Saturday, December 18, 2010

Rep. Bachus Hints at Legislation to Delay SEC-CFTC Implementation of Dodd-Frank Derivatives Regime as Concerns Grow

The incoming Chair of the House Financial Services Committee has voiced concern over the direction and pace of the SEC-CFTC efforts to implement the derivatives regulatory regime mandated by the Dodd-Frank Act. In a letter to SEC Chair Mary Schapiro and CFTC Chair Gary Gensler, Rep. Spencer Bachus (R-Ala)warned that derivatives regulations adopted hastily and without due care could damage the economy. He said that Congress will consider legislation to delay the statutory deadlines in Dodd-Frank if that will allow the SEC and CFTC to move deliberately and carefully to ensure that the derivatives regulatory regime is correctly implemented. More broadly, Rep. Bachus warned that creating a prohibitively expensive and rigid market for using and trading derivatives in the US could shift the market overseas.The letter was co-signed by Rep. Frank Lucas (R-Okla), the incoming Chair of the House Agriculture Committee.

Alluding to the earlier Dodd-Lincoln letter and a House colloquy between Rep. Frank and Rep. Peterson, the new Chair said that is critically important that the SEC and CFTC implement the commercial end user exemption consistent with legislative intent and allow companies to engage in the hedging of legitimate business risks. For example, end users must not be required to post margin, he said, and must be able to rely on their exemption from clearing and trading rules without having to overcome ``unnecessary bureaucratic obstacles.’’ He also cautioned the SEC and CFTC not to apply margin to existing derivatives contracts since doing so would retroactively upset the rational expectations of thousands of end users.

Rep. Bachus also urged the Commissions to consider carefully the scope of who is defined as a swap and security-based swap dealer and a major swap and security-based swap participant. Creating an overly broad net in defining these terms, he said, could force smaller participants to leave the market and eliminate some types of hedging contracts, thereby exposing businesses to market volatility.

Noting that they are unlike other derivatives regulated by Dodd-Frank, Rep. Bachus said it is vital that foreign exchange swaps and forwards be exempted from Dodd-Frank’s clearing and exchange trading rules. He predicted that an already stable foreign exchange swap market would become more transparent with the imposition of Dodd-Frank reporting rules.

He also warned that implementing real-time reporting and trade execution requirements without adequate safeguards could increase the price of a derivatives contract to hedge risk by facilitating speculative front running. While recognizing that the SEC and CFTC must have real time access to derivatives data, Rep. Bachus said that mandating real time reporting of thinly-traded products and illiquid markets in an effort to force derivatives to trade similarly to exchange traded products is a fundamentally flawed approach.

Finally, Rep. Bachus urged the SEC and CFTC to use the exemptive authority given to them in Dodd-Frank to avoid establishing position limits that would force widely-held funds or firms to divest their current holdings in highly-regulated products. He warned that overly prescriptive position limits would drain existing liquidity from the capital markets, impair price discovery, and harm the futures markets.

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