participants as defined by Dodd-Frank.

“It is very easy to fit within the definitions, and there are fairly significant implications for those who are designated as being in those categories,” he said. Among other things, he noted, swap dealers or major swap participants would be required to register, likely with the National Futures Association, the self-regulating industry organization for the U.S. futures industry, or possibly the CFTC. They also would have to comply with a host of regulatory requirements, including mandatory clearing, new reporting and recordkeeping obligations, and minimum capital and margin requirements set by the CFTC or other regulators. The cost of conforming to those new regulations, Mansfield said, could have implications for the viability of stable value funds or their competitiveness with competing products.

Still, Mansfield said he could say “with a degree of certainty” that Dodd-Frank was never intended to be aimed at stable value products. “I don’t think the regulators have heard anything,” he added, “that gives them reason to believe this was anything other than an unintended consequence.”

In response to a question from the audience, Mansfield noted that if stable value contracts were held to be subject to the Dodd-Frank Act, contracts on the books prior to that decision would be exempt from clearing requirements as long as they were reported to a swap data repository. He said the industry would also take the position that existing contracts should be grandfathered out of new capital and margin requirements, although that would be a “more difficult argument.”