April 12, 2011
Thank you Mr. Chairman, and let me thank the team which has spent many long hours developing the margin rule proposal before us today.
Today we are voting on similar, but not identical margin rules as the prudential regulators.1 Despite endless attempts to conform the rules, the treatment of end-users couldn’t be further apart. The rules proposed by the prudential regulators will require that end-users pay initial and variation margin to banks. Alternatively, the Commission’s rule requires transactions between a swap dealer and an end-user to simply include a credit support agreement and nothing more. Unfortunately, this isn’t the only inconsistency between the rulemakings.
I am also concerned that we are moving forward on a margin rule without defining the new capital requirements. Throughout this entire rulemaking process, market participants have complained they can’t see the entire picture. Today’s rulemaking is no different. End-users will need to wait a couple more weeks before they see the entirety of the new capital and margin regime. I am pleased, however, that the comment period for each rulemaking will run simultaneously.
Mr. Chairman, I believe commercial end-users and many of the financial end-users will be dissatisfied with the lack of harmonization among the different regulatory bodies, and I will vote against today’s margin proposal.
The End-User Exception and Increasing Costs
First, the preamble in the proposed rule expressly states that the policy behind the Commission’s margining regime is to “create the proper incentives for moving more transactions into central clearing.” This line of thinking is representative of the Commission’s failure to accept Congress’ view that uncleared swaps must be treated differently than cleared swaps. According to the Dodd-Lincoln letter, “Congress clearly stated in this bill that the margin and capital requirements are not to be imposed on end-users, nor can the regulators require clearing for end-user trades.”2 If taken to its logical conclusion, the Commission’s policy would do just that and drive a bus right through the end-user exception. I object to that outcome.
The prudential regulators have decided to disregard the policy behind the end-user exception, the intent of Congress expressed in the Dodd-Lincoln Letter, and more recently, the bipartisan letter from Chairman Stabenow, Chairman Johnson, Chairman Bachus, and Chairman Lucas received on April 6, 2011, regarding the treatment of end-users.3 I believe the major concern of the Congress, is a concern I share, that we are imposing increased costs on non-systemically relevant commercial firms, who will now be faced with the decision of hedging risk or investing in their business.
Second, I am also struck by the fact that the prudential regulators are hiding behind the “safety and soundness” language in the Act to draft rules that prohibit bank swap dealers from posting margin to their counterparties. To be clear, this is a one-way posting of margin. Banks will not post margin to end-users – financial or commercial. What does this mean in reality? I have a few thoughts. First, it decreases the incentive for counterparties to conduct a credit analysis on the banks because the rules are implicitly signaling to the market that regulated banks are “too big to fail”. Second, it institutionalizes purchasing and negotiating power on one side of a commercial transaction. Finally, it will now be much more expensive for end-users to hedge their commercial risk using uncleared customized swaps.
Finally, today’s Commission rulemaking leaves open the possibility that end-users will be assessed margin. The proposal states that each swap dealer may accept margin in a manner agreed to by the parties in a credit support arrangement. Although no margin obligations are technically required to be directly imposed on non-financial entities, this may be cold comfort to end-users. The proposal also does nothing to prevent indirect price increases on swaps for end-users due to the capital charges dealers will incur simply for providing liquidity to end-users.
Swap Dealer Definition
I will say this, many of my concerns regarding the margin and capital rules hinge on the definition of swap dealer. I have read many of the comments and I see a recurring theme: the definition is too broad and the exceptions are too narrow. As a result, it is crystal clear that our proposal captures legitimate commercial end-users as swap dealers. It appears we missed the mark on that rule.
I am frustrated that today’s proposal has paid such little attention to the swap dealer banks that are captured by the Section 716 “push-out” rule and will be regulated by the Commission, within two years. While I find no justification for the lopsided treatment of end-users throughout the bank regulators margin proposal, I certainly would have preferred that they not require end-users to post margin to “push-out” swap dealers during the 24-month transition period.
Weak Cost Benefit Analysis
This rule is the poster child for a failed cost benefit analysis. What are the costs associated with the segregation of collateral at a custodian bank? It certainly is not free. What are the costs associated with posting margin and what benefit do we gain from allowing margin requirements to be imposed on commercial end-users that pose little, if any, systemic risk to the financial system? In short, we did not conduct a robust cost benefit analysis, which is inconsistent with President Obama’s Executive Order.
Final Order and Implementation Schedule
Before I close, I would like make a comment regarding the rulemaking schedule going forward. After the Chairman’s roundtable on the implementation process, which I support, I recommend that the Commission release a comprehensive schedule of the sequencing of final rulemakings and a proposed implementation plan in the federal register and allow the public 60 days to comment on it before we finalize any rules going forward. This level of transparency will give the market a clear picture of what is coming and the certainty it needs to make critical investment decisions to be in compliance with the rules upon implementation.
I think everyone appreciates that we will not be able to implement all the rules in time to comply with the statutory deadlines. I think we should put an end to artificial and arbitrary deadlines and work to implement a completely transparent final rulemaking and implementation process going forward. We must be thoughtful and deliberate.
In closing, I will not support today’s rule proposal, and I would strongly encourage the public to identify the cost-burden associated with this rulemaking in the comment letters they submit to the Commission and to the prudential bank regulators.
1 The prudential regulators consist of the Office of the Comptroller of the Currency, the Department of the Treasury, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Farm Credit Administration, and the Federal Housing Finance Agency.
2 Letter from Chairman Christopher Dodd, Committee on Banking, Housing, and Urban Affairs, U.S. Senate, and Chairman Blanche Lincoln, Committee on Agriculture, Nutrition, and Forestry, U.S. Senate, to Chairman Barney Frank, Financial Services Committee, United States House of Representatives, and Chairman Collin Peterson, Committee on Agriculture, United States House of Representatives (June 30, 2010); see also 156 Cong. Rec. S5904 (daily ed. July 15, 2010) (statement of Sen. Lincoln).
3 Letter from Chairman Debbie Stabenow, Committee on Agriculture, Nutrition and Forestry, U.S. Senate, Chairman Frank D. Lucas, Committee on Agriculture, United States House of Representatives, Chairman Tim Johnson, Committee on Banking, Housing, and Urban Affairs, U.S. Senate, and Chairman Spencer Bachus, Committee on Financial Services, United States House of Representatives to Secretary Timothy Geithner, Department of Treasury, Chairman Gary Gensler, U.S. Commodity Futures Trading Commission, Chairman Ben Bernanke, Federal Reserve Board, and Chairman Mary Shapiro, U.S. Securities and Exchange Commission (April 6, 2011);
Last Updated: April 12, 2011