In an effort to impose some controls on an industry that was largely unregulated, Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 mandated a sweeping overhaul of the regulation of the swaps market. The Dodd-Frank Act created a new registration category for “major swap participants” (MSPs) – entities who engage in substantial swap activities, but who are not swap dealers – and authorized the Commodity Futures Trading Commission (CFTC) and the Securities Exchange Commission (SEC) to issue rules further defining the term. The Dodd-Frank Act also charged the two agencies with implementing new business conduct standards for both MSPs and swap dealers.

The CFTC issued proposed regulations in December 2010 on both the regulation of MSPs and the business conduct standards, but have yet to finalize them. Until the rules are finalized, the CFTC has postponed the effective date of the swaps provisions under the Dodd-Frank Act, which were originally intended to take effect on July 16, 2011.

The further delay may be helpful to resolve two particular aspects of the rules proposed by the CFTC that are of particular concern to employee benefit plans. Benefit plans have historically utilized swaps as an important asset management tool. For defined benefit plans in particular, swaps provide an efficient way to manage risks associated with funding liabilities while diversifying investment portfolios. However, the use of swaps by benefit plans may no longer be practical without modification of the proposed rules.

The rules pose two main concerns from a benefits perspective: that benefit plans may fall under the MSP category, and that the business conduct requirements for swap dealers may result in the dealers being ERISA fiduciaries under the terms of proposed Department of Labor (DOL) guidance. Since December 2010, the CFTC and the DOL have been trying to find solutions to these concerns and have made some progress to that end.

Under the proposed rules, benefit plans may fall under the definition of MSP, which would subject them to rigorous compliance requirements including registration with the CFTC and/or the SEC, reporting and recordkeeping requirements, and margin and capital requirements. The cost of compliance would probably be prohibitively expensive for benefit plans – reducing the ability of benefit plans to engage in swaps.

In addition, the proposed business conduct rules would impose duties on swap dealers and MSPs that could render them benefit plan fiduciaries under ERISA. In particular, the rules require that swap dealers provide advisory services to benefit plan counterparties. The concern is that those services could cause them to fall under the expanded definition of “fiduciary” posed by the DOL in its own proposed guidance issued last fall. Should they be considered benefit plan fiduciaries, swap dealers would be prohibited under ERISA from engaging in transactions in which they have an interest adverse to the interests of the plan, and from dealing with the plan’s assets for their own benefit. Because ERISA fiduciaries are required to act solely in the interests of plan participants, swap dealers will find themselves in the untenable position of having to remain neutral among swap counterparties, while simultaneously acting in the interests of the plan counterparty and its plan participants. In a letter to the CFTC, the DOL has commented on the CFTC proposed regulations but has not taken a final position that would resolve this issue.

The CFTC is not likely to issue final rules before December 2011. Until then, benefit plans that utilize swaps should continue to monitor developments.