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Bipartisan measures to fix unintended consequences of derivatives provisions in the Dodd-Frank Act and to require the Securities and Exchange Commission (SEC) to conduct cost-benefit analyses of regulations were discussed during a hearing today of the Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises.
Subcommittee Chairman Scott Garrett (R-NJ) noted that many of the bills were approved by the House during the 112th Congress with strong bipartisan support.
The derivatives fixes are “common sense, bipartisan approaches to provide clear rules of the road for market participants while ensuring a robust regulatory regime exists over the market,” said Chairman Garrett.
Witnesses appearing before the subcommittee said the fixes are needed because provisions in Title VII of Dodd-Frank harm the economy and drive up costs for consumers by inhibiting the ability of manufacturers, farmers, ranchers and small businesses to manage risk.
The witnesses also voiced concerns that the provisions are unworkable and put American firms at a competitive disadvantage – concerns that have been echoed by regulatory officials and Republicans and Democrats in Congress.
Derivatives allow farmers, ranchers and Main Street companies – “end-users” – across the country to manage the business risk they face every day. For example, manufacturers hedge against fluctuating prices in the raw materials that go into production; hospitals hedge against rising interest rates on financing more beds and new technology; and farmers use derivatives to lock in the prices of their crops for the coming season.
“We are very concerned that an impending regulatory burden on end-users of derivatives will result in higher costs to Main Street companies that will limit their growth, harm their international competitiveness and ultimately hamper their ability to sustain and, we hope, grow jobs,” said Thomas Deas, Jr., Vice President and Treasurer of Philadelphia-based FMC Corporation and Chairman of the National Association of Corporate Treasurers. “The consequences of getting derivatives regulation wrong will be borne by American business and ultimately our fellow citizens.”
Deas also testified that at the time of Dodd-Frank’s passage, it was understood from legislative language and from letters and public discussions between the law’s principal drafters that end-users would be exempt from certain provisions related to derivatives.
“In addition, recognizing the potential adverse consequences on the competitiveness of American business and ultimately on jobs here at home, regulators vowed to keep their actions in sync with those of our international trading partners and not impose any undue regulatory burdens on U.S. end-users. However, at this point over two-and-a-half years after passage of the Dodd-Frank Act, there are several areas where continuing regulatory uncertainty compels end-users to appeal for legislative relief from actions we believe will raise costs unnecessarily and hamper our ability to manage business risks,” Deas told the subcommittee.
In his testimony, former Democratic congressman Ken Bentsen, now the acting president and CEO of the Securities Industry and Financial Markets Association, said there are concerns “about how regulators are interpreting and proposing to implement many of these provisions…Incorrect implementation of Title VII has the potential to detrimentally limit the availability and increase the cost of derivatives, which are a valuable risk management tool for American businesses, including manufacturers and the agricultural industry.”
Members of the subcommittee noted that none of the bipartisan bills discussed today would dramatically change the Dodd-Frank Act but would rather ensure regulators do not implement rules that conflict with – or are contrary to – what Congress intended.
The following is a summary of the legislation the subcommittee discussed today:
H.R. 634, “The Business Risk Mitigation and Price Stabilization Act of 2013” introduced by Reps. Michael Grimm (R-NY), Gary Peters (D-MI), Austin Scott (R-GA) and Mike McIntyre (D-NY), would exempt end-users from the margin and capital requirements of Title VII of the Dodd-Frank Act. During consideration of the Dodd-Frank Act, a colloquy among the chairmen of the four committees with primary jurisdiction over Title VII (Senators Christopher Dodd and Blanche Lincoln and Reps. Barney Frank and Collin Peterson) clarified Congress’s intent that the Act did not grant regulators the authority to impose margin requirements for end-user transactions. Notwithstanding this expression of Congressional intent, some regulators have interpreted Title VII as granting them the authority to impose margin requirements on end-users merely because they are counterparties to swaps with a regulated entity, such as a swap dealer or financial institution.
In the 112th Congress, Reps. Grimm and Peters introduced the same bill (H.R. 2682), which passed the Committee by voice vote on November 30, 2011, and passed the House by a vote of 370-24 on March 26, 2012.
