The U.S. Labor Department said $6.8 trillion in pension funds can be invested in cleared swap transactions as long as certain conditions are met.
The market for privately negotiated derivatives, with $639 trillion in notional value as of June, is being regulated for the first time in its three-decade history, requiring most trades to be backed by a clearinghouse where banks and brokers act as intermediaries. The Labor Department already allows pension funds to be invested in futures contracts under similar guidelines, said Supurna VedBrat, co-head of market structure and electronic trading at BlackRock Inc.
“We needed clarity that similar exemptive relief was available for swap clearing,” VedBrat said in a telephone interview. With swap clearing becoming mandatory starting March 11 under Commodity Futures Trading Commission rules, getting clarity before then “has been very helpful to the industry,” said VedBrat, whose firm is the world’s largest money manager, overseeing $3.79 trillion in assets.
The role of clearing was expanded by the 2010 Dodd-Frank Act based on the track record of clearinghouses during the credit crisis. The idea took hold after Lehman Brothers Holdings Inc. failed in 2008 and LCH.Clearnet Ltd., the world’s largest interest-rate swap clearinghouse, settled $9 trillion of the derivatives held by the New York-based investment bank.
LCH needed only about two weeks and 35 percent of the collateral Lehman had posted, Dan Maguire, head of U.S. operations at LCH’s SwapClear service, said last year.
Clearinghouses cut risk by collecting collateral known as initial margin at the start of each transaction, monitoring daily price moves and making traders put up more cash as losses occur. Traders have to deal through clearing members, typically the biggest banks and brokerages. Unlike privately traded, or over-the-counter derivatives, prices for cleared trades are set every day and publicly disclosed.
Pension investments are governed by the Employee Retirement Income Security Act, or Erisa. It sets fiduciary standards that plan managers must follow, among other requirements.
The Labor Department said on its website Feb. 7 that default procedures and other clearinghouse rules don’t breach Erisa fiduciary standards if they are spelled out in preliminary clearing agreements. Margin payments don’t constitute plan assets and clearing members don’t have a fiduciary duty while closing out a pension-fund customer account that has defaulted, the Labor Department also said.
The conclusion is important because it means an asset manager such as BlackRock won’t have to tailor investment strategies for funds that contain money governed by Erisa and those that don’t, VedBrat said. It also allows access to the added protection of clearing to pension investments, she said.
“We wanted to make sure this option was available to Erisa funds just as it’s available to our other clients,” VedBrat said.
The market for swaps, in which investors trade payments for as long as 30 years, is measured by notional value to calculate money flows and doesn’t represent cash that has changed hands.