Derivatives Vote Could Ignite Debate on Dodd-Frank Fixes

WASHINGTON — The House Financial Services Committee is scheduled to vote on a host of derivatives bills next week, a debate that's likely to spur momentum in the drive to amend some provisions of the Dodd-Frank Act.

The nine bills to be considered cover a range of concerns over Title VII of the Dodd-Frank law and related issues, from how swaps rules should be regulated internationally to how such trades can be made across banks and their affiliates. Several of the proposed changes passed the House last year, though none were picked up in the Senate.

The fate of the legislation this year remains unclear, although some in the industry are hopeful that at least a few of the measures can be enacted, either as standalone bills or as part of a larger package. Liberal groups and some Democrats, however, have pushed back against the measures, warning that the package of legislation rolls back important regulatory provisions for the swaps market and effectively guts the financial reform law.

"This is the debate that's been going on since Dodd-Frank was enacted," said Brian Gardner, a policy analyst at Keefe, Bruyette & Woods. "Everybody thought there was a need for technical corrections — I don't think that's partisan issue, a lot of Democrats agree. However, then you get down to the question of whether something's a technical correction or substantive change … with people trying to push the envelope as far as possible."

The debate over these bills also sheds new light on the interplay between the banking industry, regulators and lawmakers in the wake of the crisis, and the ways that Congress can attempt to sway regulators without necessarily having to pass a new law. Similar arguments have also been made about recent legislative attempts to break up the big banks in the Senate.

"All of these bills have consequences regardless of whether they get enacted, because of the signal it sends to regulators," said Daniel Crowley, a partner at law firm K&L Gates.

He added: "We've never seen this kind of interplay between regulation and legislation before. Congress enacted Dodd-Frank in such a limited time frame that it gave regulators unprecedented discretion, but lawmakers don't want to let go. You have to read between the lines to try and divine the actual intent — is the intent to pass a law or to influence regulators?"

Several of the items slated for markup by the Financial Services Committee on Tuesday are high priorities for the banking industry. They already passed the House Agriculture Committee, which shares jurisdiction on some of these issues, in March.

One of the most discussed measures, H.R. 992, addresses Section 716 of the Dodd-Frank Act. The so-called "swaps pushout" provision required banks to move some derivatives trades to separate affiliates or subsidiaries, which industry has warned could prove inefficient and costly.

The House bill would allow institutions to keep certain types of derivatives trades within depository institutions, narrowing the scope of Section 716.

"If banks are required to push these activities out, they have to separately capitalize the subsidiary or affiliate and they also lose the benefit of netting," said Bradley Edgell, the managing director of federal government affairs at the Securities Industry and Financial Markets Association.

But liberal groups argue Section 716 was important, and say easing it amounts to providing a public subsidy for risky trades.

"When these swaps are done out of a depository institution, it's effectively getting a public subsidy from deposit insurance," said Marcus Stanley, policy director at Americans for Financial Reform.

Nevertheless, the measure, like many of the others up for consideration, has bipartisan support. A companion bill was also introduced by several lawmakers in the Senate.

A second key provision to watch on Tuesday is H.R. 677, which would exempt certain trades made between affiliates within a single company from margin, clearing and other requirements. Such trades are used primarily to manage risk, industry officials argued.  

"It is unnecessary and counterproductive to impose these requirements on affiliate swap transactions, because an inter-affiliate trade doesn't have the same risk and it doesn't have the same systemic issue," said Cecelia Calaby, senior vice president for the American Bankers Association's center for securities, trust and investments. "It's simply a way for the banking enterprise to manage interest rate or foreign exchange risk centrally. The transactions put risk in the right place."

But critics argue the Commodity Futures Trading Commission has already issued a rule that distinguishes between the affiliate trades and those outside of the company, calling into question the need for the legislation.

"The bill goes a lot further because it writes inter-affiliate swaps out of the definition, so the CFTC" doesn't have jurisdiction, said Stanley. "It also describes inter-affiliate extremely loosely — the affiliates don't even need to share majority ownership. That's a big, whopping exemption."

The ABA, meanwhile, has its own complaint over the current version of the bill, which was passed by the House in a modified form last year. Unlike last year's version of the bill, the legislation wouldn't include a carve-out for affiliate swaps with insured depository institutions, which would still be subject to the more burdensome swap requirements.

"The reason this strikes me as counterproductive is that it's the financial institutions where we most want these swaps to happen," said Calaby. "Because they are so active in the market, we want those risks to be centrally managed, and the only way to do that effectively is to have an affiliate swap."

The third bill to track is H.R. 1256, which deals with cross-border swaps and the harmonization of requirements coming out of the Securities and Exchange Commission and the CFTC with respect to international trades.

Both agencies have now issued proposals on this issue. The SEC's plan, released earlier this month, has already been greeted more warmly by the industry than the CFTC's previously published guidance, which is viewed as more restrictive. The House bill would require the two agencies to adopt one set of formal rules and would generally not subject G-20 countries to U.S. rules.

"We're going to have two different sets of rules," said Edgell. "If you have conflicting or divergent rules, it's going to be very difficult for market participants to comply."

But Stanley disagreed, pointing instead to ongoing industry concern over the CFTC's guidance.

"The real complaint is not about coordination. The real complaint is that the CFTC is exercising jurisdiction over foreign subsidiaries in U.S. banks," he said. "The SEC is going to be a lot more lenient, and [the industry] just wants the easier regulatory regime."

Some of the other bills up for consideration would address a number of additional issues with Title VII of the Dodd-Frank law and other actions by the SEC and CFTC. Those bills include measures to remove margin requirements for derivatives end users, eliminate of an indemnification requirement for foreign regulators to access data repositories and require the SEC to complete a cost-benefit analysis on its rules, among other issues.

Because the package of bills to be considered spans such a diverse set of issues, it's difficult to predict their chances of passage in broad strokes. One issue for industry supporters is that some Democrats in both chambers share advocates' fears about the measures.

Rep. Maxine Waters, the top Democrat on the banking panel, has said she will proceed cautiously in reviewing the bills.

"Though it has been three years since the crisis, we still await final regulations on about two thirds of the provisions requiring rulemaking," Waters said at an April 11 hearing. "And while I remain open to changing the act to respond to legitimate concerns, I'm very nervous about potentially undermining our reforms or otherwise tying the hands of regulators before they've had a chance to finish their work. So I will closely scrutinize each bill before us today, and consider each one both individually and cumulatively."

A spokesman for Waters declined to comment further on the California Democrat's view of the bills on Thursday, noting that she is waiting to see the final bill language and amendments offered.

Waters also wrote to the Financial Stability Oversight Council several weeks after the hearing asking the group to examine the proposed derivatives bills, including how "their enactment would affect FSOC's statutory responsibilities to identify threats to the financial system."

Nevertheless, many of the bills have bipartisan support in the House, with some having passed the chamber last Congress. But it's uncertain what chances the bills will have in the Democratic-controlled Senate that has so far been more guarded against making significant changes to the Dodd-Frank law.

"So far, there's very little appetite in the Senate majority to revisit anything to do with Dodd-Frank. There's a visceral defend-the-franchise reaction to it," said Crowley.