H.R. 677, the Inter-Affiliate Swap Clarification Act, introduced by Reps. Steve Stivers (R-OH), Marcia Fudge (D-OH), Chris Gibson (R-NY) and Gwen Moore (D-WI), would exempt inter-affiliate trades from the Dodd-Frank Act’s margin, clearing, and reporting requirements. Inter-affiliate swaps are swaps executed between entities under common corporate ownership. Inter-affiliate swaps allow a corporate group with subsidiaries and affiliates to better manage risk by transferring the risk of its affiliates to a single affiliate and then executing swaps through that affiliate. Inter-affiliate swaps do not create additional counterparty exposures or increase the interconnectedness between parties outside the corporate group; nonetheless, the Dodd-Frank Act subjects inter-affiliate swaps to the same requirements as swaps between unrelated parties.
In the 112th Congress, Reps. Stivers and Fudge introduced a similar bill (H.R. 2779), which passed the Committee by a vote of 53-0 on November 30, 2011. The House passed H.R. 2779 by a vote of 357-36 on March 26, 2012.
H.R. 742, the Swap Data Repository and Clearinghouse Indemnification Act of 2013, introduced by Reps. Rick Crawford (R-AR), Sean Patrick Maloney (D-NY), Bill Huizenga (R-MI) and Gwen Moore (D-WI), would remove an indemnification requirement imposed on foreign regulators by the Dodd-Frank Act as a condition of obtaining access to data repositories. Sections 728 and 763 of the Dodd-Frank Act require swap data repositories and security-based swap data repositories to make data available to non-U.S. financial regulators, including foreign financial supervisors, foreign central banks, and foreign ministries. Before a U.S. data repository can share data with a foreign regulator, however, the foreign regulator must agree that it will abide by applicable confidentiality requirements and that it will indemnify the data repository and the SEC or the Commodity Futures Trading Commission (CFTC) for litigation expenses that may result from the sharing of data with the foreign regulator. Section 725 imposes similar requirements for data sharing between derivatives clearing organizations and foreign regulators, including the requirement that foreign regulators indemnify derivatives clearing organizations and U.S. regulators for litigation expenses that may result from the sharing of data with foreign regulators.
These indemnification provisions threaten to make data sharing arrangements with foreign regulators unworkable. On February 1, 2012, the CFTC and the SEC staff issued a “Joint Report on International Swap Regulation,” which highlighted problems arising from the indemnification provisions in Sections 728 and 763. The Commissions’ staff reported that the indemnification provisions have “caused concern among foreign regulators, some of which have expressed unwillingness to register or recognize [a swaps data repository] unless able to have direct access to necessary information.” The staff noted that “Congress may determine that a legislative amendment to the indemnification provision is appropriate.”
In the 112th Congress, Reps. Robert Dold (R-IL) and Gwen Moore (D-WI) introduced a similar bill (H.R. 4235), which passed the Committee by voice vote on March 27, 2012.
H.R. 992, the Swaps Regulatory Improvement Act, introduced by Reps. Randy Hultgren (R-IL), James Himes (D-CT), Richard Hudson (R-NC) and Sean Patrick Maloney (D-NY), would repeal most of Section 716 of the Dodd-Frank Act. Section 716 prohibits “federal assistance”—defined as “the use of any advances from any Federal Reserve credit facility or discount window . . . [or] Federal Deposit Insurance Corporation insurance or guarantees”— to “swaps entities,” which include swap dealers and major swap participants, securities and futures exchanges, swap-execution facilities, and clearing organizations. Section 716— known as the swap desk “push out” or “spin off” provision—forces financial institutions that have swap desks to move them into an affiliate to preserve their access to Federal Reserve credit facilities and federal deposit insurance. Although the provision allows banks to continue dealing in swaps related to interest rates, foreign currency, and swaps permitted under the National Bank Act, they are prohibited from engaging in swaps related to commodities, equities, and credit.
Rather than making the financial system more stable, Section 716 appears to have made it more fragile. Federal Reserve Board Chairman Ben Bernanke has noted that Section 716 “would make the U.S. financial system less resilient and more susceptible to systemic risk” because “forcing [commercial and hedging activities] out of insured depository institutions would weaken both financial stability and strong prudential regulation.” To address this unintended consequence, H.R. 992 would repeal all of Section 716 except subsection (i), which prohibits the use of taxpayer funds to bail out swaps entities.
