CFTC publishes final business conduct standards rule

The Commodity Futures Trading Commission (CFTC) has released its final business conduct standards rule under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new rule addresses many concerns raised by retirement plan sponsors. Most significantly, under the new rule, generally, where an ERISA plan has an ERISA fiduciary advisor, rules that would have made a swap dealer subject to problematic “advisor” conduct standards would not apply, and the swap dealer would not have to “approve” the plan’s advisor.

In this article we review those elements of the new rule that directly affect retirement plans.


For many sponsors of defined benefit (DB) plans, the ability to hedge interest rate risk by using an interest rate swap is an important element of risk management. Dodd-Frank identifies ERISA plans, along with government entities, government plans and endowments, as “Special Entities,” with respect to which swap dealers (SDs) (and, with respect to certain rules, major swap participants [MSPs] ) owe certain special duties.

When Dodd-Frank passed, many sponsors were concerned that the Special Entity element of the Dodd-Frank business conduct standards would limit their access to swap markets. In that regard, sponsors found two elements of the CFTC’s proposed business conduct rules especially problematic.

SDs as advisors

Generally, under Dodd-Frank, an SD acting as an advisor to a Special Entity must act in the best interests of the Special Entity. This is an obligation that no SD acting as or for a counterparty to the plan would undertake. A critical question thus becomes, what makes an SD an advisor? Under the proposed rule, an SD that merely made a “recommendation” to a Special Entity would have been an “advisor” — a very low bar.

SDs as “mere” counterparties

Under Dodd-Frank, an SD acting as a “mere” counterparty (and not as an advisor) also has obligations to a Special Entity. Among other things, it must have a reasonable basis for believing that the Special Entity has a representative that:

  1. Has sufficient knowledge to evaluate the transaction and risks.

  2. Is not subject to a statutory disqualification.

  3. Is independent of the SD/MSP.

  4. Undertakes a duty to act in the best interests of the Special Entity.

  5. Makes appropriate and timely disclosures to the Special Entity.

  6. Evaluates, consistent with any guidelines provided by the Special Entity, fair pricing and the appropriateness of the swap.

  7. In the case of employee benefit plans subject to ERISA, is an ERISA fiduciary.

There has been a question about whether all of these rules, or just the last one [item (7) ], would apply to ERISA plans. The  CFTC proposal would have made all of them applicable, but the CFTC did ask for comments on the issue.

The most problematic element of this rule is probably item (1) — in effect a requirement that a plan’s SD-counterparty be satisfied with the expertise of the plan’s advisor. The CFTC, in the preamble to the proposal, acknowledged that “[s]ome stakeholders have expressed concern that the independent representative requirement places undue influence in the hands of the SD or MSP by allowing it to use [the applicable criteria] to control who qualifies as an independent representative.” Even without “undue” influence, it’s entirely conceivable that SDs concerned about exposure here would limit the acceptable universe of “qualified” independent representatives in a way that would disqualify some plans’ advisor-representatives. As the universe of advisor-representatives is restricted, advisor-related costs will go up and/or some plans will lose access to swap markets.

Conflict with DOL’s proposed redefinition of fiduciary

In 2010 the Department of Labor proposed a regulation re-defining the term “fiduciary” under ERISA. There were many who believed that the obligations imposed on SDs dealing with retirement plans under Dodd-Frank (even “mere counterparty” SDs) would make those SDs fiduciaries under ERISA. DOL has withdrawn its proposal (it intends to re-propose early this year). In doing so, DOL stated:

EBSA will continue to coordinate closely with the Securities and Exchange Commission and the Commodity Futures Trading Commission to ensure that this effort is harmonized with other ongoing rulemakings.

To summarize, three key issues in the CFTC’s original proposal that concerned plan sponsors were:

  1. Would an SD who merely “recommends” a swap to a plan be an advisor and subject to the “act in the best interests of the Special Entity rule?”

  2. Would an SD who is a “mere counterparty” have to approve of the plan’s advisor?

  3. How would the Dodd-Frank business conduct standards interact with ERISA fiduciary rules?

The final rule — advisor test

Under the final rule an SD will not be an advisor with respect to an ERISA plan if:

[T]he ERISA plan represents that it has an ERISA fiduciary; the ERISA fiduciary represents that it does not rely on SD’s recommendations; and the ERISA plan has policies and procedures ensuring any recommendation the Special Entity receives from the SD materially affecting a swap transaction is evaluated by a fiduciary before the transaction occurs, or that any recommendation the Special Entity has received from the SD materially affecting a swap transaction was evaluated by a fiduciary before that transaction occurred.

