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From Securities Regulation Daily, May 7, 2013

House Financial Services Committee Approves Derivatives Bills

By Lene Powell, J.D.

In a lengthy markup session of the House Financial Services Committee, five bills amending the derivatives title of the Dodd-Frank Act were reported favorably out of committee.

Committee Chairman Jeb Hensarling (R-Tex) said that Dodd-Frank was not chiseled in stone, nor was handed down from Mt. Sinai. He hoped that no one would fail to act to improve deficiencies “out of loyalty to a brand name,” and added that as companies are able to hedge their risk, so go their employment opportunities.

Ranking Member Maxine Waters (D-Cal) said that although she was open to legislation that truly represented technical fixes, because any landmark reform will have imperfections, she was "exceedingly nervous" about reopening Dodd-Frank, especially derivatives reform under Title VII.

The congresswoman noted that the committee had recently received a letter from Treasury Secretary Jack Lew urging members to oppose the bills because regulators should be permitted to complete their rulemaking (please see “Treasury Secretary Calls Dodd-Frank Derivatives Corrections Premature,” this issue). In addition, her reluctance was heightened by recent financial scandals underlining the need for strong regulation, including money laundering to drug cartels, LIBOR manipulation, and the JP Morgan "London Whale" incident.

Remove international barrier to swap data reporting. As a condition of obtaining access to swap data repositories, Dodd-Frank required foreign regulators to indemnify repositories and the CFTC and SEC for any litigation expenses that may arise from sharing information. This requirement would be removed by H.R. 742, the "Swap Data Repository and Clearinghouse Indemnification Correction Act of 2013."

Rep. Bill Huizenga (R-Mich) said the bill was necessary because according to a joint CFTC-SEC report, international entities objected to the indemnification requirement and were unwilling to register or recognize swap data repositories without access to data.

According to Rep. Gwen Moore (D-Wis), the bill was non-controversial and the SEC has said outright that it supports the bill. In addition, three of five CFTC commissioners support the bill, she said.

Rep. Waters concurred, saying that the issue truly required a technical fix.

Exempt end users from margin requirements. H.R. 634, “The Business Risk Mitigation and Price Stabilization Act of 2013,” would exempt counterparties to uncleared swap transactions who are not swap dealers or major swap participants from margin requirements. The exemption would be available to entities that are exempted from clearing requirements or meet certain criteria governing treatment of affiliates in connection with clearing requirements.

Exempt interaffiliate swaps. H.R. 677, the "Inter-Affiliate Swap Clarification Act," would exempt interaffiliate swap transactions from the Dodd-Frank Act’s margin, clearing, and reporting requirements. Interaffiliate swaps are swaps executed between entities under common corporate ownership.

According to Rep. Steve Stivers (R-Ohio), the federal government shouldn’t penalize businesses for how they choose to do business. Rules on interaffiliate swaps don’t consider increased costs on business. Interaffiliate swaps are simply an accounting method used to assign transactions and centralize and aggregate risk. They don’t create systemic risk, he said.

Rep. Waters said she remained concerned about potential for abuse, and questioned why a legislative fix was still needed after the CFTC has issued rules on the subject. She noted that CFTC Chairman Gary Gensler expressed concern that an interaffiliate exemption may provide a loophole. She recognized the commercial reason for the bill, she said, but maintained that it should not undermine efforts to create a stable financial system.

Rep. Stephen Lynch (D-Mass) said he was concerned that the bill would eliminate the margin requirements, which provide collateral in case an entity goes down. But also, he said, there were bankruptcy implications. JP Morgan Chase and Goldman Sachs have thousands of affiliates globally, and each of those jurisdictions has different levels of regulation. With the possibility of an affiliate going bankrupt, the matter of which affiliate holds an obligation becomes extremely important. In some jurisdictions, assets would be unavailable to U.S. claimants, he said.

Clarify jurisdiction over non-U.S. persons. H.R. 1256, the "Swap Jurisdiction Certainty Act," would require the SEC and CFTC to jointly issue rules relating to swaps transacted between U.S. persons and non-U.S. persons.

The bill would direct the Commissions to exempt from U.S. swaps requirements any non-U.S. person in compliance with the swaps regulatory requirements of a G20 member nation (or other foreign jurisdiction as jointly determined by the Commissions), unless the swaps regulatory requirements are not "broadly equivalent" to U.S. swaps requirements.

Amend swaps pushout. Section 716 of the Dodd-Frank Act required financial institutions to move swap desks 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.

H.R. 992, the "Swaps Regulatory Improvement Act," would declare the prohibition against federal government bailouts of swaps entities inapplicable to: (1) a foreign banking organization supervised by the Federal Reserve; and (2) an insured depository institution or a U.S. uninsured branch or agency of a foreign bank that limits its swap and security-based swap activities to hedging and similar risk mitigating activities, non-structured finance swap activities, and certain structured finance swap activities.

The bill would repeal the exemption from the prohibition for any insured depository institution that limits its swap and security-based swap activities to acting as a swaps entity for: (1) swaps or security-based swaps involving rates or reference assets that are permissible for investment by a national bank; or (2) credit default swaps, including those referencing the credit risk of asset-backed securities unless they are cleared by a derivatives clearing organization or a clearing agency registered, or exempt from registration, under the Commodity Exchange Act or the Securities Exchange Act.

According to Rep. Huizenga, the bill addresses valid criticisms of section 716 without weakening financial reform laws or safeguards.

Rep. Waters opposed the bill, as she was against expanding the scope when it is still unclear what will happen with the Volcker rule. Given the recent JP Morgan “London Whale” incident, putting commodity, equity, and certain other swaps back into banks is not appropriate at the present time, she said. It is important to have a complete set of workable rules before we reverse some of the pieces that were put in place by the Dodd-Frank Act. In response to reassurances by Jim Himes (D-Conn) that the anti-bailout provisions of Title II and Section 716 still stand, Keith Ellison (D-Minn) said that the declaration that there will be no more bailouts is like saying there will be no more murder.

MainStory: TopStory ClearanceSettlement Derivatives DoddFrankAct ExchangesMarketRegulation

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