In the 112th Congress, Rep. Nan Hayworth (R-NY) introduced a similar bill (H.R. 1838), which passed the Committee by voice vote on February 16, 2012.
H.R. 1062, the SEC Regulatory Accountability Act, introduced by Capital Markets Subcommittee Chairman Garrett (R-NJ), would direct the SEC to follow President Obama’s Executive Order No. 13563, which requires government agencies to conduct cost-benefit analyses to ensure that the benefits of any rulemaking outweigh the costs. The Executive Order also requires that regulations be accessible, consistent, written in plain language, and easy to understand. Because the SEC is an independent agency, it is not required to follow the Executive Order. Former SEC Chairman Schapiro indicated that the SEC will abide by the Executive Order. This bill codifies the Executive Order, mandating by statute that the SEC conduct cost-benefit analyses rather than leaving the decision to comply with the Executive Order to the discretion of the SEC’s Chairman. H.R. 1062 requires the SEC to identify the problem to be addressed by a proposed regulation and to assess the significance of that problem before the SEC issues a rule. The legislation requires the SEC’s Chief Economist to conduct a cost-benefit analysis of potential rules to ensure that the burdens on economic growth and job creation from a proposed regulation do not outweigh the benefit of the regulation.
In the 112th Congress, Chairman Garrett introduced a similar bill (H.R. 2308), which passed the Committee by a vote of 30-26 on February 16, 2012.
H.R. 1256, the Swap Jurisdiction Certainty Act, introduced by Reps. Garrett (R-NJ), John Carney (D-DE), Michael Conaway (R-TX) and David Scott (D-GA), would require the SEC and CFTC to jointly issue rules relating to swaps transacted between U.S. persons and non-U.S. persons. H.R. 1256 would also exempt a non-U.S. person in compliance with the swaps regulatory requirements of a G20 member nation from U.S. swaps requirements unless the SEC and CFTC jointly determine that the regulatory requirements are not “broadly equivalent” to U.S. swaps requirements.
Title VII of the Dodd-Frank Act seeks to regulate the over-the-counter derivatives (OTC) market similar to the way that equities and futures exchanges are regulated. Because the OTC market is global, Title VII raises questions about the extent to which U.S. regulations will apply to swap and security-based swap transactions that take place outside the U.S. Title VII’s plain language makes clear that Congress intended it to apply outside the U.S. only in certain limited circumstances. Section 722 directs that provisions relating to swaps will not apply to activities outside the U.S. unless those activities (1) have a direct and significant connection with activities in, or effect on, commerce of the United States or (2) contravene anti-evasion rules promulgated by the CFTC. The comments and actions of U.S. regulators indicate that they are considering regulations that would result in Title VII being applied more broadly than Congress intended. Further, the Dodd-Frank Act requires both the CFTC and the SEC to issue rules on the extraterritorial scope of Title VII, creating the possibility of two different, potentially conflicting, regulatory regimes.
In the 112th Congress, Rep. Himes (D-CT) introduced a similar bill (H.R. 3283), which passed the Committee by a vote of 41-18 on March 27, 2012.
H.R. 1341, the Financial Competitive Act of 2013, introduced by Rep. Stephen Fincher (R-TN), requires the Financial Stability Oversight Council (FSOC) to study the likely effects of the differences between the U.S. and other jurisdictions in implementing the derivatives credit valuation adjustment (CVA) capital requirement. The Capital Requirements Directive IV package, announced by the European Union on February 28, 2013, includes the CVA requirement and Basel III, which will implement internationally agreed-upon standards on capital and liquidity across the European Union. Derivatives transactions with sovereign, pension fund and corporate counterparties (which are exempt from clearing obligations) will be exempt from the CVA. The EU CVA exemption has raised concerns that there will not be global derivatives regulatory alignment and that the CVA exemption could impact the pricing of trades and the amount of liquidity available for non-financial U.S. derivative end-users, as their transactions would not receive the CVA exemption. The FSOC study is due within 90 days of enactment to the Chairman and Ranking Members of the Committees on Agriculture and Financial Services of the House of Representatives, as well as the Chairman and Ranking Members of the Committees on Agriculture, Nutrition and Forestry and Banking, Housing and Urban Affairs of the Senate.
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