Getting its Act together

US pension funds won two important battles in the debate that led to the approval of the Dodd-Frank Wall Street Reform Act in July. One is concern over the use of swaps to hedge plan risks, and the other is with stable value funds. The Act is also so complex that institutional investors are still waiting to see how it will affect them. It runs to more than 2,300 pages and its full impact might not be felt for years: according to conservative estimates, regulators have been conducting nearly 100 studies and writing more than 350 new rules implementing the changes.

Among the those satisfied with the reform is the Vanguard Group, whose experts gave advice and counsel to legislators. “Many provisions of the Act include concepts we supported,” says Ann Combs, head of Vanguard’s government relations unit. “One of the lessons taken from the financial crisis was the need for a more integrated approach to assessing risks to the overall market. The new financial services oversight council will allow regulators to spot and address problems that pose a risk to the financial system as a whole.” According to Combs, the provisions on derivatives is a major improvement.
“Vanguard was a strong proponent for clearing and margin requirements in the investment management industry The aspects related to retirement plans are much improved over early versions of the legislation, and the solution on stable value issues was a big win for plan participants,” she says.

Carl Hess, the global head of investment consulting at Towers Watson, is more sceptical. “The cost of regulation will probably be passed on to customers, including pension funds, and not fixing Fannie Mae and Freddie Mac is a big omission,” says Hess. “Regulating derivatives is not bad by itself, but prohibiting derivatives where they are useful is not a good thing.”

Bob Collie, managing director, investment strategy and consulting, at Russell Investments, is also concerned. He says there is a lot of uncertainty about unintended consequences of the Act, which is “such a big document, with so many requirements”. The two areas of most concern for institutional investors are the regulations of swaps - traded on the OTC market - and the definition of stable value funds. “Swaps are very convenient tools to achieve certain investment exposures, but they became so widely used that legislators felt they needed more regulation,” says Collie. “An early version of the reform required that anyone entering a swap deal had to acquire a ‘fiduciary’ status. That could have prevented pension funds from entering into swaps. But in the final version that particular requirement has been pulled back. The new regulation will probably increase the cost of dealing with derivatives, because companies will have to increase the size of their compliance departments, and more documentation will be required. But there won’t be any fundamental change in the way pension funds operate with swaps and other derivatives.”

The other problem is with stable value funds, which are usually offered by insurance companies and used to be more popular in defined contribution plans before the Pension Protection Act (PPA) of 2006 omitted them from its list of approved ‘qualified’ default options. According to the Stable Value Investment Association, assets for this sector are over $561bn (€441bn). Collie says: “It is possible, but nobody is quite sure, that within their construction there is a swap, so the question was whether the derivative regulation should apply to these funds. The final bill requires the SEC and the Commodity Futures Trading Commission to look at these products and see if and how they use derivatives. Now the agencies have until October 2011 to determine whether stable value wrap contracts should be considered swaps and, if so, to decide what to do about it.”

The nation’s two largest public pension funds, the California Public Employees Retirement System and the California State Teachers Retirement System are happy about another part of the Act - namely, the provision that allows institutional investors to put their candidates for board of directors on the voting material sent to shareowners. They lobbied for it, and against business groups such as the US Chamber of Commerce and the Business Roundtable. The two funds are negotiating with a firm to help them develop a diverse director list in order to put more women, minorities and people with different skills, experiences and areas of knowledge on corporate boards.


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