This exception should allow most SDs to present trades (and, e.g., new strategies “engineered” specifically for plans) directly to plan sponsors. The “ERISA plan market” for SDs should, with the aid of this exception, remain reasonably strong. That’s a good thing.

The new rule — choice of representative

Generally, the rule requiring that the SD have a reasonable basis to believe that the Special Entity has a “representative” that meets criteria 1-7 (discussed above) would not apply to ERISA plans. Instead, for ERISA plans, the SD simply must have a reasonable basis for believing  that the plan’s “representative” is an ERISA fiduciary, for which purpose the SD may rely on the plan’s representation. Again, this is a huge improvement over the proposal and will allow plans to make their own arrangements for consideration and analysis of proposed swap trades, without review/veto of their advisor by the SD counterparty

Coordination with DOL

It looks like the changes made by the CFTC will help, somewhat, to solve the “ERISA fiduciary” problem, although issues remain. In this regard, CFTC and DOL said:

DOL has reviewed the Commission’s final business conduct standards rules for swap dealers and majors swap participants and provided the Commission with the following statement:

The Department of Labor has reviewed these final business conduct standards and concluded that they do not require swap dealers or major swap participants to engage in activities that would make them fiduciaries under the Department of Labor’s current five-part test defining fiduciary advice 29 C.F.R. [Sec.] 2510.3-21(c). In the Department’s view, the CFTC’s final business conduct standards neither conflict with the Department’s existing regulations, nor compel swap dealers or major swap participants to engage in fiduciary conduct. Moreover, the Department states that it is fully committed to ensuring that any changes to the current ERISA fiduciary advice regulation are carefully harmonized with the final business conduct standards, as adopted by the CFTC and the SEC, so that there are no unintended consequences for swap dealers and major swap participants who comply with these business conduct standards.

Furthermore, DOL stated its intention to continue to coordinate and appropriately harmonize with Commission rules when it re-proposes its rule on the definition of fiduciary. Thus, the Commission has determined that issues and concerns raised by commenters regarding ERISA requirements have been addressed appropriately.

The final answer on this issue will have to await DOL’s re-proposed re-definition of fiduciary.

Other provisions of the new rule of direct interest to retirement plans

Swap regulation and Dodd-Frank generally are not core retirement plan regulation issues, and we are not going to discuss the new rule in detail. We note the following elements of it that will be of interest to some ERISA retirement plans:

Master trusts — The rule allows compliance with the business conduct standards at the master trust level (that is, for instance, each separate plan in a master trust does not have to have a fiduciary-representative). This approach is helpful.

Collective trusts — “Look-through” rules (that might, e.g., impose Special Entity standards if a collective trust holds some assets from a Special Entity) will not be applied. Again, this approach is helpful.

Exception for cleared swaps — The Special Entity rules do not apply:

  1. When a transaction is initiated by a Special Entity on a DCM [designated contract market] or SEF [swap execution facility]; and

  2. the swap dealer or major swap participant does not know the identity of the counterparty to the transaction.

How this rule will actually work is a little unclear, but given the scope of the exception for ERISA plans, it is not likely to be a problem.

Effective date

The new business conduct standards rule is effective 60 days after publication in the Federal Register; however, SDs must comply with the rule on the later of 180 days after the effective date or the date on which swap dealers or major swap participants are required to apply for registration under applicable Commission rules.

According to the CFTC

The compliance schedule established by the Commission for the [business conduct rules] will allow swap dealers and major swap participants to, among other things, implement appropriate policies and procedures, train relevant personnel, execute any necessary amendments to counterparty relationship documentation, receive any representations from counterparties and enable Special Entities to ensure that they have qualified independent representatives ….

Overall the final business conduct standards rule is very good news. It will generally allow ERISA plans to operate within the (comparatively) well understood limits of ERISA fiduciary rules when dealing with swap dealers.

We will update you as there are further developments with respect to the implementation of Dodd-Frank.