By John Hintze
But legislation to exempt corporates is getting much closer to passing.
Legislation to exempt corporate swap end-users from margin requirements may finally have found a route to passage. It arrives right around the time regulators are expected to re-issue their longstanding proposal requiring bank swap dealers to impose swap margin requirements on corporates past a pre-determined threshold.
The prudential regulators, including the Federal Reserve and Federal Deposit Insurance Corporation, have interpreted the Dodd-Frank Act to require them to impose margin requirements on financial as well as nonfinancial swap counterparties.
In April 2011, they issued a proposal to that effect that has caused much consternation among corporates that use swaps to hedge interest rate, foreign exchange and other risks. First introduced in 2011 as H.R. 2682, legislation to ensure regulators do not impose margin requirements on corporate end users was reintroduced in early 2013 by Representative Michael Grimm (R-NY) as the Business Risk Mitigation and Price Stabilization Act of 2013 (H.R.634). It passed the full House with strong bipartisan support in June of last year.
A comparable Senate bill has remained in limbo, although a bill to reauthorize the Commodity Futures Trading Commission (CFTC) may provide a vehicle legislation exempting corporates from margin requirements as well as legislation exempting corporate treasury centers from margin and clearing requirements.
The reauthorization bill was reported out by the House Committee on Agriculture in April and is expected to come to the full House floor in June, and pass with bipartisan support. The Senate Committee on Agriculture is also anticipated to report out its own reauthorization bill with bipartisan support, although when the full Senate addresses the bill remains an open question.
“Our thought is the bills will likely have to be conferenced, because the odds of them diverging at least in some respects is pretty high. We would hope for that to happen this summer or in the fall,” said Michael Bopp, chair of Gibson, Dunn & Crutcher’s public policy practice group and one of the founders of the Coalition for Derivative End-Users.
In the meantime, talk is circulating that the long dormant regulatory proposal’s revival may be imminent. Luke Zubrod, a director at Chatham Financial, said US regulators will likely change the proposal to resemble more closely the recommendations issued by the Working Group on Margin Requirements (WGMR), which was formed in 2011 by the Basel Committee on Banking Supervision (BCBS) and the International Organizations of Securities Commissions (IOSCO). For example, US regulators proposed separate margin requirements for high-risk and low-risk financial end users, whereas the WGMR recommended only one.
The WGMR also recommended exempting nonfinancial corporates from margin requirements, and European regulators recently re-proposed margin rules—comments due by July 14—that exempt most nonfinancial corporates. Alas, that recommendation is unlikely to carry over to the US proposal. “We fully expect at this juncture that bank regulators will not walk back their determination to impose a margin requirement on corporate end users,” Mr. Zubrod said.
That’s because they’ve interpreted Dodd-Frank as requiring them to impose the requirement on corporates, and they’ve continued to state that publicly while also saying they are comfortable with Congress rescinding the requirement. “So they’re not necessarily [going ahead with the proposed requirement] because they think it’s appropriate but because they believe Dodd-Frank requires it,” said Mr. Zubrod.
CFTC’s different view
The CFTC, on the other hand, does not require swap dealers to impose margin requirements on their corporate counterparties, but the regulator oversees nonbank swap dealers and most corporate counterparties are banks. The swap-margin and treasury-center bills are each also proceeding as standalone legislation, although progress using that strategy has essentially stalled. Attaching the amendments to the CFTC reauthorization bill appears to offer best chance yet of achieving relief for corporates.
“The ray of light here is there’s sentiment this time to fix some of the obvious problems with Dodd-Frank, and that’s something we haven’t seen for many months, even years,” Mr. Zubrod said. “It looks like the beginning of a thaw in the Senate.”
The Coalition has long argued that corporates use swaps for hedging purposes and did not play a role in the financial crisis. Indeed, it has explained in letters to Congress that margin requirements would be detrimental to the overall economy, noting the results of its survey finding they could “funnel cash away from productive commercial use—as much as $5.1 billion to $6.7 billion among S&P 500 companies alone—costing 100,000 jobs or more.” Imposing margin and clearing requirements on corporate treasury centers would have a similarly detrimental impact. The Coalition found that nearly half of surveyed companies use treasury centers, which essentially net swap transactions from a company’s various affiliates before seeking counterparties, and the vast majority of respondents said they would be impacted by the Dodd-Frank requirements or they weren’t sure. Majorities of Democrats and Republicans alike appear to support the Dodd-Frank “fixes,” but politics may get in the way.
“Generally speaking, with Dodd-Frank a lot of Democrats feel any changes are a referendum on the law, which they strongly support,” said Kelli McMorrow, senior manager of government affairs at Financial Executives International (FEI).
Fear and lumping
The political issue isn’t with the legislation lumped under the category of “end-user issues,” but rather with other amendments that could get attached to the bill, potentially prompting lawmakers to streamline it by restricting it to CFTC funding and excluding amendments. “The question is how ambitious does the Senate Ag committee seek to be in the spectrum of changes it tries to address,” Mr. Zubrod said. For example, Mr. Zubrod said, banks would strongly support an amendment rescinding Dodd-Frank’s “swap push out” provision, which requires them to put most of their swap activities into separately capitalized affiliates of the bank holding company. Banks argue that the provision introduces costly complexities and does so in a manner that doesn’t address problems arising in the financial crisis, but addressing the issue at this time could appear to be weakening Dodd-Frank.
Another potentially problematic bill that could be tacked on to the reauthorization bill passed by the House in mid-May along mostly party lines: it would require the Securities and Exchange Commission to more extensively apply cost-benefit analysis to assess the impact of its rules.
“We’re concerned Congress might decide to do a straight, one-line reauthorization of the CFTC, but right now it looks like both the House and Senate Ag committeeswant to do more,” Mr. Bopp said.
If Tarullo Has His Way
Federal Reserve Governor Daniel Tarullo has as usual a tougher take on requirements for the short-term funding markets: make them hold collateral. Mr. Tarullo, who has been the Fed’s point man (some would say draconian) in setting the Fed’s regulatory agenda, said after a recent speech that a minimum margin requirement makes sense. “It’s a little hard, I think, to make a compelling case against doing something like that,” he said Monday in response to a question from the audience after a speech before the Association of American Law Schools, according to The Wall Street Journal. The Fed is reportedly considering a margin rule and Mr. Tarullo said he believed the Fed would be justified in doing so. And new Fed Chairman Janet Yellen has also said she supports initial margin, even if it locks up cash.