Derivatives and Hedging

9 Months Ended

Sep. 30, 2012

Derivatives and Hedging

7. Derivatives and Hedging

In May 2011, the Company entered into a designated cash flow hedge consisting of a $750 million interest rate swap maturing in 2013 to hedge future cash flows on the Company’s floating rate notes due in 2013. Interest on this swap is at a fixed rate of 1.03%, payable semi-annually on May 24 and November 24 of each year and commenced November 24, 2011. The fair value of the interest rate swap at September 30, 2012 was not material to the Company’s condensed consolidated financial statements.

The Company maintains a program to enter into total return swaps to hedge against market price exposures with respect to certain seed investments in sponsored investment products. At September 30, 2012 and December 31, 2011, the Company had eleven and six outstanding total return swaps, respectively, with an aggregate notional value of approximately $83 million and $43 million, respectively. The fair value of the outstanding total return swaps as of September 30, 2012 and December 31, 2011 was not material to the Company’s condensed consolidated financial statements.

Market risk from forward foreign currency exchange contracts is the effect on the value of a financial instrument that results from a change in currency exchange rates. The Company manages certain exposure to market risk associated with foreign currency exchange contracts by establishing and monitoring parameters that limit the types and degrees of market risk that may be undertaken. At September 30, 2012, the Company had outstanding forward foreign currency exchange contracts with an aggregate notional value of approximately $83 million. The fair value of the forward foreign currency exchange contracts as of September 30, 2012 was not material to the Company’s condensed consolidated financial statements. At December 31, 2011, the Company did not have any outstanding forward foreign currency exchange contracts.

The Company acts as the portfolio manager in a series of credit default swap transactions, referred to collectively as the Pillars synthetic CDO transaction (“Pillars”). The Company entered into a credit default swap with Citibank, N.A. (“Citibank”), providing Citibank credit protection of approximately $17 million, representing the Company’s maximum risk of loss with respect to the provision of credit protection. The Company’s management has performed an assessment of its variable interest in Pillars (a collateral management agreement and the credit default swap) under ASC 810-10, Consolidation, and has concluded the Company is not Pillars’ PB. Pursuant to ASC 815-10, the Company carries the Pillars credit default swap at fair value based on the expected future cash flows under the arrangement.

On behalf of clients of the Company’s registered life insurance company, which maintains separate accounts representing segregated funds held for the purpose of funding individual and group pension contracts, the Company invests in various derivative instruments, which may include futures and forward foreign currency exchange contracts, interest rate swaps and inflation rate swaps. Net realized and unrealized gains and losses attributable to derivatives held by separate account assets accrue directly to the contract owners and are not reported in the Company’s condensed consolidated statements of income.

The following table presents the fair value at September 30, 2012 and December 31, 2011 of derivative instruments not designated as hedging instruments:

	September 30, 2012				December 31, 2011
(Dollar amounts in millions)	Assets		Liabilities		Assets		Liabilities
Credit default swap (Pillars)
Other liabilities	$	—	$	4	$	—	$	3
Separate account derivatives
Separate account assets		29		—		1,495		—
Separate account liabilities		—		29		—		1,495
Total	$	29	$	33	$	1,495	$	1,498

The fair value of the derivatives held by separate account assets is equal to and offset by a separate account liability.

Gains (losses) on total return swaps are recorded in non-operating income (expense) on the condensed consolidated statements of income and were ($10) million and ($13) million for the three and nine months ended September 30, 2012, respectively, and were $8 million and $6 million for the three and nine months ended September 30, 2011, respectively.

Gains (losses) on the interest rate swap, forward foreign currency exchange contracts and Pillars were immaterial for the three and nine months ended September 30, 2012 and 2011.

The Company consolidates certain sponsored investment funds, which may utilize derivative instruments as a part of the funds’ investment strategies. The fair value of such derivatives At September 30, 2012 and December 31, 2011 was not material to the Company’s condensed consolidated financial statements. The change in fair value of such derivatives, which is recorded in non-operating income (expense), was not material to the Company’s condensed consolidated financial statements for the three and nine months ended September 30, 2012 and 2011.