By Andrew P. Cross and Allison W. Sizemore, Reed Smith LLP

This posting summarizes Advisory Opinion 2013-01A, which was issued by the U.S. Department of Labor in February 2013 in order to address key interpretive issues relating to the ability of pension plans to trade centrally cleared swaps.  This posting will be of interest to pension plans and their asset managers, as well as swap clearinghouses and their futures commission merchant members ("CCPs" and "Clearing Members," respectively, in the language of the Advisory Opinion).


In Advisory Opinion 2013-01A, the U.S. Department of Labor ("DOL") concluded that:

(1) A Clearing Member is not a fiduciary under section 3(21)(A)(i) of the Employee Retirement Income Security Act of 1974 (ERISA), solely by virtue of its exercise of account liquidation rights negotiated between the Clearing Member and a plan fiduciary in connection with the documentation required to establish a centrally cleared swap trading account for the plan at the Clearing Member (the "Swap Account Documentation"). 

Significantly, in connection with this conclusion, the DOL opined that margin held by a Clearing Member or the CCP is not a plan asset for purposes of Title I of ERISA – rather, the plan assets are the rights the plan has to receive a payment from the Clearing Member in connection with the exercise of the account liquidation rights under the Swap Account Documentation.

(2) A cleared swap transaction will not constitute a "prohibited transaction" under Section 406 of ERISA, as long as the Swap Account Documentation was entered into by a qualified professional asset manager (or "QPAM") that acted prudently in making its decision to enter into, and negotiating, such documentation and otherwise satisfied the requirements of Prohibited Transaction Exemption (PTE) 84-14 (the QPAM Exemption). 

This conclusion was based, in pertinent part, on the DOL’s opinion that a Clearing Member would provide clearing related services to the plan and constitute a "party in interest" under ERISA section 3(14)(B).  It is noteworthy, however, that the DOL did not view the CCP as a party in interest, on the basis that it only provided services to the Clearing Members and the market as a whole, but not directly to the plan.

The DOL’s conclusions were made in reliance on the legislative history and policy objectives of the Wall Street Reform and Consumer Protection Act, Title VII of the  Dodd-Frank Act (the "Dodd-Frank Act"), which imposed clearing and trade execution requirements on standardized swaps with the goal of reducing overall risks to the U.S. financial system.  And, as regular readers of The Swap Report may recall, we have on many occasions in the past described the goal and effect of the Title VII reforms as changing the swap markets from a principal-to-principal, contract-based market to customer-to-agent, regulation-based market.  This certainly is the view expressed by, and literal foundation of, the DOL’s relief provided to pension plans under Advisory Opinion 2013-01A.

 ERISA Fiduciary Status

The Dodd-Frank Act imposes swap clearing and execution requirements on swap dealers and major swap participants in their transactions with counterparties, which may include ERISA plans.  Pursuant to the Swap Account Documentation, the Clearing Member is given certain rights upon the plan’s default, which frequently include the right to liquidate the plan’s position, sell assets from a margin account, enter into offsetting transactions, or take other de-risking action to decrease the impact of the plan’s default on other market participants and the financial system as a whole (collectively, "Default Rights").

Against this backdrop, a question arises as to whether, by taking control of assets of an account established by an ERISA plan in this manner, the Clearing Member is a plan fiduciary within the meaning of Section 3(21)(A)(i) of ERISA.  That statutory provision defines such a fiduciary as a person who "exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets."

The DOL noted initially that margin deposited by the plan with the Clearing Member of CCP is not a plan asset, so ERISA’s trust requirements do not apply to the margin account.  Instead, the plan asset consists of the rights embodied in the Swap Account Documentation, particularly as such rights permit the plan to receive certain payments from the Clearing Member following the member’s exercise of Default Rights.  Assuming then that the Swap Account Document ion was negotiated between the Clearing Member and ERISA plan counterparty through an independent fiduciary to the plan, the DOL determined that the mere exercise of contractual default remedies by the Clearing Member does not make it an ERISA fiduciary.

Prohibited Transactions

The next question addressed is whether the CCP or the Clearing Member is a "party in interest" under ERISA (i.e., a party that provides services to the plan) and, if so, whether performing swap clearing related services or exercising contractual rights under the Swap Account Documentation constitute a prohibited transaction.  The DOL concluded that the CCP is not a party in interest because it provides services to the Clearing Member and the central clearing system as a whole, but does not provide services directly to the ERISA plan counterparty.

The Clearing Member, on the other hand, has a direct contractual relationship with the ERISA plan counterparty and provides services in respect of the cleared swaps, including the collection of margin.  Thus, the DOL views the Clearing Member as a party in interest as defined in ERISA § 3(14)(B).  As a party in interest, the Clearing Member would engage in a prohibited transaction by providing swap services to the plan for a fee, unless an exemption applies.  The DOL concluded that most swap contracts between a plan and a Clearing Member are exempt under Prohibited Transaction Exemption 84-14, which provides relief for transactions in which the plan’s interest is managed by a qualified professional asset manager ("QPAM").  The relevant portion of Prohibited Transaction Exemption 84-14 is satisfied if the QPAM and the Clearing Member enter into a contract that contains sufficient detail such that default remedies and other subsidiary transactions are reasonably foreseeable to the QPAM upon entering into the Swap Account Documentation.  As a related item, the DOL provided representative examples of provisions affecting account liquidation rights that should be included in the Swap Account Document ion and further stated that:

Under Section 404 of ERISA, a QPAM must act prudently with respect to the decision to enter into [Swap Account Document ion] as well as in negotiating specific terms of the [Swap Account Documentation].  We note that in order to satisfy its responsibilities under section 404, a QPAM may need to request and evaluate additional information beyond what is set forth in the [Swap Account Document ion] regarding liquidation and close-out transactions and pricing methodologies covered by the [Swap Account Documentation], before making a determination to enter in such [Swap Account Documentation].

Thus, on the basis that all of these forgoing conditions and requirements would be satisfied, the DOL concluded that a Clearing Member will not engage in a prohibited transaction with respect to a cleared swap transaction.

Closing Considerations

The DOL’s analysis is influenced significantly by:

(1) its interpretation of the Dodd-Frank Act and its legislative history, which indicate that centralized swap clearing is intended to be integral to the stability of the financial system and that applying ERISA’s fiduciary requirements to Clearing Members of CCPs would be incompatible with the intent of the Dodd-Frank Act; and

(2) the DOL’s assumption and caution that the original decision for an ERISA plan to enter into a cleared swap or related Swap Account Documentation must be undertaken by an independent plan fiduciary. 

The Advisory Opinion provides a significant degree or comfort to Clearing Members and CCPs that the transactions described above, standing alone, will not create a fiduciary obligation or result in a prohibited transaction — however, a Clearing Member that oversteps or goes beyond the facts described in Advisory Opinion 2013-01A will not be covered by the relief afforded by that opinion.

Good day.  Good opinion. TSR