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From Securities Regulation Daily, December 12, 2014

Spending bill funds SEC and CFTC, amends Dodd-Frank swaps push-out provision

By Jim Hamilton, J.D., LL.M.

The House passed, by a vote of 219-206, omnibus budget legislation that would provide $1.5 billion for the SEC, which is $150 million above the fiscal year 2014 enacted level and $200 million below the Administration’s budget request.  The Consolidated and Further Continuing Appropriations Act, H.R. 83, also amends the swaps push-out provisions of the Dodd-Frank Act to allow some financial institutions enjoying the umbrella of federal deposit insurance to keep some derivatives trading in house. H.R. 83 also would require an OMB report on the costs to the federal government of the Dodd-Frank Act.

SEC. With regard to the SEC budget, the measure designates $57 million of the total for the Division of Economic and Risk Analysis to improve the use of economic analysis in the SEC’s rule-making process. The legislation also rescinds $25 million from the SEC Reserve Fund, which the House Appropriations Committee described as a “slush fund” for SEC programs that have no congressional oversight. The measure also states that the SEC Office of Inspector General must receive no less than $9,239,000.

In its written notifications to Congress regarding amounts obligated from the Reserve Fund as required by statute,  the SEC must specify the balance in the fund remaining available after the obligation is deducted;  the estimated total cost of the project for which amounts are being deducted; the total amount for all projects that have withdrawn funding from the Reserve Fund since fiscal year 2012; and the estimated amount, per project, that will be required to complete all ongoing projects which use funding derived from the Reserve Fund.

The Commission is also directed to submit an updated report to the Committees on Appropriations of the House and Senate on its efforts to modernize disclosure requirements within 90 days of enactment, including an update on cybersecurity.

CFTC. The CFTC is funded at $250 million, which is $30 million below the President’s budget request. The legislation also promotes transparency, with a directive requiring a vote by the full CFTC, instead of just staff, on financial regulations that greatly increase regulatory burdens for ranchers, farmers, and job creators.

The Act further provides that funds made available to the CFTC and SEC may be used for the interagency funding and sponsorship of a joint advisory committee to advise on emerging regulatory issues.

Dodd-Frank swaps push-out provision. Currently, Section 716 of Dodd-Frank prevents federally insured financial institutions from conducting certain swaps trading, including trading of commodity, equity, and credit derivatives. This prohibition compels financial institutions to push out swaps trading into separately capitalized affiliates. The measure would amend Section 716 of the Dodd-Frank Act to protect farmers and other commodity producers from having to put down excessive collateral to get a loan, expand their businesses, and hedge production.

It would allow financial institutions to continue to conduct risk-mitigation efforts for clients, such as farmers and manufacturers, who use swaps to insure against price fluctuations. It would also modify Section 716 to allow commodity and equity derivatives in financial institutions with federal deposit insurance. However, derivatives involving structured finance transactions would still need to be pushed out of a federally insured financial institution.

The swaps push-out provisions of the consolidated budget legislation are substantially identical to language in the Swaps Regulatory Improvement Act, H.R. 992, which passed the House as a stand-alone bill in 2013.

Under the legislation, the only swaps that covered depository institutions must spin out to separately capitalized entities are structured finance swaps unless they are undertaken for hedging or risk management purposes or expressly permitted by prudential regulators to take place in a covered depository institution. The bill also ensures that uninsured U.S. branches and agencies of foreign banks are treated the same as insured depository institutions by defining both groups as covered depository institutions.

Legislative history reveals that many members of Congress believe that Section 716 could result in at least two negative consequences for the U.S. financial system and U.S. financial institutions. First, proponents argued that Section 716 may make the U.S. financial system less stable by forcing swaps trading into the unregulated shadow banking system. Second, current Section 716 may place U.S. financial institutions at a significant competitive disadvantage against their foreign counterparts because foreign jurisdictions do not plan to adopt a provision similar to Section 716 in their ongoing efforts to reform the global derivatives marketplace.

Office of Financial Research. The measure contains additional reporting requirements to increase transparency of the activities of agencies whose funding jurisdiction fall outside annual congressional review. Specifically, the Office of Financial Research must provide quarterly reports on its activities to Congress. The reports must include, among other things, the obligations made during the previous quarter by object class, office, and activity and the estimated obligations for the remainder of the fiscal year by object class, office, and activity.

Administration Statement of Policy. While the Obama Administration supports passage of H.R. 83, it objects to the inclusion of what the White House calls “ideological and special interest riders” in the House bill. In a Statement of Policy, the Administration particularly objected to a rider amending the swaps push-out provisions of Section 716 of the Dodd-Frank Act. The White House said that the swaps push-out rider would weaken a critical component of financial system reform aimed at reducing taxpayer risk.

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