On August 19, 2011, the CFTC and SEC requested comments on whether stable value contracts should be considered as derivatives. The release included several questions on definition and exemption issues. One question is about contract immunization provisions with stable value fund managers which allows them to terminate contracts based on negotiated triggers, e.g. underperformance of the portfolio against a benchmark.
The history of stable value contract begins with guaranteed insurance contracts. This is a contract between an insurance company and a corporate profit sharing or pension plan that guarantees a specific rate of return on invested capital over the life of the contract. The investors main risk is the issuers creditworthiness.
With the new synthetic and separate account stable value contracts the issuer provides a guarantee of principal and accumulated interest. However, a 401(k) Plan’s stable value contractholders accounts are invested in stable value funds where the funds participates in gains or losses due through amortized adjustments to the crediting rate. Thus the fund is directly assuming default, call or extension, and reinvestment risk on the portfolio being wrapped. The impacts on plan withdrawals or new contributions is generally passed through to the fund on these synthetic or separate accounts. In addition, the return on investment depends upon the performance of the underlying assets. And therefore the future performance of the asset manager becomes a risk. If there is no maturity on the product, the purchaser also incurs a risk of needing to terminate when market values are depressed.
The providers of these instruments are wealth and life cycle platforms sold by mutual fund supermarkets. Also insurance companies agents offer these instruments to retail investors.
If the regulators decide that the stable value contracts are swaps, they must determine if an exemption from the regulatory requirements of swaps are appropriate and in the public interest.
Comments were due by September 26, 2011.