The missing-money controversy surrounding MF Global Holdings Ltd. is leaving large corporate and public pension plan executives feeling pulled in two directions when it comes to using swaps.
While plan executives wonder if the next case of disappearing cash could involve them, they also are keeping a nervous eye on federal regulators who are finalizing new rules for derivatives trading, including swaps, that could sacrifice the collateral protection they now enjoy for greater transparency.
Pension plans use swaps for several reasons, including to hedge against drops in interest rates that can increase pension liabilities and harm cash flow. “Hedging is one of the very few things people can do to manage the volatility,” said an industry source who did not want to be identified. “Even plans that don't use it, feel strongly that they want to preserve that strategy.”
To make swaps more transparent to all parties involved in the transactions, the Dodd-Frank Wall Street Reform and Consumer Protection Act ordered the Commodity Futures Trading Commission to require that whenever possible, swaps go through registered derivatives clearing organizations. These organizations, while they practice legal segregation of customers' money, do not physically separate funds. That could become a big problem if the clearinghouses encounter financial problems like bankruptcy and cannot readily sort out commingled funds. Unless the clearinghouse has kept scrupulous records, another customer's losses could jeopardize all customers' assets.
That has alarmed institutional investors, who feel strongly that their current practice of using physically segregated accounts, where the third party — usually custodians or brokers — holding the swaps knows whose money is whose, is the safest.
By contrast, the CFTC's proposed rule simply stipulates the legal separation of collateral and does not explicitly allow for physical segregation, out of concern that it would contradict bankruptcy laws.