Thursday, June 17, 2010

New Democrat Coalition Seeks Removal of Ban on Bank Derivatives Trading and Swap Dealer Fiduciary Duty from Senate Reform Bill

The New Democrat Coalition opposes provisions in the Senate financial reform bill that would ban bank trading of derivatives and impose a fiduciary duty on swap dealers and the governmental entities and pension funds with whom they contract in swaps. In a letter to House and Senate leaders currently reconciling different versions of the bills, the Coalition, composed of many House members, said that the swaps desk spinoff proposal would increase systemic risk by forcing derivatives transactions into less regulated and less capitalized institutions and impede effective regulatory oversight of the derivatives markets. In the Coalition’s view, legitimate conflicts of interest are addressed by the ban on proprietary trading in the Volcker rule.

In addition, while the fiduciary duty provision is designed to prevent public entities from deceptive practices, noted the Coalition, the provision will impair their ability to manage risks and issue bonds. The House legislation requires municipalities to retain advisors who have a fiduciary duty to the municipalities and are similar to standards already in effect for pension funds under ERISA. The letter was signed by over 20 members of the House.

Section 716 of the Senate bill prohibits federal assistance (including federal deposit insurance, and access to the Federal Reserve discount window) to swaps entities in connection with their trading in swaps or securities-based swaps. This section would effectively require most derivatives activities to be conducted outside of banks and bank holding companies. According to Senator Blanche Lincoln, author of Section 716, the section has two goals. The first goal is getting banks back to performing the duties they were meant to perform, such as taking deposits and making loans for mortgages, small businesses, and commercial enterprise. The second goal is separating out the activities that put these financial institutions in peril. Section 716 makes clear that engaging in risky derivatives dealing is not central to the business of banking. Cong. Record, May 5, 2010, p. S3140.

Sen. Lincoln refuted the suggestion that this provision will push derivatives trading off into the dark without oversight. The legislation makes it abundantly clear that all swaps activity will be vigorously regulated by the SEC and CFTC. Just because these swaps desks will no longer be overseen by the FDIC does not mean that they will not be subject strong regulation by the SEC and CFTC under Title VII of the Restoring American Financial Stability Act.